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Home arrow Political science arrow Dancing with the devil : the political economy of privatization in China


It is important to note that the changes in fiscal relations highlighted above were not simply concerned with the division of revenue and spending between different levels of government. They also embodied redefined political responsibilities and were integrated with the changing practices of political performance assessment in the reform era. These practices experienced major shifts—from emphasizing political behavior to focusing on economic issues and from relying on broadly defined guidelines to using concrete met- rics.[1] With the unfolding of fiscal decentralization and subsequent restructuring, how to raise revenue and manage fiscal flows became an important consideration in the self-interest calculus of local officials.

Under the fiscal contract system during the 1980s and early 1990s, fulfilling the revenue targets with higher-level authorities was key to the careers of local leaders and officials in charge of economic affairs. A common avenue through which to address this concern was to expand the local revenue base by promoting the growth of locally “affiliated” economic organizations, which were predominantly public enterprises during that period of time. More importantly, given that the bulk of locally extracted revenue came from indirect taxes on the volume of transactions, especially those in the industrial sector, boosting the sales of industrial enterprises became the dominant economic strategy of many local governments. Since such an undertaking necessitated an expansion of the industrial workforce and increased output value, it facilitated nonfarm job creation and output growth, which were also important factors included in political performance evaluation. Nonetheless, as will be shown in the next chapter, the pursuit of this strategy was not necessarily consistent with the agenda of improving profitability. Where competition was strong and local public enterprises’ competitiveness was weak, political considerations and expediency often led sales growth to override the importance of profitability, resulting in extensive borrowing beyond the debt-servicing abilities of local public enterprises. As a result, the fundamental financial health of many public enterprises was compromised. Understanding the basic setup and evolution of the fiscal system, especially the predominant importance of indirect taxes, therefore, helps explain the orientation and consequences of political actors’ behavior.

An interesting twist here is that, while there was a clear tendency on the part of local authorities to boost revenue growth, it did not lead to the maximization of formal revenue, as evidenced by the widespread phenomenon of fulfilling the fiscal contract to the “just right” extent (of moderately surpassing revenue targets). The setup of the fiscal contract system left open channels through which a sizable part of local revenue was stashed away in extrabudgetary revenue and other resource pools at the discretion of local officials. Sales growth of local enterprises, especially those in the local public sector that were more convenient tools than private enterprises (which tended to be more profit-conscious) for the manipulation of fiscal flows, therefore, served not only to help secure and advance the careers of local officials but to accommodate their self-defined agendas, including making private gains. The use of (public) enterprise accounts for revenue shuffling also entailed collusion between the enterprises concerned and their supervising officials and authorities. The outgrowth of such collusive ties was a precursor to the more explicitly private undertaking of asset stripping amid the deepening crisis of public enterprises in the mid to late 1990s.[2]

The 1994 restructuring represented a drastic overhaul of the fiscal contract system. But it did not fundamentally change the drive of local governments for revenue. In fact, efforts to promote sales growth of public enterprises continued through the mid-1990s. But the restructuring did prod local officials to adjust their fiscal strategies so as to reposition themselves favorably in political performance evaluation and in the generation and control of discretionary resources. In face of the hardened constraint on revenue diversion through tax exemptions and reductions under the system of revenue partitioning based on a separation of tax categories, local governments concentrated their attention on their redemarcated revenue bases and on new sources of revenue. Although the industrial sector remained an important revenue source, especially in the immediate aftermath of the restructuring, its relative significance gradually declined because the central government controlled the lion’s share of the growth portion of the taxes from industrial activities. In the meantime, the sales expansion of public enterprises (especially those in the industrial sector) ran into increasing difficulties due to intensification of competition, tightening of credit under banking reforms that gained momentum in the mid-1990s, and cumulative liabilities. In contrast, the relative contributions from urban services and construction to local revenue assumed elevated importance in local public finance.

Coevolving with these shifting trends was a refocusing of local economic policies from industrial development to urbanization, with a growing emphasis on land-related transactions and land-leveraged resources. Along the way, the opportunity cost of keeping afloat poorly performing (and predominantly industrial) and overexpanded public enterprises became increasingly evident and unbearable. Also factored into the new self-interest calculus of local officials was the potential of redeploying the land use rights of existing public enterprises, especially those occupying central locations in urban or urbanizing areas, for more lucrative uses (i.e., generation of discretionary revenues and private gains). These considerations, coupled with the public sector’s lack of an initial stronghold in service activities because Maoist economic policy favored industrial development at the expense of the tertiary sector, converged into the forces that led to the tipping point of massive ownership restructuring in the mid to late 1990s and quickened the demise of the vast majority of public enterprises thereafter.

I will lay out the empirical details underlying these general observations in the following chapters. It should be stressed here, though, that the unfolding of the aforesaid implications of the changing fiscal system was by no means uniform across space and over time. Some local governments, for example, pursued the strategy of public-enterprise-led industrial development until the onset of massive privatization. Some others began to deviate from it as early as in the mid-1980s. Governments of different locales and at different levels (i.e., provincial, city, county, and township) targeted and emphasized different revenue sources and streams (e.g., taxes vs. nontax revenues, revenues directly extracted from local sources vs. fiscal transfers from higher levels). Even after the clear authorizing signals from the central government in the late 1990s, the precipitousness and depth of privatization also varied among different regions. The next four chapters are devoted to detailing these differences. In particular, I will examine how the extent and pace of privatization were related to the varying responses of local governments to the common challenges from growing demographic pressures and to the evolution of the state’s fiscal system. The goal is to reveal how the causal mechanisms of privatization played out in different historical and local contexts.

  • [1] See chapter 4 for a discussion of the shifts of focus in political performance assessment.
  • [2] Collusive ties among officials also grew with the expansion of off-budget funds, which further weakened their interest in the long-term financial health of public enterprises, as I have shown in a previousstudy (Lin 2001).
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