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Web of Interests and Patterns of Behaviour of Chinese Local Economic Bureaucracies andEnterprises during ReformsAuthor(s): Huang YashengSource: The China Quarterly, No. 123 (Sep., 1990), pp. 431-458Published by: Cambridge University Press on behalf of the School of Oriental and African StudiesStable URL: http://www.jstor.org/stable/654151 .Accessed: 07/03/2011 00:57

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432 The China Quarterly

economy, albeit on a more decentralized basis, and fuses the economywith profit ncentives and limited market unctions. Under this system,

economic bureaucrats and enterprise managers have come to sharesome of the crucial economic decision-making powers without clearlydefined rules or well-specified divisions of labour.4 This half-way housebetween planning and market has the effect of lodging a web of interestsbetween the local economic supervisory agencies and the enterprisesunder their control.5 This web of interests, n turn, dictates a pattern ofmutually beneficial behaviour between these two crucial actors in theChinese economy. Furthermore, he economic alliance between localeconomic bureaucrats and enterprise managers creates both economicand political obstacles to further economic changes.

This paper has four parts. The first part outlines the current modeof economic co-ordination in the Chinese economy. The second partdescribes the two major actors in the Chinese economic system - eco-nomic bureaucrats and factory managers. The third part discusses thebehavioural patterns of the Chinese economic bureaucrats and factorymanagers. The fourth part speculates about the consequences of suchbehavioural patterns on further economic reforms.

Part I: Between Plan and Market: The Mixed Mode of EconomicCo-ordination n the Chinese Economy

There are two princlpal ways economic activities are organized inany economy. One is the bureaucratic mode of co-ordinationcharacterized by the vertical elationship between the co-ordinatorand the co-ordinated and by the legally binding and coercive nature ofcontrol by the former over the latter. The other is market co-ordination, whose salient characteristic s its horizontal elationshipbetween the co-ordinator and the co-ordinated and the equal legalstatus between the two.6

A mixed mode of economic co-ordination is any combination ofthese two. The Chinese economic reforms in the past 10 years haveled to the instituting of a mixed mode of economic co-ordination.

4. For a good description of the partial nature of the economic reforms, see CyrilZhiren Lin, Open-Ended Economic Reform in China, Victor Nee and David Stark(eds.), Remaking the Economic Institutions of Socialism: China and Eastern Europe

(Stanford: Stanford University Press, 1989), pp. 9 5-1 36.5. The Chinese system categorizes state-owned ndustrial enterprises according tothe administrative level of their immediate supervisory agencies. The centralgovernment, he State Council and its ministries, controlled, as of 1983, about 2,500large enterprises with 30% o 50% share of gross value of industrial output. Below thislevel, provincial and city governments controlled about 30,000 to 40,000 small andmedium enterprises with 25% to 30% share of gross value of industrial output. Thethird level is county and prefectural governments, which controlled some 40,000 to50,000 enterprises with 13% to 15% share of gross value of industrial output. SeeChristine Wong, Between Plan and Market, p. 388.

6. See Janos Kornai, Bureaucratic nd market coordination, Osteuropa Wirtschaft(East European Economy), Vol. 29, No. 4 ( 1984), pp. 307-308 and Janos Kornai, The

Hungarian eform process: visions, hopes, and reality, Journal of Economic Literature,Vol. 24 (December 1986), p. 1690.


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Web of Interests and Patterns of Behaviour 433

This is shown by examining the sharing of power between localeconomic bureaucrats and enterprise managers in a few crucial

decision-making areas.

Selection and Appointment of Managers. Reforms have reducedadministrative control in the selection of managers by permittingalternative channels other than direct bureaucratic appointment.These are bureaucratic appointment with consultations, directelections and hiring by the enterprises. However, bureaucraticappointment remains dominant in the large and strategic industrialenterprises7 and an overwhelming majority of managers are stillpromoted through bureaucratic channels, as shown in Table 1.

Table 1: Distribution of Different Channels of Managerial Promotion(Percentages)*

Bureaucratic appointment 60 1Bureaucratic appointment with consultation 30 7Direct election 4-4Direct hiring 1-8Others 2 3

Source:Chinese Institute for Reform of the Economic System, Gaige: Women mianling de

tiaozhan yi xuanze (Reforms: Our Challenges and Options) Beijing: Chinese EconomicPress, 1986), p. 273.*Based on a 1985 survey of 900 enterprises. n this survey, 19-9 per cent of the data areon collective enterprises.

Determination ?f Output Targets. Output targets are, in a commandeconomy, the most important mechanism for bureaucracies o controland to assess enterprise performance. In the Soviet Union, anelaborate scheme of bonuses was instituted to ensure fulfilment ofobjectives assigned to enterprises by bureaucracies,8 and in China,before reforms, managerial motivations were ensured by principallynon-material rewards such as praise and promotion.9 The reformshave eroded the importance of bureaucratic output setting, asindicated by the reduction in the scope of mandatory planning. Thenumber of binding plan targets were reduced from eight to four (grossvalue of industrial output, physical output of main varieties, qualityand profits).l? The number of products subject to mandatory

7. Gao Shangquan, iunianlai de Zhongguo ingi tizhi gaige (Nine Years of Reformsof the Chinese Economic System) (Beijing: People's Press, 1987)7 p. 33.

8. See Joseph S. Berliner, Factory and Manager in the USSR (Cambridge, MA:Harvard University Press, 1957), p. 28.

9. See The World Bank, China Socialist Economic Development Washington, DC:The International Bank for Reconstruction and Development, 1983), Vol. 1, p. 60.

10. Gene Tidrick, Planning and Supply, n Gene Tidrick and Chen Jiyuan (eds.)China's Industrial Reform (New York: Oxford University Press, 1987), p. 178.


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production planning at the national level has decreased from 120 in1984 to 60 as of 1986.1l The importance of guidance planning,

which, according to findings by an American economic team, is aproximate indication of local planning,l2 has risen, as shown in Table2.

Table 2: The Average Number of Products Covered by MandatoryPlanning, Guidance Planning and Market of 13 State-owned Enter-prises in Qingdao (Percentages)

Mandatory lanning Guidance lanning MarketTotal

150 585 2646 1000

Source:Chinese Institute for Reform of the Economic System, Gaige. Women mianling de

wenti yi silu (Reforms: Our Questions and Thinking) Beijing: Economic ManagementPress, 1986), p. 154.

The importance of target setting has declined also because targetsare not set taut and therefore can be achieved quite easily.l3 Planrevisions, achieved through bargaining with supervisory bureaucra-cies, contribute to the softness of plan targets.14

The Arrangement of Input Supplies and Output Sales. One of theimportant functions performed by the supervisory bureaucracy s thearranging of input supplies. It can do so through ts direct control overinputs or it can include the input supplies at a higher evel of material

balance (ministerial or provincial) and intervene with local materialssupply bureaus and commercial departments.ls Whereas beforereforms, the bureaucratic ability to allocate inputs mostly affected the

11. Gao Shangquan, Nine Years of Reforms, p. 34. However this reduction per sedoes not suggest weakening of bureaucratic o-ordination as some of the targets weresimply transferred o the local governments.

12. Although guidance planning is a far cry from the usual macroeconomicinstrument n a market economy, t is a step towards market operations or two reasons.First, under guidance planning, the state provides only a portion of inputs and

enterprises are forced to cater to market needs. Secondly, although there is evidencethat some local officials can make guidance planning compulsory, uch a practice s byno means uniform and local officials are obliged to strike equitable arrangementswith enterprises. See Naughton's discussion on the contrast between Dalian andChongqing in Barry Naughton, Summary of Findings, in Janet A. Cady (ed.),Economic Reform in China: Report of the American ECconomists tudy Team to thePeople's Republic of China (New York: National Committee on U.S.-China Relations,1984),pp.11-13.

13. Tidrick, Planning and Supply, pp. 182-83.14. Ibid.15. Andrew Walder, The nformal dimension of enterprise inancial reforms, oint

Economic Committee, the United States Congress, China's Economy Looks Toward he

Year 2000: Volume I The Four Modernizations (Washington, DC: GovernmentPrinting OfBce, 1 986), pp. 632-33.



