Understanding China's Economy: from Academia to Reality

 The failures in East Asian corporate governance are blamed for the East Asian financial crisis.  In East Asia, the predominant form of ownership is control by a family, termed as "crony capitalism", and the top managers are often from the family. In  Faccio, Lang, and Young (2001 AER, citation 1861) , they document ownership and control structures among East Asian corporations and analyze the salient agency problem, namely the expropriation of outside shareholders by controlling shareholders, by looking at dividend behavior. To start with, they show an extraordinary concentration of control in East Asia, whereby 6 groups control more than 20% of the corporations in the 9 most advanced East Asian economies. This control is obscured behind layers of corporations, hence insulated against the forces of competition on less-then-transparent capital markets. However, family control is also predominant in West Europe, though the group sizes are smaller, with 5 groups control a...

Cross-country income differences for the most part reflect differences in total factor productivity (TFP) across countries. But what could explain the differences in TFP in different countries? Hsieh and Klenow (2009, QJE, citation 3021) , use establishment level data in manufacturing to measure TFP gaps between China and India and the U.S. They find that misallocation in labor and capital could explain 30%-60% of the TFP differences between developing and developed countries, which means that  China and India have low TFP mainly because that resources are not allocated in the most efficient way. Virgiliu and Xu (2014, AER, citation 571) extend the framework to study the role of financial frictions in determining TFP. They focus on one specific type of misallocation, distortion in capital allocation generated by financial frictions. However, they find that this type of misallocation explains only a small part, 5%- 10%, of the TFP differences. However, financial frictions reduc...

What makes China’s reform, started from 1979, successful? Why they are different from those of Eastern Europe and the Soviet Union? In their paper Why China's economic reforms differ: the M-form hierarchy and entry/expansion of the non-state sector (Economics of Transition, 1993 citation 648), Qian and Xu proposed the “M-Form Economy” theory and argued that it is the essential reason. In this blog, I focus more on the part about China (M-form), the counterpart analysis about Eastern Europe and the Soviet Union (U-form) can be found in the paper. Originated in Chandler (1966) – Williamson (1975) “M-Form” and “U-form” firm theory, the authors contract China’s multi-layer-multi-regional hierarchical economy based on territorial principle (the deep M-form, or briefly, the M-form) with Eastern Europe and the Soviet Union’s unitary hierarchical structure based on functional or specialization principles (the U-form). Under the M-form organization in China, interdependence between re...

How to explain the cultural and institutional bifurcations between China and Europe? In their paper Cultural and Institutional Bifurcation China and Europe Compared , Avner Greif and Guido Tabellini ( AER  2010 citation:187) demonstrated that initial distribution of values and social heterogeneity themselves alone could be the reason. Two otherwise identical societies can evolve along different self-reinforcing trajectories of both cultural traits and organizational forms. The collapse of the Chinese Han dynasty and the Roman Empire (after 220 CE) were turning points in the cultural and institutional evolution of China and Europe respectively. Large kinship organizations were common in the former but not the latter and this remarks the distinction in initial conditions. In China, the Han dynasty came to power while advocating Confucianism as an alternative to the Legalism of the previous Qin dynasty. Confucianism considers moral obligations among kin as the basis for social or...

Started in late 1978, reform of state-owned enterprises (SOE’s) is a long lasting cause in China. In the paper Competition,Policy Burdens, and State-Owned Enterprise Reform ( AER P&P, 1998,681 citations ), Lin, Cai and Li argue that the key for successful SOE reforms is to create enough a sufficient level of market competition and remove the policy burdens. In a less competitive world, the separation of ownership and controls makes managers’ incentives incompatible with those of the state. Various state-imposed policy burdens are often criticized to give a chance for soft-budget constraints. In 1996, SOE’s employed 57.4 percent of urban workers and possessed 52.2 percent of total investment in industrial fixed assets. However, over 40 percent of SOE’s are losing money. By definition, SOE’s are owned by the state. However, the state needs to delegate their control rights to the enterprises’ managers. The separation of ownership and control is a common feature of any large moder...

One central theme in academic research about China is the existence of state ownership in enterprises. State owned enterprises (SOEs henceforth) not necessarily mean lower efficiency. Rather it depends on market structure. In his paper China's State Enterprises Public Goods, Externalities, and Coase (AER P&P, 1998, 99 citations), Gary H. Jefferson studied this question through the lens of Coase theorem (Ronald H Coase, 1960) and public goods. It is clear that SOEs have negative externalities for the firm itself, the whole economy and non-state sector. The key insight of Coase theorem is the need of clear assignment of property rights and the elimination of transfer costs in order to create an efficient incentive structure. SEOs by definition (owned by all the people), lacks proper incentive structure to monitor the enterprises. SOEs is subject to opportunistic behavior of workers, managers, and local officials, such as stripping by managers, shirking by workers, predatory ...

There are remarkable geographic differences both cross and within provinces in China. What creates the poor areas? Are they catching up? What should government do? In their paper (AER, 1999, 103 citations), Ravallion and Jalan looked at these questions. There is a bunch of evidence on convergence (Raiser 1998; Chen and Fleisher, 1996; Jian et al., 1996). However, it would be too hasty to conclude that China’s poor rural areas will eventually catch up. There is sign of dualistic divergence in the post-reform period between the coastal provinces and much of inland China (Jian et al., 1996). There is evidence for interurban convergence, but also for divergence within the rural economy (Howes and Hussain; 1994, Ravallion and Jalan, 1996; Khan and Riskin, 1998). A  "geographic poverty trap” can arise if there are geographic externalities generated by local public goods, or local endowments of private goods with spillover effects, and that capital is not perfectly mobile. In this si...