After three decades of spectacular economic successes, China is facing a significant challenge. The string of recent scandals – environmental degradation, melamine-tainted milk powder, fake drugs and chemicals – have all pointed to government weakness in protecting public safety, exposing an enormous gap between China's growing economic prowess and its capacity to govern. With the leadership now focused on improving the regulatory regime, will China “catch up” and build the public institutions needed? This article argues that the reactive, incremental retrenchment of government in the 1980s and 1990s, combined with inadequate finance, had broken the intergovernmental fiscal system and created large distortions in the incentive structure facing government agencies and public institutions (shiye danwei 事业单位). Until the intergovernmental fiscal system is repaired and incentives are fundamentally reformed for the public sector, the top-down programme to redirect China's development and build a service-oriented government will have limited effect.
1 There is a veritable cottage industry of articles and books explaining China's economic successes. For comprehensive treatments of China's economic development over the past three decades, see Naughton, Barry, The Chinese Economy (Cambridge, MA: MIT Press, 2007) and Brandt, Loren and Rawski, Thomas (eds.), China's Great Transformation: Origins, Mechanism, and Consequences of the Post-Reform Economic Boom (New York: Cambridge University Press, 2008).
2 See, for examples, Shue, Vivienne and Wong, Christine (eds.), Paying for Progress in China: Public Finance, Human Welfare and Changing Patterns of Inequality (London: Routledge, 2007); Martin Ravallion and Shaohua Chen, “China's (uneven) progress against poverty,” World Bank Policy Research Working Paper, No. 3408 (2004); and UNDP, China Human Development Report 2005 (New York: UNDP, 2005).
3 Chinese media reports said that around 200 babies in Anhui alone were fed formula milk of little nutritional value. An initial inquiry showed 45 types of substandard powder were on sale in Fuyang city, Anhui, produced by 141 factories across China, Xinhua. BBC news online, “China fake milk scandal deepens,” http://news.bbc.co.uk/1/hi/world/asia-pacific/3648583.stm, 22 April, 2004, accessed 19 October 2008.
4 In November 2005, a chemical plant explosion in Jilin province caused a leakage of benzene into the Songhuajiang River. As a result, water supplies to Harbin, the tenth largest city in China, with a population of 5.5 million, were cut off for a number of days.
5 See, for examples, Yu, Jianrong, “Emerging trends in violent riots,” China Security, Vol. 4, No. 3 (2008), pp. 75–81; and Fewsmith, Joseph, “An anger-venting mass incident catches the attention of China's leadership,” China Leadership Monitor, No. 26 (2008). Both are about an incident on 28 June 2008, where at least 10,000 people, and perhaps as many as 30,000, according to some reports, participated in the riot in Wengan county in south-western Guizhou, the poorest province in China, to protest against a suspected police cover-up over the death of a girl. In the riot, police cars were overturned and burnt and the Public Security Bureau building set on fire. Yu, in particular, has studied the trend toward crowd volatility over the past few years as a significant new social phenomenon in China.
6 “China detains 22 in milk case,” New York Times, http://www.nytimes.com/2008/09/30/world/asia/30iht-30milk.16573403.html, 30 September 2008, accessed 16 August 2009.
7 The studies were: “China: public services for building the new socialist countryside,” World Bank, Report No. 40221-CN (2007), http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/01/16/000020953_20080116091210/Rendered/PDF/402210CN.pdf, accessed 16 August 2009; Chinese version: Gaishan nongcun gonggu fuwu (Improving Rural Public Service) (Beijing: CITIC Press, 2008); Achim Fock and Christine Wong, “Financing rural development for a harmonious society in China: recent reforms in public finance and their prospects,” World Bank Policy Research Working Paper, No. 4693 (2008), http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2008/08/14/000158349_20080814090712/Rendered/PDF/WPS4693.pdf, accessed 16 August 2009; World Bank, “Reforming subnational finance: lessons from northeast China,” unpublished draft (2006); and World Bank, “China: deepening public service unit reform to improve service delivery,” Other Public Sector Study, No. 32341 (2005), http://www-wds.worldbank.org/external/default/WDSContentServer/WDSP/IB/2005/08/01/000012009_20050801102726/Rendered/PDF/32341rev01CHA.pdf, accessed 16 August 2009. I am indebted to the many colleagues with whom I worked on these studies, most importantly Achim Fock, Dana Weist and Zhang Chunlin.
8 See Bingqian, Wang, Wang Bingqian lun caizheng (Wang Bingqian on Public Finance) (Beijing: Chinese Finance and Economics Press, 1994). Wang was Minister of Finance during 1980–92.
9 Most famously, the planning commission remains a powerful agency in China 30 years after the start of market reform, where it is “first among equals” among the super-ministries. Although its name has changed to the National Development and Reform Commission (NDRC), to shed the “planning” label, its core mission remains that of allocating capital investments financed by the budget, even though the share of budgetary funds is now a minor portion of total investments. The Price Commission, another powerful agency under the planned economy, was never abolished, although demoted to a department under the NDRC. Even a lowly agency like the Loudspeaker Team, which was in charge of maintaining the loudspeakers for broadcasting propaganda and instructions to the fields under collective agriculture before radio and television became widely available in rural China, remains in existence as a government agency today. While there have been several rounds of downsizing campaigns for civil servants, they have been notably unsuccessful.
