Regional Decentralization and Fiscal Incentives ... · federalism," emphasize an additional, and...

1 We would like to thank Roger Gordon, Yasheng Huang, John McMill an, and Heng-fu Zou for helpfuldiscussions and the Center for Research on Economic Development and Policy Reform at Stanford forfinancial support. An earlier version of this paper was presented in a session on "Fiscal Federalism inTransition Economies" at the American Economic Association meeting in Chicago on January 3, 1998.

Regional Decentralization and Fiscal Incentives:

Federalism, Chinese Style1

Hehui JinDepartment of Economics

Stanford University

Yingyi QianDepartment of Economics

Stanford University

and

Barry R. WeingastHoover institution and

Department of Political ScienceStanford University

March 1999

Abstract

Second generation theories of federalism extend traditional approaches by systematicallystudying the role of government incentives in economic performance. Providing government withthe incentive to promote markets is especially acute for developing economies or those intransition from central planning. In these countries, governments have often been the centralbarrier to economic development. In this paper, we investigate empirically decentralization andfiscal incentives in the central-provincial relationship during China's reform. We find strongcorrelations between local government revenue collection and local government expenditure. Further, we show that China's fiscal contracting system provides local governments with strong(marginal) fiscal incentives and at the same time improves horizontal distribution across provincesin budgetary spending. We also find that stronger fiscal incentives — measured in terms of highermarginal revenue retention rate — implies faster development of non-state enterprises and morereform in state-owned enterprises. Finally, we compare federalism, Chinese style, with federalism,Russian style.

1

I . Introduction

Reforming government is a crucial component of both the transition from a planned to a market

economy and economic development. Creating thriving markets in these economies typically

require transforming a highly centralized and economically interventionist government into one

that complements the market and fosters decentralized economic activities. Democracy,

separation of powers, and the rule of law are among the important institutions that allow citizens

to hold the government accountable for its economic actions and to secure markets from the

arbitrary state intrusion. Yet in many countries, these institutions are incomplete or absent

altogether, raising questions about how these states can improve their governance structures. In

this paper, we study federalism as an alternative approach. By devolving power from the central

to local levels, federalism may help implement a limited yet effective government.

Two related but distinct categories of theories study the economic benefits of federalism.

Traditional theories of federalism emphasize allocative benefits. According to von Hayek's (1945)

idea on the use of knowledge in society, local governments have better access to local

information, which allows them to provide public goods and services more efficiently than the

national government. Tiebout (1956) argued that inter-jurisdictional competition provides a

sorting mechanism to better match public goods and services with consumers' preferences.

Musgrave (1959) and Oates (1972) built a theory of fiscal federalism, stressing among other

things the appropriate assignment of taxes and expenditures to the various levels of government

to improve welfare. The traditional theory also stressed that too much decentralization may

induce a range of allocative distortions, regional inequality, and fiscal instabili ty.

2

2 Works of the second generation theories include McKinnon (1997), Qian and Roland (1998), Qian andWeingast (1997), Weingast (1995), and Wildasin (1997). These works, in turn, build on the importantcontributions including Buchanan and Brennan (1980), Inman (1988), Inman and Rubinfeld (1997).

Recently, "second generation" theories of federalism, such as "market-preserving

federalism," emphasize an additional, and perhaps more important, benefit of decentralization.2

These theories have two new focuses. First, they abandon the assumption of benevolent

governments, stressing the importance of the political and fiscal incentives of governments.

Second generation theories ask: under what circumstances do local governments have the

incentives to maximize local welfare? Second, the new theories look beyond fiscal issues to study

the general relationship between the government and economic agents.

The principal implication of second generation theories is that certain types of

decentralization and federalism can provide governments with better incentives to support market

development and economic prosperity. By devolving authority from the central to local levels,

federalism places limits on the interventionist role of the central government. Two important

mechanisms work to align local government's interests with economic prosperity. First, inter-

jurisdictional competition implies that heavily interventionist local governments may lose valuable

factors of production to less interventionist jurisdictions. Second, strong links between local

revenues and expenditures implies that local government officials may have strong fiscal

incentives for fostering a prosperous local economy.

The issue of aligning government incentives with promoting markets is especially acute for

economies just emerging from central planning. In these countries, as in developing countries

generally, governments have often been the central barrier to economic development because they

are not constrained from economic predation. We suggests how federalism can serve as a means

of limiting the interventionist tendencies of governments in developing and transition states. Not

3

just any form of decentralization will do, however (Parikh and Weingast 1997). In particular,

federalism needs to be structured to insure local government authority and proper incentives.

We apply the above theories to study the emergence of federalism during China's reform.

Lacking democracy, the rule of law, and other traditional constitutional constraints on the national

government, China's transition to markets has long been associated with the devolution of

authority from the central to local governments (Montinola, Qian, and Weingast, 1995; Chang

and Wang, 1998; Xu and Zhuang, 1998). Since 1979, three principal changes have altered local

governments in China. First, lower governments have assumed primary responsibili ty over the

economic matters within their jurisdictions; second, goods and factors have become mobile across

localities, and local governments have engaged in inter-regional competition; third, local

governments face strong fiscal incentives to pursue local prosperity as their local expenditures are

made closely linked to the revenues they generate.

Using a provincial data set from 1982 to 1992, we study empirically the issue of regional

decentralization and the importance of fiscal incentives in China. Our first major finding reveals

that, in post-reform China, local governments face strong fiscal incentives to pursue market

reform. The evidence shows a strong correlation between local revenue collection and local

expenditure. By way of comparison, these correlations were extremely weak before the reform.

We also investigate the possibili ty of a "ratchet effect" in which the central government reacts to

higher local revenues this year by requiring higher remittances next year (Weitzman 1980). We

find evidence for only a modest ratchet effect after the reform; further, the magnitude of this

effect fell by more than half after the reform. While China's fiscal contracting system provides

local governments with strong (marginal) fiscal incentives, surprisingly, we also find that it also

improves horizontal distribution across provinces over time in terms of per capita budgetary

spending.

4

Our second major finding concerns the effects of decentralization and fiscal incentives on

provincial economic performance and structural change, the main purposes of reform and

development. We find that, across provinces and over time, stronger fiscal incentives imply better

economic performance and faster structural change. Stronger fiscal incentives positively affect

the development of the non-state enterprises, as measured by the growth of rural enterprise

employment and increases in the shares of non-state-non-agricultural employment in total labor

force and non-state industrial output in the total industrial output. Stronger fiscal incentives also

induce more reforms in state-owned enterprises in terms of the increased shares of contract

workers in the total state employment and bonuses in total employee wages.

We compare Federalism, Chinese style, with Federalism, Russian style. Recent studies of

Russia's transition stress the problematic role of government in reform. Shleifer (1997) and Frye

and Shleifer (1997), for example, provide evidence that local governments in Russia failed to

become "helping hands" during the transition, as in Poland and China; instead they have been

"grabbing hands," retarding private business development. Zhuravskaya (1998) found that the

existing revenue sharing schemes between the Russian regional and local governments provided

the latter with no fiscal incentives to increase their tax base: increases in local government

revenues were almost entirely exacted by the regional government. This leads to the predatory

behavior of government toward private businesses.

This contrast in incentives faced by local governments presents a partial explanation for

the different performances of the Chinese and Russian reforms. Interestingly, Russia has done

more than China in terms of privatization of state-owned enterprises and liberalization of markets.

But apparently it has failed to provide local governments with good incentives to pursue local

prosperity. Our perspective suggests the critical importance of government incentives for

5

successful reform. Liberalization and privatization without altering government incentives are

insufficient to produce meaningful economic reform.

To our knowledge, there are only few empirical studies on the effects of fiscal federalism

on economic and government performance. Oates (1985) tested Brennan and Buchanan's (1980)

hypothesis that the size of the public sector should vary inversely with the extent of fiscal

decentralization. Using the data from both the U.S. states and the world, he only found very

weak evidence in supporting that hypothesis. Recently, Huther and Shah (1998) assembled a

sample of 80 nations to examine the relationship between fiscal decentralization and a series of

measures of economic and political performance (such as debt-to-GDP ratio, quality of

government, and political freedom). In nearly every case, they found a statistically significant and

positive correlation between increased fiscal decentralization and improved performance.

The remainder of the paper is organized as follows. Section II develops the two

theoretical perspectives on the benefits and costs of decentralization. Section III describes

regional decentralization and central-local relationship during China's reform. Section IV

describes the data and the construction of variables. Section V critically reviews the previous

empirical work on China's decentralization. Section VI presents evidence on the fiscal incentives

for local governments in China after the reform; it also compares this evidence with pre-reform

China and post-reform Russia. Section VII presents evidence on the effects of decentralization

and fiscal incentives on economic performance and structural change. Our conclusions follow.

6

II . Theories of Decentralization and Federalism: The Traditional and New Perspectives

Two theoretical perspectives study the economic effects of decentralization. Traditional theories

emphasize allocative benefits of decentralization for information reasons. There are two related

ideas. First, in his general study on the use of knowledge in society, Hayek (1945) emphasized

the important advantages of decentralized decision-making in terms of best utili zing local

information. In the context of public finance, because local governments have better information

than the national government about local conditions and because information transmission is

costly, local governments can make better decisions than the national government in providing

local public goods and services. Second, Tiebout (1956) introduced the inter-jurisdictional

competition dimension and argued that such a competition among local governments on public

expenditure allocation allows residents to sort themselves and match their preferences with a

particular menu of local public goods. Such a sorting mechanism would be absent if the national

government provided the public good uniformly. Federalism also permits local experimentation

from which other regions may learn and imitate that which is successful. Such an experimentation

reduces the costs of failure under centralization (so called "laboratory of federalism"). Drawing

on these ideas, Musgrave (1959) and Oates (1972) built a theory of fiscal federalism, which

stresses the appropriate assignment of taxes and expenditures to the various levels of government

to improve welfare. They also suggested that inappropriate decentralization may induce a range

of allocative distortions, regional inequality, and fiscal instabili ty.

Tiebout's idea of inter-jurisdictional competition has been extended later to address some

aspects of local government's incentives in providing public goods and services. A range of

7

3 See, e.g., Inman and Rubinfeld (1997); see also Epple and Zelenitz (1981), Inman 1988 and Buchananand Brennan (1980).

models shows how inter-jurisdictional competition limits local government's behavior.3 Also

relevant are recent attempts to investigate the fiscal properties of various types of decentralization

(e.g., Shah 1997).

