Decentralization

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Decentralization

• Separate Stoves and Single Menu
• Decentralization and the growth-inflation
  comovement
• Local elections

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Fiscal Decentralization (Tsui and Wang, 2004)

• Fiscal decentralization (starting in 1980s) was
  an attempt to give local governments more stable
  fiscal revenue and more flexibility in making
  local fiscal decision.

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Main Features of Fiscal Decentralization in China

• Intergovernmental Fiscal contracts
• Fiscal contracts between successive levels of
  governments define rules not to trespass on the
  tax rights of local governments.
• Local governments have ownership rights over
  their off-budget resources.
• Extra-budgetary revenue (charges levied by
  administrative and institutional units) grew at
  27 per year during 1982-95, reaching similar
  amount as the budgetary revenue.
• Extra-system revenue (e.g. profits from TVEs) is
  also significant.

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Fiscal Decentralization in China I Separate
Stoves (Local Autonomy)

• The Helping Hand Paradigm
• Long-term and stable fiscal sharing contracts
  between the centre and the provinces limit
  central-state predation.
• The interests of local cadres are aligned with
  those of their communities (i.e. local-state
  entrepreneurship supported)
• Competition between cities and easy migration of
  labor and capital limit local-state predation
  (voting with feet).

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Fiscal Decentralization in China II Single Menu
(Vertical Control)

• The centre still exerts a firm grip over local
  bureaucracy through its control over appointment,
  evaluation and dismissal of local cadres.
• A top-down system of incentive contracts, TRS
  (target responsibility system) align the
  interests of local cadres with the preferences of
  (ultimately) the centre.
• Too optimistic to assume sufficient
  inter-jurisdictional competition and factor
  mobility. No guarantee that the interests of
  local government and residents are aligned.

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TRS

• TRS is a set of performance criteria (targets)
  that induce local cadres to allocate their fiscal
  resources in the preferences of the centre
• Fertility control
• Nine-year compulsory education
• Environmental protection
• Suppression of inflation
• Level by level, the targets filter down and are
  decomposed among subordinate governments and
  cadres.

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Cadre Promotion Mechanism

• The performance of local cadres are ranked in
  accordance with the points based on TRS weighting
  schemes.
• The larger the weight, the stronger the
  incentive.
• Economic construction is often assigned large
  weight (e.g. 60)
• Local cadres have a strong incentive to exert
  efforts on tasks easily measured and heavily
  weighted (causing distortion).

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Voting with Feet in China

• The proliferation of predatory charges suggests
  that a voting with feet scenario may be too
  optimistic.
• Household registration or hukou system together
  with other administrative controls might hurt
  labor mobility

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Evidence against Local Autonomy

• Unstable centre-state fiscal sharing contract
• No independence enforcer of fiscal contracts
• Off-budget revenues are not secure either
• Presence of cascading mandates
• E.g., expenditure per capita for fertility
  control was stipulated as 1 yuan in the 7th FYP
  and increased to 2 yuan in the 8th FYP and 4 yuan
  in the 9th FYP.
• Prevalence of arbitrary charges
• The many tiers of government in China aggravate
  the problem of arbitrary charges.
• Of the 150 billion yuan of contributions to the
  various capital funds, 55 accrued to local
  governments.
• The less developed the region, the larger the
  fiscal pressure

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Some More Evidence (Zhang, 2006)

• Decentralized fiscal system
• Centralized governance structure
• strong top-down mandates
• Homogeneous governance structure
• Predicted effect
• Widening regional gap burden from the mandates
  are light on industrial regions but are heavy on
  agricultural regions.

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Federalism, Chinese Style (Jin et al., 2005)

• Findings
• Fiscal contracts between central and local
  governments were credible.
• Higher correlation between local budgetary
  revenue and expenditure after the reform than
  before the reform
• Regions with stronger ex ante fiscal incentives
  have faster development of non-state sector.

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Counter-evidence by Jin and Zhou (2005)

• Two phases of fiscal decentralization in China
• 1979-1993 fiscal contract system
• 1994-present tax assignment system
• Findings
• Divergence in revenue and expenditures at the
  province level is associated with higher rates of
  economic growth.

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Decentralization, Lagging State Sector, and
Growth-Inflation Comovement (Brandt and Zhu,
2000)

• A Cyclical Stop-Go Pattern in China since 1978
• Rapid growth and accelerating inflation
• Then prolonged contractions with low growth and
  inflation rates
• A Widening State-Nonstate Output Gap
• The state industrial sectors share fell from 78
  in 1978 to 34 in 1995

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The Brandt-Zhu Story

• Decentralization draws bank credits away from the
  state sector to the more efficient non-state
  sector ? Widening State-nonstate gap and
  increasing growth rate
• The central government makes up for the loss in
  credit by printing money to finance the state
  sector ? High inflation
• The central government introduces
  recentralization ? More credit to state sector,
  low aggregate growth rate, less printed money and
  lower inflation rate.

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Decentralization, Growth, and Inflation Time
Series Evidence (Feltenstein and Iwata, 2004)

• Decentralization plays a fairly important role in
  a model of growth and inflation.
• The pattern of the relation does not appear to be
  restricted to the post-reform period, but rather
  characterizes the entire postwar economy in China
• Between 1949 and 2001, the Chinese economic
  policy shifts frequently between decentralization
  and recentraliztion programs.

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Local Protectionism in China(Bai et al., 2003)

• Data
• 32 two-digit industries
• 29 Chinese regions
• 1985-1997
• China Statistical Yearbook 1985-87
• China Statistical Yearbook on Industrial Economy
  1988-94 and 1997
• China Industrial Census 1995
• China Statistics Bureau 1996.

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Findings

• Regional specialization is low for industries
  that yielded high profit and tax in the past
• Regional specialization is low for industries
  with large shares of state ownership
• Overall time trend of regional specialization of
  industrial production dropped in early 1980s then
  rose rapidly.

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Local Government Elections and its Impact in
China (Zhang et al. 2004)

• By 1994, more than 30,000 village committees were
  established through contested elections,
  empowering more than one million assembly
  representatives, or 33 representatives per
  village.
• Findings
• Elected local leaders tend to shift direct tax
  burdens from households to enterprises.
• On the expenditure side, elections and power
  sharing improve transparency, therefore reducing
  the opportunities of profligate spending.

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Data

• A total of 60 villages are surveyed from 6
  counties.
• Village characteristics (location, population,
  popular surname)
• Economic activities (TVEs, revenues and
  expenditures)
• Characteristics of village leaders
• Information collected covers the 1985-1999
  period.

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