The Research On The Governance And Incentives Of China’s Local Governments

Throughout its 30 years’ reform and opening up, China has witnessed a high-speed, sustained and steady economic growth, which is beyond quite a few people’s expectation. Thirty years ago, living standards of Chinese people were quite low with severe shortage of materials and the national economy nearly came to a halt. However, after more than 30 years’ development, China’s GDP has ascended to the second place in the world with average growth rate of nearly 10 percent every year. Although high-speed economic growth was not rare in countries like postwar Germany and Japan, the economic miracle in China, a developing country and even a socialist one, astonished and confused the west world. This is because a country with undistinguished natural endowment, whose political and economic systems don’t meet western standards either, is not likely to create economic miracles according to traditional economy theories.The confusion shows exactly that we haven’t acquired enough knowledge about the real reasons for big nation’s economic rise and the key elements and institutional factors of economic growth. By studying the institutional arrangements before and after the reform and opening up, even ones in ancient China, we can further discover unique elements in Chinese political and economic systems, which make the high-speed stable economic increase of China distinctive.In fact, as a country in transition from planned economy to market economy gradually, China’s government controls lots of resources that are able to influence economic growth such as capital, land and industry policies, which becomes a unique element in China’s economic life. However, as an old saying goes in China, "Success and failure result of the same factors", although Chinese governments created an economic miracle successfully, they are responsible for various long-standing economic and social problems. Therefore, studies on Chinese economy are unable to avoid analysis about China’s governments, especially local governments who serve in the forefront of economic development. By analyzing their governance structure and incentive mechanism, we can understand more profoundly about China’s economic issues, and thus provide practical policy proposals.In china, central government usually formulates major policies and principles while local governments are responsible for the execution of specific affairs, so the local governments play the role of agent and the principal-agent issues come into being, which makes the supervision and motivation system for agents very crucial. Principal- agent problems are mainly solved by election in Western-style democratic countries. How about other countries? According to China’s experience, central government administrates local governments and their officials by the system of "administrative contract", a set of institutional arrangement including fiscal and political promotion incentives.We conducted studies on institutional arrangements mentioned above one by one, using the methods of both theoretical and empirical study, analyzed the advantages and disadvantages, established an analytical framework combining fiscal and political promotion incentives together, and tried to expound the theories on the reasons for regional protectionism and excessive competition with the help of this framework. Making use of details of the institutional arrangements, we can observe governments’ actions and following economic performance. Besides, it can be observed that how important the administration and motivation of local governments are during the process of China’s reform.This essay primarily focused on Chinese governments’unique governance structure, and the dual incentive mechanism of both fiscal and political for local officials. Before studies on specific facts, first, we reviewed the motivation theory in economics and analyzed China’s managerial hierarchy of political centralization and decentralization of economic power, and accordingly expounded the relationship between central government and local governments. Next, in chapter four and five, starting with Chinese governments’ action, we carried out theoretical analysis on incentive system for officials with the application of the framework, and made empirical tests on the effects of fiscal incentives on economic growth. After the discussion about how the institutional arrangements of fiscal decentralization and political promotion would influence the behavior of officials and the pros and cons, we took the regional protectionism and excessive competition as an example in chapter six, and analyzed the influences of fiscal and political motivation on regional collaboration and competition, in order to compensate for the insufficient discussion about competitions among local governments. These three chapters studied rather completely on the influences of local governments’ incentive mechanism on governments’ actions.The following conclusions were reached in this paper:First, the practice of "administrative contract system" has been a feature of China’s local governments’management structure for thousands of years and has been passed so far. We also made theoretical explanation about the internal logic of the relationship between central government and local governments by the discussion on ancient decentralization method of "local division of authority". The unique political centralization and economic decentralization in China as well as the phenomenon of isomorphic responsibility in governments of different levels is the embodiment of the "administrative contract system". In order to solve the problem of local officials’ excessive discretionary power, governance model needs to be improved in future by introducing horizontal supervision mechanism, and by the transition from "contract system" to "employment system", which attaches more importance to following the rules.Second, according to our study, the changes of fiscal incentive intensity were small before and after the reform of tax-sharing system, which corrected the idea that tax sharing reform increased the local fiscal incentive intensity. The modification mainly came from the redefinition about the data scope, and that is, the change of local governments’ revenue range before and after the reform. Therefore, we concluded that, the reason of the bad performance of Fiscal Contract Responsibility System in 1980s was not the lack of fiscal incentives, but the low-level confidence limit of incentive contracts offered by the central government, which resulted in local governments’large amount of conversion from budgetary revenues to extra-budgetary revenues.Third, by comparing China’s transition performance with Russia, we discovered that except for the fiscal incentive intensity difference, one more important reason for the different performances is that Chinese central government promises local officials the political promotion incentives. That is the very stimulus that encourages local officials to develop the local economy and pursuit GDP growth with every chance they can take. However, high-intensive motivation model not only caused extensive economy growth to a great degree, but also gave rise to many problems concerning people’s livelihood.Fourth, our studies found that vicious competition in attracting investments in China is more serious than any other countries because of the existence of the political promotion incentives for Chinese local officials. By the method of setting up mathematical models, we made use of the framework that combines fiscal and political incentives together, and analyzed in detail about the phenomenon of regional protectionism and excessive competition and the reason for the lack of co-operation incentives for government officials.