China's Institutional Progress during the Transition

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Chapter 7
China's Institutional Progress during the Transition

Xia Yeliang



Globalization is bringing about strong competition and greater social inequality. Although China may keep its advantages in labor-intensive industries so that its human resources can be fully utilized, it needs to develop technology-intensive industries in order to narrow the gap between itself and the developed countries. Thus, China has to face competition both from other developing countries in international capital and goods markets and from the developed countries in capital- and technology-intensive industries. At the same time, China's accession to the World Trade Organization (WTO) has brought about greater social inequality, which means that the Chinese government will find it more difficult to provide special protection for domestic firms, including the state-owned enterprises (SOEs).

Despite the inflow of international capital and technology, the movement of labor into China is still restricted, apart from a small proportion of highly talented individuals. China's capacity to produce telecommunications switching systems, fiber-optic cable, and low-end personal computers (PCs) is comparable with the advanced industrial nations. It has more than 28,000 chemical-producing enterprises and possesses considerable potential in biotechnology. It even put astronauts into space in 2003.

Notwithstanding these successes, China has failed to develop technologies critical to these industries, so that it remains largely dependent on imported components and machinery. For example, it lacks the capability to manufacture the lithography tools used to make integrated circuits necessary for microelectronics. China's nuclear facilities have also typically relied on imports for most of the key components. Its aircraft manufacture is mostly based on Soviet technology of the 1950s and 1960s, and its ability to produce transport aircraft is limited to short- and medium-range turboprops.

China possesses strong basic research capabilities in several areas but it has frequently been unable to translate these successes into improved production technologies. Biotechnology provides a case in point. Despite strong research capabilities, China's commercial biotechnology sector remains small, and future growth in this industry could be impeded by limited production technologies, and weak protection for patents. China's software capabilities are just beginning to develop, and piracy remains a major deterrent to domestic software development. Even its huge chemical industry has typically been unable to turn research results into commercial products, leaving the country dependent on imports.

On the whole, China's prospects for technological progress are mixed. Its physical and human capabilities are substantial but insufficiently developed. The equipment found in most Chinese research and development facilities does not meet world standards, while those that possess advanced equipment do not maximize its use. China has a solid educational base for a developing country, but secondary and higher education rates compare poorly with those of more developed countries, such as South Korea and Singapore, and even worse with those of the United States and Japan.

The huge size of China's population means that, in absolute terms, China possesses a much larger human capital base for research and development than does South Korea or Singapore, but the equally huge workforce means that a greater proportion of scientists and engineers are required for routine production activities. China's technological efforts have also been limited. As a proportion of the total labor force, the number of scientists in China who are engaged in research and development is much lower than that of Singapore or South Korea, although it surpasses these countries in terms of overall research and development expenditures. China's output of scientific and technical publications is much lower than that of the United States and Japan, but significantly greater than that of South Korea and Singapore.

China's incentive and institutional structures are imperfectly developed. High domestic growth rates and relatively stable exchange rates have tended to encourage innovation. At the same time, uncertainty about the economy, fluctuating inflation rates, limited access to credit and foreign exchange, and periodic instances of political instability have tended to discourage investment in technology. Competition also provides mixed incentives, with many industries overly protected while others are subject to excessive fragmentation. Capital markets generally do not provide incentives for innovation, and most bank loans are directed toward government industry, the least technologically dynamic sector. Technology markets are also underdeveloped, although labor markets operate fairly well. In addition, China's institutional structures for technological progress, particularly the legal system, are inadequate.

The main lesson learned from the Chinese experience of reform and institutional change is that considerable growth is possible with sensible but not perfect institutions, and that some unconventional “transitional institutions” can be more effective than the best practice institutions for a period of time because of the second-best principle. Specific lessons include the need for incentives, budget constraints, competition to be applied not only to firms but also to the local and central governments. In addition, reforms can be implemented without creating many or big losers, and successful reforms require appropriate, but not necessarily optimal, sequencing.

China's nascent market economy was incorporated into the world economy through foreign investment, offshore activities, and institutional integration. The financial crises experienced in South Korea and Japan produced ripple effects in many arenas of economic life and drove regional economic integration. The organization of business enterprises, the relationship between the state and the market, and the structure of labor markets all arguably endured significant changes in these societies.

The East Asian economic models of the past may no longer be applicable to the current global economy. This may be seen not only in the dramatic transition to a market economy in China, but also in the pressures for far-reaching, market-driven institutional change in Japan and South Korea. East Asia's economies relied on a variety of state-centered models of economic development. Since the Meiji Restoration, Japan has depended heavily on the state and government bureaucrats to steer its economic ship; South Korea and Singapore have also followed state-centered strategies of market-oriented economic development. Similarly, China has pursued state socialist economic development since the mid-1950s. After its shift to a reliance on markets for its economic development, the state continues to shape the underlying pattern of structural change in China.

In the 1990s, all the East Asian economies sought a new balance between market and state coordination of economic activity. What remains unclear is whether new East Asian models are evolving from the institutional changes during that time. In the name of radical reform of its financial institutions, Japan is under pressure to adopt institutional arrangements that comply with the guidelines of the International Monetary Fund (IMF) and the World Bank. South Korea is becoming more reliant on credit cards and consumer spending to fuel its economic growth. China's private entrepreneurs and burgeoning middle class provide a new social base for a market society with less obtrusive state intervention in civil life.

China's “born-again” planners, led by Jiang Zemin, the former President, are convinced of the idea that social and economic order are impossible without the firm hand of the state. The Ninth Five-Year Plan (1996–2000) reconfirmed the Chinese Communist Party's (CCP's) faith in socialism and distrust of capitalism. The plan embraced the illusion that it is possible to revitalize the SOEs by a change in management rather than ownership.

The failure of central planning and of communism throughout the world is testimony to the ill-fated desire to engage in social engineering. Indeed, recent studies have shown that those countries that fostered economic freedom have experienced greater wealth creation than have those that failed to protect economic liberties. As people acquired greater economic freedom, they have demanded other significant rights, including the right to participate in political life.

Institutional innovation in China since the end of 1978 has produced the fastest economic growth in the world and enlarged opportunities for many people, but it has not eliminated the main obstacle to China's future prosperity. The party's monopoly of power has been eroded by the market-based reforms of China's paramount leader Deng Xiaoping, but with the Deng era ending, China is at a crossroads. The nation must decide whether to deepen reform and risk pressures for political change or slow down reform and risk alienating China's newly emerging middle class and fomenting social unrest.

