Between Separate Stoves and a Single Menu: Fiscal Decentralization in China*

A recent body of literature with the paradigm of market preserving federalism at its core contends that China is a de facto federalist state. With the autonomy and tax rights of local governments entrenched in the reform era, local governments have allegedly become decentralized engines of growth. Scrutinizing the underlying premises of the above paradigm, this article arrives at a picture of China’s local governments as less autonomous and the system of vertical bureaucratic control as more potent than that painted by the above paradigm. Emerging from our findings is an alternative interpretation of China’s central–local fiscal relations that may help us understand such recent phenomena as the proliferation of arbitrary charges. If the Russian great leap to market and democracy has so far turned out to be a litany of unfulfilled aspirations and gross miscalculations, China’s somewhat timid excursion into the uncharted waters of reform has been amply rewarded with unprecedented growth. Trying to make sense of such a great divergence is a body of literature that accentuates the role of fiscal decentralization – the devolution of decision-making powers to local governments – as the handmaiden of China’s rapid economic growth in the reform era. Throughout this article, such fiscal decentralization is referred to as the “helping-hand paradigm.” Forming the backbone to this new literature is the model of market preserving federalism, weaving together a tapestry of Chinese institutional innovations that limit central-state predation and unleash local-state entrepreneurship. Specifically, the fiscal contracting system introduced in the 1980s, the hallmark of China’s fenzao chifan, or “meals prepared by separate stoves,” allegedly commits the centre and the provinces to long-term and stable schemes of sharing the fiscal pie, clarifying their tax rights and thereby restraining central-state predation. Being “residual * The work described in this paper was fully supported by a grant from the Research Grant Council of the Hong Kong Special Administrative Region (Project No. CUHK4119/99H). We thank Christine Wong and Thomas Rawski for their valuable and incisive comments. 1. See Gabriella Montinola, Yingyi Qian and Barry R. Weingast, “Federalism, Chinese style: the political basis for economic success in China,” World Politics, Vol. 48, No. 1 (October 1995), pp. 50–81; Yingyi Qian and Barry Weingast, “ Federalism as incentives to preserving market incentives,” Journal of Economic Perspectives, Vol. 11 (Fall 1997), pp. 83–92, Qian Yingyi, “The institutional foundations of China’s market transition,” in Boris Pleskovic and Joseph E. Stiglitz (eds.), Annual Bank Conference on Development Economics 1999 (Washington DC: The World Bank, 2000); Ekaterina V. Zhuravskaya, “Incentive to provide local public goods: fiscal federalism, Russian style,” Journal of Public Economics, Vol. 76 (2000), pp. 337–368, Daniel Berkowitz and Wei Li, “Tax rights in transition economies: a tragedy of the commons?” Journal of Public Economics, Vol. 76 (2000), pp. 369–397. This body of literature also borrows ideas from the works of Jean Oi, e.g. Rural China Takes Off: Institutional Foundations of Economic Reform (Berkeley: University of California Press, 1999).  The China Quarterly, 2004 72 The China Quarterly claimants” or “shareholders” to the fruits of local development, the interests of local cadres are aligned with those of their communities. Furthermore, inter-jurisdictional competition and factor mobility limit local-state predation. With their newfound freedom and autonomy reminiscent of a federalist state, the energy of local cadres is largely channelled into ventures that ultimately account for the spectacular economic performance of China in the reform era. The story has quickly sunk in as a set of stylized facts in the community of economists. To what extent is the above story a close approximation of China’s central–local fiscal relations in the reform era? Is China really so far down the road of decentralization as to fit the description of a “de facto federalist state”? If the paradigm predicts that the grabbing hand of the central and local states are tied by the threat of people and investors voting with their feet (the exit option suggested by Hirschman), how can one rationalize the chronic and widespread problem of predatory charges (luanshoufei) which is plaguing China in the reform era? This article is an attempt to address these questions and re-examine the premises underlying the helping-hand story. The picture that emerges is a topdown and more centralized central–local governance structure, echoing and complementing the observations of such researchers as Huang Yasheng, Dorothy Solinger and Christine Wong. Of particular interest is the target responsibility system as a concrete manifestation of central control and its effect in shaping the allocation of fiscal resources at the local level. The organization of the article is as follows. The first section summarizes two features of China’s fiscal decentralization pertinent to the subsequent exposition and how the helping-hand paradigm interprets these features. An alternative portrayal of China’s central–local relations is the subject of the second section, highlighting the evolution of the cadre management system that provides the levers for upper-level governments to control their subordinates. The remaining sections examine the history in the first two decades of reforms to find out whether the empirical evidences are commensurate with these two contrasting models. 