Building on these important contributions, second generation theories emphasize

additional benefits of decentralization by addressing explicitly two concerns which are largely

ignored by the traditional theories (McKinnon, 1997; Qian and Roland, 1998; Qian and Weingast,

1997; Weingast, 1995; and Wildasin, 1997). First, the new theories focus on the incentives of the

government. In particular, these theories reject the traditional approach's assumption that

governments are benevolent with full commitment power. In many states, the government often

has a private agenda. Even if the government is benevolent in the sense that it seeks to maximize

social welfare or economic efficiency, it may not be able make credible commitments. Second,

these new theories go beyond narrow fiscal issues (the traditional theory is often called "fiscal

federalism," suggesting its focus). They explicitly address the general issue of government

regulation over economic activities or the state-market relationships. Together, these theories

recognize that the government itself is often an obstacle to economic welfare, particularly for the

transition and developing economies. Given the enormous power of government, if it is not

restrained or provided with appropriate incentives, government may do more harm than good for

the purpose of the creation and preservation of markets.

Second generation theories examine how federalism affects the behavior of the

government. "Market-preserving federalism," for example, stresses the following three new

principles of federalism. If local governments, rather than the central government, have primary

regulatory authority over the local economy, the interventionist role of the central government can

8

be limited. But what limits local government behavior? The theory focuses on two mechanisms

to align local government's interests with economic prosperity, the horizontal interactions among

local governments and the vertical interactions between different levels of government. First,

under the common market with goods and factor mobili ty, inter-jurisdictional competition serves

as an important incentive device: competition rewards local governments friendly to markets as

factors of production move to their regions, while punishes heavily interventionist local

governments as they lose valuable factors of production. Second, strong links between local

expenditures and local revenue can also align the interests of local governments to local economic

prosperity. Such strong links typically require limits on inter-governmental fiscal transfers, in two

directions — limits on central government exactions from lower governments and limits on the

central government’s creation of a soft budget constraint resulting from subsidies to fiscally

imprudent local governments (Kornai, 1986).

In a parallel fashion, second generation theories emphasize how a series of institutions can

undermine the two mechanisms above and relax the discipline on local governments' irresponsible

behavior. First, the lack of a common market allows regional protectionism and limits the effects

of factor and product mobili ty on local economic fortunes. Because trade barriers reduce the

disciplinary role of competition, market-preserving federalism requires the central government

policing of the common market. Second, delinking local government expenditure with local

economic prosperity — due to large fiscal transfers, monetary decentralization, or easy access to

credits — allows local officials to ignore the financial consequences of their decisions. Therefore,

market-preserving federalism requires limited vertical fiscal transfers, centralization of monetary

authority, and restricted access to financial resources by local governments so that they hard

budget constraints.

9

Because the new theories stress government incentives and the state-market relationships,

not surprisingly, there exist major differences between the traditional and new theories. One

difference concerns the role of revenue transfers between the central and local governments.

Assuming a benevolent government, the traditional theory argues for the benefits of

decentralization of expenditure for its informational advantages, but it also identify a number of

circumstances under which decentralization leads to allocative distortions and weakening of fiscal

capabili ty of the central government. Allocative distortions may result from expenditure

decentralization in the presence of large scale externalities, and more significantly, from

decentralized taxation in the presence of inter-jurisdictional competition. Furthermore,

decentralization may restrict the central government's fiscal abili ty to alleviate regional inequality

and maintain macroeconomic stabili ty. Because of these concerns, many traditional theories do

not consider regional "self-financing" (i.e., local governments depend on their own tax revenue

collection to finance their expenditure) desirable. They therefore recommend sizeable transfers

from the central to local governments necessary in order to fill the gap between (more efficient)

decentralized expenditure and (less distortionary) centralized revenue collection.

In contrast, theories of market-preserving federalism stress the importance of

government's incentives and, for that purpose, they emphasize the potential benefit of linking local

government's revenue collection with their expenditure and limiting central government's

redistribution among local governments. Despite possible well-known allocative distortions,

decentralization’s beneficial incentive effects for government are especially valuable for the

economies just stepping out the shadow of central planning. The previous pervasive revenue

redistribution in these economies destroyed both government’s positive incentives and its financial

discipline. Regional "self-financial sufficiency" and a proportional revenue sharing between

different levels of government effectively link local government expenditures with local economic

10

prosperity, resulting in a big step toward positive incentives and serious fiscal discipline for local

governments.

Limited transfers and strong fiscal incentives can make local governments better

promoters of market-oriented reforms. In a simple model, Zhuravskaya (1998) derives the

following predictions on the effects of the stronger fiscal incentives for local government,

measured by the closer link between local expenditure and local revenue generated. First, because

onerous restrictions on enterprises reduce their revenue, lower governments facing stronger fiscal

incentives are likely to impose fewer economic restrictions on and give more support for the

development of non-state enterprises. Second, stronger fiscal incentives may lead local

governments to restructure state-owned enterprises under their supervision; poorly performing

SOEs increase their financial burden. Third, stronger fiscal incentives may also lead local

governments to provide more productive local public goods, including making productive

infrastructure investments. To the extent that these local public goods, unlike pure redistribution,

increase the productivity of enterprises, they will i n turn increase the local governments' revenue

base.

III . Regional Decentralization and Fiscal Contracting in China's Reform

We apply the new theories of federalism to study the emergence of federalism during China's

reform. Among the three new principles of market-preserving federalism, we examine in this

paper those on regional decentralization and fiscal incentives provided for local governments. We

omit here the one on inter-jurisdictional competition for the lack of information and data, though

11

4 Below the township level, the vill age is an informal level of government. A municipali ty can be one ofthe levels of a province, prefecture, or county; most municipali ties are at the prefecture level.

elsewhere we provide considerable anecdotal evidence on this dimension (see Montinola, Qian,

and Weingast, 1995; and Qian and Weingast, 1996).

A. Regional Decentralization during the Reform

China's government administration (and its fiscal system) has five levels: (1) central; (2)

provincial; (3) prefecture; (4) county; and (5) township.4 We refer to all subnational governments

as local governments in this paper in general, but in the empirical sections we refer to provincial

governments as local governments.

Since economic reform began in 1979, regional decentralization has been a critical

component of reform. Because of the legacy of central planning, the government had

comprehensive control over the economy. Therefore, devolution of government authority from

the central to local levels is a much broader issue than just fiscal affairs. First, local governments

supervise about three quarters of the state industrial firms in terms of output; they also have a

major responsibili ty for state fixed investments, initially in industry but increasingly in

infrastructure. Second, local governments have primary authority to regulate the local economy,

such as licensing, defining the scope and role of non-state firms, coordinating urban development

plans, and even resolving business disputes. Third, local governments provide an array of local

public goods, such as schools, health care, culture, police, as well as infrastructure facili ties and

other support for economic development. For example, they play an important role in attracting

foreign investment into their localities.

Before the reform, the shares of local government expenditure in total government

expenditure were 46% for 1971-75 and 50% for 1976-80. After the reform, the shares were 51%

12

5 Only a few countries, such as Switzerland and the United States, have a share of local governmentspending as total government spending above 40 percent. On average, the share for industrialized countriesis 34 percent and, for developing countries, 22 percent (World Bank, 1996). Therefore, by thismeasurement of decentralization alone, China has always been very decentralized as compared to othercountries.

for 1981-85 and 60% for 1986-90. After excluding price subsidies for 1986-90 to make the data

comparable to previous periods, the shares of local spending came down to about 50% (see

section IV for details). Therefore, the local-central spending ratio has been basically flat before

and after the reform.5

However, the share of local government expenditures itself does not capture the important

elements of reform and decentralization in China. Prior to the reforms, local governments had no

authority over the structure of local expenditures. After the reforms, local governments acquired

authority over expenditures within a broad set of guidelines set by the central government. In

particular, ministries at the central government could no longer issue mandatory spending targets

for provinces. Provinces also gained the authority to decide on the fiscal arrangements with the

sub-provincial governments within the provinces (Oksenberg and Tong, 1991). Given that the

local government has the authority over its spending structure, the higher the share of local

spending in total government spending, the more the fiscal decentralization.

Another dimension of decentralization concerns the characteristics of local government

officials in their relationship with the central government. Although in China the central

government appoints all top provincial government officials, the central government after the

reform has often sought to promote officials who are capable of managing local economies. Prior

to the reforms, the central government was far more concerned about loyalty in its appointment of

top provincial officials. Many provinces now have officials who have deeper roots in their

localities; for example, they were promoted from within the provincial ranks rather than being

13

6 The third category is off-budget funds (also known as "self-raised funds"), which include surcharges,user fees, and other types of fees. Because they are not recorded, we cannot include them in the research.

transferred from the outside by the central government. These local officials clearly have better

local information and better local connections, and they are more committed to local prosperity.

B. The Fiscal Contracting System

Second generation theories argue that the decentralization of authority will l ead to better

economic performance only if the interests of the local governments are aligned with local

prosperity. Indeed, if the central government takes away all the locally generated revenue, or the

central government always subsidizes local expenditure, the local government is more likely to

play "grabbing hands" than "helping hands" as far as local economic development is concerned.

China's decentralization involved more than just the devolution of government authority.

It also involved changes introduced between 1980 and 1993 in the fiscal incentives for local

governments through a major institutional innovation called the "fiscal contracting system"

(caizheng chengbao zhi).

Government revenue in China falls into two categories: budgetary funds and extra-

budgetary funds.6 Budgetary funds include major taxes and some surcharges. Up to 1994, all

budgetary revenues except custom's duties were collected by local governments and shared

upward with the central government. In 1980, reforms put into place the fiscal contracting

system, which is also known by the nickname "eating from separate kitchens" (fenzao chifan).

This system represents a dramatic departure from the previous system of "unified revenue

collection and unified spending" (tongshou tongzhi), or what is known as "eating from one big

pot" (chi daguofan). The previous system provided few incentives for the local governments to

collect revenues or develop their local economies. The new system altered the vertical

14

relationships between the central and provincial governments. The local governments not only

had the authority over local expenditures, more importantly, they also entered long-term fiscal

contracts (typically five years) with the central government. The new fiscal contracting system

was created for two purposes: first, to guarantee the central government a certain flow of revenue

from local governments; second, to provide local governments with incentives to build up local

economies and the revenue base.

