David Li
Shorenstein Reports on Contemporary East Asia
Number 18
March 1998
The 1997-98 Shorenstein Seminars on Contemporary East Asia sponsored a talk by Professor David Li on economic reform in China on March 31, 1998 at the Instutite of East Asian Studies.
Professor David Li is an Assistant Professor of Economics at the University of Michigan and a National Fellow at the Hoover Institution. Much of his research deals with the economic of transition, political economy, corporate finance and applied economic theory. He has written on corporate debt, the transformation of the Chinese state enterprise system, reforming the Chinese banking system and contract enforcement.
Professor David Li's paper, "Changing Incentives of the Chinese Bureaucracy," examines the striking transformation of China's bureaucracy into a force supporting economic reform and economic development, despite the lack of political liberalization. He points out that in looking at economies in transition from socialism, government attitudes toward economic development are an important variable. In China, the government functions as a "helping hand" for economic development, promoting economic growth, while in Russia, the government is like a "grabbing hand," suffocating economic development. Using China as a case study, Li argues that a proper transformation of the role of government, rather than mechanical implementations of standard reform packages, is a critical determinant of the success of transition. He points out that, in China, serious bureaucratic reforms preceded any economic reforms.
According to Li, a brief review of China's history reveals the dramatic contrast between the Maoist bureaucracy and the Dengist bureaucracy as well as the initial conditions created by the Cultural Revolution that made China's unique bureaucratic changes possible. Forty years ago, the same authoritarian regime under the control of the same Communist Party waged a massive campaign under the name of the Great Leap Forward, resulting in the loss of tens of millions of lives. Thirty-two years ago, the same regime launched the so-called Cultural Revolution, denouncing any traces of economic incentives. Li points out that conventional theories of the political economy of the former socialist systems emphasize that unless the one-party (Communist Party) monopoly is abolished, reforms are doomed to fail. Yet the same one-party system without political liberalization toward the rule of law, freedom of the press, and representative democracy continues in reform-period China.
Motivated by the desire to prevent a recurrence of the Cultural Revolution and drastic bureaucratic breakdown, Deng returned to power to promote the Four Modernizations and institute a radical mandatory retirement system for the bureaucracy's cadres. Li suggests that the Cultural Revolution perhaps also gave Deng a position of unique credibility to pursue such radical reform. This reform, initiated in 1980, abolished the lifetime tenure cadres had always enjoyed and retired old revolutionary veterans whose political loyalty had been valued more highly than their administrative capabilities, thereby "moderniz[ing] the contingent of government officials." (Deng Xiaoping, 1983). A strict retirement age was enforced for government officials, and an education requirement was also introduced at each level of government positions. It is important to note that this reform was actually implemented between February 1982 and September 1984, before the central government's decision in October 1984 to carry out official economic reforms.
The massive mandatory retirement program was facilitated by a one-time buyout strategy, giving outgoing officials both economic and political incentives to leave their full-time positions. The buyout program was a special arrangement for revolutionary veterans, who were the first and biggest potential opponents of this reform. In concordance with preserving the social status of these officials, a special name was coined for their type of retirement: lixiu, meaning literally to leave the post and rest. After lixiu, retired officials continued to enjoy all their former political privileges, such as reading government circulars of the same confidentiality level. Some served as special counselors for their successors. Their economic perquisites-such as official cars with chauffeurs, security guards-were also maintained. In addition, officials under lixiu received an extra month of wages each year as well as extra housing that their children and grandchildren were entitled to enjoy after their death. Finally, for the most senior officials, there were implicit and informal arrangements whereby their children were allowed to enter politics in senior positions, the origin of the so-called princeling party in China.
This first bureaucratic reform has resulted in two major consequences. The most direct consequence is that many younger and more-educated bureaucrats have replaced the older revolutionary veterans. Newer and younger officials are generally more supportive of reforms, more adaptable, and more pragmatic. Being better educated in almost all cases, they are also generally more competent than their predecessors. The percent of provincial governors with college degrees, for example, has increased from 20 before the beginning of reforms in 1982 to 43 after reforms in 1984. Their average age has decreased from 62 to 55. Even more dramatic, the percent of county-level or division-level chiefs with college degrees has increased from 11 to 45 while their average age is now below 45. By 1988, 90 percent of officials above the county-level had been newly appointed after 1982. In contrast, in Russia, Shleifer (1997) reported that the local leaders are largely the same people who were there before the reform began.
The second consequence of the reform is that the average duration of a bureaucrat's tenure in a government position has been reduced and turnover rates have increased. Compared with the old bureaucracy, the reformed bureaucracy generates more vacancies per unit of time, providing the younger and more-educated cadres with more upward mobility. In addition, the central government seems to have increased the frequency of lateral job reassignments, e.g., the transferring of a provincial-level official to another province, perhaps because the central government fearf to lose control to entrenched local officials under decentralization. One potential negative effect is that cadres will now exhibit more short-termist behavior. On balance, however, Li finds and cites much evidence for the critical role of the changed human capital composition of the Chinese bureaucracy in the successful implmentation of economic reforms.