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fulfilment of mandatory targets, two recent reform measures linkenterprises' profitability with bureaucratic allocation of inputs.

The first reform measure was the introduction of a dual pricesystem, under which investment goods produced above the plan couldbe sold at market prices. One effect is that sizable premiums-thedifferences between ofEcial and market prices-are conferred onadministratively allocated goods.l6 Enterprises an capture he premi-ums simply by selling administratively obtained goods at marketprices. Although this practice is illegal, it is sufficiently widespreadthat the State Council issued two documents in March 1985specifically prohibiting the practice.l7

The second reform measure, announced in 1984, stipulated thatinput needs above the fulfilment of mandatory production plans mustbe met at negotiated or market prices.l8 This measure allows anenterprise's profit level to depend crucially on the setting ofmandatory production targets, as the low mandatory targets enablethe enterprise to use the administratively allocated inputs to producefor the market where its goods could command higher prices.l9

While enterprises may be averse to bureaucratic control of theirproduction targets, incentives to reduce dependency on bureaucraticsupplies of inputs are weak, because the inputs bureaucrats ontrol arenecessarily scarce-energy and raw materials-and developing this

vertical dependency is one way to avoid capricious supplies.20 Forthis reason, progress toward market co-ordination in input procure-ment has been much slower than production of outputs, as seen inTable 3.

16. For example, the ex-factory price of number 6 5 steel wire was 610 yuan in 1985but its market price was between 1,S00 and 1,600 yuan in the same year. Also the

market price of coal was several multiples of state allocation price. See Wu Jinglian andZhao Renwe, The dual pricing system in China's industry, Journal of ComparativeEconomics, No. 11 (1987), p. 313.

17. See the State Council, Guowuyuan guanyu jiaqiang wujia guanli he jiandoujiancha de tongzhi ( Circular of the State Council concerning the strengthening ofadministration and monitoring of prices ) and Guowuyuan guanyu jianjue zhizhijiudi zhuanshou daomai huodong de tongzhi ( Circular of the State Councilconcerning prohibition against spot arbitrage ), n Legal Bureau, State Council,Zhonghua Renmin Gongheguo xianxing fagui huibian, 1949-1985 (Collection ofPeople's Republic of China Current Laws and Regulations, 1949-1985), volume ontrade and finance (Beijing: People's Press, 1987), pp. 749-751 and pp. 834-35. Thedocuments list various illicit transaction practices including market sales of goods

obtained within the plan directly and through transfer sales to the subordinatebranches, buying and selling of rationing coupons, plan quotas, contracts, etc.18. Guojia jingii weiyuanhui, guojia tizhi gaige weiyuanhui guanyu zengqiang

dazhongxing guoying gongye qiye huoli ruogan zhanxing guiding Some provisionalregulations by the State Economic Commission and State Economic Reform Commis-sion concerning he furthering f the autonomy of big and medium size enterprises ), nibid. p. 37.

19. Of course, this is a strategy pursued by those enterprises that produce for aseller's market. Presumably hose in a buyer's market would prefer an opposite strategy.

20. Indeed American economists found, through nterviews with factory directors, adesire to return to mandatory planning because of the supply problems. See BarryNaughton, Summary of Findings, p. 12. For a description of the effort of factory

directors o cultivate bureaucratic ies, see Andrew G. Walder, Factory and Managerin an Era of Reform,' China Quarterly, No. 118 (1989), pp. 253-54.


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Table 3: Average Number of Outputs and Inputs under Mandatory,Guidance and Market Co-ordinations of 13 Enterprises in Qingdao

(Percentages)

Mandatory Guidance Market

Production 15 58 5 26 46Procurement 60*8 25 3 13 9

Source:Chinese Institute for the Reform of Economic System, Gaige: Women mianling de

wenti yi silu (Reforms: Our Questions and Thinking) Beijing: Economic Management

Press, 1986), p. 154.

Supervisory bureaucracies control output sales first by theirdiscretion to alter the mandatory/market ales' ratios. Often, this ratiocan be altered without explicit approval from the supervisorybureaucracy. However, such alterations can, in effect, be endorsed ifthere are no punitive measures taken such as reducing administrativeinput supplies and bonuses.2l Secondly, the bureaucracies can setprices, either in co-operation with the State Price Bureau and its localbranches22 r because of their authority to adjust state procurementprices in cases of enterprises' need to purchase nputs from the marketfor their mandatory portion of production.23

Control over Financial Resources. Control over financial resources hasbecome a focal point in the interactions between bureaucracies and

enterprises. Thiscontrol falls into three broad areas: profit retention,

wages and bonuses and investment.(1) Profit retention: Before instituting the tax for profit system,

the main issue between the bureaucracy and the enterprises was theapportionment of the revenue after deduction of the 55 per centindustrial and commercial tax. Although the ratio of revenue sharingwas supposed to be fixed by the authorities,24 he retention rates weresubject to bargaining, as indicated by the varied retention rates as wellas low correlation between falling profits and retained profits (but high

21. The failure to punish enterprises' non-performance f mandatory argets can bebeneficial to those producing producer as well as consumer goods. Although in theabove plan consumer goods directly marketed by enterprises an be sold only at state-listed prices, these prices embody profits o the marketing gencies, herefore, ncreaseddirect marketing at state-listed prices in effect amounts to a transfer of revenue fromcommercial departments o production enterprises.

22. See the State Council, Wujia guanli zhanxing iaoli, Articles No. 9, l O, l and12, in Legal Bureau, Current Laws and Regulation, 1949-1985, volume on trade andfinance, pp. 716-19.

23. See Regulations on autonomy of big and medium size enterprises, p. 38.

24. According to Andrew Walder, 90% of after-tax profit was remitted to the stateand 10% was retained by the enterprise. See Walder, The informal dimension.



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correlation between rising profits and retained profits).25 The tax forprofit system, instituted in two phases in 1983 and 1984, merely

shifted the focus of enterprise and bureaucratic bargaining to thescheduling of adjustment taxes and of an assortment of fees, and togranting of tax exemptions, rather than eliminating the bargainingphenomenon itself.

(2) Setting of wages and bonuses: The discretionary power ofsupervisory bureaucracies and the autonomy of enterprises regardingwage policy seem fairly limited, especially compared with theirHungarian counterparts, who are not constrained by any nationalcontrol of the total wage bill.26 The central government controls thetotal wage bill by issuing an annual aggregate wage plan to lower levelbureaucracies to be disaggregated nto planned wage quotas at thelevel of enterprises. Local bureaus of personnel, planning and financemonitor the plan's execution. The central government also uses banksto control wage levels. Enterprises are required to open a wage fundaccount in one bank and to draw wage payments only from that fund.It is an administrative and, in serious cases, criminal offence to paywages from other funds, such as those of production, welfare, andreserve and bank loans.27

Bonuses are controlled more indirectly and local supervisorybureaucracies have more authority. The central government regulatesbonus-giving practices through bonus taxes. In recent years, the taxeshave been set at a prohibitively high level. They are 30 per cent onbonuses in excess of four months of wage equivalent, 100 per cent inexcess of five months and 300 per cent in excess of six months.28Secondly, supervisory bureaucracies have the authority to enforce thecentrally set ratios for allocations of production, welfare and bonusfunds among the retained profits. These ratios are, in principle, 50 percent for the production fund, 20 per cent for the welfare and 30 percent for the bonus fund.29

(3) Investment: The various fund-retention schemes, includingdepreciation fund retention introduced as long ago as 1967, tremen-dously strengthened the financial standing of enterprises. Theirretained profits rose from 3r7 per cent in 1978 to 42 2 per cent in1986.3? Enhanced enterprise financial standing, however, is not an

25. The World Bank found, in its sample enterprises, a very low correlation ndex

(0-15) between retained profits and total profits when the total profits were falling, but arather high correlation 0 66) when the profits were rising. See Tidrick, p. 206.26. Kornai, The Hungarian Reform Process, p. 1696.27. See the State Council, Gongzi jijin zhanxing guanli banfa ( Provisional

regulations on the management of the wage fund ) 24 September 1985, Articles Nos. 3,5, 6, and 18 in Legal Bureau, Current Laws and Regulations, 1949-1985, volume onlabour and personnel, pp. 214-17.