Under the fiscal contracting system, the central and provincial revenue and expenditures

were determined in three steps (Wong, 1997). First, central fixed revenue was defined to include

custom's duties, direct tax or profit remittance from the central government supervised state-

owned enterprises (SOEs), and some other taxes. All other revenue falls under the heading "local

revenue."

Second, the local revenue was divided between the central and provincial governments

according to pre-determined sharing schemes. These schemes evolved through three phases. The

first phase ran from 1980 to 1984, the second from 1985 to 1987, and the third from 1988 to

1993. Examples of these pre-determined sharing schemes include: between 1980 and 1987,

Guangdong province would remit a fixed amount of 1 billi on yuan per year, and between 1988

and 1993, it would remit a fixed amount per year, which increased by 9 percent per year.

Guizhou province would receive fixed subsidies which increased by 10 percent per year. On the

other hand, Jiangsu province would remit a fixed share of revenue to the central government.

Over time, many provincial governments retained 100 percent of the total local revenue at the

margin, which effectively made them residual claimants. Figure 1 plots the average of the

provincial marginal revenue retention rates and the share of provinces with 100 percent marginal

retention rates.

[Insert Figure 1 here]

15

Third, after the division of local revenue according to the sharing schemes, some extra

remittance from provinces to the central government and additional transfer payments from the

central government to the provinces took place. For example, the central government sometimes

"borrowed" from the provinces. It also made additional transfer payments (not specified in the

sharing schemes) to provinces, which generally fell into two categories: earmarked subsidies

(zhuanxiang butie) for specific purposes (the most important one is price subsidies for urban

residents compensating them for food price increases) and matching grants (peitao buokuan),

such as funds for highway building.

The second revenue category, extra-budgetary revenue, consists of tax surcharges and

user fees levied by central and local government's agencies, as well as earnings from SOEs. The

extra-budgetary revenue emerged in the 1950s but only became institutionalized after the reform.

Unlike the budgetary local revenues, the extra-budgetary local revenues are not subject to sharing

with the central government, although the latter may impose taxes on them.

In 1978, total extra-budgetary revenue was about 10 percent of the GDP while total

budgetary revenue was about 31 percent. In 1993, the extra-budgetary revenue was up to 16

percent of the GDP and the budgetary revenue was down to 16 percent of the GDP (Statistical

Yearbook of China, 1995). While about three-quarters of the extra-budgetary funds are earnings

from SOEs retained by SOEs and their supervisory government agencies at the central and local

levels, at least 30 percent of the extra-budgetary funds are used for government expenditures to

supplement the budgetary funds (Fan, 1996).

16

7 The data excludes Tibet, and the data of Hainan was incorporated into Guangdong before 1988 andbecame separately listed after it obtained a provincial status in 1988.

IV. Data and Variables

For most of our empirical work, we use a panel data set of 29 provinces from 1982 to 1992.7 For

comparison purposes, we also use revenue and expenditure data of these provinces from 1970 to

1981. We obtained most of our data from the State Statistical Bureau (1997), supplemented by

data from various sources of official government publications at the national, provincial, and

municipality levels. Table 1 presents summary statistics of the variables defined below.

[Insert Table 1 here]

A. Variables for Decentralization

We use three variables to measure decentralization. The first, fiscal decentralization, is

the ratio of local government spending (per capita) to central government spending (per capita) as

in Zhang and Zou (1998). Under the assumption that local government has the authority over its

expenditure, the higher the ratio, the more the fiscal decentralization. We note that although this

is the standard measurement for fiscal decentralization and is commonly used in the literature, it is

best suited for a time series or cross-country analysis. It is not ideal for cross provincial analysis

because the ratio has a common denominator (central government spending) across provinces for

any given year. We cannot find a better variable to measure fiscal decentralization between the

17

8 An alternative measure would be the ratio of sub-provincial government spending to provincialgovernment spending for measuring fiscal decentralization inside a province, but we don't have that dataeither.

9 Notice that this variable is not a measure of local fiscal capabili ty, the latter is better measured by percapita local spending or local spending over GDP.

central and provincial governments in a panel data set.8 We use this variable mainly for the

purpose of comparison with the previous literature.9

We make one adjustment to the fiscal expenditure data because the original data has an

inconsistency problem: price subsidies were netted out from revenue and expenditure before 1986

but included as revenue and expenditure after 1986. Most of the price subsidies are the central

government's earmarked transfers to local governments (Wong, 1997). To make the data

consistent throughout the sample period, we exclude the price subsidies from the government

expenditure data after 1986. Because we do not have explicit provincial data on their price

subsidy expenditures, we use the following method estimate them. First, we apply the central and

local share of price subsidies nationwide (Hofman, 1993) to calculate the total local expenditures

of the price subsidies for each year. Because the price subsidies are exclusively for urban

residents and they are provided more or less uniformly across provinces, we then use the

provincial share of urban residency in the country to allocate price subsidies to each province.

The second variable used to measure decentralization is state industry decentralization,

measured by the share of industrial output from the SOEs supervised by local governments in the

total industrial output from all SOEs in a province. This variable reflects the relative importance

of the local government vis-a-vis the central government in supervising the SOEs within a

province. Ideally, we would like to use the share of fixed assets rather than output because the

former measures more precisely the authority of local government. But we do not have that data.

18

The third variable for decentralization concerns characteristics of top provincial officials.

Huang (1996) constructed an index to measure "bureaucratic integration" of provincial officials

with the central government. The index is based on the career background of the provincial Party

Secretaries. For any provincial Party Secretary, the score is 1 if he was promoted from within the

same province; 2 if he was moved to the current post from another province; 3 if he served in the

central government before his current appointment; and 4 if he concurrently holds a post in the

central government (such as a Politburo seat). We transform Huang’s scores into an index we call

bureaucratic distance, which is equal to (4 - "bureaucratic integration"), to measure the distance

between top provincial officials and the central government. For our index, the higher the score,

the farther is the top provincial officials from the central government. For example, for provincial

officials who are promoted from within provinces rather than moved from other ministries in the

central government, a higher score is given in our index. These are the provincial officials who

are more likely to have better local information and local connections, and moreover, they are

more committed to the local prosperity.

B. Variables for Local Government Revenue and Expenditure

We want to examine provincial budgetary revenue and budgetary expenditure separately

to find out the extent of central government revenue redistribution. As explained in section III ,

provincial budgetary revenue is the revenue generated in the province, excluding those revenues

designated as central government fixed revenue. Provincial budgetary revenue is subject to

sharing with the central government according to the fiscal contracts. It is also subject to ex post

19

10 The data is adjusted for price subsidies after 1986: local portions of price subsidies are excluded fromlocal expenditure.

11 All provincial budgetary and extra-budgetary data are consolidated figures within a province.

12 In addition, we use the 1992 data with caution, because in that year four provinces were selected forthe experiment of a new tax system to be implemented nationwide in 1994. Therefore, these provinceswere not off icially on the fiscal contracting system any more. Dropping off these four data points has li ttleeffect on our results.

renegotiation. On the other hand, provincial budgetary expenditure is the actual provincial

government spending, after contractual obligations are fulfill ed and renegotiation takes place.10

We also consider provincial extra-budgetary revenue and extra-budgetary expenditure.

Although there is no sharing arrangement through fiscal contracts on extra-budgetary revenue

between the central and provincial government, the central government can impose taxes on the

local extra-budgetary revenue. Moreover, there is no reason for us to believe a priori that the

central government will not take away any funds from local extra-budgetary revenue. Therefore,

these two variables can take different values.11

C. Variables for Fiscal Incentives

The fiscal contracting system was implemented between 1980 and 1993. However, data

for 1980 and 1981 are incomplete. Data for 1993 is problematic due to the anticipation of a

major change of the fiscal system in 1994. For example, one provision of the 1994 reform

compensated local governments based on their 1993 figures of local expenditure. This provision

gave an incentive for local governments to inflate the local expenditure figures of 1993. We

exclude 1993 and use only the data from 1982 to 1992.12

Fiscal decentralization as measured by the ratios of local to central government

expenditure does not capture the fiscal incentives facing local governments. We focus on the

variable of (ex ante) fiscal incentives for provincial government. This variable is the marginal

20

13 The incorporated information on "plan separately listed cities" include Wuhan (1986-92) in Hubei;Chongqing (1986-92) in Sichuan; Shenyang (1988-92) in Heilongjiang; Ningbo (1988-92) in Zhejiang; andQingdao (1991-92) in Shandong. Information sources are the provincial and city statistical yearbooks.

14 Again, the data is adjusted for price subsidies after 1986: local portions of price subsidies areexcluded from local expenditure. They were earmarked central government transfers and were determinedsolely by the number of urban residents anyway.

retention rate of local revenue collection by provincial governments as contained in the fiscal

contracts between the central and provincial governments. In contrast to the ratio of local to

central government expenditure, the fiscal incentive variable measures how local governments are

rewarded (or punished) at the margin from an increase (or decrease) in local prosperity. The

information about provincial marginal retention rates in the fiscal contracts is provided by Chen

(1988), Oksenberg and Tong (1991), and Bahl and Walli ch (1992). In cases where there are

several marginal retention rates for different revenue brackets, we use the rate for the highest

revenue bracket because the data reveals that all the provinces in fact ended up with that bracket.

The provincial marginal revenue retention rates involve one complication. Starting in

1986, several large cities became fiscally independent from the provinces where they were

located, directly contracting with the central government (they are known as "plan separately

listed cities"). We have tried to incorporate the information on these city contracts into the

provincial contracts by constructing an average provincial marginal retention rate using city

revenue and provincial revenue (excluding the relevant city) as weights.13

With the information on fiscal contracts, we can examine the deviation of actual

implementation of the fiscal contract from the promised one by using a variable we call (ex post)

fiscal readjustment. This variable is a measurement of the difference between actual provincial

expenditure and "pre-defined" revenue retention as indicated in the fiscal contracts.14 A negative

value of fiscal readjustment means that the province spends less than the contractual provision

would entail; a positive value indicates that it spends more. We interpret the first case to be the

21

15 We make a few quali fications regarding the interpretation of the variable fiscal readjustment. First,we implicitly assume that each province has a balanced budget each year without carry-overs from theprevious year or savings into the next year. This is basically true. Second, because our information aboutthe fiscal contracts is limited to fixed subsidies/remittances and marginal retention rates, we have to omitother pre-defined transfers or transfers based on exogenous criteria such as natural disaster relief. However, such transfers are not significant. Third, because we look at net transfers (i.e., expenditureminus revenue retention), it is possible that two way transfers are high but net transfers are low. Despitethese limitations, this variable provides useful information on the significance of ex post readjustment offiscal revenue retention.

one in which the province ex post remitted extra revenue to the central government, for example,

if it was forced to "lend" revenues to the central government. These cases may potential represent

central government "predation." On the other hand, a positive value of fiscal readjustment

indicates that the province ex post received extra subsidies from the central government. This

province can thus be viewed as having a problem of "soft budget constraint."15 For any given

year, we use the average of this variable across provinces weighted by provincial expenditure to

measure the average deviation of actual implementation of the fiscal contracts from the promised

ones.