The second important structural reform of the bureaucracy has been an extensive administrative and fiscal decentralization. During the early 1980s, a fiscal contracting system was introduced for provincial governments in China in which each province was responsible for collecting tax revenues in its region and then entitled to retain a high proportion of the marginal tax revenue. Administrative decentralization was also implemented, shifting formal authority for certain matters from the central government to lower-level governments, including the authority to appoint subordinate government officials and the right to supervise state-owned enterprises. Many provinces, in turn, implemented similar reforms with their subordinate cities or counties.
Perhaps the most important outcome of decentralization has been the formation of coalitions between entrepreneurs and local government officials, between local business and local government. There has been a massive entry of new business entities, which are either partially owned or supported enthusiastically by various governments, whose motivation for doing so comes from increasing tax revenues and enlarging local employment. Typically, the manager is one of the founding entrepreneurs who have contributed their own financial as well as human capital. Often, one of the founding entrepreneurs is a former government official, a phenomenon discussed below. Most important, the manager shares substantial residual control rights with the sponsoring local government. Bureaucrats, providing information and connections, and entrepreneurs, providing business vision and managerial skills, thus jointly form an indispensable force for the success of new businesses in the half-reformed Chinese economy.
The development of these semiprivate businesses has had a substantial effect on the incentives and behavior of Chinese bureaucrats. First, bureaucrats are now beginning to act like businessmen. Jean Oi has likened the community enterprises of a local jurisdiction to a multidivisional corporation. Bureaucrats are now also less interested in pleasing their superiors, given the benefits they receive from the enterprises under their jurisdiction-better official cars, bigger budget revenues, and better office facilities. More important, officials have become de facto shareholders rather than short-termist bribe-takers. This new behavior reduces the potential for local officials to adopt irrational decisions from the top to maximize their political interests, a bureaucratic pattern associated with the Great Leap Forward.
Bureaucrats have thus begun to lobby higher-level agencies for general deregulation on behalf of entrepreneurs in their jurisdiction. In addition to continuous individual efforts, local governments have begun sponsoring activities to influence the central government indirectly. Li gives the example of an academic conference held in Guangzhou, it was intended to provide publicity to perspectives in favor of developing Guangzhou as a financial center.
Concomitant with this government-supported business growth has been the temptation for government cadres to join and directly participate in the business community themselves, a phenomenon that has become known as xiahai, ("leaping into the sea"). Former bureaucrats can obtain a much higher economic payoff as well as personal freedom by joining the business world, despite being exposed to more economic uncertainty. There is a high demand for these bureaucrats, since in the half-reformed economy, many nonstate enterprises need their knowledge and skills to deal with the remaining government regulations. Since 1992, one survey reports, 30 percent of surveyed officials have thought about "leaping."
Although few systematic analyses of the impact of xiahai on the Chinese bureaucracy exist, Li ventures the hypothesis that xiahai has had a positive effect on China's reform process in two ways. First, xiahai changes the ex ante behavior of bureaucrats before they leave the government by making them more interested in local economic growth, especially in the growth of the non-government-controlled sector. A more prosperous nonstate sector generates better opportunities for the incumbent bureaucrats leaving their government positions. Moreover, the ex ante behavior is also affected through a reputation effect. An incumbent bureaucrat must establish a probusiness and proreform reputation to find a good position in the local business community after leaving the government. The best way to enhance this reputation is to promote growth and reform and to nurture personal rapport with local entrepreneurs by helping their businesses thrive. In the Chinese business community, personal relations, reputation, and trust (guanxi, in general) are very important. A known antireformist bureaucrat would therefore find it impossible to find a good position in the local business community after leaving his government position.
Second, after quitting the bureaucracy, many cadres are still in a good position to lobby their former connections for deregulation. These former cadres find that the bureaucratic regulations they helped maintain in the bureaucracy are now obstacles to their business interests. With their bureaucratic knowledge and skills, they are more effective lobbyists for reforms of these regulations than outsiders are.
But as one commentator pointed out, it will become more important for China's government to institute recruitment strategies that provide young, talented people with enough incentives to join the government rather than the private sector.
Finally, Li notes that xiahai seems to be a phenomenon unique to China, at least in its effect on the bureaucracy. In Russia, with the exception of Moscow, politicians are not accepted by the private sector. When the private sector grows, they lose power. Bureaucrats remain much closer to the former state enterprises, many of which continue to seek government subsidies. In Poland, local politicians seem to be mostly concerned with getting reelected rather than with joining private businesses after leaving their government positions.
Li thus analyzes the role of the bureaucracy in China's economic reforms as an illustration of successful institutional change as theorized by Douglas North. Changes in formal and informal rules have led to new incentives and patterns of behavior among cadres, which have in turn facilitated reforms of economic institutions and spurred economic growth. However, as pointed out by commentators, this virtuous cycle remains vulnerable to actors left out of the theoretical framework ("such as disgruntled peasants and workers"), to exogenous shocks, and to corruption. Li has, in any case, offered a compelling model to apply to the next set of bureaucratic reforms recently initiated by Zhu Rongji.
Summarized by Lily Tsai.