28. State Council, ;'Guoying qiye jiangin zhanxing guiding ( Provisional regula-tions on the bonus tax of state-owned nterprises ), n Legal Bureau, Current Laws andRegulations), p. 233.

29. See the Ministry of Finance, Caizhengbu uanyu guoying qiye tuixing ligaishuidierbu gaige de baogao ( Report by the Ministry of Finance on the Second Step of

Reform of Tax for Profits'), bid. p. 152.30. Gao Shangquan, Nine Years of Reforms, p. 32.


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accurate ndication of enterprise autonomy as enterprises till dependon bureaucracies or investment approval. Project-approving uthor-

ity is divided along administrative and regional ines according o theyuan amount that is required by the project in question. This can beseen in Table 4 which lists the project-approving authority at andbelow the provincial level. As of 1984, the yuan amount whichrequired approval from the State Planning Commission was 30million. Projects financed by extra-budgetary unds are, in principle,approved by line ministries and provinces in charge.3l

Table 4: Project-approving uthority along Administrative Lines, 1984

unit: 10, 000 yuanAdministration/projects Fixed investment Transformation

Counties 100-500 50-100Counties (comprehensive

reforms) 500-1,000 50-200Prefectures, cities,

provincial leading agencies 100-1,000 300-500

Cities under the provincialadministration 1,000-3,000 1,000

Cities of provincial rank 3,000 1,000

Source:Chinese Institute for the Reform of the Economic System, Gaige: Women mianling

de tiaozhan yi xuanze (Reforms: Our Challenges and Options) (Beijing: ChineseEconomic Press, 1986), p. 166.

Part II: The Two Main Actors in the System: Economic Bureaucratsand Enterprise Managers

To understand the behavioural consequences as a result of thepartial nature of economic reforms, we need to study the two majoractors n that system, the economic bureaucrats nd factory managers,in more detail. Specifically two issues are relevant. The first one iswhat might be called operative characteristics of Chinese economicbureaucrats and factory managers. This refers to ways compliance issecured in their job performance- whether through bureaucratic iator reciprocity as in a case of financial nducements. The second aspectis the objectives that motivate bureaucrats and managers n the dailyexecution of their tasks and the factors that shape and help form these

. . .

ObJectlves.

31. See Guowuyuan zhuanpi guojia jingwei guanyu gaijin jihua tizhi de ruoganzhanxing guiding de tongzhi ( Circular by the State Economic Commissionconcerning certain regulations on the improvement of the planning system approved

and transmitted by the State Council ), in Legal Bureau, Current Laws andRegulations, volume on industry, transport and urban construction, pp. 25-26.



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Operative Characteristics. lthough the Chinese nomenclature reatseconomic bureaucrats and factory managers as simply two layers in

the same bureaucracy, they are actually quite different in terms offactors that motivate them in their job performance. What makes therelationship of an industrial bureau chief with his subordinateenterprise manager qualitatively different from his relationship with anormal subordinate bureaucrat are the ways the bureau chief securescompliance from him. Bureaucracy, viewed in the Weberian tradi-tion, is characterized by a hierarchy of authority. 32 Authority isexercised when a subordinate accepts a decision by his superiorwithout independently questioning its merits and he does not haggleover the reward that accords his performance, at least not on a quidpro quo basis.33 The ability of the bureaucracy o secure compliancethis way is said to be one of its sources of superior efficiency overalternative organizations.34

Before the reforms, a Chinese manager was in an analogoussituation: he carried out production plans very much as adminstrativeorders and his motivation to comply was to avoid punishment as wellas to gain possible promotion. As a result of reforms, the incentivestructure hat governs a Chinese manager's performance of his task isat least a partial departure rom this mode. His remuneration s basedon a piece-rate implementation of orders he receives, which meansthat non-performance riggers reward withholding only, but does notreduce current benefits. This change in the incentive structure cameabout as a result of the recognition that efficiency requires a degree ofenterprise autonomy. This autonomy is institutionalized in the

contract responsibility system, (chengbao) dopted incrementallysince the early 1980s and on a large scale in 1987.35 The principalfeature of this system is a contract between a supervisory agency andits enterprise hat specifies the manager's duties such as tax and profitremittance quotas and their respective rights-protection from un-warranted policy changes and guaranteed delivery of productioninputs.36 The relationship between an industrial bureaucrat and anenterprise manager has evolved to be what Charles Lindblom calls

control through exchange, whereby the controller gives up somevalue to induce the controlled to do what he wishes.37 The reciprocalnature of this relationship, as will be argued later, has important

implications for the ways in which bureaucracies interact withenterprises n the current Chinese system.

32. Max Weber, Politics as a vocation, in H.H. Gerth and C. Wright Mills (eds.and trans.) From Max Weber: ssays in Sociology New York: Oxford University Press,1958), pp. 77-128.

33. Herbert Simon, Administrative Behavior New York: Free Press, 1976), p. 11.34. Ronald H. Coase, The Nature ofthe Firm, Economica, Vol. 4, No. 16 (1937),

pp. 386-405.35. As of October 1988, 93% of large and medium size enterprises and 83% of

enterprises under government budget have adopted contract responsibility ystem. SeeRenmin ribao (People's Daily), 2 November 1988, p. 1.

36. Regulations on autonomy of big and medium size enterprises , p. 35.37. Charles E. Lindblom, Politics and Markets New York: Basic Books, 1977), p. 19.


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Objectives f Bureaucrats nd Managers. t is diflicult to determineempirically what the objectives of Chinese economic bureaucrats are

because of the paucity of information. The usual approach is toassume that economic bureaucrats ry to maximize revenue.38 This isa plausible assumption but it begs a question in itself: for whatpurposes do economic bureaucrats maximize revenue? This is a muchharder question to answer.

There are basically two competing categories of explanations. Thefirst one argues that a bureaucrat maximizes revenue becauseincreased flow to the coffer pleases his superiors and enhances hispromotional prospect. The second one claims that increased revenue

itself benefits the bureaucrat and/or the office he is identified with.The increased rearenue ncreases his autonomy vis-a-vis his superiorsor it increases his or his office's spending power to purchase desiredgoods and services.

The difference between the first and second postulates is vast interms of implications for bureaucratic behaviour. If the first postulateis correct, then the bureaucrats would only maximize revenue to theextent and in ways approved by the superior agencies. If the secondpostulate is correct, then the bureaucrats may maximize revenue toan extent and in ways detrimental to their superiors. In the followingparagraph, we are going to determine which postulate is moreapplicable in the Chinese case.

In order for bureaucrats to maximize revenue for promotionalconsiderations, the bureaucratic selection and promotion criteriahave to be merit based, predictable and well specified. The Chinesenomenclature ystem falls short of these qualities. First, vicissitudesin Chinese politics have probably deprived cadre selection criteria ofany temporal consistency and predictability which might have beenoriginally intended. Family origin was added and then dropped as acriterion; political integrity has been defined and redefined severaltimes to suit the shifting political currents.39 econdly, promotionaldecisions do not give sufficient weight to professional accomplish-ment. Before and during the Cultural Revolution, political criteriawere stressed at the expense of other considerations in the promo-tion and selection process, as indicated by the dominance by thepolitical functionaries rather than by technical specialists in theleading positions.40 n recent years, while the importance of political

38. See William A. Niskanen, Bureaucracy nd Representative Government Chicago:Aldine, 1971).

39. During the Maoist era, political integrity meant adherence o a set of orthodoxcommunist virtues and in recent years, the reformist leadership has redefined theconcept to embrace its emphasis on economic development. (See John P. Burns,

Civil service reform in contemporary China, The Australian Journal of ChineseAffairs, No. 18 (1987), pp. 62-63.) However, in the wake of Tiananmen, the Chineseleadership attempted to revert to the traditional definition of political integrity. In hisreport on Party building o the heads of Organization Departments, Song Ping, thePolitburo member in charge of Party discipline and personnel, renewed emphasis onthe ideological purity of cadres. See Renmin ribao, 23 August 1989.