In less than two decades, China has become one of the top ten trading nations in the world. In the past decade nearly US$90 billion in direct foreign investment has flowed into China's emerging markets. If the Chinese economy continues to grow at an average annual rate of 9 percent, it could soon become the world's largest.

The challenge for China is to develop the hard institutional infrastructure of a market economy. The centerpiece of that infrastructure is a rule of law that protects property rights and limits the power of government. Therein lies the difficulty, for the CCP is unlikely to give up its power and let freedom reign. Nevertheless, there are internal and external forces at work that may push China in the direction of greater liberalization and democratization. Internally, China's reformers have created an economic space that allows individuals the freedom to improve their living standards outside the state sector. Externally, China's “open-door” policy has allowed foreign competition and know-how to help the non-state sector grow. In the process, new business practices have evolved together with the legal norms associated with a market-liberal order.

China has created a new economic space but has resisted political change. Even so, there is reason to believe that it may initiate a second round of political reform in the near future. The key to China's progress has been its willingness to allow institutional change on a trial-and-error basis and to promote success. It has reduced the relative size of the state sector by cultivating the non-state sector, rather than by privatizing large state enterprises. State-owned firms now account for less than 25 percent of China's total output (including agriculture and services), and their share of industrial output has fallen from more than 80 percent in 1978 to less than 40 percent today.

On the failure of central planning, Deng had no clear vision for institutional change, but he was willing to experiment. His guiding principle was, “Once we are sure that something should be done, we should dare to experiment and break a new path.” Deng began to break a new path in 1978 when he launched the agricultural reforms. Communal ownership of land was abolished and a system of contractual relations was introduced through the “household responsibility system.” Rural families were allowed to hold long-term leases and acquire the right to use the land at their disposal. They could sell their crops in the open market provided they first satisfied the state quota. Under the new incentive structure, farmers increased their production and began to invest their profits in town and village enterprises (TVEs), which are beyond the reach of state ministries.

Although TVEs are legally owned by the local governments, individual households are allowed to share their profits, hold (non-transferable) shares, and receive dividends. Wages are tied to profits, and the managers of TVEs face severe budget constraints, unlike the politically motivated managers of the SOEs. As a result, TVEs have mushroomed while SOEs continue to wither on the vine of state subsidies.

In addition to creating new ownership arrangements, the reforms decontrolled prices, opened China to the outside world through trade liberalization and the establishment of Special Economic Zones, devolved power from the central government to local governments, and instituted a system of fiscal contracts that limited Beijing's share of tax revenue and provided local officials with an incentive to promote markets—a system that Yingyi Qian and Barry Weingast (1995) have called “market-preserving federalism.”

These institutional changes resulted in a parallel economic structure that competes with the SOEs, reduced the central government's share of tax revenue from 60 percent in 1978 to 40 percent in 1993, and helped weaken the central government's grip on everyday life.

These reforms, however, have failed to create a genuine market system founded on the principles of private ownership and freedom of contract. The goal of China's “born-again” planners is not market liberalism but market socialism. The resultant lack of clear rules at the enterprise level and attempts to plan the market are, in the absence of a constitution that protects property and contracts, reflections of what F. A. Hayek aptly called the “fatal conceit” of socialism.


The quiet revolution that has been taking place in China's economy since 1978 together with the information revolution can only strengthen the fabric of civil society. As China expanded the freedom for individuals to earn a living outside the state sector, these people have gained greater control over their lives. They are learning how markets work by participating in the growing non-state sector and by engaging in foreign trade. As the market gradually replaced the planned economy, newly acquired ideas and wealth have given rise to a spirit of independence and a rebirth of civil society, especially in China's southern coastal provinces.

The economic reforms have created new opportunities, new dreams, and to some extent, a new atmosphere and new mindsets. The old control system has weakened in many areas, especially in the economy and lifestyle. There is a growing sense of increased space for personal freedom (as long as people stay out of politics).

New towns and cities are evolving naturally as people leave the countryside for improved living conditions and the chance to strike it rich in the non-state sector. Villages that were once small fishing centers along the southern coast are now booming with the flow of trade and people. The new urban centers, such as Shishi in the province of Fujian, are characterized by the market economy, not the planned. Their model of development is “small government, big society” (xiao zhenfu, da shehui) which advocates less involvement by cash-strapped governments and more by society. Ambitious young people aspire to become capitalists, not communists. A recent survey found that many young people ranked being an entrepreneur first among sixteen job choices, while employment with the national government ranked eighth. Freer labor markets have led to a growing demand among college students for business courses, and the universities are responding. The CCP has thus lost much of its credibility and influence.

The freedom to trade has become an important human right in China. As trade expands, there will be a growing middle class with a large stake in China's future. Moreover, China's high savings rate will enable all those who sacrifice current consumption to invest their earnings in the non-state sector. The formation of an active economic and civil society will naturally lead to greater participation in political life. Yet as long as the

CCP stands in the way of the spontaneous market order, controls the flow of information, and prevents free association, the future of China's civil society will be in jeopardy.


If democratization is to proceed in China, the government must continue to allow experimentation and new forms of ownership. It is necessary to find the best model for ownership by the whole people so that they can constitute the core of market competition and operate with vigor and vitality in accordance with the rules of the market economy. Gradually, the market will mature and become more compatible with international standards, and competition more fair and open. Then China will have been structurally transformed. Political change will follow since many educated urban Chinese subscribe to this thinking. There is reason to believe, therefore, that institutional change in China will bring about creeping democratization.

Deepening market reforms, the positive impact of China's “open-door” policy on political norms, public opinion, and knowledge of Western liberal traditions, such as the rule of law, have set implicit limits on the state's use of power and have promoted the democratization of the legal system. People are starting to use the court system to contest government actions that affect their lives, liberty, and property. There has been a sharp rise in the number of civil lawsuits against the state, and individuals are beginning to win—perhaps as many as 20 percent of the cases, according to official sources. The opening up of the legal system is important because it paves the way for the transition from “rule by law” to “rule of law.” The state's steel-clad monopoly on the legal process, which makes the courts just another arm of government, is corroding. China's economic liberalization has spawned a parallel legal reform that raises the prospect of the rule of law. Nevertheless, many recognize that legal ambiguity remains a ruthless weapon for harassing the population. Until that facet of China's institutional structure changes, no one's rights will be secure.