D. Variables for Economic Performance and Structural Change

We use two variables to measure overall provincial economic performance during the

reform period: provincial GDP growth, and provincial growth of non-agricultural employment.

The non-state sector in urban and, especially, rural areas is widely regarded as China's

engine of growth (e.g., Qian and Xu, 1993; Xiao, 1994). We use several variables to examine the

structural change reflecting the entry and expansion of non-state enterprises vis-a-vis state

enterprises. We consider two growth variables: growth of non-state industrial output, which

includes both urban and rural non-state industry, and growth of rural enterprise employment,

which covers all non-agricultural activities in the rural areas. We also use two variables

concerning the structural changes in terms of the relative weights between the non-state and state

22

sectors. We use the change of the share of non-state-non-agricultural employment in labor force

to measure the overall development of the non-state sector, and we use the change of the share of

non-state industrial output in total industrial output to measure the development of non-state

industry.

We study the structural change within the state sector by examining two variables: the

changes in the share of contract workers in total state employment and in the share of bonuses in

total state employee wages. Prior to 1992, China had no privatization of state enterprises nor any

layoffs of state employees. But the state-owned enterprises also underwent some modest reforms.

For example, they changed the employment practice by hiring workers on a contractual basis

rather than giving them permanent positions. They also increasingly used bonuses as a form of

payment rather than fixed salary. Both reforms were intended to improve workers' incentives.

These two variables are used previously by Groves et. al. (1994) as the measurements of state-

owned enterprise reform in China, although their data set is drawn from enterprise surveys in four

provinces and thus is different from ours.

One important aspect of local government activities concerns local fixed investments,

which include investment in industrial capacity as well infrastructure, the latter received more and

more weight over the time. Ideally, we would like to have a variable measuring local government

infrastructure investment only, but the statistics on that is incomplete. Therefore, we use the total

local government fixed investment and the ratio of local to central government fixed investment

in a province. The latter variable reflects the relative weight of the local governments' role in

investment vis-a-vis the central government in a province.

During the period spanned by our data, the state banking system was quite decentralized,

and local governments had enormous influence over credit policy. We use the ratio of new loans

23

to GDP as a measure of local government's access to credit. Alternatively, we also use loans

from credit cooperatives as another variable.

V. The Effects of Decentralization: A Critical Review of the Previous Results

Two recent empirical works utili ze provincial panel data to study the relationship between

decentralization and economic performance in China. Both challenge prevaili ng theories of the

economic benefits of decentralization by reporting negative findings about decentralization in

China's reform. Zhang and Zou (1998) found a negative and significant effect of fiscal

decentralization, measured by provincial-central spending ratios, on provincial growth. They

interpreted their results to imply that greater fiscal centralization is good for China's growth. On

the other hand, Huang (1996) studies the effect of "bureaucratic integration" of local government

officials with the central government on investment and inflation. As defined in the last section,

higher values of Huang’s variable indicate a closer connection between the top provincial officials

and the central government. He found that higher values of bureaucratic integration had a

positive and significant effect on curbing local government's fixed investment. Viewing excessive

local investment as the primary cause for higher inflation in the 1980s and the closer bureaucratic

integration as a direct result of the central government control over appointment, Huang

concluded that political centralization was the main reason for better inflation control and

macroeconomic performance in China.

In this section we reexamine the effect of decentralization along the lines of Zhang and

Zou (1998) and Huang (1996). Specifically, we investigate the following model:

24

16 This result holds for the "between estimators" (i.e., averages) as well , provided variables such as"openness" are included in the control variable W.

(5.1) X it = �i +

�t + � 'Zit + � 'Wit-1 + uit.

In equation (5.1), X it is a vector of variables measuring economic performance. The � i's represent

the provincial specific effects, which we assume they are constant for each province. This implies

that our specification is a fixed effect model. The � t's are the annual dummies, which are intended

to capture the effects of nationwide macroeconomic fluctuation. Zit is a vector of variables

measuring the degree of decentralization. Wit-1 is a vector of control variables. The uit's are the

disturbance terms. Our fixed effect model implies that any correlations between X and Z cannot

be attributed to inherent provincial characteristics.

Using their data set between 1986 and 1992, we were able to reproduce the results of

Zhang and Zou (1998). By estimating a variant of equation (5.1), excluding the annual dummies

as in their study, we found a negative and significant relationship between fiscal decentralization

and provincial growth.16

We obtained different results, however, when we included the set of annual dummy

variables. Doing so reverses the sign of the effect of fiscal decentralization on provincial growth,

which becomes positive and significant. Examining the estimations of the year dummies, we

found that they are highly cyclical: the coefficients are positive for the boom years (such as 1987-

88 and 1992) and negative for the recession years (such as 1989-90). This suggests that the

negative findings of Zhang and Zou of fiscal decentralization resulted from the failure to filter out

economy-wide cyclic effects. These cyclic effects are likely to be caused by factors unrelated to

fiscal decentralization, such as agricultural output fluctuation and political climate changes over

time.

25

Using our provincial panel data set between 1982 and 1992, we estimated equation (5.1)

and we report our results in Table 2. As in Zhang and Zou, we include the growth of labor force

and the provincial tax rates into the control variables of W. We found that fiscal decentralization,

as measured by the ratio of local to central government spending, has positive and significant

effects on the provincial GDP growth (column (1) in table 2), it also has the same effects on the

growth of non-agricultural employment and the growth of non-state-non-agricultural employment

(columns (2) and (3) in table 2). Clearly, Zhang and Zou's results have not provided convincing

evidence on the negative effects of fiscal decentralization. Whether our findings of the opposite

effects can be interpreted as evidence of the positive consequences of fiscal decentralization

depends on how well the local to central spending ratios represent fiscal decentralization in the

panel data.


In his study of the relationship between the local government's fixed investment and the

central government's control over appointments, Huang (1996) found that the higher degree of

bureaucratic integration of the top provincial officials into the central government, the lower the

local government's fixed investment. The problems with Huang's results and their interpretations

are twofold. First, his results only demonstrate a negative relationship between the level of local

government investment and bureaucratic integration; he cannot tell when local investment is

excessive. Only excessive local investment may potentially put pressure on inflation. Second,

more importantly, controlli ng inflation is only one aspect of macroeconomic performance and not

necessarily the most important. Perhaps more important as performance criteria are the growth of

the local economy and structural changes.

In contrast to our equation (5.1), Huang's estimates did not include provincial fixed

effects. We report our estimates in table 3. We found our results (which include provincial fixed

26

effects) similar to Huang's, that is, greater bureaucratic distance from the center (i.e., less

bureaucratic integration with the center) has a positive and significant effect on both the level of

local fixed investment and the ratio of local to central government fixed investment (columns (1)

and (2) in table 3). To see if bureaucratic distance might be responsible for excessive investment

during the expansionary period of a business cycle, we include interaction terms between

bureaucratic distance and "economic expansion" and between fiscal decentralization and

"economic expansion," where "economic expansion" is a variable taking 1 for the fast-growth

years of 1985, 1987-88, and 1992 and 0 for the rest. We did not find a significant effect on the

interaction terms. This questions the hypothesis that bureaucratic distance produces abnormally

high local investment during periods of high economic expansion.


We now turn to investigate the effects of bureaucratic distance from the center on

economic growth and structural changes. In contrast to the spirit of Huang, we found that

greater bureaucratic distance from the center has a positive effect on the growth of provincial

non-agricultural employment (column (3) in table 3), an important indicator for development. We

also found that it has the positive effect on the growth of non-state industrial output (column (4)

in table 3), a measure for structural change. Our findings indicate that greater bureaucratic

distance of provincial officials from the center not only increases local government investment, it

also fosters provincial development and structural change, the ultimate goals of reform.

To summarize our review of previous work: the above findings demonstrate that the

negative results of Zhang and Zou and Huang on China's decentralization and the corresponding

interpretations are either problematic or need to be qualified. To better understand the impact of

decentralization, we turn to the issue of fiscal incentives.

27

VI. Fiscal Incentives for Local Governments

In this section we examine the fiscal incentives facing local governments in China, which has not

been done before in any systematic way.

A. The Link between Local Revenue and Expenditure

We first look at the correlations between provincial revenue and expenditure. We run the

following fixed effect model:

(6.1) X it = � i + � t + � Y it + µit,

where X it is province i’s expenditure in year t, Y it is province i’ revenue in year t, the i's are

provincial fixed effects, � t's are the year dummies, and µit's are the disturbance terms. These tests

are designed to tell us how closely linked are local expenditures to local revenues, after

controlli ng for provincial inherent characteristics and nationwide changes over time.

Table 4 reports our results using data between 1982 and 1992. Row (1) shows a

coefficient quite close to 1 of provincial budgetary revenue in its budgetary expenditure equation

(0.955 with unadjusted data and 0.752 with adjusted data), and row (2) shows an even larger

coefficient for the extra-budgetary expenditure equation (0.965). These results imply that a one

yuan increase in provincial budgetary revenue results in more than three-quarter yuan of

provincial budgetary expenditure, and the relationship becomes almost one to one for extra-

budgetary revenue and expenditure.

Row (3) examines the cross effects between budgetary expenditure and extra-budgetary

revenue. In principle the central government might require greater budgetary remittances for

28

those provinces with larger extra-budgetary revenue (which was not subject to sharing), resulting

in a smaller budgetary expenditure. Our results show that the change of extra-budgetary revenue

does not have this kind of negative effect on the change of budgetary expenditure. The coefficient

here is actually positive, which in part reflects the fact that budgetary and extra-budgetary

revenues have similar tax bases.