40. A. Doak Barnett, Cadres, Bureaucracy, and Political Power (New York:Columbia University Press, 1967), pp. 54-55.


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criteria may have declined, any ambitious cadres cannot simplyignore them. Party officials still openly intervene in the recruitment

process, even in cases where recruitment is based on civil serviceexaminations.4l The endurance of political criteria also stems fromthe institutional arrangement and the selection procedure itself.Parallel to each personnel department in government agencies is theParty's Organization Department, which, using the personnel dossi-ers it controls, is in charge of cadre evaluation-background andperformance appraisal, etc.42 Furthermore, the new criteria, insti-tuted to dilute the dominance of political considerations, stresseducational attainment43 and this may inadvertently discriminateagainst many of the current government functionaries, especiallythose working at the local level.

The third cause for weak promotional considerations n the Chinesebureaucratss alculus to perform s the role of intangible and informalrules of thumb in the promotion process. Satisfaction of theestablished criteria, be it political or professional, is not the soleconsideration in the cadre evaluation. Another important factor iscollegiality. Hence built into each appointment decision is a negotia-tion and consensus-building process, whereby the superiors ensurecollegial acceptance of their choice.44 One important effect of thisprocess is that many appointments and promotions tend to be in-house, regionally (difang) r departmentally (bumen).45 his is incontrast with the appointment design of the commune system, whichconsciously sought to root out any conflicts of interest by alwaysappointing an outsider as the commune's Party secretary.46 The in-house transfer of personnel enhances the role of an informal politicalnetwork -that appointment and promotion decisions depend onacquaintances and personal relationships guanxi), diluting any effectof formal criteria.

41. Burns, Civil Service Reform, pp. 60-62.42. Melanie Manion, The cadres management ystem, post-Mao: The appointment,

promotion, transfer and removal of Party and state leaders, China Quarterly June1985), p. 216.

43. In a document by the Central Committee, it was decreed that the minimumrequirement for promotion to the central departments of the government must be

educational and professional competence of high school or middle-level technical

school. See Zhonggong zhongyang he guowuyuan guanyu zhongyang dangzhengjiguan ganbu jiaoyu de jueding ( Decision by the Central Committee and the StateCouncil concerning he education of the cadres n the central departments of the Partyand the government ), n Shierda yElai zhongyao wenxian xuanbian (Selections ofImportant Documents Since the 12th Party Congress), Vol. l, (Beijing: People's Press,1986), p. 104.

44. Manion, p. 217.45. According to one study, between 1949 and 1985, 24% of appointments at the

provincial level were of individuals native to their own provinces; 19%, hough notnatives of provinces of appointment, pent the majority of their working ives there anda further 23% were appointed from positions within the same province. David S.G.Goodman, Political Perspective, China's Regional Development London: Routledge

for the Royal Institute for International Affairs, 1989), p. 31.46. See Barnett, pp. 344-45.


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If promotional considerations constitute a weak motivation tomaximize revenue in the calculus of Chinese economic bureaucrats,

how likely is it that they do so in order to directly benefit themselvesand their own agencies? The discussion requires an examination ofconstraints in the Chinese system for this kind of behaviour.

It seems that the constraints for bureaucratic appropriation of therevenue for his or his agency's own benefit at the expense of that of hissuperiors have declined. The first constraint is ideology. Albert 0.Hirschman argues that supply of corruption is a cause for itsoccurrence, in addition to opportunities for it. The supply ofcorruption, he reasons, is a product of the values of those who holdpositions of power.47 The values of government functionaries dependon their socialization process, one major component of which iseducation.48 By that criterion, Chinese bureaucrats should be fairlycommitted to the purpose of their institution due to intensive anddirected efforts to mould political consciousness. Party schools areestablished specifically to provide ideological preparation beforecadres' tenure and there is a six-month training period for cadresevery three years during their appointment.49

But Chinese cadres' commitment to the values of their institutionswere weakened considerably during the Cultural Revolution, whichundermined the institutional and the ideological apparatus of theParty. Their commitment is also affected by the general change insocial attitudes and norms. There is no reason to expect that thebureaucracy as a whole should be immune from the money fetishism(xiangqiankan) hat is prevalent in Chinese society today. Therepeated concerns voiced by Party and government leadership overcorruption, embezzlement and nepotism are a reflection of the extentof erosion of the ideological commitment of cadres.

As the ideological commitment has waned the erosion in theincome position of Chinese cadres as a result of reforms has probablyincreased their susceptibility to money fetishism. The economicreforms, by linking benefits with performance, have not improved thematerial welfare of bureaucrats and enterprise employees by the samedegree. This is a result of several differences between governmentofficials and enterprise employees. First, the income structure isdifferent. While a government official receives a basic salary andvarious subsidies, an enterprise employee receives

bonuses in addi-tion to a basic salary and subsidies. Secondly, while the bulk of thesalary of a government ofEcial s fixed, that of an enterprise employeevaries with pieces of work performed and time and effort expended.Thirdly, enterprise employees enjoy other forms of compensation and

47. Albert 0. Hirschman, Shifting Involvements: rivate Interest and Public Action(Princeton: Princeton University Press, 1982), pp. 123-25.

48. Joel D. Aberback, Robert Putnam and Bert A. Rockman, Bureaucrats andPoliticians n Western Democracies Cambridge, MA: Harvard University Press, 1981),

p. 7.49. See Central Committee, Education of cadres, p. 105.


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provision of benefits such as highly demanded housing on account ofretained profits.

Table 5: Income Structures of Party and Government Officials andState-Owned Industrial Enterprise Employees, 1986 (Percentages)

Officials Employees

Grade salary 4 8 54-1Basic salary 68-1 2-2

Piece rate salary 0-0 10 0Above quota payment 0-0 2-0Bonuses 9-1 15 2Subsidies 16-2 14-0Overtime payments 0 3 2 7Miscellaneous payments 1 5 1 6Total 100-0 100-0

Source:Zhongguo Tongi Nianjian 1987 (China Statistical Yearbook

1987) (Beijing: China Statistical Press, 1987), p. 690.

These factors, compounded by lack of job mobility between publicand profit-oriented sectors, have contributed to a widening incomegap between government officials and enterprise employees. This isshown in Table 6.

Table 6: Inflation-adjusted Average Annual Per Capita Incomes ofGovernment Officials and State-owned Enterprise Employees in allSectors, 1978 and 1986 ( Yuan)

1978 1986

Government officials* 662 00 837 80Enterprise employees 680 60 921 -80(1) minus (2) -18 20 -83-99

Sources:Zhongguo Tongii Nianjian 1981 and Zhongguo Tongji Nianjian

1987 (China Statistical Yearbooks) Beijing: China StatisticalPress, 1981 and 1987).

*Also includes members of the Communist Party and massOrganlzatlons.

The other constraint relevant to a bureaucrat's calculation is the

potential punishment that a bureaucrat may face when he exercisesthe so-called extended use of authority use of power beyond its



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original purposes.50 There are two issues involved here. One is theextent to which the category of punishable acts is clearly delineated sothat an unambiguous association exists between acts deemed punisha-ble and the actual visitation of punishment. In this regard, theChinese system fares rather poorly. Acts deemed punishable are oftennot determined by their nature but by the purposes they are supposedto serve. Thus government officials quickly learn how to couch self-benefiting activities in terms acceptable to superior authorities.Another source of ambiguity is the vagueness in policy directives,giving significant leeway to various interpretations. Terms like inprinciple and reasonable are abundant in Chinese policy direc-tives with no clear guidelines as to their intended meanings. This doesnot mean that wrong policy interpretations do not stand to becorrected; only that corrections are not accompanied by punishmentssuch as demotion and reduction in pay.