The challenge for China is for the CCP to get out of the way of the market and to let it grow naturally together with civil society. Doing so, however, requires an understanding of the institutional infrastructure that drives the market system, and an appreciation of the spontaneous order that emerges when private property and freedom of contract are protected by a rule of law. Democracy is neither necessary nor sufficient for a market system. What is necessary is a stable legal framework that protects life, liberty, and property. If China is to prosper in the global economy, it will have to adopt common-law practices and abide by international commercial codes and customs. Old habits are hard to break, but the forces for change are strong, and there is reason to believe that China will “creep along in the right direction.”

China has been willing to experiment, but it has not yet provided the climate of freedom necessary for growing market-liberal institutions. There is an effort to give the central government greater power by ending the system of fiscal federalism. Putting more money into the pockets of Beijing bureaucrats by recentralizing the tax system, however, is not the answer to China's problems. Nor will improving the management of SOEs do anything to solve the problems of loss-ridden enterprises that have no real owners.

Real stability will come to China only when the leaders realize that it is impossible to plan the market or society. Although the leadership seems willing to tolerate gradual reform to keep the economy strong, there is no indication that they will encourage political reform. To depoliticize economic life, China needs constitutional change and new thinking. The United States, as the world's leading constitutional democracy, can help to spread its ethos of liberty by keeping its markets open and extolling the principles that made it great. The emerging market, as Milton Friedman pointed out in 1988, is not a planned market but a “free private market.” What China needs is not market socialism but market liberalism.

It would be naive to think that China's rapid integration into the global economic system has been driven by anything but self-interest. Even economic liberals in China believe that the first goal of its economic policy should be to create a strong industrial base that can carry China into the future. There is continuing debate within China, at all levels of government and society, over how best to achieve this goal. In this respect, China is no different from any other country, including the United States.

Yet in its attempt to create a modern economy through economic integration with the outside world, China has not been a disruptive power. It has adapted to the existing system, not vice versa. Moreover, throughout the integration process thus far, the global trade, investment, financial, and institutional systems have remained stable, and have proven quite capable of handling this newcomer.

A significant contribution to this is attributable to the “round-tripping” efforts by Chinese firms which send money abroad and then reinvest it in China under the more favorable terms offered to foreigners. China's investment abroad has also risen dramatically from a handful of politically motivated aid projects to large commercial business ventures.

In the past ten years, China has become a commercial borrower in the financial markets, although it experienced some fallout from the Asian financial crisis. Moreover, it has participated in international capital markets by issuing both stocks and bonds overseas. The present leaders in China tend to view market norms and market enforcement as neutral and apolitical. Indeed, the Chinese are keenly aware that there is nowhere but the established international market for them to go.

Moreover, the rapidity of China's integration into the world economy has not torn the global system apart nor caused it to list unsteadily. It is the Chinese who have traveled down the learning curve. Of course, there have been market dislocations to some producers as competition from Chinese goods emerged, particularly in East and Southeast Asia. Yet this is a natural occurrence in the global market.

When China first decided in the late 1970s to open up its economy to the outside world, its leaders assured internal critics that by using strong regulatory controls it would be able to absorb the benefits of integration while avoiding its harmful effects on China's

economy, sovereignty, and culture. In pursuit of this goal, the government established a host of regulations designed both to attract and to control foreign business.

Since that time, however, China has seen the erosion of such controls and greater acceptance of the norms of the global trade regime. Chinese reformers, disappointed with the levels and quality of investment inflows, particularly from the West and Japan, not only clarified but also eased those controls. Thus, changes have occurred in numerous sectors and functional areas, including the restructuring and decentralization of the foreign trade system, tariff reduction, liberalization of controls on foreign exchange and profit-repatriation, greater transparency, and the establishment of rules for dispute resolution and contract enforcement. Foreign companies have gained greater market access in sectors such as light industry, foodstuffs, automobiles, petroleum, chemicals, and, more recently, financial and other information services.

Some liberalization came in the wake of acrimonious disputes with the United States— for example, the changes made in the domestic regime for intellectual property rights (IPR) protection. What is often forgotten amid the ongoing tension is that China has made far-reaching changes in its basic conception of IPR protection. The official norm has moved away from the view of intellectual creations as social goods subject to state control and toward the view that they are the property of the creators. To this end, China has drafted numerous domestic regulations on copyright, trademarks, and patents; established institutions responsible for oversight and enforcement; and joined a number of international conventions and organizations, such as the World Intellectual Property Organization.

Direct external pressure was not the only impetus for many of China's policy changes. Chinese leaders recognized that they not only had to “talk the talk” by promising changes at the negotiating table, but they had also to “walk the walk” by introducing concrete policy shifts. Indeed, while outside pressure has been instrumental at some junctures in influencing changes in Chinese policy, virtually none of these changes would have occurred if the economic reformers did not believe that, on the whole and in the long run, they were best for the Chinese economy.

The liberalization of the regulatory environment has not been without its ups and downs, of course, and some industries have benefited more than others. Moreover, China has by no means given up all efforts to tailor regulations to meet its development goals. Yet the attempt to make China a more hospitable environment for foreign capital, both in terms of rules at the sovereign level and operations on the ground, has continued slowly and steadily.


The World Bank's experience with China has been extensive. Since joining the Bank in 1980, China has acquired long-term funding, technical assistance, and strategic advice on reforming its economy. The Bank has become China's largest single source of long-term foreign capital, and China became the Bank's largest client in 1993. As of June 1999, the Bank had committed a total of US$32.5 billion to China.

World Bank officials often cite China as a model member. The quality of the Bank's project portfolio in China is one of its best. According to Bank officials, China's projects are well implemented, within budget guidelines, and on time, and China has grown from a quiet presence to a mature partner. Over time, the Chinese officials and economists posted to the Bank have gained confidence as well as knowledge, and have become more able to contribute to the Bank's daily operations.

China's relations with the IMF have been less significant. China has borrowed minimally from the IMF and has repaid it quite quickly. More importantly, China has been an active recipient of IMF advice, particularly in the steps taken toward currency convertibility.

China is not perceived as a disruptive force in either of these institutions. On the contrary, China has absorbed the advice offered by experts from these organizations and has made institutional changes in its own governing structure to accommodate their presence. Both the World Bank and IMF have served as a kind of airlock between the Western financial world and China, providing Chinese reformers with a training ground and a cushion until their personnel and expertise are brought up to standard. Far from resenting these foreign institutions, Chinese reformers have often benefited from China's participation in them. In domestic debates in particular, Chinese officials have been able to use World Bank and IMF standards to foster China's desire to be an accepted member of these global organizations and as an impetus for economic liberalization.