Taken together, the results from rows (1)-(3) demonstrate that the fiscal system in China's

reform has produced, on average, a strong link between local expenditure and local revenue

generation. As a result, the provinces in China tend to be "self financing" at the margin. This

translates into strong fiscal incentives for local governments to pursue local prosperity in order to

increase their revenue base.


We also investigated the possibili ty of a "ratchet effect." The ratchet effect occurs when

higher revenue collection this year leads to a higher revenue remittance or fewer subsidies in the

future years. We study this problem by regressing the current year difference between budgetary

expenditure and revenue (i.e., "subsidies" or negative "revenue remittance") on the previous year's

budgetary revenue. The ratchet effect implies a negative coefficient from this regression, and the

larger the (negative) number, the greater the effect.

Row (4) of table 4 shows no ratchet effect during the reform with unadjusted data, but a

modest ratchet effect with adjusted data. With adjusted data, for every 1 yuan increase in

provincial revenue in the current year, the province will see a 0.24 yuan increase of remittance to

the central government in the next year. This is not too surprising because the fiscal contracts

were formally renegotiated every five years (further, some informal adjustments occurred within

each period). This result implies that, on average, the actual remittance to the central government

increased modestly over time from provinces experiencing economic growth.

29

17 Of course, we do not expect an exact correspondence, due to ex post adjustments to exogenous eventsthat occur during the year.

B. The Discrepancy between the Ex Ante Contracts and Ex Post Implementation

The strong link found above between provincial marginal revenue collection and marginal

expenditure is clearly related to fiscal contracting. We now examine the provincial ex ante fiscal

contracts and compare the actual provincial expenditure with the revenue retention amount

implied by these fiscal contracts. This allows us to estimate the extent of ex post readjustment of

revenue remittance and subsidies beyond the contracts. Large ex post readjustments would force

us to qualify our interpretation of the fiscal contracting system. In particular, large ex post

readjustments would signify the inabili ty of the central government to commit to its agreements

with the provincial governments.

We present the results in table 5, breaking the data set up in two ways, all provinces and

then disaggregating to provinces paying extra remittances and those receiving extra subsidies

beyond the ex ante contractual arrangements. Several interesting findings emerge. First, consider

the first panel on all provinces in table 5. It reports in column (6) that, between 1982 and 1992,

the weighted average of the fiscal readjustment across provinces, as measured by the absolute

difference between actual expenditure and contractual revenue retention divided by adjusted

expenditure, has a declining trend. After 1986, this variable fell below 8 percent. This evidence

suggests that the extent of ex post readjustments have become more limited over time; and,

further, that after 1986, they have been relatively limited in scope. On average, actual provincial

expenditures correspond reasonably closely to their contractual revenue retention.17


Second, we also disaggregate the set of provinces in each year into two categories: extra

remittance provinces, defined as those whose expenditures fall short of pre-defined revenue; and

30

18 This may also due to the fact that we were unable to account for some earmarked subsidies.

extra subsidy recipient provinces, defined as those whose expenditures exceed pre-defined

revenue. Examining the two groups separately, we find that there are generally fewer extra

revenue remittance provinces (see column (7), second panel of table 5) than extra subsidized

provinces (see column (7), third panel of table 5). This may indicate that the ex post extra

transfers from the center to provinces (i.e., the problem of soft budget constraints) is

quantitatively more significant than extra transfers from the provinces to the center.18

Because of the potential problem of central government predation, the phenomena of extra

remittance provinces is of special interest. If the central government behaved in a predatory

fashion — for example, if it consistently forced the more successful provinces to remit significant

amounts of additional revenue — the magnitude of this figure would be significant. The results in

second panel of table 5 suggest that these additional remittances are small. After the difficult year

of 1989, only one-third of the provinces remitted additional money, and the average amounted to

a relatively small portion of expenditure, under four percent.

Third, table 5 reveals two aspects of a sudden increase in extra remittances from provinces

to the central government in 1989. First, the average quantity of extra remittances increased to

7.67 percent of expenditures (see column (6), second panel). Second, the number of provinces

making the extra remittances also increased, a jump to 19 out of 28 (see column (7), second

panel). The table also shows a decrease in extra subsidies from the central to local governments

as compared with other years (columns (6) and (7), third panel).

The changes in 1989 are not surprising. In that year, conservatives in the government

temporarily gained more power after the Tiananmen Square incident, causing a temporary setback

for reform. Importantly, table 5 reveals two aspects of this setback. First, this change was

relatively short lived: after 1989, the fiscal data return to their normal trend. Second, the absolute

31

19 Indeed, these data constitute evidence supporting the more common anecdotal evidence in theli terature that the setback to reform after Tiananmen Square was in fact temporary.

amount was relatively modest. Although many more provinces were subject to additional

remittances in 1989, remittances averaged less than eight percent of expenditures.19 By the early

1990s, the number of provinces with extra remittances were small, as were the average magnitude

of the extra remittance.

C. Horizontal Redistribution

Economists have long been concerned that regional self-finance leads to problems of

inequality — potentially the growing regions may leave the others behind. We therefore turn to

investigate whether China’s fiscal contracting system and its strong fiscal link between local

revenue and expenditure found above imply less horizontal redistribution and thus more greater

inequality across provinces. Greater inequality is not necessarily a product of self-financing for

two reasons: first, provinces lagging behind have incentives to alter their policies; and second,

self-financing’s strong marginal incentives do not preclude inframarginal redistribution.

Table 6 reports the coefficients of variation (i.e., standard deviation divided by mean) for

per capital revenue and expenditure across provinces. If inequality grows over time, we would

expect these coefficients also to grow. Several interesting patterns emerge. First, the coefficients

of variation for both provincial per capita budgetary revenue and expenditure followed a declining

trend (columns (1)-(3) in table 6), indicating less inequality over time. For example, the

coefficient of variation for per capita adjusted budgetary expenditure fell from 0.68 in 1982 to

0.52 in 1992.


32

Second, in contrast, the coefficient of variation for per capita budgetary remittance (the

difference between budgetary revenue and expenditure) increases over time, from 4.25 in 1982 to

7.78 in 1992 (column (4) in table 6). This means that the mean adjusted standard deviation nearly

doubled in ten years so that richer provinces in fact pay greater remittances to the central

government on per capita terms.

Third, the coefficient of variation for extra-budgetary revenue is comparable to that for

budgetary revenue, that of extra-budgetary expenditure is much larger (columns (5) and (6) in

table 6), suggesting much less redistribution within the extra-budgetary funds.

The combination of declining dispersion of per capita budgetary expenditure and

increasing dispersion of budgetary remittance implies an increasing revenue redistribution from

rich to poor provinces. This is particularly interesting because, in the fiscal contracts, both the

average marginal provincial revenue retention rates and the number of provinces which faced 100

percent marginal rates increased during the period (see figure 1 in section III) . This observation

implies that, over time, there were less and less budgetary revenue redistribution at the margin.

Therefore, China has managed to increase redistribution from rich to poor inframarginally without

distorting the marginal incentives facing provinces. According to standard economic theory, this

kind of inframarginal redistribution, such as lump sum transfers, will not adversely affect

incentives. We conclude that the Chinese fiscal contracting system seems to exhibit the feature of

creating incentives without worsening distribution.

D. Contrasting with Pre-Reform China and Post-Reform Russia

To put the above results in perspective, we compare them with the results from pre-reform

China and post-reform Russia. Our analysis uses data on pre-reform China from 1970 to 1979.

Row (1) of table 4 reveals a very small coefficient of provincial budgetary revenue in the

33

budgetary expenditure equation, 0.184 before the reform as compared to 0.955 with unadjusted

data or 0.752 with adjusted data after the reform.

These results provide evidence for the impact of the fiscal reforms. First, prior to

economic reform, the central government extracted revenue from high revenue provinces while

transferring revenue to low revenue provinces. The coefficient of 0.184 in row (1) indicates that,

prior to the reforms, the central government, on average, extracted over eighty percent of any

increase in local revenues. This figure fell dramatically after the reform, indicating that the central

government, on average, extracts less than twenty-five percent of any increase in revenues. The

results imply that the fiscal contracting system represents a drastic departure from the past,

allowing provinces to keep the lion's share of increases in revenue. The results are consistent with

our interpretation that the new fiscal system greatly enhanced the fiscal incentives for local

governments to foster local economic growth.

Moreover, row (4) of table 4 shows a very strong ratchet effect before the reform: a one

yuan increase in this year's provincial revenue results in a 0.55 yuan reduction in next year's

subsidies (or, an increase in the next year's revenue remittance). In comparison, at 0.24, the

ratchet effect after the reform was less than half this pre-reform value. After the reform,

provinces had less concern about increased future obligations from the increase of revenue

collection this year.

A comparison of our findings with similar investigations of Russia is also revealing.

Zhuravskaya (1998) examined the fiscal incentives of city governments in the region-city fiscal

relationship in post-reform Russia, revealing a pattern which she interpreted as predation. Using

the data of 35 cities for the period 1992-1997, she investigated a regression similar to the ones

reported in row (3) of table 4. By regressing the change in "shared revenues" between local and

regional governments (corresponding to the change of budgetary expenditure here) on the change

34

of "own revenue" (corresponding to the change of extra-budgetary revenue here), she finds that

the coefficient is -0.90. This value means that increases in a city's revenue are almost entirely

offset by decreases in shared revenues from the region to the city. Exactions of this magnitude

destroy cities’ fiscal incentives to increase their tax base. These results stand in sharp contrast

with the post-reform China: the results presented in row (3) of table 4 shows that, in China, any

increase in extra-budgetary revenue (corresponds to "own revenue" in Russia) is not associated

with any decrease of budgetary expenditure (corresponds to "shared revenue" in Russia).

Treisman (1999) studies two important aspects of Russia’s fiscal system. First, citing

previous studies, he notes that the coefficients of variation for per capita regional spending in

Russia's regions for 1992 and 1993 were, respectively, 0.83 and 0.77. These coefficients are

larger than those we found for China, which are below 0.70 and falli ng. This comparison

indicates that, by this measure of inequality, local government spending is less unequal in China

than in Russia.