The second issue is the efficiency and efEcacy of the monitoringsystem. The Chinese system is relatively efficient in detecting andmonitoring flagrant official improprieties, but rather inadequate indealing with routine deviations in policy implementation. A majorcontributing factor here is the institutionalized conflict of interestbuilt into the way in which the Chinese monitoring agencies aresupervised. These agencies are usually under a dual leadership- jointleadership by the central and local governments-and when localgovernment officials themselves are a part and parcel or directbeneficiaries of policy deviations, the system breaks down rathereasily.5'

Next, we turn to objectives of Chinese managers. The approach issimilar to the one in the previous sections, i.e., we first examine theoperative constraints that shape the psychology of Chinese

managersand then deduce their most plausible objectives.There are two commonly alleged objectives of managers of socialist

firms. One is the desire to conform to the commands of superiorregulatory and supervisory agencies. The other is output maximizing.It seems that both objectives are not applicable to managers in theChinese economy.

The tendency for socialist managers o conform to the commands ofsuperior agencies is attributed to the design of the appointment

system. As pointed out in the first part of this paper, factory managersare appointed, fired and promoted by superior agencies. This verticaldependency is to ensure that self-interested managers place theirsuperior's wishes above those of their employees, in cases when theycome into conflict. Despite the seeming plausibility of the assertion, tis not empirically established that factory managers are actually

50. Lindblom, Politics and Markets, p. 24.51. For an example of this kind of problems encountered by the Party's control

organization, he Party Discipline Inspection Commission, see Lawrence R. Sullivan,The role of the control organs n the Chinese Communist Party, 1977-1983, AsianSurvey, Vol. 24, No. 6 (1984).


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rewarded and punished solely for their performance of superiors'commands. As pointed out before, there are factors in the Chinese

cadre system that may mitigate a merit-based promotional processand managers may not be certain of the correlation between effort andpromotional opportunities. The uncertainty of reward s compoundedby the uncertainty of the cost of failure to perform bureaucraticcommands. The reason is simple. When production or financialtargets are not met, the factory manager can blame the poorperformance of his enterprise on a host of objective conditions -defined as anything beyond the direct control of the enterprisemanager.S2 As a result, the manager may retain his post or can betransferred to another job without significant loss of income andprestige.

The second commonly held objective of managers in socialistcountries is output maximizing. However, as pointed out earlier, inChina, unlike the Soviet system, bonuses to factory managers werenot used extensively to ensure the fulfilment of production targetsbefore reforms and in the reform era production targets are usually setwell below production capacity, and the need for incentives forachieving plan targets is small or non-existent. By the mid 1980s,output maximization had become a minor concern to Chinese firmmanagers. A survey conducted by the Chinese Institute for Reform ofthe Economic System revealed that 359 enterprise managers put

fulfilment of production quotas and doubling of product value inthe 11th and last places respectively.53

The dominant objective of Chinese managers, his paper argues, sto increase benefits and security to enterprise employees in the formof bonuses, housing and employment opportunities.54 There areseveral reasons. One is that although most managers are appointed bysuperior authorities, appointment decisions are based on some degreeof consultation with employees. Employees' right to have some sayover the managerial appointment process is a part of the industrialreforms and is formally acknowledged in the recent law on enter-prises.55 The other reason, which is probably more important, is theroute of managerial promotion. Since there is no market formanagers, most managers are promoted from the ranks of theemployees of the same factory. According to a survey conducted in1985 of 900 enterprises, 81 3 per cent of the

managers or cadres ofequivalent rank had worked in their factories for over 10 years and

52. Walder, Factory and Manager n an Era of Reform, p. 258.53. Chinese Institute for Reform of Economic System, Gaige: Women mianling de

tiaozhan yi xuanze (Reforms: Our Challenges and Options) Beijing: Chinese EconomicPress, 1986), p. 16.

54. This is one of several objectives a World Bank team found in its field research.See William Byrd and Gene Tidrick, Factor Allocation and Enterprise ncentives, nTidrick and Chen (eds.), pp. 61-65.

55. Zhonghua Renmin Gongheguo quanmin suoyouzhi gongye qiye fa (Law of the

People's Republic of China on industrial tate-owned enterprises), Article 44, Chapter4, Renmin ribao, 18 April 1988, p. 3.


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42*2 per cent for over 20 years. These statistics also show that Chinesemanagers spend a long time working as factory employees before they

become managers. According to the same survey, the average timeChinese managers spend working in factories is 18 years.56

The personal ties between managers and employees and thestrength of such ties, fostered over a long period of time, give rise to

organizational oyalty -commitment to the interests and goals oftheir own organizations.57 The direct result of this organizationalloyalty on the part of factory managers s the way they prioritize theirgoals. Managers are, first and foremost, to enlarge the enterprise'sbonus fund and the pursuit of other targets, such as profits andfulfilment of planned targets, becomes the means to this end.

Part III: The Pattern of Behaviour n the Mixed Mode of EconomicCo-ordination

This part of the paper focuses upon what Kornai calls the politicaleconomy of co-ordination -the complex social relationships andinterests generated as a result of the way economic activities are co-ordinated.58 pecifically we seek to show a pattern of behaviour on thepart of Chinese economic bureaucrats and factory managers in anenvironment of mixed mode of economic co-ordination.

Two contrasting mages emerge from the current iterature on thisissue. The first image presents local governments as developmentallyoriented and thus very protective of their subordinate enterprises.According to this image, local governments share with enterprises heurge to expand local production and adopt policies such as easy creditand tariff protection against inter-regional rade.59 The second imageportrays local government as exploitative and predatory on theirsubordinate enterprises. According to this image, pecuniary-mindedlocal government officials use their administrative authority andeconomic control to extract exorbitant fees from the helplessenterprises, often to the extent of crowding out production anddevelopment funds.60

The argument of this paper is that these two images do notnecessarily contradict with each other. Rather they are merely twodifferent facets of a pattern of behaviour beneficial to both supervi-

56. Chinese Institute for Reform of Economic System, Reforms: Our Challenges ndOptions, pp. 276-77.

57. For an excellent description of the web of interests formed between managersand employees and their tacit agreement to provide generous compensations, seeAndrew Walder, Wage reform and the web of factory interests, n China Quarterly,No. 109 ( 1987), especially pp. 30-33.

58. Janos Kornai, Bureaucratic nd Market Coordination, p. 309.59. See, for example, Christine P.W. Wong, Material allocations and decentraliza-

tion: Impact of the local sector on industrial reform, n Perry and Wong (eds.), pp.274-75.

60. This view is prevalent n the Chinese economic press and central government'spolicy directives prohibiting the predatory practices engaged n by the local govern-ments.


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sory bureaucrats and their subordinate enterprises. The relationshipbetween bureaucrats and managers s, as pointed out before, recipro-

cal and interactive. The pattern of behaviour refers to the exchange ofrespective resources as each try to jointly maximize their objectives.

The resources which supervisory bureaucrats have are their policyfunctions. As described in the first part of this paper, they have threepolicy resources that can directly affect an enterprise's profitability.First, they control the allocation of physical inputs - especiallyscarcity inputs such as energy and raw materials or at least have theability to arrange nput supplies. Secondly, they invariably have somemeasure of discretionary authority, arising from either the inherentambiguity n the central policy directives or their authorized decision-making power. Thirdly, they are in charge of enforcing policydirectives and monitoring their compliance by enterprises under theirjurisdiction.

The resource on the part of the subordinate enterprises isexclusively economic: revenue in the form of taxes and contributionof other fees. An enterpriseSs contribution of its resources to itssuperior agencies would vary greatly according to the latter's formaltax or fee-setting authority and its informal policy alterations.

There are basically two general avenues through which localbureaucrats provide direct benefits to themselves and through whichenterprise managers enlarge bonus fund. The obvious one is toincrease production through investment in factory facilities andimprovement of production techniques, etc. For the local govern-ment, increased production and increased profits can widen thetax/fee base and for enterprises they can bring in higher levels ofretained profits. The second avenue is simply to allocate a largerportion of existing resources to provision of direct benefits tobureaucrats and to enlarging of bonus funds. Since resources arefinite, increased spending would necessarily reduce nvestment, whichis to generate future income streams to finance consumption. For anyorganization or individuals, there is a real trade-off between con-sumption and investment.