In understanding how much China has adapted to the existing global economic system, it is important to remember that reforms in its foreign economic and trade policies continue to be works-in-progress. The effective transmission and enforcement of central laws and policies to the local level remains a particular concern for business. This means that China's development of a legal environment supportive of contract enforcement and dispute adjudication must continue in all areas of the country. Such problems still plague efforts to support IPR protection in China. Though China's legal enforcement record is improving, it remains spotty and haphazard. These changes take time, of course; the notion that major institutional and normative developments, such as the rule of law, can take place overnight is unrealistic.

The fractiousness within China over trade policy also remains a concern, and cannot be expected to wane soon. It is somewhat ironic that the more extensive the exposure of Chinese industries to the global economy, the more those industries stand to be hurt by competition, such as the automobile and telecommunications sectors, which have mobilized to protect their own interests. This phenomenon contributed to the slow pace of China's WTO accession negotiations.

Because of China's complex political environment and its less-than-ideal state of institutional development, there will continue to be a role for pressure from external institutions. At the same time, having China as a member of global institutions allows for a partnership with government reformers and business people in the country who have used, and will continue to use, external expectations to press for internal change.

Since economic reform began in China at the end of 1978, there has been a remarkable growth in gross domestic product (GDP), of 9.5 percent per year, on average

Table 7.1 Growth rate of GDP and wages, 1978–1998
Time intervalRetail price indexReal GDP growth rateNominal wageReal wage

(Table 7.1). What accounts for this tremendous success? To answer briefly, the government has adopted institutions and policies that enable the resourceful Chinese people, as well as foreigners, to unleash their energy to develop the Chinese economy. The farmers became energetic and productive after 1979. The township and village enterprises were the most dynamic element of growth in the 1980s and early 1990s. Many private and foreign enterprises flourished. By 2002, the number of state-owned industrial firms has decreased to 46,800 from 103,300 in 1989. The key to China's success in economic reform was to allow the non-state sectors to develop in the setting of a market economy.

The open-door policy is an essential element of the economic reform process. It encourages foreign investment and promotes foreign trade. Foreign investment has provided capital, new technology, managerial skills, and labor training to China. It has introduced modern managerial systems, business practices, and a legal framework for conducting business transactions. In addition, it has provided competition in the domestic market, which has forced domestic enterprises to become more efficient. Foreign trade has enabled the low-cost and high-quality labor in China to produce goods to be sold at higher prices in the world market, thus increasing the compensation to Chinese labor. It has also enabled the import of technology and high-quality capital goods for use in production in China, as well as the import of high-quality consumer goods. The availability of high-quality capital goods can improve productive efficiency while high-quality consumer goods not only contributes to consumer welfare directly, but also acts as an important competitive force in the Chinese consumer market, which in turn stimulates the improvement of the quality of domestically manufactured products.

China's entry into the WTO has opened China's door even wider. Both foreign investments and foreign trade have increased. Foreign firms have begun to penetrate China's financial and telecommunications sectors, and trade has increased in both directions. Tariffs have been lowered and Chinese goods have better access to world markets that are open to members of the WTO. The Chinese government is well aware of the economic and socio-political costs and benefits of joining the WTO. While it has been pursuing institutional reforms in the SOEs and the banking and financial sectors, it knows that the reforms and the accompanying globalization of the Chinese economy have to proceed at an appropriate speed. If foreign competition enters China too rapidly, adjustments by

Chinese producers and enterprises may be too drastic to be socially desirable. Thus, the harmful effects of foreign competition are monitored by gradually reducing import tariffs and allowing foreign competition in the financial and communication sectors.


What are the prospects for continued reform and progress? There are three sets of forces that determine institutional changes in China. These are the role of the government, the incentives generated in the market, and the inertia inherent in economic institutions. In the last twenty years, the government has guided the changes in economic institutions. In the future, the government will remain active. Science/technology and education for the betterment of the economy was stated to be the main theme of his tenure when former premier Zhu Rongji responded to a question raised during his first press conference in March 1998. The building of infrastructure, in line with the plan for development based on the western model in particular, will be a priority. Other areas that will receive serious government attention include the improvement of technology in agriculture, environmental protection, the social welfare system, and health care and housing reform. These will provide many opportunities for foreign investors.

Secondly, it can be expected that private enterprises, joint ventures, and foreign-owned enterprises, under a better legal system and with China as a member of the WTO, will contribute positively to growth in the next two decades. These enterprises are expected to serve as the most dynamic sector of the economy, particularly in the towns and villages. They will also provide competition to the state and collective enterprises, which can help them to become more efficient.

Thirdly, inertia will prevent economic institutions from changing rapidly. Institutional inertia usually comes from a lack of information and knowledge, as well as social and political pressure which can affect economic decisions, or simply the persistence of customs and habits. Inertia can explain the difficulties encountered in reforming the state enterprises and the banking system. One common problem affecting both institutions is the lack of well-trained managers and staff. The second element of inertia is the tendency to retain the old ways of doing things. In many state enterprises which have been converted to shareholding companies, the shareholders tend to retain the same board of directors and there is no change in management. It is therefore unlikely that the Chinese state enterprises and banks can evolve into modern institutions in a few years simply by enacting new laws. The reform of these institutions will be a slow and gradual process as it has been in the past, but continued progress will certainly come.

When the above three sets of forces are balanced, the Chinese economy can be expected to grow at a faster rate in the next two decades. The negative factor, namely, institutional inertia, has not prevented the economy from growing at an average rate of about 9.5 percent per year. Thus, there is no need for perfect institutions for the economy to grow rapidly as long as market incentives are allowed to operate in

important sectors of the economy. Foreign investors can take this into account in their investment decisions.

In recent years, the largest sources of foreign direct investment (FDI), as defined in official statistics, have been Hong Kong, Japan, Taiwan, and the United States. Foreign capital from Taiwan that was actually used amounted to more than US$3.5 billion per year. Since there was no direct transport from Taiwan to the mainland, Taiwanese investors had to travel via Hong Kong or Tokyo, and thus were greatly inconvenienced in the process. The stopover in Hong Kong means that a round trip from Taiwan to the mainland takes about one extra day and is more costly, and time is money for investors.

