经济发展论坛工作论文
FED Working Papers Series
No. FE20050095
Decentralization and Local Governance in China’s Economic Transition
Justin Yifu Lin Ran Tao Mingxing Liu
https://www.doczj.com/doc/bf11254107.html,
Decentralization and Local Governance in China’s Economic
Transition
Justin Yifu Lin* Ran Tao** Mingxing Liu***
Abstract
This chapter will focus on the decentralization and governance issues at local level, and strive to illustrate the structure and evolution of inter governmental arrangements at higher levels that constitute the institutional background in China. We argue that the centralization-decentralization cycle is endogenous to the traditional plan system, which featured heavy industrialization. Although decentralization in market-oriented reforms helped to promote economic growth by hardening local budget constraints and promoting local incentives to foster economic growth, it has led to lower central redistributive power and enlarging spatial inequality. Without clear and appropriate intergovernmental expenditures, responsibility division and equalizing transfer arrangements, the recentralization in 1994 has significantly impaired the local capacity to provide decent public goods and services in less developed regions and brought about serious local-governance issues in China.
Keywords: Decentralization, Transition, Unfunded Mandate.
* China Center for Economic Research, Peking University, e-mail: jlin@https://www.doczj.com/doc/bf11254107.html,; ** Institute for Chinese Studies, the University of Oxford, Center for Chinese Agriculture Policy, China Academy of Sciences, e-mail: ran.tao@https://www.doczj.com/doc/bf11254107.html,;*** School of Government, Peking University, e-mail: mxliu@https://www.doczj.com/doc/bf11254107.html,.
Introduction
In any discussion of China’s decentralization and local governance, three aspects deserve special attention. First, China is a large country with five levels of government. Below the central government are 31 provincial level units (42 million population on average), 331 prefecture level units (3.7 million people on average), 2,109 counties (580,000 people on average), and 44,741 townships (27,000 people on average). Furthermore, there are about 730, 000 more or less self-governed villages in rural areas below the township level (World Bank, 2002). The multi level nature of Chinese bureaucracy frequently causes confusion when people talk about decentralization and local governance in China, since the level can range from provincial to village.
Second, the fact that China is still a transitional economy in a process of marketization makes the existing literature on China’s decentralization somewhat different from the general decentralization literature. Since China used to be a planned economy and most of the economic activities were under center’s control in the plan period, the reforms initiated since the late 1970s can be viewed as a process of delegating more decision-making powers in investment approval, firm entry, revenue mobilization, and expenditure responsibilities to lower levels of government and granting more autonomy in production and marketing to state-owned enterprises. As a result, much of the literature on China’s decentralization actually dealt with China’s economic transition and liberalization (see Qian and Weingast, 1996, as an example), compared to the general literature of decentralization that focuses on the transfer of public functions to lower-level governments.
Third, China is still a party state with all levels of government officials
appointed from above by the ruling Communist Party. Unlike many countries of Africa or Latin America that are often plagued by bureaucracies that lack experience or organizational capacity, the Chinese bureaucracy is an elaborate network that extends
to all levels of society, down to the neighborhood and working unit, and exhibits a high degree of discipline by international standards (Parish and White, 1978, 1984). Within each level, an impressive organizational apparatus is able to transmit state policies down to lower-level government agencies step-by-step through several layers of government bureaucracy (Oi, 1995). In the 1990s, grass root elections took place extensively at the village level, which is not formally a level of government. Therefore, the concepts of constitutional decentralization and political decentralization do not quite fit in the case of China since there are no institutionalized rights of local governments in the central decision-making procedures and no widely accepted genuine elections at and above the township level.
This chapter focuses on a limited number of topics considered essential to an understanding of China’s decentralization and local governance by the authors. Considering the multi level nature of Chinese bureaucracy, we focus on the decentralization and governance issues at local level, and strive to illustrate the structure and evolution of inter governmental arrangements at higher levels that constitute the institutional background. Since China is still a transitional economy, the Chinese state is involved in some competitive sectors and intervenes in its citizens’ social and economic lives on many fronts. The decentralization process in China has been accompanied by institutional changes, such as the granting of more power in nonpublic functions (such as investment approval and entry of non state firms) to local
governments. Given that the decentralization of nonpublic functions constitutes an important element in China’s economic transition and in many cases took place simultaneously with the decentralization of public functions, both dimensions are explored here. Furthermore, the centralized political system has shaped the administrative and fiscal decentralization process, and also constitutes the basis for understanding major local-governance issues in China, such as unfunded mandates, farmer’s tax burdens, and ineffectiveness in antipoverty programs.