2. For a sample, see e.g. Oliver Williamson, “The institutions and governance of economic development and reform,” in Michael Bruno and Boris Pleskovic (eds.), Proceedings of the World Bank Annual Conference on Development Economics, 1994 (Washington, DC: The World Bank, 1995), pp. 171–197; Aoki, Masahiko, Toward Comparative Institutional Analysis (Cambridge, MA: MIT Press, 2000), pp. 165–69; Gerard Roland, Transition and Economics (Cambridge, MA: MIT Press, 2001), pp. 279–281. 3. Albert O. Hirschman, Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States (Cambridge, MA: Harvard University Press, 1970). 4. See Huang Yasheng, “Administrative monitoring in China,” The China Quarterly, No. 143 (1995), pp. 828–842; Huang Yasheng, Inflation and Investment Controls in China: The Political Economy of Central–Local Relations during the Reform Era (Cambridge: Cambridge University Press, 1996), ch. 4; Huang Yasheng, “Political institutions and fiscal reforms in China,” Problem of Post-Communism, January/February, 2001, pp. 16–26; Dorothy J. Solinger, “Despite decentralization: disadvantages, dependence and ongoing central power in the inland – the case of Wuhan,” The China Quarterly, No. 145 (1996), pp. 1–34; Christine Wong, “Central–local relations in an era of fiscal decline: the paradox of fiscal decentralization in post-Mao China,” The China Quarterly, No. 128 (1991), pp. 691–715. 73 Between Separate Stoves and a Single Menu In particular, the third section reviews the evolution of China’s central– local fiscal relations suggesting a less clear-cut picture of the centre credibly committed to maintaining local autonomy through fiscal contracts and keeping its hands off funds of which local governments are supposed to have ownership rights. The fourth section presents evidence that the proliferation of unfunded mandates is a concrete manifestation and vivid reminder of a vertical control system lurking behind central– local fiscal relations. With local cadres answerable to the upper levels of governments and weak mechanisms holding local cadres accountable, the next section suggests that the different tiers of governments can be quite predatory as witnessed by the proliferation of arbitrary charges in China. The concluding section summarizes the major findings and discusses their implications with respect to the reform of China’s central–local fiscal relations. Fiscal Decentralization and the Helping-hand Paradigm Before re-examining the premises underlying the helping-hand paradigm, and to clarify some concepts used throughout the article, this section gives a brief introduction to two dimensions of China’s fiscal decentralization critical to the helping-hand story. Fiscal decentralization was allegedly a remedy to the highly centralized system of remitting all funds to the centre to be then disbursed among subordinate governments (or what the Chinese often refer to as tongshou tongzhi). It was an attempt to assign to local governments more stable sources of revenues and to devolve more decision-making powers to local governments so that they could have greater flexibility in the disposition of their shares of revenues. There are two main features of China’s fiscal decentralization pertinent to the subsequent discussion. One of them is the introduction of fiscal contracts between successive levels of governments stipulating formulae to share locally generated revenues as well as subsidies from or remittances to the next level of government. In theory, local governments were supposed to have more discretion over the disposition of local fiscal revenues though they were supposed to face a hard budget constraint and live within their means (or metaphorically local governments had their own separate stoves). The second important feature is a freer rein given to local governments in tapping off-budget resources. Local governments were encouraged in the reform era to raise funds through multiple channels (duoqudao jizi) to make up for their budgetary shortfalls, thereby setting off an explosion in 5. There is already a large literature on the subject. See e.g. Christine P.W. Wong, Christopher Heady and Wing T. Woo, Fiscal Management and Economic Reform in the People’s Republic of China (Oxford: Oxford University Press, 1995); Susan Shirk, The Political Logic of Economic Reform in China (Berkeley: University of California Press, 1993), ch. 9. For a recent and particularly perceptive Chinese account, see Jia Kang and Yan Kun, Zhongguo caizheng: zhuangui yu fazhan (Chinese Public Finance: Transition and Development) (Shanghai: Shanghai yuanyang chubanshe, 2000), ch. 2. 