The current population of China is characterized by its huge number and uneven geographic distribution, as well as its irregular age structure, and significant fluctuations in fertility. Although fertility has reached a very low level, China's population will continue to grow for another twenty to thirty years, with significant changes in its composition. The unique and rapidly changing demographic environment in China poses both great opportunities and challenges for government planners and marketing managers to develop appropriate marketing strategies and programs to meet the needs of the population.

Chinese economic reforms began with decentralization rather than privatization. However, in the past two decades, and particularly since the early 1990s, privatization in China has been accelerating and becoming more widespread. Casual observation suggests that the major players behind the ongoing privatization process are local governments at various levels. What are the driving forces behind this unintended, accelerating and widespreading process of privatization? In particular, what motivates the local governments to privatize the enterprises under their control? This chapter argues that the ongoing privatization in China is a consequence of the cross-regional competition that has followed the decentralization policy introduced in the early stages of the reforms.

Among the transition economies, the Chinese case is particularly intriguing. When Deng Xiaoping and his colleagues started the reform process at the end of 1978, no one, including Deng himself, expected a nearly double-digit annual growth rate in the following two decades and a predominant non-state sector in today's China. Many economists and policymakers throughout the world refer to China's extraordinary performance as a “puzzle” (International Business, 1996). It is important to understand this “puzzle” in order to project the future of China and glean useful lessons for other transition and emerging economies where state control of the economy is significant. At the theoretical level, the Chinese case provides lessons for the study of institutional change.


The economic reforms in China and the country's high growth rate are often cited by economists as examples of why privatization is not a necessary condition for efficiency. They argue that the remarkable performance has occurred under the dominance of public ownership (Stiglitz, 1994). However, the Chinese experience does not

support this argument. In the past two decades, and particularly since the early 1990s, both explicit and implicit privatization has been accelerating in China. In 1978, at the beginning of the reforms, 78 percent of the total industrial output came from the SOEs. By 1995, the SOEs’ share had shrunk to only one-third (China Statistical Yearbook, 1996). A recent survey estimates that more than 70 percent of the small SOEs have been fully or partially privatized in Shandong and a few other provinces (China Reform Foundation, 1997). These statistics account for only explicit, not implicit, privatization.

China's town and village enterprises (TVEs) have been one of the major driving forces behind rapid economic growth. Although some external observers argue that the success of the TVEs challenges the standard property rights theory (Weitzman and Xu, 1994; Li, 1996), ironically, Chinese practitioners follow this theory by privatizing their TVEs in various forms, such as “shareholding cooperatives” or simply “sellouts.” In fact, the privatization of TVEs has taken place even faster than that of the SOEs. For instance, in Zibo municipality of Shandong province, private shareholders owned 30 percent of the shares of the TVEs in 1992 but was 70 percent in 1995. By 1997, about half or more of the TVEs had been privatized in provinces such as Guangdong, Shandong, Zhejiang, and even Liaoning, a relatively backward and politically conservative region. By 1996, about one-third of the TVEs had been privatized in Nanhai, Guangdong. By the first half of 1997, more than 60 percent of the township enterprises in Shenyang, Liaoning province, had become shareholding companies or shareholding cooperatives, and 90 percent of the township enterprises with assets under 5 million yuan had been privatized in Zhejiang and Jiangsu. In general, privatization tends to accelerate more quickly in those townships where the neighboring areas have more private enterprises.

Furthermore, casual observation suggests that the major players behind the ongoing privatization process are local governments at various levels. Although not all the local governments are undertaking explicit, wholesale privatization programs, almost all of them are considering privatization of their enterprises in one way or another.

The Chinese experience shows that knowledge about institutional change is still very limited. What are the driving forces behind this unintended, accelerating, and widespreading process of privatization in China? In particular, what motivates local governments to privatize the enterprises under their control? Firm ownership is defined by residual claimant and control rights. Privatization is a process of shifting residual claims and control rights from the government to managers. How does this happen? It appears that cross-regional competition in the product market triggers the privatization of former SOEs and collectively-owned enterprises (COEs) in China.

When the central government in China implemented the decentralization policy in the late 1970s, local governments began to compete with each other in product markets. As cross-regional competition became intense, each region had to cut production costs significantly in order to maintain a minimum market share for survival. Given that the efforts of managers are not apparent, in order to induce managers to reduce costs, local governments tend to grant them total or partial residual shares. In general, the more intense the competition the higher the degree of privatization. It is in the interest of the local bureaucrats to forgo some profits to the managers since the “incentive effect”

usually outweighs the “distribution effect” as competition intensifies. In contrast, if the central government sets the after-tax residual share, or if two local governments can collude to maximize their joint revenue, then public ownership may prevail.

According to the World Bank, SOEs still account for a large share of GDP in many countries, including not only the transition economies but also the developing economies, and even the industrial economies. However, across country and time, SOEs are generally poor performers. In the past decade, the privatization of SOEs has taken place not only in socialist and developing economies, but also in developed economies. It appears that intensifying cross-country competition resulting from globalization has been, and will continue to be, one of the most important driving forces behind the worldwide privatization movement.

The local government's revenue consists of two parts: tax revenue and profit revenue. The trade-off for the local government is that granting a higher residual share to its manager generates a higher total profit and therefore higher tax revenue, but decreases its own profit revenue. The first effect is referred to as the “incentive effect,” and the second, the “distribution effect.”

The local government will be induced to privatize a firm only if competition is sufficiently intense. If this happens the incentive effect will dominate the distribution effect. However, the local government prefers to obtain only tax revenue, as the revenue increase resulting from a bigger profit share will not offset the tax revenue loss. The underlying reason for this is that the sensitivity of market shares to managerial incentives depends on the intensity of competition. The effects of both its own and its rival's incentives on its own market share decrease as competition becomes less intense. Since the local government's revenue depends directly on its market share, the pressure on the manager to cut costs is stronger when the competition is more intense.

For competition to be effective, regional governments must not erect trade barriers. Yet they must have the autonomy to make other economic decisions to respond to competitive pressures. When the autonomy of the regional governments is restricted by the central government, the privatization process slows down.

As mentioned earlier, the economic reforms in China began with decentralization rather than privatization. In the past two decades, however, and particularly since the early 1990s, privatization in China has been accelerating and spreading widely. The rationale is that decentralization induces cross-regional competition which, in turn, triggers privatization. Partly as a result of such a high degree of centralization, public ownership was predominant from the mid-1950s to the early 1980s. During this period, the fiscal budget was centralized and the majority of SOEs were under central government control. The economic reforms launched in 1979 can be characterized as an evolutionary process of reassigning the economy's residual claims and control rights from the central to the local governments, and from the government to firm managers. The former process is termed “decentralization,” and the latter, “deregulation.” Some leading Chinese economists have been opposed to decentralization. They argue that decentralization can undermine the autonomy of enterprises since local governments can, at their own discretion, tighten controls over the enterprises (Wu and Liu, 1992).