The chapter begins with a review of the centralization-decentralization cycles in the plan period before 1978 and the logic for such cycles. We discuss administrative and fiscal decentralization in China’s market-oriented reforms since the late 1970s; their impacts on economic growth, spatial inequality, and poverty reduction; the recentralization since 1994 and its affect on local public finance and public goods provision; and based on analyses of China’s intergovernmental fiscal and political arrangements, explore two major local governance issues in China, unfunded mandates and ineffectiveness in antipoverty efforts.
The Centralization-Decentralization Cycle in the Plan Period
The founding of the People’s Republic of China in 1949 marked a new era in Chinese history. Government leaders believed that to defend the new socialist system and to keep pace and even overtake Western industrial countries, rapid industrial development, especially the establishment of a complete set of heavy industries, was essential. Learning mainly from the Soviet experiences, the Chinese government began to
formulate and implement the first five-year plan which gave priority to heavy industrial development beginning in 1953.
However, the development of capital-intensive industries would have been extremely costly if the free market had been allowed to operate in a capital-scarce economy. To mobilize resources for such a heavy industrialization, a plan system was established that was characterized by a trinity of a macro-policy environment of distorted prices for products and essential factors of production such as trained personnel, funds, technologies and resources, highly centralized planned resource allocation, and a micro-management mechanism in which firms and farmers had no decision-making power (Lin, Cai, and Li, 2003).i For instance, a commune system was set up in the rural areas in the late 1950s to guarantee a state monopoly on grain procurement. Besides supplying grain at depressed prices, the communes and production brigades were also responsible for mobilizing financial and human resources for local public goods provision by organizing farmers for compulsory labor.
Under the plan system, a heavily centralized fiscal system was established. The accounting systems of state-owned enterprises (SOEs) were incorporated directly into the government’s budget, and major resources were controlled by the center. The State Planning Commission determined local revenue and expenditure plans on an annual basis, known as unified revenue and unified expenditure (tongshou tongzhi). Local governments (at the province, prefecture, county, and commune levels) did not have independent budgets.ii As to expenditure assignment, the central government was responsible for national defense, economic development (capital spending, R&D, universities, and research institutes), industrial policy, and administration of national
institutions such as the judicial system. Responsibility for delivering day-to-day public administration and social services, such as education (except universities), public safety, health care, social security, housing, and other local and urban services, was delegated to local governments.
However, in a country of the size of China, formulating, administrating, coordinating, and monitoring the central plans were time-consuming and became more and more so as the economic system became larger and more complicated. For example, the number of state-owned enterprises(SOEs) subordinated to the central government increased from 2,800 in 1953 to 9,300 in 1957, and the number of items in material allocation under central planning increased from 55 in 1952 to 231 in 1957(Qian and Weingast, 1996). The classical problem of control and monitoring under information asymmetry emerged soon after the planned system was set up. As the economy grew larger with more projects initiated and enterprises started, the plan system became increasingly unmanageable. To make things worse, a highly centralized planned system inevitably undermined the incentives of local governments when local coordination in industrial development was essential.
Under this background, China initiated its first decentralization within the planned framework by delegating more powers to local governments in 1957. The policies then included (1) delegating nearly all SOEs to local governments, such that the share of industrial output by the enterprises subordinated to the central government shrank from 40 percent to 14 percent of the national total; (2) changing central planning from a national to a provincial basis, with decisions about fixed investment to be made by local governments rather than the central government; and (3) fixing the revenue
sharing schemes for five years, and granting local governments some authority over taxes. The share of central revenue decreased from 75 percent to around 50 percent within two years.