The common purpose on the part of the leading agencies andenterprises is to avoid this trade-off and to increase the level ofinvestment funds without adversely affecting current consumption.

For this purpose, a series of illicit shuffling of fundsand exchange of

resources occurs both within an enterprise and between an enterpriseand its leading bureaucracy. The illicit shuflling of funds takes place attwo levels. At the enterprise level, managers concentrate retainedprofits overwhelmingly into the bonus funds. A study finds that theenterprises' division of funds among bonus, welfare, and productionuses favours the bonus fund by far and exceeds legally specifieddistribution by wide margins. This can be seen in Table 7.

Another indication of the same trend is that the growth rate of thebonus fund far exceeds that ofthe retained profits. As shown in Table 8,


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Table 7: Employee Bonuses, Retained Profits and Legally SpecifiedUses, Selected Enterprises Yuan)

1. Nanchang 2. Jiangxi 3. JiangxiDiesel Insecticide Polyester

Engine Factory FactoryFactory

1983 1984 1983 1984 1983 1984

Annual retained profits(yuan/employee) 130 219 826 413 119 462

Bonuses actually received(yuan/employee) 100 136 167 195 86 128

Actual bonus/profit ratio (%) 77 62 20 47 72 28Bonus/retained profits

legally specified (%) 20 27 20 22 20 35

Source:Chinese Institute for the Reform of the Economic System, Gaige: Women mianling

de wenti yi silu (Reform: Our Questions nd Thinking) Beijing: Economic ManagementPress, 1986), p. 24.

retained profits allocated to bonus purposes grew at astronomical rateseven when the growth rates for retained profits themselves were low ornegative.

Table 8: Growth Rates of 1984 over 1983 of Retained Profits and BonusFunds

12 enterprises in 10 enterprises inNanchang Fuzkou

Growth rates % Growth rates %

Retained profits -3-24 17 83Bonus of retained profits 71 -94 55-50

Source:

Chinese Institute for the Reform of the Economic System, Gaige: Women mianlingde wenti yi silu (Reform: Our Questions nd Thinking) Beijing: Economic ManagementPress, 1986), p. 25.

The second method managers use to preserve the growth of thebonus fund is to pay various fees demanded by local governments bydrawing from their production, welfare and technical transformationfunds. According to a study of 100 enterprises, he incidence of fees to

the local government among the various funds is: 20 per cent countedas production costs, 10 per cent from the welfare fund and 70 per cent



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from the technical transformation und.6l The direction of the flow offunds in the shufiling at the enterprise level is illustrated in the

following chart.

Chart 1: Direction of Flows of Funds among Competing Purposes

| Local government |

Fees

Enterprise's l l lfunds: |Bonus | | Welf are |Transformation |Production |

f I I I

Managers' shuffling practices would normally create two problemsfor the enterprise. First, by shuMing retained profits out of theproductive and welfare funds into the bonus fund, the enterpriseviolates the specific ratios established by the central government forthe use of retained profits. Secondly, since the increase of the bonusfund is achieved at the expense of the production, technicaltransformation and welfare funds, the enterprise has to seek resourceselsewhere for production and investment. It is in these two areas thatthe crucial role of local governments and supervisory agencies is to beunderstood.

Scholars of Chinese economic reforms have pointed out theexistence of a bargaining regime between bureaucracies andenterprises: they jointly make decisions regarding enterprises' pro-duction and profit targets and typically in cases of faltering perform-ance, bureaucracies revise these targets downward and providefinancial and other support to enterprises n trouble.62 t is argued hatit is this bargaining process that leads to what is known as soft-budget constraint -the ability for the enterprises to make losseswithout suffering severe financial consequences.

It is clear, in this formulation, about the benefits enterprises obtainfrom bureaucracies. What is not clear is why the supervisorybureaucracies should grant these benefits to the enterprises at all.63 Avery convenient explanation for bureaucrats o provide help is simplythat it is a bureaucratic

mandate to do so. Chinese bureaucrats aresupposed to distinguish between policy losses -those losses result-ing from irrational operations of or changes force majeure in the

61. See the Chinese Institute or Economic System Reform, Reforms. Our Challengesand Options, p. 231.

62. SeeS for example, Barry Naughton, False Starts and Second Wind: FinancialReform in China's Industrial System, n Perry and Wong (eds.), pp. 235-38.

63. For example, a World Bank study concluded that bargaining and negotiationscharacterize interactions between supervisory agencies and enterprises and thatconcessions are made to enterprises with regard o profit retention rates. But the study

did not show the motive of these agencies in granting hese concessions. See Tidrick,Planning and Supply, pp. 198-99.



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economic system-and performance osses -those losses resultingfrom managers' mistakes. They are to compensate for the former and

enforce punishment in the latter. But the problem is that enterprises'knowledge of the softness of their budget would create a problemknown as moral hazard -the conscious and deliberate failure tooptimize. It is next to impossible for Chinese bureaucrats to tellobjectively whether an enterprise's faltering performance is due toexternal exigencies or lesser exertion of managers' effort. Unless eachrequest for help is automatically granted, something other than theofEcial bureaucratic mandate must guide bureaucrats' decisions tohelp selectively - both in terms of amount of support granted and theirchoices of the recipients of the support.

The argument put forward n this paper is that bureaucrats benefitfrom helping their subordinate enterprises. They benefit not just inthe sense that production of important goods is maintained and adesirable level of regional employment is maintained, but in a morespecific and direct sense: they provide benefits to enterprises becauseit helps their appropriation of enterprise revenue for their privateuses.

The crucial link between bureaucratic argesse and their pecuniaryinterest is what is known in Chinese as tanpai-the imposition ofvarious fees on enterprises in addition to formal tax obligations.These fees which come under numerous names, are levied bothwithin and beyond formal authority of local governments. Centraldirectives are often vague on this issue and include such nebulouscriteria as the amount and puiposes to which these fees are put.64 neither case, local governments have complete control over the use ofthis money and they use it extensively for private purposes.65

Bureaucracies can use their policy resources o exchange for fees ina variety of ways. First, they can explicitly and directly ink supplies ofcrucial inputs with the enterprise's payment of fees. This practice ismost common when the inputs in question have an inelastic demandand over which bureaucracies have an exclusive control, such as

64. For example, a document jointly issued by the General Offices of the CentralCommittee and of the State Council in 1983 declared that the fees could only beimposed in cases where projects undertaken were beneficial o the people and urgent

and should go through consultations with the masses. See the General Offices of theCentral Committee and the State Council, Guanyu ianjue zhizhi yi 'jizi' weimin xiangqiye shiye danwei he geren uan tanpai de tongzhi ( Circular n firmly prohibiting eeimpositions on enterprises, non-profit nstitutions and individual households in thename of raising funds ), the Policy Research Office of Industry and CommerceAdministration Bureau (ed.), Gongshang ingzheng uanli zhengce agui xuanbian(Selections of Policies and Regulations n the Administration f Industry andCommerce) Beijing: China's Financial Economic Press, 1986), pp. 207-208.

65. An example of how this money is used for private benefits is the industrialbureau of Hejin County n Shanxi province. Between 1984 and 1986, the bureau eviedfees on its 16 subordinate nterprises, mounting o 1 7 million yuan. t used the moneyto finance the renovation of staff housing, building a staff hospital, purchase ofconsumer durables and payment of bonuses in kind to its employees. See Jingji Ribao(Economic aily), 5 September 1987, p. 2.


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electricity, water, etc.66 The second way is subtler. Bureaucracies andenterprises could reach an implicit or explicit understanding: enter-

prises agree to the schedule of fees imposed on them and bureaucra-cies use their discretionary authority over price setting, projectapprovals and credit allocations to supply help. The third way is thatbureaucrats alter policy enforcement; for example they can withholdpunishment to fee-paying enterprises when these enterprises engage nillicit arbitrage activities-transacting of administratively allocatedgoods at market prices.67 Next, allocation of bank credits and policyenforcement are used to illustrate this process.