China's decentralization policy has two major components: the first is a “fiscal revenue contracting system” (caizheng baogan) between adjacent levels of government, and the second is the “delegation of state enterprises to local governments” (qiye xiafang). The first component was introduced in 1980, renewed in 1984 and 1988 with some modifications, and continued through 1993. Under this system, lower-level governments have an obligation to hand over a fixed amount or a fixed proportion of their revenues to the higher-level government, and keep the residue for themselves. It is no longer possible to make arbitrary transfers between different levels of government and between different regional governments at the same level. This fiscal decentralization was accompanied by the localization of SOEs. By the end of 1983, the majority of SOEs had been transferred to local governments. By 1985, state-owned industrial enterprises controlled by the central government accounted for only 20 percent of the total industrial output from all enterprises at, or above, the township level, while provincial and municipal governments controlled 45 percent, and county governments controlled 9 percent (Qian and Weingast, 1995). By 1994, local governments at various levels were controlling about 65 percent of the assets of all SOEs (China Reform Foundation, 1997).

Governments at each level control their enterprises through industrial bureaus and regulatory agencies, such as the State Planning Agencies, the State Economic and Trade Agencies, the State Assets Administrations, and the Economic State Reform Agencies. The highest level government officials and industrial bureaucrats at each level appoint the managers of most SOEs and decide on their remuneration schemes. Politicians and bureaucrats get both pecuniary and non-pecuniary rewards. Their bonuses are tied to, and their promotions depend on, the revenue or profits in the region under their jurisdiction. Decentralization policies, particularly the fiscal revenue contracting system, has provided them ample opportunities for “on-the-job consumption.”

The decentralization policy gave local government officials a great deal of autonomy to control their economies, including the power to establish new firms and to make investments with self-raised funds but, more importantly, to manage and restructure their firms (including setting the residual share for managers). Overall, decentralization has, in effect, delimited the property rights between governments at different levels, such that each becomes the real residual claimant and controller of its own public economy—that is, each region acts as a conglomerate or holding company.

This system has encouraged the local governments to make profits but, more importantly, it has forced them to compete with one another, and thus contribute to the marketization of the entire economy. Although the local governments may still use some planning mechanisms to control their enterprises, they can only conduct business with other regions through a bargaining process, since no region has authority over the others. The relationship between provinces, municipalities, counties, townships, and villages is more or less marketized. It may be said that in the 1980s the dominant market players in the Chinese economy were not firms but the local governments. The bargaining process between the local governments has helped to marketize the national economy by bypassing the central planning system. The increasing autonomy of the local governments made the central planning system more and more difficult

to operate, and eventually forced it to evolve into a dual-track system which is now converging to a single-track market system.

At the early stage of decentralization, many local governments tried to protect their own enterprises from competition with other regions by erecting trade barriers. This caused much concern among economists. However, protectionism often failed because efficiency gains from the exchange significantly exceeded the net benefits of erecting trade barriers. Critics of the decentralization policy seem to have underestimated the force of the market mechanism: competition allows only the fittest to survive. As the size of each local economy becomes smaller and the number of local economies becomes larger at lower governmental levels, the erection of trade barriers becomes more costly and less effective, and hence competition becomes more intense. Protectionism may be effective for a short time but anti-protectionism forces are also powerful. The more efficient firms and regions will always try to break down the barriers of other regions.

In 1993, the Chinese government enacted the Law of Anti-improper Competition, of which Article 7 prohibits local governments from using administrative means to erect trade barriers. Most government bureaucrats are prone to rent-seeking and are reluctant to give up their power. Without a monopoly, however, rent-seeking can only be achieved by improving the efficiency of their firms. Because the competitiveness of each local economy depends on its cost effectiveness relative to that of its rivals, competition eventually forces the local governments to grant more residual shares to their enterprises and, finally, to privatize. In fact, regions with a higher proportion of non-state-owned enterprises have grown much faster than those that have a higher state-sector concentration. The latter eventually realize that they must follow the former as the market system gradually replaces the planning system. As the Governor of Heilongjiang, one of the most SOE-dominant provinces, indicated in 1995, their mistake has been that they spent too much time and energy in developing and protecting the state sector. They must now open a new field, that is, non-state enterprises.

Under the planning system, SOEs essentially submitted all their earnings to the governments, and there was no distinction between taxes and profits. In 1984, most SOEs began to submit taxes and profits to the governments separately. The contract management responsibility system (CMRS) became widespread after 1987 and by 1989, most SOEs had adopted this system. Under the CMRS, local governments at various levels decide how they and the managers will share after-tax profits. This contracting system can be viewed as a form of partial privatization, and it has indeed greatly boosted managerial incentives in state enterprises (Zhang, 1997). However, it has also encouraged a pervasive short-term outlook which is harmful to long-term competitiveness. In particular, intensified competition has made the SOEs less and less profitable compared with the non-state sector, and local governments have become burdened with the increased losses of their SOEs (Table 7.2). Thus, it can be seen that various forms of privatization began to emerge and accelerate in the 1990s (China Reform Foundation, 1997). For small-sized enterprises, “management (or employee) buyouts” have been a popular solution. For instance, 77.2 percent of Zhucheng municipality's enterprises were bought out by managers and employees between 1992 and 1994. The largest manager-and-employee buyout

Table 7.2 Ratio of pre-tax profits to total assets
YearState-owned industrial enterprises (1986–1995)All enterprises (1991–1997)
Average1986–1997 : 12.75
1991–1997 : 8.821991–1997 : 9.23

firm known is a sugar manufacturer in Hainan Province. It has more than 800 employees and 130 million yuan of net assets. It was bought out by its managerial team and workers in three yearly installments (less than 10 percent of the workers did not participate).