Indeed, local incentives responded quickly to decentralization. Local small industries boomed in this period. This program, however, did not succeed because of serious coordination failures caused by the radical decentralization. The soft-budget constraint faced by local governments and SOEs soon led to excessive investment expansion and inefficient interregional duplication of production. Recentralization began in 1959, when all large and medium-sized industrial enterprises were again subordinated to the center. However, centralization again brought about the incentive problem and economic stagnation in the 1960s. Thus a second wave of decentralization followed in the late 1960s, when local governments gained more authority over fixed investment and local revenue. Afterwards, a similar but less serious investment boom led to yet another round of recentralization in the mid-1970s.
In retrospect, it is easy to see that decentralization under a plan system was not able to alleviate the inefficiency problem since it could neither improve micro efficiency through market discipline nor change the heavy-industry development strategy inconsistent with China’s comparative advantage. Under the soft-budget constraints faced by local government and SOEs, a cycle of decentralization leading to disorder, disorder leading to centralization, centralization leading to stagnation, and stagnation leading to decentralization was inevitable.
Decentralization under Market-Oriented Reforms, 1978 to 1993
Low efficiency in the plan system was considered to be a serious problem as early as the 1950s before the first round of decentralization was initiated(Mao, 1956), but not until 1978 were some fundamental reforms undertaken. What was evident to policy makers in the late 1970s was the correlation between production inefficiency of enterprises and communes and lack of stimulus for workers and farmers. That explains why the reforms began with the micro management system in the late 1970s in an attempt to improve work incentives. In rural areas, the household responsibility system (HRS) emerged in 1978. In just a few years, the system became a dominant form of microeconomic organizations in rural areas. In cities, reforms in SOEs were initiated in the early 1980s, centering on power delegation and profit sharing. Such reforms rendered rural households and SOEs de facto residual claimers of their production and thus greatly promoted work incentives.
Administrative and Fiscal Decentralization
Accompanying the micro reforms in rural areas and SOEs was a process of administrative and fiscal decentralization, which was deemed necessary in a large country like China to induce local coordination in market-oriented reforms.
Administrative Decentralization From the administrative perspective, the reform period witnessed a significant strengthening of local governments’ role in local economic management, such as investment approval, entry regulation, and resource allocation. A particularly striking example is the opening-up policy initiated in the
coastal regions. Starting from 1979, many provinces were allowed to set up their own foreign-trade corporations. From then on, regional experimentation with opening-up began, which includes the “one-step-ahead” policies implemented in Guangdong and Fujian in 1978, the establishment of four special economic zones (Shenzhen, Zhuhai, and Shantou, and Xiamen) in 1980, and the declaration of fourteen coastal cities as "coastal open cities” in 1984. Not only did these areas enjoy lower tax rates and a higher share of revenues, but perhaps more important, they enjoyed special institutional and policy environments and gained more authority over local economic development and the establishment of special economic zones and economic-development zones.
Another dimension of administrative decentralization was the delegation of more state-owned enterprises to local governments at the provincial, municipality, and county levels beginning in the early 1980s. By 1985, the state-owned industrial enterprises controlled by the center accounted for only 20 percent of the total industrial output at or above the township level, while provincial and municipality governments controlled 45 percent and county governments 35 percent (Qian and Xu, 1993). With an ownership shift from central to local, local governments were provided with incentives in taxes and profits to step up their effort in revenue collection. At the same time, the spending of the fixed investment for local-government-owned-enterprises fell naturally on the shoulders of local government. Since SOEs had provided a wide range of social services to their employees, more local ownership implied that local governments would take primary and final responsibilities for these expenditures.
Fiscal Decentralization The fiscal dimension of decentralization was no less dramatic. In 1980, the inter governmental fiscal system shifted away from unified revenue and unified expenditures and toward a "cooking in separate kitchens” (fenzhao chifan) that divided revenue and expenditure responsibilities between the central and the provincial governments.iii After that, the central-provincial fiscal arrangement experienced further changes, such as the proportional-sharing system in 1982 and the fiscal-contracting system in 1988. In the 1988 fiscal-contracting system, the center negotiated different contracts with each province on revenue remittances to the center and permitted most provincial governments to retain the bulk of new revenues. There were six basic types of sharing schemes in 1988, and they continued through 1993 (Bahl and Wallich, 1992). Besides fixed subsidies from the center (in fourteen provinces), fixed-quota deliveries to the center (in three provinces), fixed sharing with the center(in three provinces), and quota deliveries with a pre specified growth(in two provinces), other provinces adopted either an incremental sharing(a certain share is retained locally up to a quota, and then a higher share is retained in excess of the quota in three provinces), or a sharing up to a limit with growth adjustment (ten provinces retained a share within a specific percentage of revenue from the previous year and then retained all revenues above that quota).