74 The China Quarterly off-budget resources. Two sources of quasi-public funds fall outside the orbit of local budgets: extra-budgetary (yusuanwai) and extra-system (zhiduwai) funds. The growth of the former is largely attributable to many charges levied by administrative and institutional units (xingzheng shiye danwei). For example, the extra-budgetary funds grew at an astonishing rate of 27 per cent per annum between 1982 and 1995, reaching 223.5 billion yuan, as compared with the total budgetary revenue of 298.6 billion yuan. The composition of extra-system funds is more complicated. Profits from township and village enterprises are no doubt an important contribution for some regions, a point emphasized by the helping-hand paradigm, but they are by no means the only source. In fact, a broad array of charges often ends up in this account. The two features are the threads with which the helping-hand paradigm knits together its rendition of China’s fiscal decentralization. To understand how they fit into the story, one can do no better than to review the building blocks of the helping-hand paradigm: • Long-term and stable fiscal contracts gradually nurture a reputation of credible commitment by the centre. Commitment is further enhanced by off-budget funds being hidden from the centre’s grabbing hand thanks to informational asymmetry. China is thus a de facto federalist state with local governments enjoying a high degree of fiscal autonomy. • With the property rights of local revenues entrenched and a freer rein in tapping local resources, raising funds through multiple channels leaves room for local cadres’ ingenuity to pursue such profitable 6. For details see e.g. Christine Wong (ed.), Financing Local Government in the People’s Republic of China (New York: Oxford University Press, 1997); Sun Tanzheng, Zhu Gang and Wang Chaocai, Xiandai Zhongguo nongcun caizheng wenti yanjiu (Study on Modern Chinese Rural Public Finance) (Beijing: Jingji kexue chubanshe, 1995); Guojia jiwei zongheshi ketizu, “20 shiji 90 niandai woguo hongguan shouru fenpei de shizheng yanjiu” (“Empirical study of China’s income distribution at the macro level”), Jingji yanjiu cankou, 25 April 2000. 7. While part of the revenue under administrative and institutional units accrues to units under the central government, the lion’s share is local. For example, in 1990, the amount accruing to units under local governments was 51.602 billion yuan as opposed to 6.093 billion yuan belonging to units under the central government; see Caizhengbu zongheshi, Zhongguo caizheng tongji 1950–1991 (China Finance Statistics 1950–1991) (Beijing: Kexue chubanshe, 1992), p. 194. 8. The English name “extrasystem funds” has been used by Albert Park, Scott Rozelle, Christine Wong and Changqing Ren, “Distributional consequences of reforming local public finance in China,” The China Quarterly, No. 147 (1996), pp. 751–778. There does not seem to be any commonly agreed name for this category of quasi-public funds. For example Jia Kang and Bai Jingming, “Xianxiang caizheng jiekun yu caizheng tizhi chuangxin” (“The resolution of township and village fiscal difficulties and innovations of the fiscal system”), Jingji yanjiu, No. 2 (2002), coin the term non-budgetary funds (feiyusuan shouru). 9. For useful discussions of the sources of funds included, see Guojia jiwei zongheshi ketizu, “Empirical analysis of China macro income distribution in the 1990s”; see also Jia Kang and Bai Jingming, “The resolution of township and village fiscal difficulties.” 10. Montinola, Qian and Weingast, “Federalism, Chinese style”; Qian and Weingast, “Federalism as incentives”; Berkowitz and Li, “Tax rights in transition economies”; Zhuravskaya, “Incentive to provide local public goods.” 75 Between Separate Stoves and a Single Menu ventures as township and village enterprises that ultimately lift local communities out of poverty, thereby fostering economic growth. • Instead of abusing their newfound freedoms, the grabbing hands of local governments are handcuffed by inter-jurisdictional competition and factor mobility. The threat of people and investors voting with their feet helps circumscribe local state predation. Conspicuously crafted by these premises is an image of either a self-restrained centre refraining from trespassing on the rights of subordinate governments, or an ill-informed centre too weak to meddle with local off-budget resources. There is much to admire in this novel interpretation of China’s fiscal decentralization experience and one cannot agree more with the philosophy behind the helping-hand paradigm that institutions matter. Having said that, there still remains the question whether China is really so far down the road of decentralization and local governments so autonomous as to fit the description of a de facto federalist state. Insofar as the local autonomy of local governments is at issue, what seems conspicuously missing in the helping-hand story is some discussion of China’s system of bureaucratic control or what the Chinese refer to as the cadre management system. The voluminous literature on the subject reveals that an elaborate system of vertical control has evolved in the reform era to monitor and assess local cadres, with significant impact on their careers. Since this is one dimension of China’s central–local relations too important to be ignored, we put together a brief discussion of the crucial aspects of China’s evolving cadre management system and provide an alternative paradigm of central–local relations that highlights the vertical control system. Separate Stoves under a Single Menu: Local Autonomy versus Vertical