For large and medium-sized enterprises, forming joint ventures and going public by issuing shares are the two most attractive ways to privatize. By forming joint ventures with domestic or foreign private enterprises, the local governments can partially privatize their SOEs with minimum disruption to their operations. In order to attract foreign investors, the local governments compete to set up development zones and to offer substantial tax concessions and other incentives to foreign investors. As for going public, two official stock exchanges, in Shanghai and Shenzhen, were inaugurated in the early 1990s, both of which were initiated by the local governments. Although the government often holds an absolute majority of the shares when they are first issued, typically its stake increasingly shrinks while privately held shares expand after the listing (Xu and Wang, 1996). Again, local governments compete to get their firms to go public. More recently, privatization through Hong Kong has become fashionable. In many cases, the state-owned shares are taken over by non-state owners through the stock market. Some Hong Kong companies also directly take over the SOEs.

The economies of the coastal regions in China are more privatized than those of the inland regions because the former enjoy not only lower transportation costs (which facilitates cross-regional competition) but more importantly, greater autonomy. Similarly,

SOEs in the northeastern and southwestern parts of China tend to be less privatized since their high concentration in these regions makes competition less intense and there are few private enterprises in the neighboring regions. Sectors with simple or standard contracts are more privatized than those with complex or specific contracts since the former involve lower enforcement costs and hence face stronger competition. The former include labor-intensive industries, such as textiles and consumer electronics. The latter generally include capital-intensive and contract-intensive industries, such as machine tools, banking, and insurance. For instance, in 1985 the output of SOEs accounted for 17 and 64 percent of total output in the garment and machine tools industries, respectively. By 1995, the SOEs’ share in the garment industry had shrunk to 6.9 percent while the SOEs’ share in the machine tools industry was still 40 percent (China Statistical Yearbook, 1986). The privatization of TVEs takes place more quickly than that of SOEs because they operate in more competitive markets and their (township) governments have no leverage to protect them.

In reality, the direct motivation for privatization is often related to the financial health of the enterprises (Xu and Wang, 1996). This is a consequence of competition, which erodes the monopoly profits that SOEs formerly enjoyed. In many regions, because the local governments are unable to get funds from capital markets to cover their massive losses, they are forced to privatize those firms. Another important reason for privatization is that the SOEs and COEs cannot retain good managerial teams and skilled workers because the more efficient private and foreign joint ventures are able to offer much higher salaries (Liu, 1995).

Privatization of state- and collectively-owned enterprises can also occur as a consequence of cross-regional competition. The Chinese economic reforms initially did not intend to privatize state and collective enterprises. However, the decentralization policy eventually triggered privatization through cross-regional competition. The CCP's Fifteenth Party Congress promoted the formation of joint stock systems to bail out the vast majority of failing SOEs, a move widely viewed as a covert act of privatization. Formal privatization in China has thus far not been adopted as a central government policy for ideological reasons. However, competition is far more powerful than ideology. Regardless of whether the central government will draw up a blueprint for full privatization, both in theory and the reality of the situation show that the privatization process will continue and will accelerate with its own logic and vigor.

The Chinese experience demonstrates that the “invisible hand” is powerful not only in allocating resources, but also in creating institutions. Once decentralization starts, market competition may precipitate a self-enforcing process of privatization. As a result, decentralization may induce greater privatization than a deliberate privatization policy. This is a major lesson that can be drawn from the experience of China for other transition and emerging economies.

Nevertheless, privatization calls for a sound legal system to protect property rights. In particular, the de facto ownership of managers must eventually become de jure ownership. Commercial laws are needed to enforce contracts between privatized enterprises. Although China enacted the General Principles of Civil Law in 1986, the Law of Civil

Litigation in 1991, and the Contract Law in 1981 (revised in 1993), there are two major problems in its current commercial law system. First, there are no clear and detailed rules to protect private property. To facilitate efficient private investment, detailed civil codes and procedures are needed to protect private property under different contingencies. Secondly, cross-regional commercial disputes are settled in local courts that are virtually controlled by the local governments, in that they provide the courts with both financial and personnel resources. To mitigate local protectionism and to facilitate competition, the local courts must be independent of local government control, or major cross-regional commercial disputes must be settled by national courts or national arbitration associations which the central government can provide.


The Chinese urban pension system has moved since 1986 from an enterprise-based pay-as-you-go (PAYGO) system to a multi-pillar partially funded, municipal-based old-age support system. However, as in the rest of the world, the transition has been hindered by historical burdens and political reality (James, 1996). At least in the case of China, there is still room for further discussion, particularly on the treatment of implicit pension debt (IPD).

The reform of China's pension system goes hand-in-hand with the reform of the SOEs. At the beginning of the economic reforms in the early 1980s, while employees in government agencies were taken care of by the state budget, each enterprise had to support its own retirees. As inequality among firms grew and labor mobility became more desirable, the pooling of pension funds was recognized as essential for spreading risks and leveling labor mobility, albeit in a limited way. The State Council Document No. 77 of 1986 called for financial pooling across SOEs at the municipal/county level (World Bank, 1996). Recognizing the rapidly aging population in China, Document No. 33 of 1991 established individual accounts funded by members’ contributions in order to alleviate the burden of old-age support on the enterprises and the state. It also called for the pooling system to be extended to the province level as a redistribution device.

In 1995, the State Council's Document No. 6 proposed two models for establishing a multichannel pension system, comprising a social redistribution channel and an individually funded channel. As years of experimentation had led to fragmentation of the pension pools at the local level and along industry lines, impeding labor mobility and leading to misuse of pension funds, Document No. 26 of 1997 called for the unification of public pension benefits, the standardization of the amount of contributions, and streamlining the management of funds.

The new system (Tables 7.3 and 7.4) would embody three channels: a defined public benefit channel for redistribution, a mandatory contribution channel for each worker, and a voluntary supplementary pension to be managed by each firm or private insurance company. The first channel would be funded by a payroll tax of 13 percent, which would

Table 7.3 Contribution rates as a percentage of wages required for establishing fully-funded pension accounts, with a compensation rate of 60 percent
Growth rate of wagesYears of contributionReal rate of returnLife expectancy at retirementImplied contribution rate if pension is indexed to inflation
Table 7.4 Tax rates required for paying off implicit pension debt in fifty years
IPD as percentage of 1998 GDPAnnual GDP growth rateRequired tax rate as percentage of GDPUrban employment growth rateRequired tax rate as percentage of wages

come from pre-tax enterprise revenues and guarantee a compensation rate of 20 percent of the prevailing average wage at the time of retirement, with a minimum of fifteen years contribution.1 The second channel would be funded by a payroll tax of 11 percent, and would come from both enterprise revenues and individual wages. At retirement (55 years, on average, taking into account early retirement) the worker would be paid a monthly pension that would be equal to his or her account balance divided by 120. This calculation assumed a life expectancy of seventy years and a wage growth rate that would equal the interest rate. Assuming that an individual contributes into his or her account for thirty-five years, the pension fund is expected to provide a compensation rate of 38.5 percent. Under these schemes, the two channels together will provide a compensation rate of 58.5 percent (MOLSS, 1998).