At the lower level, the provinces had substantial flexibility in setting the rules for subordinate levels. Each province specifies the sharing system with its prefectures, the prefecture for its counties, and so on. Expenditure assignments were structured in a similar way: the central government sets the division of expenditure responsibilities
between the center and the provinces, and the intermediate layers decide how they share responsibilities with subordinate levels.
Decentralization and Economic Performance, 1978 to 1993
In general, with the decentralization of 1978 to 1993, political powers were still heavily centralized, but local governments began to enjoy more autonomy in local economic management, to control a larger share of fiscal resources, and at the same time to assume primary responsibilities for local public-goods provision. This implies a very decentralized fiscal-expenditure arrangement in which local government assumed greater responsibility for providing education, health, housing, social security, local infrastructure, and so forth. In the context of marketization reforms (deregulation), the decentralization in this period was associated with significant economic growth as well as mixed performances in spatial inequality and poverty reduction.
Economic Growth and TVE Development Decentralization in this period played an important role in promoting national as well as local economic growth. From 1978 to 1993, China's per capita gross national product (GNP) increased in real terms by around 280 percent. National absolute poverty was reduced by more than 50 percent in the first half of the 1980s, dropping from 17.9 percent of the population in 1982 to 6.1 percent in 1984 (World Bank, 2001). This downward trend corresponds to the growth of real income and real GNP. China also witnessed an across-the-board growth in both coastal and inland regions. Indeed, if each China’s province were taken as an economy, about
twenty out of the top thirty growth regions in the world in the period would be provinces in China.
Much of the economic growth in the period could be attributed to a spectacular entry and expansion of non state enterprises, especially the township and village enterprises (TVEs), which actually have been one of the most distinctive features in China’s economic development and transition (Qian and Xu, 1993). Nationally, the output of TVEs grew more than six fold in real terms between 1985 and 1997, leading China’s rapid industrial and overall growth. By 1993, TVEs already accounted for 36 percent of the national industrial output, up from 9 percent in 1978. Within the rural sector, the TVEs accounted for three-quarters of rural industrial output (Che and Qian, 1998).
The rise of TVEs was closely related to administrative and fiscal decentralization from the late 1970s to the mid-1990s. Local governments actively supported market-oriented, non state enterprises to expand their revenue base under competition between jurisdictions for getting rich first. With the decollectivization of agricultural production, local governments had to seek further revenue sources, and the fiscal reform that gave higher shares of revenue (TVE tax or profits) to local governments and granted them the rights to use the fiscal surplus paved the way for local governments to support the TVE developments under a better incentive system. The decentralization policies granted local officials large autonomy over their economies, including the autonomy to set prices, to make investment with self-raised funds, and to restructure their firms, and to issue licenses to newly established firms.iv By delimiting better the property rights between governments at different levels,
decentralization rendered governments at each level the residual claimant and controller of its own public enterprises.v
In the transitional process, local governments at the county, township, and village levels played unique roles in fostering local economic development, especially in supporting the TVEs. In the early to mid-1980s, when the TVEs started their golden period of growth, private entrepreneurs were still uncertain about the directions of central policy regarding private enterprises. Local governments assumed the entrepreneurial role and started rural industrial development.
According to empirical investigations carried out by Byrd and Gelb (1990) and Oi (1995), although most TVEs enjoyed a considerable degree of enterprise autonomy, the community government made strategic decisions in investment and finance, manager selection, and the use of after-tax profits for public expenditure. The community governments usually initiated internal fund raising, either from collective accumulation or from individual contributions to start up the community-owned enterprises. The community governments were also pivotal in securing loans from either the Agricultural Bank of China (ABC) or rural credit cooperatives (RCCs), two major external sources of financing, using the community assets as collateral and providing loan guarantee for TVEs. Using information and contacts that they developed beyond the locality through a government network, local officials could usually provide many essential services to local enterprises, such as raw materials and information about new products, technology, and markets for TVE products. vi Local officials also often tried their best to circumvent government regulations to allow TVEs to receive the maximum tax advantages and exemptions so that more revenues could be kept
within the locality to further the competitive advantages of TVEs, and they provided local governments with more funding for local public goods and service provision.
