DECREMENTAL BUDGETING IN AN INCREMENTAL ERA: A STUDY OF THE CENTRAL-PROVINCIAL BUDGETARY RELATIONSHIP IN THE PEOPLE'S REPUBLIC OF CHINA AFTER 1978 by BAI YAN, B.A., M.P.A. A DISSERTATION IN POLITICAL SCIENCE Submitted to the Graduate Faculty of Texas Tech University in Partial Fulfillment of the Requirements for the Degree of DOCTOR OF PHILOSOPHY Approved
May, 1995 Sol A^O^^' T5 ^ ACKNOWLEDGEMENTS })0 lSh-:> ^\. I am greatly indebted to Professor Mark Sorama whose
genuine efforts, direction, encouragement, and sincerity
made this study a reality. My gratitude goes to the other
members of the committee—Professor Siegrun Fox Freyss,
Professor Aman Khan, and Professor Aie Rie Lee—for their
thoughtful suggestions and criticisms. All my committee
members have been generously supportive in providing me wit:
encouragement and specific comments through my writing.
I am thankful to the Department of Political Science
for its support of my entire graduate work.
I would like to dedicate this study to my wife Anling
Lai and my son Bai Ou, whose faithful support and
understanding have been indescribable.
11 TABLE OF CONTENTS
ACKNOWLEDGEMENTS ii
ABSTRACT vi
LIST OF TABLES ix
CHAPTER
I. INTRODUCTION 1
General Introduction 1
Organization of the Study 10 II. LITERATURE REVIEW, RECONCEPTULIZATION, AND METHOD 13 General Survey 13 The Caiden and Wildavsky Model of Poverty-Uncertainty 18 The Development Theories 25
Dichotomous Mode of Thinking 29
From Single Factor to the Context 31 The Caiden and Wildavsky Model Reconceptualized 32 Seeking A Common Point of Departure. ... 32
Uncertainty Reduction and Avoidance. ... 35
State Capacity 39
Method 42 III. CHANGES BEFORE AND AFTER THE 1978 DECENTRALIZATION 47 The Imperial Period 48
The Republican Period 51
The Socialist Period to Present 52
111 Prior Decentralizations 54
1978 Fiscal Decentralization 61
Changes After the 1978 Decentralization. . . .69
The Decline of Extractive Capacity 75 Fiscal Decline as a Result of Decentralization 77 Action-Reaction Syndrome 83
IV. CHINESE BUDGET SYSTEM AND PRACTICE 95
Budget System: A General Introduction 95
Components of Budgetary Receipts 99
Taxation 100
Central Taxes 104
Local Taxes 112
Shared Taxes 114
The Coercive Draft 116
Revenue Sharing 116
Retention System 121
Borrowing 126
Domestic Borrowing 127
Foreign Borrowing 130
Components Of Budgetary Expenditures 134
Tax Transfer 136
Subsidies 141
Provincial Expenditure 144 V. A TYPOLOGY OF CHINESE BUDGETING POLITICS 155 iv Central Planning-Mass Movement 156
Authoritarian-Party/State 162 Bargaining-Decentralization: Current Fiscal Politics 166 The Provincial Extra-Budget 169
Tanpai 173
Foreign Capital 177
Bank Loans 182
Rent Seeking 188
The Decline of State Capacity 193
National Deficit 195
Inflation 200
VI. SUMMTIRY AND CONCLUSION 208
Unintended Consequences 210
Decentralization and Fiscal Politics 216 Outlook for the Future—Unitary or Confederate? 219 Possible Contributions and Limitations. . . .227
BIBLIOGRAPHY 228
V ABSTRACT
The Caiden and Wildavsky work of 1974 postulates a model of poverty-uncertainty: the governments of poor countries face disappearing and decremental budgets in financing public programs because of a lack of economic growth or poverty. The core argument is that economic development, as a critical variable, determines increments in budgeting practices. In other words, budgeting is incremental, and incremental budgeting results from the growth of GNP. This model has since become a set of principles with identifiable attributes to explain the budgetary processes in poor nations.