In the early 1980s, China implemented its rural reforms that dismantled the commune system and restored family farming. A direct and intended outcome was the extraordinary growth of agricultural output (Lin, 1992; McMillan et al., 1989). An indirect and somewhat unintended outcome was the creation of a space, albeit within the limitation of collective land ownership, for rural institutions to evolve into diverse forms (Liu et al., 1998). This has much to do with the decentralizing characteristic of the reforms. In the commune era, localities were deprived of every right, ranging from land ownership to matters of production and labor allocation. The reform established the role of the village collective as the sole owner of village land.2 Therefore, the right to determine village land tenure was shifted to the village itself. As land tenure is a collection of a bundle of rights, such as the right to transfer, to free disposal, to residual claims, to secure tenure, and so forth, it could develop into different combinations of the rights bundle as local conditions change.

Periodical land reallocations shorten farmers’ horizons and dampen their incentives to invest in their land. As a result, long-term agricultural productivity is compromised (Yao, 1996; Carter and Yao, 1998; Jacoby et al., 1998; Rozelle et al., 1998). In addition, land reallocation involves major negotiation costs. Each time land reallocation is about to take place, household representatives, usually the heads, have to spend several nights discussing whether and how the reallocation should proceed. A detailed plan of the redistribution has to be agreed by at least a majority of households. For example, to ensure fairness, the plan has to carefully design a mix of land with different types of quality.

1 The payroll tax is based on a “contributory wage,” with a minimum of 60 percent of the average local wage and capped at 300 percent of that wage.

2 It is not clear, however, whether the “village” refers to the natural village or the administrative village that in many cases includes several natural villages. This ambiguity creates confusion in practice. The convention regards the “village” as the unit that administered the initial land redistribution in the early 1980s.

In reality, the plan also has to take into account the weightage of adults versus children, and household labor versus household population. (Liu et al., 1998). To reach agreement on such a plan is therefore quite expensive in terms of time spent.3 Consequently, land tenure evolution is likely to be guided by some form of social welfare aggregation within the conditions set by the collective mentality. One such condition is the provision of subsistence living to each member of the village. In underdeveloped villages, such as those in Jiangxi and Henan in the sample study, where most farm households live just above the poverty line, the norm means to prevent a villager from falling below the subsistence level. The fear of being overwhelmed and falling into poverty is constant because of environmental and market risks. Under these circumstances, land reallocation provides a mechanism for risk pooling that minimizes the risks faced by the households with less land (Kung, 1994; and Dong, 1996). Indeed, as Burgess (1998) shows, egalitarian land distribution has contributed significantly to the Chinese farmers’ higher nutritional intakes than their counterparts in India. It is noteworthy that this risk pooling mechanism can only be conceived when there exists social aggregation embedded with the provision of subsistence for every member of the village, because households with above average land endowments incur a loss in the risk pooling.4

The link between general factor scarcities and institutional choice is important for explaining the relationships observed in the sample villages.

Income from both agricultural and industrial jobs is subject to fluctuation. It is assumed that the random portion of the income is additive to the mean of the income— that is, income fluctuation is independent of the amount of activity carried out by the household. This is a highly simplified assumption as income fluctuation is usually associated with the amount of activity being undertaken by a household. However, this association is far from linear. For example, larger farms will incur bigger losses when a covariate shock (such as a flood) hits the village; however, they may be more efficient in handling idiosyncratic risks by being able to engage in crop and environmental diversification within their large and possibly environmentally diverse plots (Carter, 1997). The same is true for industrial employment. A household with more members may lose more of its income when a covariate shock (such as a setback in the local or national economy) happens, but it can better handle the risks in specific sectors by allocating its members to different sectors.

In summary, it appears that wealth (as represented by per capita income) is the most significant factor that reduces the probability of land reallocation. A freer land rental market and higher government taxation also reduce the probability. In addition, a weak inverse U-shaped relationship is found between land endowment and the number of land reallocations, and a village was more likely to have a reallocation in the period 1989–1993 than in the period 1981–1988.

3 Zhou and Liu (1988) argue that the egalitarian land distribution scheme is the result of the farmers’ efforts to save on transaction costs because such a scheme can be more easily agreed on by a majority of households.

4 Dynamic considerations based on reciprocity may raise the willingness of those households to pool their land at one point in time. However, the collective land ownership scheme grants each legitimate member of the village the right to ask for land at any time so that the reciprocity consideration becomes redundant.


The induced institutional change hypothesis is regarded as “naïve” by Hayami (1997) because it omits the political process from which an institutional innovation emerges. Therefore, Hayami looks to political theory for the right approach to the study of institutional innovation. However, most of the political theories (including those by economists) seldom provide well-formed and testable hypotheses. By resorting to economic theory, the linkage between institutional change and economic parameters, including relative factor scarcities is reestablished. However, this chapter has gone beyond the classical inspired institutional change literature by analyzing how a collective choice can also be induced by the change of relative factor scarcities.

In terms of the consequences, the pursuit of egalitarian land distribution helps China alleviate the extent of rural malnutrition, which is prevalent in many other developing economies. As the development of a well-functioning land market hinges on the development of other markets, especially the credit market which is frequently found to be incomplete in developing economies (Carter et al., 1996), the implication of this is beyond the context of China.

In terms of policymaking in China, a sound government policy would be not to impose a predetermined land tenure for all the villages across the country, but to provide proper legal, administrative, and financial frames to foster the development of an active land rental market. When the land tenure reform was carried out in the early 1980s, the central government had stipulated that the contract term would be fifteen years, that is, that no readjustment would take place till the mid-1990s.

There is no sign that the Chinese government will give up collective land ownership in the foreseeable future. Within this collective system, the development of a land lease market could serve as an effective substitute for administering land reallocations. As land rentals can be carried out on a seasonal basis, secure long-term land tenure is not likely to be a deterrant. Nevertheless, the government should have clear guidelines on how contracts are to be drawn up and honored, as well as provide a proper due process to resolve disputes. In addition, the development of a land market is related to the development of other factors, such as credit and labor markets. Thus, the government has much to do in these fields.


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China's Institutional Progress during the Transition

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