Second, Treisman (1999) studied the patterns of central to region fiscal transfers and

regional tax retention in post-reform Russia between 1992 and 1996. He found evidence that

fiscal transfers followed a political pattern. Regions that demonstrated discontent with the central

government — for example, by voting against Yeltsin or his pro-reform alli es, by declaring

sovereignty, or by staging major strikes — were able to receive greater per capita net transfers

from the center and obtained a higher share of tax revenue retention. Treisman interprets his

findings as showing that the Russian central government used fiscal transfers mainly for the

political purposes of appeasing regions which were prepared to threaten the existing political

order. We have not studied the determinants of fiscal transfers in China. But the strong fiscal

incentives for local government and the falli ng trend of inequality in provincial per capita

budgetary spending we found seem to suggest that these economic considerations, in contrast to

35

20 To avoid the error-in-variable problem for our fiscal incentive variable, we also run the parallelregressions replacing the fiscal incentive variable with the one taking values of 0 or 1 (1 if the marginalretention rate is 100 percent and 0 otherwise). The results are similar and not reported in tables.

the set of political and sovereignty issues as in Russia, have played important roles in China's fiscal

system.

In contrast to our characterization of China’s decentralization as market-preserving

federalism (Montinola, Qian, and Weingast 1995), the work of Frye and Shleifer (1997), Shleifer

(1997), Treisman (1999), and Zhuravskaya (1998) on Russia are consistent with Slider’s (1997)

characterization of Russia’s system as “market-distorting federalism.”

In summary, this section presents significant evidence that the fiscal contracting system in

post-reform China provides provincial governments with strong fiscal incentives to expand their

revenue base. The strength of the fiscal incentives seems particularly impressive when compared

with pre-reform China and post-reform Russia. But the fiscal contracting system is ad hoc and is

subject to renegotiation. We found some evidence showing a modest ratchet effect and extra

subsidies through fiscal transfers, although they are not quantitatively very large.

VII . The Effects of Decentralization and Fiscal Incentives

In this section we study how fiscal incentives, in combination with the devolution of authority

from the from the central to local governments, affect economic performance and structural

change in a province. We utili ze a variety of measures to indicate economic changes in four

areas: the development of the non-state sector, the reform of the state sector, local government's

investment, and local government's access to credit.20

36

21 What in our mind is a model in which a "convergence" tendency exists: the higher the level of incomeor the level of a share of the non-state sector in the economy, the less room exists to grow or furtherincrease the share of the non-state sector. This "frontier" can be pushed outward by the increase of"effort," which in turn is determined by the fiscal incentives of local governments.

We investigate a model similar to equation (5.1) but include the fiscal incentive variable in

the decentralization vector Z. In regressions with growth rate or a change of shares as the

dependent variable, we also include the levels of the corresponding variables in the previous year

in the control variable W.21 In fact, this is the only control variable we include in W in equation

(5.1).

A. The Development of the Non-State Sector

Table 7 presents our results on the effects of fiscal incentives on the development of the

non-state sector. Our results reveal the following. First, we found that both the bureaucratic

distance and the fiscal incentives have positive and significant effects on rural industrialization

measured by the growth of rural enterprise employment. Second, similar effects were also found

for the structural change, as measured in terms of ownership of firms: bureaucratic distance and

fiscal incentives have positive and significant effects on the increase of the shares of non-state-

non-agricultural employment in total labor force as well as the increase of the shares of non-state

industrial output in total industrial output. In all transition economies, the entry of non-state

enterprises are the determining factor of growth, and thus this incentive effect is very significant.


B. The Reform of the State Sector

Table 8 reports our results of the effects of fiscal incentives on the reform of state-owned

enterprises. First, stronger fiscal incentives foster reform by faster increasing the share of contract

37

workers relative to permanent workers. In contrast to permanent workers, who are under the

traditional socialist labor conditions of "iron rice bowls," contract workers do not have tenure and

are more likely subject to market conditions. More contract workers relative to permanent

workers mean that enterprises are better restructured to market orientation. Second, stronger

fiscal incentives also make faster increase in the share of bonuses in total employee wages.

Because bonuses, as compared to fixed wages, represent a compensation form that is more

closely linked to workers performance, a higher share of bonuses in total employee wages implies

enterprise workers are better motivated.


C. Local Government's Investment

We now revisit the issue about the relationship between decentralization and local

government's fixed investment, first raised by Huang (1996) and studied in section V above. In

our new investigation, we add the fiscal incentive variable to the regressions. The results in table

9 show that fiscal incentives have positive and significant effects on the level of local government

fixed investment, as well as the ratio of local to central government fixed investment. These

results have another implication. In the presence of our fiscal incentives variable, the bureaucratic

distance variable becomes insignificant. This result contrasts with those results reported in

columns (1) and (3) in table 3, where bureaucratic distance is significant. Depending on how the

role of local government's fixed investment is interpreted, we can either say that fiscal incentives

motivated local governments in local development (by making more local investment in

productive ways), or in excessive local investment to fuel inflation and more distortions.


38

D. Access to Credit

Finally, we examine the effect of decentralization on financial control, and present our

results in Table 10. Regressions results show that stronger fiscal incentives lead to higher ratio of

new loans to GDP or more loans from credit cooperatives. This provide some evidence that

stronger fiscal incentives for local governments associated with more local government's access to

credit and financial resources.


E. Parallel Findings on Russia

The above results of the effects of decentralization and fiscal incentives for China parallel

those found for Russia. To proxy fiscal incentives, Zhuravskaya (1998) uses a binary indicator of

the presence or absence of crowding-out of changes in own revenues by changes in shared

revenues. The value of -1 of this variable means changes in own revenues and shared revenues

have opposite signs and +1 means opposite. She found several results. First, in Russia cities,

stronger fiscal incentives affect private business formation in a positive way. Second, stronger

fiscal incentives also increase the shares of local public spending on education and health care.

Third, they improve the outcome of local public goods provision, as measured in terms of

reducing infant mortality rates and the percentages of school children who have to go to evening

schools to compensate for the lack of education provided by the local governments.

Freinkman and Yossifov (1998) studied the impact of fiscal decentralization between

Russia regional and local governments, investigating its effects on the regional fiscal and

economic performance. They used the share of local governments total revenue in the

consolidated regional budgetary revenue as a measure of fiscal decentralization within a region.

They found that fiscal decentralization increases the share of expenditures on education in

39

regional government budget, increases regional industrial output growth, but it also increases

regional budget deficits.

In summary, we found evidence showing that stronger fiscal incentives played positive

role in structural change and economic performance in China. As predicted by second generation

theories of federalism, the evidence shows that stronger fiscal incentives matter and furthermore,

they promote structural change and economic reform. We also found some evidence of the lack

of restraints on local governments in accessing financial resources, which potentially is a problem

for inflation. Overall, our evidence shows much more positive than negative effects of the fiscal

contracting system.

VIII . Conclusions

In the spirit of second generation theories of federalism, our hypothesis is that a major benefit of

decentralization derives from the incentives it creates for local governments. Beyond the

traditional theory’s focus on local public goods provision, second generation theories argue that

the incentives facing local governments have a critical impact on the degree to which they foster

local economic growth. This theme represents the principal way in which second generation

theories extend the work of the traditional theories of federalism.

The issue of government incentives is especially relevant for contemporary transition and

developing countries, as well as historical development in the West. Although traditional theories

of federalism are adequate for the study of many issues in contemporary industrialized economies,

the second generation theories of federalism are necessary to study decentralization in transition

40

and developing economies. The reason is that transition and development require reorienting the

role of government from one that commands and controls the economy to one that fosters

decentralized markets. In a large, non-democratic country like China where the traditional liberal

mechanisms of the democratic West — elections, separation of powers, a legal system

independent of politics — are absent, federalism may be one of the few ways to provide the

credible limits on government behavior that are necessary to underpin reform and stimulate

growth.

We present two major findings about the fiscal contracting system in China between 1982

and 1992. First, we found that the fiscal contracting system provides local governments with

strong fiscal incentives and at the same time also improves horizontal distribution of per capita

budgetary spending over time. The strong correlations between local government revenue

collection and local government expenditure represents a dramatic progress over the pre-reform

period, when the central government extracted most increases in revenue and held lower

government authority in check. Surprisingly, the strong fiscal incentives were accompanied with

an improvement of horizontal distribution across provinces over time. Some economists have

argued that strong fiscal incentives likely lead to equity problems, as the revenue in the better

performing provinces grows disproportionately relative to revenue in the poorer or slower growth

provinces (e.g., Rose-Ackerman and Rodden, 1997; Wong, 1997). Our evidence suggests that

there is no necessary connection between strong fiscal incentives and worsening of distribution.

Second, we found that, not surprisingly, stronger fiscal incentives imply a faster development of

the non-state sector and greater reforms in the state sector, arguably the most important goals of

reform and development.

First and second generation theories agree about most allocative issues, so second

generation theories do not attempt to displace the vast portion of the economics of federalism.

41

The principal difference between first and second generation theories is that second generation

theories systematically study the role of government incentives in economic performance. Many

anecdotal stories ill ustrate this point in the previous studies on China's reforms (for example,

Montinola, Qian, and Weingast, 1995). But our econometric results in this paper provide some

systematic evidence on the importance of these incentives. These results therefore suggest that

the extension of first generation theories by second generation theories to encompass the question

of government incentives is important and necessary.

Economists, relying on traditional theories of federalism, criticize China's decentralization

and provincial "self-financing" on three grounds. First, some argue decentralization and fiscal

contracting seemed to create a variety of microeconomic distortions (Wong, 1992). For example,

decentralization may have induced local governments into over-investment, duplication, regional

market protectionism, and more local bureaucratic interventions. Second, decentralization and

fiscal contracting seemed to have increased regional inequality due to the constraints on revenue

redistribution by the central government (Wong, 1991). Third, the fiscal contracting system also

greatly reduced the central government's abili ty to conduct fiscal policy because it surrendered

fiscal instruments and received fewer tax revenues (Bahl and Wallace, 1992). Focusing on

incentives of government, our results show that these criticisms of China's decentralization and

fiscal system need to be qualified or even reconsidered.

Comparisons of local government incentives between China and Russia are striking.

There are of course many differences between the Chinese and Russian transition paths, including

political and historical reasons as well as initial conditions. Our study of federalism, Chinese style,

and the other studies on federalism, Russian style, indicate that one crucial difference concerns the

decentralization of government and the incentives provided for local governments to pursue

market-oriented reform. Therefore, discussions on transition should go beyond the usual focus on

42

stabili zation, liberalization, and privatization to pay more attention to the government's incentives

and the institutional foundations shaping them.