Fiscal Decline and Impacts on Spatial Inequality and Poverty Reduction Though decentralization was correlated to high economic growth in the 1980s, it also led to significant fiscal decline of the state. The total budget revenues fell from 35 percent of GDP in 1978 to below 12 percent in the mid-1990s. This was because the old revenue mechanism became unsustainable as central planning was dismantled. Profitability in industry fell as prices adjusted to market forces, sharply cutting the government revenue intake through state-owned enterprises. The emergence of non state enterprises competing for profits also contributed to revenue decline. Since the enterprise reforms required profit-sharing schemes to provide incentives, it reduced revenue flows to the budget, while creating extra budgetary funds that were managed independently by enterprises.
The decentralization also led to fiscal decline of the center. In most instances, the revenue-sharing contracts between the center and provinces were regressive, since they allowed richer localities to keep a larger portion of collected revenue. The contracting system tended to favor richer localities with more local enterprises since local firms were the richest sources of extra budgetary or off-budgetary revenue. Taking extra budgetary revenue into account, poor regions with few local enterprises had to share an even larger proportion of total collected revenue with the center. As similar contracts were made between the provinces and sub provincial units, the bias against poor localities extended to the grass roots levels (World Bank, 2002). As a
result, local shares of budget revenue rose steadily from 54 percent of the total government revenue in 1978 to 61 percent in 1988 and rose further to 78 percent in 1993.
With fiscal declines of the state as a whole and the central government, the center’s redistributive power was seriously damaged. Fiscal stress and declining central revenues had already led to dwindling inter governmental transfers and a de facto devolution of responsibilities to local governments. With the introduction of fiscal contracts in 1988, the central government formally ended its responsibility for financing local expenditures. The role of local governments was thereby shifted from providing services to financing them, a decentralization of responsibilities.vii While these levels of government had always provided such services, they had previously provided them as agents of the central government, that is, the center always subsidized the financial gap when necessary. By the end of the 1980s, fiscal decentralization, which tied budgetary expenditures more closely to local revenues, had created a budgetary crisis in nearly all poor counties that they experienced difficulties even in paying basic salaries (Park, Rozelle, Wong, and Ren, 1996). In these regions, high nondiscretionary outlays for personnel on the government payroll, including local officials, teachers, health workers, and other social-services personnel generally account for well over half of local budgetary revenues. Educational spending, most of which goes for teachers' salaries, often accounts for 40 to 50 percent of local budgetary revenues in poor counties. Poor-county governments had to employ a range of creative mechanisms to cope with their persistent and accumulating fiscal deficits. These mechanisms include deferring wages, borrowing from the budgets of various local-
government bureaus, and borrowing against the next year's budgeted fiscal transfers from higher levels of government (Park et al., 1996). Local governments in less developed regions had to cut spending on social development and let individuals share more health-care and education expenses (West and Wong, 1995).
Partly because of the limited redistributive power of the state, especially that of the center, China witnessed an increasing spatial inequality and stagnation in poverty reduction. Spatial inequality began to rise after an initial decline of urban-rural as well as inter provincial inequality from 1978 to the mid-1980s (Chen and Wang, 2001; Kanbur and Zhang, 1999). Such initial decline can be accounted for largely by increased agricultural prices as well as by rapid rural growth in this period. However, when China further decentralized, opened up, and experienced an explosion of trade and foreign direct investment in the mid-1980s, spatial inequality began to rise steadily. The Gini index of provincial per capita income declined from 29.3 percent in 1978 to 25.6 percent in 1984, but then rose to 32.2 percent in 1993 (Kanbur and Zhang, 1999). At the same time, the urban-rural average income ratio declined from 2.87 in 1978 to 1.86 in 1985, then increased to 2.5 by 1993 (SSB, 2004). After the mid-1980s, the poverty rates even increased—reaching 14.7 percent in 1989—and then stagnated, hovering around 10 percent in the early 1990s. This was despite continuous growth in national income and GNP, indicating that in these years the poor did not share the benefits of overall economic growth.