10 Wong, Christine, “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. The figures cited in this paper differ somewhat from those in the earlier paper because the GDP data have been revised by the Chinese government. The figures used here are based on the updated GDP series.
11 State Council, “State Council Decision on implementing local fiscal contracts,” Beijing, 1988.
12 These figures are based on quota subsidies of 8.6 billion yuan and deflating them by CPI. In fact the reported total rose slightly because of other adjustments in the system that are unrelated to equalization objectives.
13 Net transfers are calculated as total transfers minus tax rebates.
14 For a discussion of the detailed workings of this revenue sharing regime, see Wong, Christine, Heady, Christopher and Woo, Wing Thye, Fiscal Management and Economic Reform in the People's Republic of China (Hong Kong: Oxford University Press, 1995), pp. 85–99.
15 The eight provinces were: Guangxi, Guizhou, Inner Mongolia, Ningxia, Qinghai, Tibet, Xinjiang and Yunnan, all with high proportions of ethnic minority populations. The term “transfers” (zhuanyi zhifu) was adopted by the Ministry of Finance only over the past decade or so. Previously, they used the term “subsidies” (butie).
16 West, Loraine and Wong, Christine, “Equalization issues,” in Wong, Christine (ed.), Financing Local Government in the People's Republic of China (Hong Kong: Oxford University Press, 1997). World Bank, China: National Development and Sub-national Finance – A Review of Provincial Expenditures, Report No. 22951-CHA (2002).
17 The rich provinces receive mostly tax rebates based on increased VAT and excise tax collections. Since around 2003 the Ministry of Finance has attempted to exclude tax rebates (around 40% of total transfers) from the reporting of “transfers,” but statistical reports continue to count them.
18 This was the subject of my paper in this journal in 1991. In that paper, I showed that the ongoing fiscal decentralization did not benefit local governments, as was widely perceived, because the pressures emerging from fiscal decline and expenditure needs of the changing economy were distributed asymmetrically, and were falling more heavily on local governments. See Wong, “Central–local relations in an era of fiscal decline.”
19 Wong, Christine, “Fiscal reform and local industrialization: the problematic sequencing of reform in post-Mao China,” Modern China, Vol. 18, No. 2 (1992), pp. 197–227.
20 Wong, Heady and Woo, Fiscal Management and Economic Reform.
21 Calculated from data from CSY 1998 and 2006. These figures are based on the new GDP figures, which had raised GDP estimates by more than one-third.
22 Calculated from National Health Statistics.
23 World Bank, The Chinese Economy: Fighting Inflation, Deepening Reforms (Washington, DC: World Bank, 1996).
24 OECD data.
25 Smith, Peter, Wong, Christine and Zhao, Yuxin, “Public expenditure and the role of government in the Chinese health sector,” World Bank Rural Health in China Briefing Notes, No. 5 (2005).
26 World Bank, Fighting Inflation, Deepening Reforms and World Bank, Deepening Public Service Unit Reform.
27 For details, see World Bank, Deepening Public Service Unit Reform.
28 In a 2004 paper, Nansheng Bai detailed how local police departments typically receive only budgetary support for salaries, but have to buy their uniforms, batons and other equipment from own revenues collected through fines and penalties. See Nansheng Bai, “A police story,” paper presented at the Conference on Rural Change in China, Peking University, 5–6 July 2004.
29 World Bank, National Development and Sub-national Finance, Table 7.8.
30 World Bank, “Rural public finance in Ninglang county of Yunnan province,” an interim report for the World Bank–Ministry of Finance Study, 2004.
31 Christine Wong, “Can the retreat from equality be reversed? An assessment of redistributive fiscal policies from Deng Xiaoping to Wen Jiabao,” in Shue and Wong, Paying for Progress in China; and “Fiscal management for a harmonious society: assessing the central government's capacity to implement policies,” in Lee, Keun, Kim, Joon-Han and Woo, Wing T. (eds.), Power and Sustainability of the Chinese State (London: Routledge, 2008).
32 World Bank, Reforming Subnational Finance.
33 Wong, “Can the retreat from equality be reversed?”
34 Ibid. and World Bank, National Development and Sub-national Finance.
35 Wong, “Can the retreat from equality be reversed?” and World Bank, National Development and Sub-national Finance.
36 Wong, Christine, “Fiscal dualism in China: gradualist reform and the growth of off-budget finance,” in Brean, Donald (ed.), Taxation in Modern China (New York and London: Routledge, 1998); Gang Fan, “Market-oriented economic reform and the growth of off-budget local public finance,” in ibid.; and Christine Wong and Richard Bird, “China's fiscal system: a work in progress,” in Brandt and Rawski, China's Great Transformation. In this article I use “off-budget” and “extra-budgetary” interchangeably to refer to all non-budgetary resources controlled by government, rather than follow official terminology, which uses “extra-budgetary” to refer narrowly to a prescribed list of revenues by source and type.
