How Chinese Reform Worked, Part 8-B

[nodular]

a look at this paper in my own words:
How Reform Worked in China
Yingyi Qian , Department of Economics
University of California, Berkeley

http://elsa.berkeley.edu/~yqian/how%20reform%20worked%20in%20china.pdf


One of the problems addressed an interesting way by the Chinese system of economic development is the problem of the distribution of benefits to the population by the government. The author points out that in developing countries, governments tend to spend more money in urban areas for political reasons. While this point is not explicitly developed, I presume the cities are seen as more crucial for the developmental process.

By basing its economic growth primarily on Township Village Enterprises (TVEs) in the early phase of its economic development, China hit on a natural way of work equally distributing the benefits of government expenditure resulting from economic growth throughout the country. Because the TVEs were owned by local governments, the local governments benefited from their operations, both in terms of increased taxes and profits. Since a local governments were the owners, they got the profits. They naturally tended to spend the money locally on their own populations.

Tax reform was another crucial element to the early phases of Chinese economic development. In China, tax reform meant changing the relationship between the central and local governments. Before 1970, local governments only ended up keeping about 17% of the local taxes raised. After 1970, this shot up to an average of 70%. The central government devised a scheme that included certain fixed remissions of taxes from the local governments to the central government--- thus insuring that the central government would have enough taxes to function. Other taxes were divided between the central and local governments. The system of dividing up these revenues provided fiscal incentives to the local governments. Essentially, as local governments percentage of these tax revenue streams increased, their motivation to increase the volume of the streams went up. The way to increase the volume of these revenue streams was to stimulate the local economy. In this way, local governments became "helping hands" for local businesses instead of "grabbing hands."

In Russia, on the other hand, where these types of incentives were not put in place, local governments tended to undermine high-level reforms designed to create greater profits and more capitalism. A 2000 study of "city governments" in post-reform Russia helps prove this point. "City governments" in Russia means the level of government underneath regional (which is underneath federal). The study found that as city governments increased their tax revenues, their share of funds from the central government was reduced by about the same amount as the increase. Therefore their motivation to increase tax revenues was really zero.