The reforms of Chinese banking system-creation of a centralbanking institution and granting some autonomy to commercialbanks in their credit decisions-aimed at strengthening macroeco-nomic control, improving microeconomic efficiency and allocatingresources on economic rather han political grounds.68 he experienceso far has been largely disappointing. Political interventions intensi-fied and the central government lost its grip over macroeconomiccontrol several times. In the 1983-84 period, for example, bank loans,rather than extra-budgetary unds and enterprises' retained profits,contributed heavily to the investment drive and, in turn, themacroeconomic imbalance at the time. This can be seen in Table 9.

The reason for this heavy reliance on bank loans for investment issimple. As pointed out before, enterprises may have depleted theirproduction-related unds by striving to increase their bonus fund andby paying a portion of their fees to the bureaucracy rom production-

66. This practice of direct linkage is not confined to production inputs nor to

payment of fees. Public security offices in some regions have threatened o withholdprotection f fees were not paid. Elsewhere he provision of jobs is linked with suppliesof inputs by those bureaucracies n charge. Chinese managers refer to their supervisorybureaucracies s grandmothers nd those bureaucracies eeking benefits this way as

uncles. See Jingji ribao, 17 December 1986, p. 1.67. There is a fourth way bureaucracies an use their allocative authority o benefit

themselves. They could charge enterprises higher prices than the state-stipulated ricesbut lower than market prices, appropriating he difference. Another method would beto sell supplies and materials under heir control at market prices, appropriating he fullamount. The direct appropriation y the bureaucrats ecomes a more serious problemwhen the product market s liberalized. n the earlier period, this kind of problem seemsto be confined to transactions among enterprises, as indicated by a circular ssued by

the State Council in 1981, which listed various fees enterprises paid to obtain scarcitygoods in addition to prices. The 1985 decision to allow market prices to flow freelyamounts to rendering his kind of activity legitimate but may have shifted the samepractice o interactions between material upply bureaus and enterprises. There are twoindications for this shift. First, in 1985, it was the Central Committee of theCommunist Party that issued a document (No. 57), addressing rregularities n thecadres' work style. Second, the problem was revealed by a deputy Party secretary of theState Material Bureau, ndicating hat the criticism was aimed at cadres working n hisbureau. According to his speech, in the first six months of 1986, 657 cases of illegalmaterial supplies were exposed. See Wuzi guanli (Material administration), August1986, p. 3.

68. Zhou Xiaochun and Zhu Li, China's Banking System: Current Status,

Perspective on Reform, Bruce Reynolds (ed.) Chinese Economic Reform (Boston:Academic Press, 1988), pp. 1 16-17.


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Table 9: Growth of Fixed Asset Investment rom 1983 to 1984 in 23Cities (Percentages)

Growth rates

Extra-budgetary unds 7 4Total fixed asset investment funds 20-42Bank loans to state enterprises

for fixed asset investment 52 79

Source:Chinese Institute for the Reform of the Economic System, Gaige:

Women mianling de tiaozhan yi xuanze (ReJnorm: ur Challengesand Options) Beijing: Chinese Economic Press, 1986), p. 230.

related funds. Thus enterprises must seek resources elsewhere torefurbish these and banks are the most natural candidates. Enter-prises' requests for bank loans are met with the eager desire on thepart of bureaucracies to co-operate as refurbishing enterprise pro-duction-related unds this way serves the twin objectives of satisfyingfactory employees' consumption requirements and of strengtheningthe enterprises' ability to pay fees. Furthermore, since maintainingmonetary balance is a central concern, local bureaucrats have extraincentives to free-ride banks' resources. Thus not only do they givemany approvals for loan requests, they also arrange ubsidized or freeinterest rates and deferred schedules for the repayment of principals.69

Bureaucrats can selectively enforce regulations and policies toattain similar purposes. In recent years, Chinese government has

reported widespread pricing irregularities, illicit transactions ofadministratively allocated goods, and poor performance of manda-tory production contracts.70 Fiscal fraud is also a serious problem. Asurvey conducted in 1987 and 1988 revealed that 1-8 per cent ofbudgetary ncome was lost in fiscal fraud and another report showedthat about 70 to 80 per cent of enterprises engage in tax evasions.7l

This paper argues that the ability of enterprises to engage in large-scale policy violations is due to the fact that local economic

69. See the Chinese Institute or Economic System Reform, Reforms: Our Challengesand Options, p. 231.

70. Price violations take numerous forms from arbitrage to collusive pricing.According o an investigation by the State Council, between May 1986 and May 1987,33,797 cases of price violations were found in 14 provinces (Jin


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bureaucrats have strong incentives not to enforce certain policies andregulations. For example, they can deliberately fail to collect central

taxes and appropriate a portion of central revenue by imposing fees,which go to local coffers.72 Similarly, local bureaucrats have incen-tives to tolerate illicit transactions because part of the revenue is

taxed away by them. This complex collusive scheme of using policyresources o exchange for Enancial benefits between bureaucracies andenterprises s summarized in Chart 2.

Chart 2: Mutually Beneficial and Collusive Pattern of Behaviour on thePart of Bureaucracies and Enterprises

Administrative decreesLocal Government ____________o Banks

Taxes Fees | ( v) Input supplies(ii) Lax enforcement of policies

l and regulations

| Enterprise S(i) For fixed asset investment

(ii) For technical transformation* o: Direction of flows of funds

_: Direction of flows of policy benefits---_: Direction of orders

Part IV: Implications or Future Reforms

Next, we come back to the issue posed at the very beginning of thispaper- the effects of the kind of behavioural pattern discussed aboveon future direction and pace of reforms. Here we speculate about twokinds of effects. The first kind has to do with the problems posed forcentral government's macroeconomic management and central gov-ernment's responses to these problems. The second relates to thepossible formation of a coalition of vested interest in the system thatmay render future drastic changes difficult.

Macroeconomic Management. Macroeconomic management is takento mean control over the level of aggregate demand for investmentand consumption goods and services. One of the most importanteffects of the collusive behaviour between local bureaucracies andenterprises s that is makes it very difficult for the central governmentto control aggregate demand.

72. Although there is no direct proof of this scheme, a division chief in the Ministryof Finance confirmed o me in April 1989 that this was an important reason why central

government had difficulties collecting taxes and why fee impositions-tanpai-per-sisted despite strenuous efforts to control them.


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taken included re-imposition of state monopoly over marketing ofcertain important production inputs such as steel, fertilizer andplastic films and setting of price ceilings on those goods, whose priceshad been liberalized before, and abolition of non-bank financialinstitutions and non-state trading companies.76

To make administrative directives effective requires a set ofbureaucratic agencies for implementation and supervision. The resultis a proliferation of ad hoc bureaucratic agencies in charge of runningeconomy.77 In March 1987, the State Council created an officemanned by the State Economic Commission, the Ministry of Finance,the State Auditing Agency and the State Tax Bureau to control localgovernments' mposition of fees on enterprises.78 o control aggregatedemand, in May of the same year, an office was created to controlspending by government agencies and enterprises on consumerproducts.79 Toward the end of 1987, another office was created tomonitor local governments' taxation, spending and pricing practices.All these oflices were created in addition to the existing institutionsthat performed similar functions.

The cumulative result is what Kornai calls the tenacity ofbureaucracy the paradoxical phenomenon of bureaucracies toproliferate themselves at the very time when their functions aresupposed to decline. There is no perfect index for increasingbureaucratization n the economy. Table 10 looks at the steady rise innumber of economic decrees issued by the State Council.

