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Careerism and Moral Hazard in Early Marketization

from the late 1970s to the mid-1990s the Chinese economy experienced a fundamental transformation from central planning to markets (Naughton 1995, 2007). Public enterprises were the leading force of this process. Initially championed by township and village enterprises (TVEs) in rural areas and subsequently joined by urban state-owned enterprises (SOEs), marketization provided the main engine for fast economic growth through the mid-1990s. In the five to six years that followed, however, the momentum of public enterprises quickly dissipated, and their financial performance and sustainability seriously deteriorated. The debacle of public enterprises was accompanied by a rising tide of privatization, which drastically redefined the ownership structure of the economy. Why public enterprises were unable to carry on is what I seek to explore in this chapter.

The starting point of the exploration is the driving force behind the behavior of local officials. They controlled the overwhelming majority of China’s public enterprises, and it was the enterprises under their purview that failed to survive beyond the early years of the twenty-first century. My basic argument is that both the initial expansion of local public enterprises and their subsequent implosion were closely related to the calculation and pursuit of self-interest by local officials. As political actors, they responded to the changing incentives and constraints in the evolving structural conditions of their decision-making. In face of the new focus on economic development in political performance assessment, many local officials actively promoted sales growth of local public enterprises, which had an immediate glossing effect on key performance indicators. This strategy helped secure and advance the careers of local leaders. It also contributed to the expansion of the discretionary resource pools that they and lower-ranked local officials controlled, therefore broadening the base for addressing the diverse concerns of different interest groups.

A major consequence of the sales growth strategy is that the expansion of public enterprises was gradually delinked from their profitability and organizational health. What drove it was the heavy reliance of the fiscal system on indirect taxes, and what sustained it was the supply of financial resources leveraged directly or indirectly from the banking system, which had weak profit agenda before 1994. Over time, however, the cumulative debts of local public enterprises grew way beyond their loan-servicing abilities, making them unable to withstand the credit tightening during banking reforms in the mid-1990s. The moral hazard inherent in this process was closely associated with the transient tenures of local leadership and the lack of clear cost accounting of administrative decisions. The sales growth strategy was also coupled with various revenue-hiding and diversion tactics that entailed collusion between local officials and public enterprise managers. Moreover, the fast expansion of local public enterprises increased monitoring costs, which further spurred the growth of agency problems, such as managerial corruption, and thereby added to the growing woes of public enterprises. In the end many of these enterprises fell victims to their own “success.”

While widely pursued by local officials in the early years of reform because of the relatively low political risk involved and the property rights they held over local public enterprises, the sales growth strategy was nevertheless continued with varying degrees of tenacity among different locales. The tendency and ability to stay with it hinged on the varying strengths of local public enterprises and on the historical and geographic conditions of different locales. The use of alternative or complementary economic development strategies that involved greater political risks, such as measures to facilitate private business and promote foreign investment beyond the initial regulatory limits imposed by the central leadership, represented a parallel line of the story. They will be considered in the next two chapters.

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