In closing, we raise two final issues. First, our perspective yields an important cross-

national prediction about federalism and economic growth, namely, that there should be a positive

relationship between the strength of fiscal incentives faced by lower-level governments and

economic growth (or performance, more generally). Countries with strong fiscal incentives

should experience relatively high growth while those with low fiscal incentives should experience

low or no growth. A cursory inspection of a few federal systems suggests the plausibili ty of our

prediction: The United States and China fall in the first category; Canada is somewhere in

between high and low fiscal incentives; and India, Mexico, and Russia, all have low fiscal

incentives. Whether this prediction holds under closer statistical scrutiny awaits further work.

Second, our empirical findings also demonstrate that some aspects of the fiscal system in

China were problematic and need further reforms. We found that the contracting system was

subjected to the problem of renegotiation, as shown by the ratchet effects over time and ex post

extra subsidies, and the stronger fiscal incentives were associated with more credit available to

local governments. While enormously valuable during the transition period, the fiscal contract

system has shortcomings. This suggests that this system is best viewed as a transitional

arrangement. In fact, China began to correct some of these problems with its 1994 fiscal and

monetary reforms. These new reforms replaced the fiscal contracting system with a rule-based

fiscal federal system and, at the same time, it also hardened local government budget constraints

by recentralizing monetary policy and restricting local governments' access to credit. Evaluations

of these new reforms also await further research.

43

Table 1. Summary Statistics of Variables

Mean Minimum Maximum Standarddeviation

Decentrali zation

Fiscal decentrali zation 1.78 0.61 7.11 1.32

State industry decentrali zation 0.75 0.10 1.00 0.16

Bureaucratic distance 2.26 0.00 3.00 0.86

Provincial Revenue andExpenditure

Budgetary revenue 53.56 1.30 222.64 42.01

Budgetary expenditure 52.65 5.71 219.61 34.18

Budgetary expenditure (adjusted) 45.46 5.71 197.93 27.93

Extra-budgetary revenue 44.21 0.46 160.47 33.89

Extra-budgetary expenditure 42.20 0.49 161.40 32.96

Fiscal Incentives

(ex ante) Fiscal incentives 0.84 0.11 1.00 0.23

(ex post) Fiscal readjustment 0.13 0.00 0.60 0.11

44

Table 1. (continued)

Mean Minimum Maximum Standarddeviation

Economic performance and structuralchange

GDP Growth 0.10 -0.03 0.34 0.05

Growth of non-agricultural employment 0.06 -0.04 0.26 0.05

Growth of non-state industrial output 0.19 -0.11 0.77 0.11

Growth of rural enterprise employment 0.13 -0.16 1.20 0.17

Share of non-state-non-agriculturalemployment in labor force

0.23 0.05 0.46 0.09

Share of non-state industrial output 0.36 0.19 0.96 0.16

Share of contract workers in total stateemployment

0.09 0.00 0.33 0.06

Log of local government fixedinvestment

24.94 1.89 273.55 26.76

Ratio of local to central governmentfixed investment

1.28 0.31 6.97 0.86

Ratio of new loans to GDP 0.13 0.01 0.39 0.06

Log of loans from credit cooperatives 0.06 0.00 0.24 0.04

Notes: (1) Revenue, expenditure, and government fixed investments are in 100 milli on yuan.

45

Table 2. The Effects of Fiscal Decentrali zation

(1)GDP growth

(2)Growth of non-agriculturalemployment

(3)Growth of non-state-non-agricultural employment

Fiscal decentrali zation 0.016*(1.832)

0.012*(1.796)

0.039*(2.262)

Growth of labor force 0.277*(1.903)

0.349***(3.183)

0.631**(2.178)

Provincial tax rate -0.058(0.791)

0.038(0.678)

-0.166(1.130)

Adjusted R2 0.531 0.742 0.771

Standard errors 0.031 0.024 0.063

Number of observations 311 311 311

Note: (1) Each regression includes a full set of provincial dummies and year dummies.(2) t-statistics are in parentheses.(3) * , ** , and *** represent 10 percent, 5 percent, and 1 percent significance levels, respectively.

46

Table 3. The Effects of Bureaucratic Distance

(1)Log of local governmentfixed investment

(2)Ratio of local to centralgovernment fixedinvestment

(3)Growth of non-agriculturalemployment

(4)Growth ofnon-stateindustrialoutput

Fiscaldecentrali zation

0.224***(5.170)

0.228***(5.241)

0.246***(3.129)

0.256***(3.239)

0.056***(3.448)

0.032(0.581)

Bureaucraticdistance

0.035**(2.083)

0.024*(1.914)

0.057*(1.857)

0.056(1.536)

0.012**(1.969)

0.039*(1.797)

Interactionbetween fiscaldecentrali zationand "economicexpansion"

-0.012(0.772)

-0.038(1.312)

Interactionbetweenbureaucraticdistance and"economicexpansion"

0.020(0.819)

0.010(0.231)

Level control -0.912***(3.515)

-0.599***(10.42)

Adjusted R2 0.957 0.957 0.730 0.730 0.808 0.402

Standard errors 0.167 0.167 0.302 0.303 0.062 0.212

Number ofobservations

311 311 311 311 311 311


47

Table 4. The Correlations between Local Revenue and Expenditure

1982-92(budgetary expenditure

unadjusted)

1982-92(budgetary expenditure

adjusted)

1970-79

R2

R2

R2

(1) BEt and BRt 0.955(31.77)

0.974 0.752(30.18)

0.973 0.184(8.674)

0.938

(2) EEt and ERt 0.965(59.85)

0.992

(3) � BEt and � ERt 0.100(1.872)

0.674 0.261(4.244)

0.665

(4) (BE-BR)t and BRt-1 -0.007(0.183)

0.964 -0.244(7.821)

0.975 -0.553(15.406)

0.981

Note: (1) BE = budgetary expenditure; BR = budgetary revenue; EE = extra-budgetary expenditure; ER = extra-budgetary revenue.

(2) Each regression includes a full set of provincial dummies and year dummies.

48

Table 5. The Discrepancy between the Ex Ante Contracts and Ex Post Implementation

(1)Budgetaryrevenue

(2)Budgetaryexpenditure

(3)Pricesubsidiesincluded

(4)Adjustedbudgetaryexpenditure

(5)Contractualbudgetaryrevenueretention

(6)Weighted averageof fiscalreadjustment

(%)

(7)Number ofprovinces

All provinces

1982 863.5 572.4 0 572.4 521.7 10.9 28

1983 881.6 645.3 0 645.3 546.7 15.3 28

1984 968.5 800.1 0 800.1 602.8 24.7 28

1985 1185.0 1038.2 0 1038.2 852.0 18.3 28

1986 1324.5 1366.5 256.0 1110.5 992.4 9.4 28

1987 1466.4 1411.5 292.9 1118.7 1124.6 6.0 28

1988 1597.6 1650.2 315.0 1335.2 1267.3 6.9 28

1989 1926.5 1937.2 370.3 1566.8 1624.6 7.4 28

1990 1967.7 2105.5 380.8 1724.7 1657.4 6.6 28

1991 2258.1 2402.5 373.8 2028.8 1917.2 6.8 28

1992 2430.7 2564.6 321.6 2243.0 2085.1 7.3 28

49

Table 5. (continued)

(1)Budgetaryrevenue


(3)Pricesubsidiesincluded

(4)Adjustedbudgetaryexpenditure

(5)Contractualbudgetaryrevenueretention

(6)Weightedaverage of fiscalreadjustment

(%)

(7)Number ofprovinces

Provinces paying extra remittance (adjusted budgetary expenditure < contractual revenue retention)

1982 193.4 110.1 0 110.1 116.0 -5.3 6

1983 0 0 0 0 0 N/A 0

1984 0 0 0 0 0 N/A 0

1985 184.2 46.1 0 46.1 47.9 -4.0 1

1986 79.8 82.9 16.3 66.6 72.0 -6.6 1

1987 611.5 702.8 150.9 551.9 597.2 -6.5 14

1988 418.2 392.6 79.1 313.4 336.6 -5.9 6

1989 1368.3 1313.7 259.4 1054.3 1155.1 -7.7 19

1990 873.7 827.3 149.8 677.6 713.5 -4.3 10

1991 694.4 742.2 107.8 634.4 660.2 -3.5 7

1992 591.7 596.4 60.0 536.4 550.8 -2.4 4

Provinces receiving extra subsidies (adjusted budgetary expenditure > contractual revenue retention)

1982 670.2 462.3 0 462.3 405.8 12.2 22

1983 881.6 645.3 0 645.3 546.7 15.3 28

1984 968.5 800.1 0 800.1 602.8 24.7 28

1985 1000.7 992.1 0 992.1 804.1 19.0 27

1986 1244.7 1283.6 239.7 1043.9 920.4 9.6 27

1987 855.0 708.8 142.0 555.8 527.4 5.6 14

1988 1179.4 1257.6 235.8 1021.8 930.7 7.3 22

1989 558.3 623.5 111.0 512.5 469.5 6.9 10

1990 1093.9 1278.2 231.0 1047.1 944.0 8.1 19

1991 1563.8 1660.4 266.0 1394.4 1256.9 8.3 22

1992 1839.0 1968.3 261.7 1706.6 1534.3 8.8 25

50

Table 6. The Coeff icients of Variation for Per Capita Revenue and Expenditure Across Provinces

(1)Budgetaryrevenue


(3)Budgetaryexpenditure(adjusted)

(4)Budgetaryrevenueremittance

(5)Extra-budgetaryrevenue

(6)Extra-budgetaryexpenditure

1982 1.99 0.68 0.68 4.25 1.02 0.88

1983 1.86 0.64 0.64 5.00 1.02 0.97

1984 1.78 0.62 0.61 6.17 1.05 1.00

1985 1.68 0.62 0.63 6.91 1.04 0.99

1986 1.53 0.61 0.62 5.39 1.08 1.01

1987 1.36 0.58 0.59 3.92 1.05 1.03

1988 1.20 0.57 0.57 4.55 1.02 1.01

1989 1.08 0.54 0.54 4.83 0.94 0.95

1990 1.06 0.54 0.53 6.27 0.95 0.93

1991 0.98 0.53 0.52 6.19 0.96 0.94

1992 0.98 0.52 0.52 7.78 0.84 0.81

51

Table 7. The Effects of Fiscal Incentives on the Development of the Non-State Sector

(1)Growth of ruralenterprise employment

(2) Changes of share of non-state-non-agriculturalemployment

(3)Changes of share ofnon-state industrialoutput

State industrydecentrali zation

0.043(0.444)

0.003(0.405)

0.017(0.498)

Bureaucraticdistance

0.014*(1.702)

0.002***(2.621)

0.006*(1.761)

Fiscal incentives 0.153**(2.545)

0.010*(1.889)

0.044**(1.994)

Level control -0.325*(1.933)

-0.183***(5.537)

-0.298***(6.230)

Adjusted R2 0.744 0.780 0.190

Standard errors 0.085 0.008 0.034

Number ofobservations

313 313 313


52

Table 8. The Effects of Fiscal Incentives on the Reform of the State Sector

(1)Changes of share of contract workersin total state employment

(2)Changes of share of bonuses intotal employee wages

State industry decentrali zation -0.031(0.770)

0.381(1.097)

Bureaucratic distance 0.003(1.581)

0.052(0.369)

Fiscal incentives 0.047***(3.359)

0.608*(1.732)

Level control -0.371***(5.477)

0.071***(4.093)

Adjusted R2 0.194 0.170

Standard errors 0.018 0.012

Number of observations 256 116

Note: (1) Regression (1) includes a full set of provincial dummies and year dummies.(2) Regression (2) includes a dummy for minority regions and a full set of year dummies, and data areonly for 1987, 1990, 1991, and 1992.(3) t-statistics are in parentheses.(4) * , ** , and *** represent 10 percent, 5 percent, and 1 percent significance levels, respectively.