The bureaucratization of economy is also indicated by the fact thatmany of these directives are concerned with very detailed micro-management issues. For example, in order to control enterprises'bonus policies, the State Council first imposed a bonus ceiling. Whenenterprises' bonus practice shifted to payment in kind, the StateCouncil had to issue two orders prohibiting enterprises rom makinguniforms and from reimbursing costs of luncheons for their employ-ees. Also these directives are issued repeatedly and frequently.Between 1982 and 1987, the State Council and other government andParty agencies issued seven decrees prohibiting local governments'fee-imposition practices.

Formation of a Coalition of Interest in the System. The collusive

pattern of behaviour between local economic bureaucrats and factorymanagers may have led to the formation of an implicit politicalcoalition between them. The formation of this coalition is a stabilizerin the system in that it may help perpetuate the current half-way

76. See Renmin ribao, 13 October 1988, p. 1, 14 October 1988, p. 1 and 13November 1988, p. l, and Jingii cankao (Economic References), 5 October 988, p. 2.

77. The number of ad hoc agencies under the State Council before the SeventhNational People's Congress stood at 82 and was then reduced to 43. Renmin ribao(overseas edition), 4 May 1988, p. 1.

78. Jingji ribao, 7 March 1987, p. 1.79. Jingji ribao, 30 May 1987, p. 1.


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Table 10: Number of Economic Decrees Issued by the State Council,1979-87

Years/Decrees No. of Decrees

1979 171980 201981 181982 401983 351984 321985 441986 381987 59

Source:Yu Meisun, A Preliminary Discussion of Economic

Legal System in China, manuscript, October 1988,annex 2.

house between planning and market and resist further economicchanges-either in the direction of further marketization or in thedirection of re-centralization.

Most of the reform measures carried out so far are what is known asadministrative decentralization, whereby the central government

transferred significant economic power to local governments andallowed limited market forces to function. In many ways, this is thebest arrangement or both local economic bureaucrats and enterprisemanagers. Bureaucrats are able to use many policy tools to exactbenefits from enterprises; enterprises, on the other hand, compete todevelop dependency on bureaucracies to obtain protection and thesizable premiums in the system - the large differentials betweenmarket and administrative prices.

Economic decentralization and re-centralization strip both sets ofprivileges. Decentralization reduces the number of policy tools atbureaucratic disposal that can be used to exact private benefits.Market allocation of goods will remove, at one stroke, manycategories of behaviour that need to be disciplined by economicbureaucrats. The remaining policy tools, such as the power to tax, willbe much less potent instruments without concurrent control overdirect allocation and regulatory unctions. In a market environment,enterprises possess what Charles Lindblom called automatic punish-ing recoil -the mechanism whereby the attempt to control triggersrebounding punishments.80 Enterprises can exit, when excessive taxesare levied, either by filing bankruptcy or geographically to regionswith lighter tax burdens a prospect that often keeps predatory


80. Charles E. Lindblom, Market as prison, Thomas Ferguson and Joel Rogers(eds.), The Political Economy (Armonk: M.E. Sharpe, Inc., 1984), p. 4.


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taxation at bay in market economy.8l Furthermore, he power to tax isultimately limited by the ability to pay. The more government taxes,

the less profitable the enterprise becomes, which reduces the futuretax base. This is in sharp contrast to the current arrangement n Chinawhere bureaucracies can channel support to those enterprises thatcontribute the most tax/fee revenue and therefore those enterprisesare able to remain profitable despite the exacting demand

Enterprises, on the other hand, may also find complete decentrali-zation not in their best interest. First, with gains in autonomy, theylose bureaucratic protection and support. Vagaries n the marketplacemean more foresight and effort on the part of management andworkers and sacrifices of their leisure and security. Secondly, becauseadministrative allocation contributes to shortage, which, under adual-price system, leads to large premiums, those enterprises cur-rently with close ties with bureaucracies will be likely to resist furthermarketization n input procurement.82

Economic re-centralization, however, is also detrimental to theinterests of local bureaucracies and their factories. The ability on thepart of local economic bureaucrats and factory managers to profitfrom the current arrangement critically depends on the policydiscretion in the hands of local economic bureaucrats and theexistence of a market outlet. Economic re-centralization, o the extentthat it removes bureaucratic discretion at the local level as well aspremiums-differentials between official and market prices-in thesystem, may generate forces of opposition at the local level.

How important this coalition of interest will be for the future courseof reforms depends on the degree that the central government is ableto act independently of the wishes of Chinese local economicbureaucrats and enterprise managers. There are a number ofconstraints for central government's autonomy in this area. First, theweakening of the central authority, due both to power struggles at thetop and its willing relinquishing of power over the years, has madelocal leaders pivotal political players n deciding China's future policycourse.83 n this respect, it is worth noting that principles of centraland local revenue sharing, foreign exchange retention scheme andfactory contract responsibility system were re-affirmed n the wake ofthe Fifth Plenum of the 13th Party Congress in November 1989,despite the issue of an economic document at the Plenum that

81. On the notion of exit, see Albert O. Hirschman, Exit, Voice and Loyalty(Cambridge, MA: Harvard University Press, 1970), pp. 22-29.

82. The attempt to seek re-centralization y enterprises s observed in Hungarianeconomy. See Peter Galasi and Gyorgy Sziraczki, State regulations, enterprisebehaviour and the labour market in Hungary, 1968-83, Cambridge ournal ofEconomics, o. 9 (1985), pp. 203-219.

83. Zhao Ziyang, in his report to the Third Plenum of the 13th Congress, candidlyadmitted the demise of the central authority and the need to bring provinces in linewith the central government. See Zhao Ziyang, Zai Zhonggong shisanjie sanzhong

quanhui shangde baogao ( Report to the Third Plenum of the 13th Congress of theChinese Communist Party ), Renmin ibao, 8 October 1989, p. 1.


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reflected the economic philosophy of Li Peng and Yao Yilin.84 Thiswas principally due to the pressures exerted by the provincial leaders

at the Plenum and at the subsequent economic working conferences.85The second constraint is the vast information asymmetry between

them. The central government has to rely on information suppliedbelow to make decisions and the information can be distorted to suitparticular needs. The third one is their ability to lobby at theimplementation stage.86 Like their Hungarian counterparts, Chinesebureaucrats and managers will advocate the preservation of bureau-cratic position in their own sphere of power only- as an exception tothe general rule. 87

In conclusion, this paper predicts that the current half-way housebetween planning and market may continue in the Chinese economyfor a long time. Two reasons are offered in this paper. First, the mixedmode of economic coordination has produced possible politicalopposition to further changes decentralization or re-centralizationas the two major actors in the Chinese economic system, localeconomic bureaucrats and enterprise managers, operate under amutually beneficial framework and have common economic interestsin the status quo. Second, the problems with macroeconomicmanagement by the central government as a result of the collusivebehaviour on the part of local bureaucrats and managers demandmore bureaucratic nterventions. Bureaucratic unctions persist out ofthe necessity both to implement central objectives and to superviselocal implementors. As a poet once queried, Who will take care ofthe care-takers? The answer is: more and higher-level bureaucracies.

84. See Zhonggong hisanjie zhongyang weiyhuanhui zhaokai di wuci quanhui( The 13th Central Committee of the Chinese Communist Party convened the FifthPlenum ) Renmin ibao, 10 November 1 989.

85. See Shijie ribao The World ournal), December 1989, p. 33.86. There is evidence that Chinese enterprises are capable of sophisticated publicityefforts to influence policy makers. Soon after Zhao Ziyang announced, at the Third

Plenum of the 13th Party Congress n September 1988, the policy shift from pricereforms to deepening of enterprise reforms, specifically he introduction of joint stockcompany system, the Beijing Capital Steel Works, one of the earliest enterprises oadopt contract responsibility ystem, launched a fierce campaign against he joint stockcompany system, and organized a large-scale conference in mid October to assessperformance f the contract responsibility ystem. Conference participants argued hatthe talk about joint stock company system had created disorder. Then in earlyDecember 1988, the Capital Steel Works organized another conference, this time tocoincide with the national planning and economic system reform conferences. Bothconferences got prominent coverage in the Chinese press. See Renmin ribao,11 November 1988, p. 1 and 10 December1988, p. 1.

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