37 The nature and size of extra-budgetary funds are explored in Wong, Christine, “Converting fees into taxes: reform of extrabudgetary funds and intergovernmental fiscal relations in China,” in Bird, Richard, Ebel, Robert and Wallich, Christine (eds.), Shehuizhuyi guojia de fenquanhua: zhuangui jingji de zhengfujian caizheng tizhi (Decentralization of the Socialist State: Intergovernmental Finance in Transition Economies), Chinese edition (Beijing: Central Translation Press, 2001); and Wong and Bird, “China's fiscal system: a work in progress.”
38 Reported extra-budgetary revenues have fallen to just 3.4% of GDP in 2003.
39 World Bank, Deepening Public Service Unit Reform.
40 Since this was a period of mild deflation, these increases are approximate in real terms.
41 The coefficient is 0.34, and the R-square is 0.84.
42 Local newspaper report. See http://news.sina.com.cn/c/2004-06-07/01593389284.shtml, accessed 16 August 2009. Cited in World Bank, Deepening Public Service Unit Reform.
43 Ministry of Education, Yearbook of Education Finance Statistics. The tragic story of an explosion in a rural primary school in Jiangxi that killed four teachers and more than 36 children in March 2001 was probably the result of this practice: reports of the accident indicated that parents had long complained that the school was using students to assemble fireworks for sale. See “Zhu Rongji zongli tan jiangxi wanzai xiaoxue baoza shijian” (“Premier Zhu Rongji's talk on explosion incident in school in Wanzai county of Jiangxi province”), China News Online, http://www.chinanews.com.cn/2001-03-15/26/78781.html, 15 March 2001, accessed 16 August 2009.
44 One director general of a powerful central ministry told me that she spends a significant portion of her time looking for revenue-generating opportunities to augment “bonus pay” for her staff.
45 Lu, Xiaobo. “From rank-seeking to rent-seeking: changing administrative ethos and corruption in reform China,” Crime, Law and Social Change, Vol. 32, No. 4 (1999), pp. 347–70.
46 One official in a medium-sized city in the south-west told me it began in the early 1990s, when Deng Xiaoping's “southern tour” seemed to open the door to all entrepreneurial activities within and outside government (field visit in February 1998).
47 In the province's Putian prefecture, for example, in 2000 the lowest annual incomes (5,722 yuan) were earned by the departments dealing with mineral extraction, while the highest (12,957 yuan) were in the departments dealing with finance and insurance. See 2003 China Investigation Report. I am indebted to Frank Pieke for this reference.
48 Xie, Yu and Wu, Xiaogang, “Danwei profitability and earnings inequality in urban China,” The China Quarterly, No. 195 (2008), pp. 558–81.
49 Yang, Dali L., “Economic transformation and state rebuilding in China,” in Naughton, Barry and Yang, Dali (eds.) Holding China Together: Diversity and National Integration in the Post-Deng Era (New York: Cambridge University Press, 2004), p. 143.
50 Wang, Shaoguang, “Dazhuanxing: 1980 niandai yilai Zhongguo de shuangxiang yundong” (“The great transformation: the two-way movement in China since the 1980s”), Zhongguo shehui kexue (Social Sciences in China), No. 1 (2008), pp. 129–48.
51 Hu, Angang. “Zhongguo zhengfu zhuanxing yu gonggong caizheng” (“Government transition and public finance in China”), in Cai, Fang (ed.), Zhongguo jingji zhuanxing sanshinian (30 Years of Economic Transition in China) (Beijing: Social Science Academic Press, 2009), pp. 151–92.
52 A very partial list would include Oksenberg, Michel and Tong, James, “The evolution of central–provincial fiscal relations in China, 1953–1983: the formal system,” The China Quarterly, No. 124 (1991), pp. 1–32; Shaoguang, Wang and Angang, Hu, State Capacity of China (New York: Oxford University Press, 1994); World Bank. China: Revenue Mobilization and Tax Policy (Washington DC: World Bank Publications, 1990); National Development and Subnational Finance; and Wong, “Central–local relations in an era of fiscal decline” and Financing Local Government in the People's Republic of China.
53 These problems were also explored from different perspectives in Wong, “Can the retreat from equality be reversed?” and Wong, “Fiscal management for a harmonious society.”
54 A series of excellent articles in Caijing (Finance), a bi-weekly magazine, document the mad rush of local governments to raise funds for infrastructural spending under the fiscal stimulus call, grabbing bank loans and creating new debt instruments. For example, Liuan, a county-level city in Anhui province, had by March 2009 issued debts of 1.5 billion yuan through its urban construction investment corporation and started work on projects totalling 4.8 billion yuan, even though its fiscal revenues were only 3 billion yuan in 2007, Caijing, No. 239 (2009), p. 76.
* This study draws from research that was partially funded by the Smith-Richardson Foundation. I thank Frank Pieke and Carl Riskin for helpful comments on an earlier draft.
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