53

Table 9. The Effects of Fiscal Incentives on Local Government Investment

(1)Log of local governmentfixed investment

(2)Ratio of local to centralgovernment fixed investment

State industry decentrali zation 0.346*(1.857)

0.297(0.912)

Bureaucratic distance 0.007(0.388)

0.034(1.232)

Fiscal incentives 0.322***(2.803)

0.565***(2.815)

Level control

Adjusted R2 0.953 0.722




54

Table 10. The Effects of Fiscal Incentives on Access to Credit

(1)Ratio of total new loans to GDP

(2)Log of loans from creditcooperatives

State industrydecentrali zation

-0.015(0.332)

0.430(1.401)

Bureaucratic distance -0.001(0.175)

-0.024(0.839)

Fiscal incentives 0.057*(1.943)

0.423**(2.236)

Level control -0.004(0.116)

Adjusted R2 0.526 0.961




55

0.4

0.5

0.6

0.7

0.8

0.9

Sha

re

1980 1982 1984 1986 1988 1990 1992

Average of marginalrevenue retention rates

Share of provinces with100% marginal retention rate

Figure 1. Provincial Marginal Revenue Retention Rates

As Specified in Fiscal Contracts (1980-92)

56

References

Bahl, Roy, and Christine Walli ch. "Intergovernmental Fiscal Relations in China," WorkingPapers, Country Economics Department, The World Bank, WPS 863, 1992.

Brennan, Geoffrey, and James M. Buchanan. The Power to Tax: Analytical Foundations of aFiscal Constitution. New York: Cambridge University Press, 1980.

Chang, Chun; and Yiji ang Wang. "Economic Transition under a Semi-Federalist Government:The Experience of China." China Economic Review, Spring, 1998, 9(1), pp. 1-23.

Chen, Rulong (ed.). The Fiscal System in Contemporary China (Dangdai Zhongguo Caizheng),Beiji ng: China Social Science Press, 1988.

Epple, Dennis, and Alan Zelenitz. "The Implications of Competition Among Jurisdictions: DoesTiebout Need Politics." Journal of Politi cal Economy, 1981, 89, pp. 1197-1217.

von Hayek, Friedrich A. "The Use of Knowledge in Society." American Economic Review, 35,pp. 519-30, 1945.

Hofman, Bert. "An Analysis of Chinese Fiscal Data over the Reform Period," China EconomicReview, 1993, 4(2), pp. 213-230.

Fan, Gang. "New Norms in Public Revenue and Expenditure," in Shuguang Zhang (ed.), CaseStudies in China's Institutional Change, Shanghai People's Publishing House, 1996.

Freinkman, Lev, and Plamen Yossifov. "Decentralization in Regional Fiscal Systems in Russia:Trends and Links to Economic Performance." Mimeo, the World Bank, 1998.

Frye, Timothy, and Andrei Shleifer, "The Invisible Hand and the Grabbing Hand." AmericanEconomic Review, May 1997, 87, pp. 354-358.

Groves, Theodore, Yongmiao Hong, John McMill an, and Barry Naughton. "Autonomy andIncentives in Chinese State Enterprises," Quarterly Journal of Economics, 1994, 109(1),pp. 183-209.

Huang, Yasheng. Inflation and Investment Controls in China: The Politi cal Economy ofCentral-Local Relations During the Reform Era. Cambridge: Cambridge UniversityPress, 1996.

57

Huther, Jeffrey; and Shah, Anwar. "Applying a Simple Measure of Good Governance to theDebate on Fiscal Decentralization." Policy Research Working Paper 1894. The WorldBank, 1998.

Inman, Robert. “Federal Assistance and Local Services in the United States: The Evolution of aNew Fiscal Order,” in H. Rosen (ed.), Fiscal Federalism: Quantitative Studies. Chicago:University of Chicago Press, 1988.

Inman, Robert P., and Daniel L. Rubinfeld. “The Political Economy of Federalism,” in Dennis C.Meuller (ed.), Perspectives on Public Choice. New York: Cambridge University Press,1997.

Kornai, Janos. "The Soft Budget Constraints," KYKLOS, 1986, 39(1), pp. 3-30.

McKinnon, Ronald. "Market-Preserving Federalism in the American Monetary Union," in M.Blejer and T. Ter-Minassian (eds.), Macroeconomic Dimensions of Public Finance:Essays in Honour of Vito Tanzi. London: Boutledge, 1997, pp. 73-93.

Montinola, Gabriella, Yingyi Qian, and Barry Weingast. "Federalism, Chinese Style: The PoliticalBasis for Economic Success in China," World Politi cs, October, 1995, 48(1), pp. 50-81.

Musgrave, Richard, Theory of Public Finance: A Study in Public Economy, New York:McGraw, 1959.

Oates, Wallace. Fiscal Federalism, New York: Harcourt Brace Jovanovich, 1972.

Oksenberg, Michel, and Tong, James. "The Evolution of Central-Provincial Fiscal Relations inChina, 1971-1984: The Formal System." China Quarterly, March 1991, pp.

Parikh, and Barry R. Weingast. “A Comparative Theory of Federalism: The Case of India.” Virginia Law Review, October 1997, 83, pp. 1593-1615.

Qian, Yingyi, and Gerard Roland. "Federalism and the Soft Budget Constraint," AmericanEconomic Review, December 1998, 88(5), pp. 1143-1162.

Qian, Yingyi, and Barry R. Weingast. "China's Transition to Markets: Market-PreservingFederalism, Chinese Style," Journal of Policy Reform, 1996, 1, pp. 149-185.

Qian, Yingyi, and Barry R. Weingast. "Federalism As a Commitment to Market Incentives,"Journal of Economic Perspectives, Fall 1997, 11(4), pp. 83-92.

Rose-Ackerman, Susan; and Rodden, Jonathan. "Does Federalism Preserve Markets?" Mimeo,Yale University, 1997.

58

Shah, Anwar. “Fiscal Federalism and Macroeconomic Governance: For Better or Worse?” Unpublished working paper, World Bank, 1997.

Shleifer, Andrei. "Government in Transition." European Economic Review, 1997, 41, pp. 385-410.

Slider, Darrell. “Russia’s Market-Distorting Federalism,” Post-Soviet Geography andEconomics, 1997, 38, pp. 489-504.

State Statistical Bureau. China Regional Economy: A Profile of 17 Years of Reform andOpening-Up, Beiji ng: China Statistical Press, 1997.

Tiebout, Charles. "A Pure Theory of Local Expenditures." Journal of Politi cal Economy, 1956,64, pp. 416-24.

Treisman, Daniel. "Fiscal Transfers and Fiscal Appeasement," Chapter 3 from After the Deluge:Regional Crises and Politi cal Consolidation in Russia. Ann Arbor, MI: University ofMichigan Press, 1999.

Weingast, Barry R. "The Economic Role of Political Institutions: Market-Preserving Federalismand Economic Growth," Journal of Law, Economics, and Organization, April 1995, 11,pp. 1-31.

Weitzman, Martin. "The Ratchet Principle and Performance Incentives." Bell Journal ofEconomics, 1980.

Wildasin, David E. "Externalities and Bailouts: Hard and Soft Budget Constraints in Inter-Governmental Fiscal Relations," mimeo, Vanderbilt University, 1997.

Wong, Christine P.W. "Central-Local Relations in an Era of Fiscal Decline: The Paradox ofFiscal Decentralization in Post-Mao China." China Quarterly, December 1991, pp. 691-715.

Wong, Christine P.W. "Fiscal Reform and Local Industrialization: The Problematic Sequencingof Reform in Post-Mao China." Modern China, April 1992, 18(2), pp. 197-227.

Wong, Christine P.W. (eds.). Financing Local Government in the People's Republic of China. Hong Kong: Oxford University Press, 1997.

World Bank. The Chinese Economy: Fighting Inflation, Deepening Reforms, A World BankCountry Study, Washington, D.C., 1996.

59

Xiao, Geng, "Central-Local Relations from the Perspective of State and Non-State Industries," inHao Jia and Zhimin Lin (eds.) Changing Central-Local Relations in China: Reform andState Capacity, San Francisco: Westview Press, 1994.

Xu, Chenggang, and Juzhong Zhuang. "Why China Grew: The Role of Decentralization," inPeter Boone, Stanislaw Gomulka, and Richard Layard (eds.), Emerging fromCommunism: Lessons from Russia, China, and Eastern Europe, Cambridge: MIT Press,1998.

Zhang, Tao, and Heng-fu Zou. "Fiscal Decentralization, Public Spending, and Economic Growthin China." Journal of Public Economics, 1998, 67, pp. 221-240.

Zhuravskaya, Ekaterina V. "Incentives to Provide Local Public Goods: Fiscal Federalism,Russian Style." Mimeo, Harvard University, 1998.

Regional Decentralization and Fiscal Incentives ... · federalism," emphasize an additional, and...

Documents

Transcript of Regional Decentralization and Fiscal Incentives ... · federalism," emphasize an additional, and...