Recentralization since 1994
Fiscal Reform in 1994
As a response to the fiscal decline, the center in 1994 initiated a drastic fiscal reform to raise the central revenue share from around 35 percent of general revenue to 60 percent along with a substantial increase in fiscal transfer. Among a comprehensive package of measures, the centerpiece of 1994 fiscal reform was to introduce the tax-sharing system (fenshuizhi), which fundamentally changed the way revenues are shared between the center and the provincial governments. Under the tax-sharing system, taxes were assigned either to the central or local government, with the center having the bulk of the tax revenue, especially the 75 percent of newly created value-added tax (VAT). Local taxes consist mainly of business taxes, personal and enterprises income taxes, and other small taxes such as urban construction, land-use and real estate taxes, and agricultural taxes.
The expenditure responsibilities were nominally unchanged with the sub provincial levels (prefecture, county, and township) still facing the expenditure responsibilities that were delegated to them through the decentralization in the 1980s. While in most other countries social security and welfare are almost always provided by the central government and education and health are often shared responsibilities with the provincial and central governments, in China the county and township levels together provide the bulk of vital public services, including 70 percent of budgetary expenditures for education, and 55 to 60 percent of those for health. Cities at the prefecture and county levels account for all local expenditures on unemployment insurance, social security, and welfare (World Bank, 2002). A critical difficulty has arisen in maintaining the social safety net due to large-scale restructuring of China’s
state-owned sectors since the mid-1990s. Many of the social-service and social-security responsibilities that used to be taken care of by SOEs have now been passed to local governments without corresponding resources being set aside to meet these responsibilities. Many local governments, now insolvent, are in urgent need either of additional transfers or of a further rationalization of the intergovernmental fiscal system.
Not only there is an expenditure structure out of line with international practice, but there also is a serious lack of a clear assignment of responsibilities among different levels of governments below the province. This leads to a high degree of concurrent and overlapping expenditures among the sub national levels in China. In practice, concurrent responsibilities have made it more difficult to identify what level of government should be accountable for the delivery of particular services. Due to the weak bargaining position of lower-level governments under the centralized political system, there has been a tendency of concentration of revenue to upper-level governments and delegation of expenditure responsibilities to lower-level governments. The tendency became increasingly apparent after the 1994 fiscal reform. Provincial governments has tended to squeeze larger shares of revenues from lower-level governments and at the same time assigned more responsibilities to the latter.viii The center had originally planned to mobilize fiscal resources to channel more transfers from richer areas to poorer ones, but the promised transfers have not materialized. To satisfy the needs of coastal provinces that generate much of the revenues, lump-sum tax rebates were offered to guarantee them their pre-1994 income. In addition, to permit each province to share in the growth of its lost tax base over time, the center committed to giving back 30 percent of its increased revenue from the newly
created value-added tax as well as consumption tax each year. The tax rebates, the largest item in overall transfers, are highly correlated with incomes and disequalizing in nature. The earmarked grants, the second-largest item of transfer, have been found to be mildly disequalizing because they were dominated by food and other consumer subsidies that favored urban areas (Wong, 1997). To offset this regressive effect, the government introduced an equalizing (general-purpose) transfer to aid poor regions in 1996. They are rule based and rely on variables such as provincial gross domestic product (GDP), student-teacher ratios, number of civil servants, and population density. However, these transfers have been under funded since their inception, accounting for just 2 percent of total transfers. For example, in 1998 the central government allocated 2.2 billion yuan to equalization transfers, compared to the estimated fiscal gap of 63 billion yuan produced by the formula. What each eligible province received was its estimated fiscal need multiplied by a coefficient of 0.035, which was derived from 2.2 divided by 63.
Impacts of Revenue Centralization
Since the mid-1990s, revenue centralization without corresponding equalizing transfers has been partially responsible for enlarging inequality in both income and public spending across regions. The Gini index of provincial per capita income further rose from 32.2 percent in 1993 to a historical high of 37.2 percent in 2000. Urban-rural average income ratio increased from 2.5 in 1993 to 3 by 2003. The combination of heavy responsibilities and inadequate transfers means that the levels of service provision vary across localities according to levels of local economic development.