This study is about application of that model in
China's budgeting. China has a unitary budget system. The central government used to draw most of its revenues from provinces and its budget includes those of 31 provinces.
Provinces thus play a dual role of collecting revenues from within and remitting them to the center in the name of revenue sharing. In 1978 China decided to open to the world, reform its economy, and decentralize budget to provinces.
But the original intent of decentralization was to give incentives so that provinces accumulate more resources for
VI further central extraction. The decentralization, however, has led to fiscal decline not anticipated by the reformers.
Data shows a declining ratio of government budget to the fast growing GNP in the post-Mao China, and a declining central government's share to the province budget revenue.
Why decremental budgeting in an incremental era of economic development? To explain this variation, this case study brings in the budgetary system and operation in China and explores the fiscal relations between the center and the provinces before and after 1978, the year China began to decentralize. The proportions retained by provinces have increased sharply. Extra-budgetary funds kept by provinces have skyrocketed, which can be easily converted into political strength. At the same time as the central extractive capacity is in decline, central control over consumption also became so loose that the expanded expenditures resulted in less redistributions from rich to poor provinces, and less allocations to the national infrastructures. Moreover, the expanded expenditures spurred inflation.
Though the center, no longer an imperial emperor relying upon provincial extractions, tries to regain its budgetary leadership, it has found itself already so vulnerable in the face of emerging confederacy. There are as vii many emperors as provinces. Wealth does not render increments in the Chinese budgeting, but provides impetus to provincial initiatives to be independent. As a result,
China's budgeting is decremental in an incremental era.
VI11 LIST OF TABLES
1. GNP (Billion Yuan) and Government Revenue, Expenditure as Percentage 45 2. GNP per Capita (constant 1987 yuan) 46
3. China: Administrative Divisions 85
4. Indicators of Financial Decentralization 87 5. Sectoral and Demand Linked Sources of Growth 1980-88 88
6. Provincial Per Capita in 1977 and Average Annual Growth Rates 1978-88 89 7. State Budget Share of National Income, 1952-89. . . .91
8. Sources of Revenues by Sector (%) 93 9. Revenue-Sharing Rates of China's Provincial Units, 1980-1983 147 10. Central-Local Shares of Budget Revenues 149
11. Foreign Capital Flow into China, 1979-1987 150
12. China's Total Debt and Debt Indicator, 1980-90. . .151
13. Sources of Government Financing 152
14. Government Expenditure by General Categories. . . .153 15. Extra-budgetary Revenue and Expenditure of Central & Local Governments 206 16. Central Government Budget Deficit and China's Inflation Rates 207
IX CHAPTER I INTRODUCTION
General Introduction
A government budget implements the functions of the public sector—allocation, redistribution, stability, and growth. It symbolizes the authoritative allocation of priorities and determines who gets what, when, and how. In this sense, budgeting is the life-blood of government, the medium through which flows the essential life-support systems of public policy (Wildavsky, 1988).
Budgeting, however, is subject to many constraints, and one of them is economic development. According to the conventional wisdom of incrementalism (Wildavsky, 1964), budgetary decisions are premised on last year's budget.
Since only a small portion of the budget is examined, a change is only marginal from year to year. "Annual increases in spending in the range of 5-10 percent were cited as confirmation of the inherently incremental nature of budgeting" (LeLoup, 1988:21). As a decision making model, incrementalism is preferable because it moderates conflict, reduces search costs, and saves the amount of time that budget makers must invest in budgeting (Lindblom,
1968). What underscores and enables incrementalism in budgeting? "Incrementalism depends on increments, that is, on an increase in the resources available for distribution through the budget process. These increments can come from economic growth or from an enlargement in the relative size of the public sector" (Schick, 1992:410). To paraphrase, the increments are the base of incrementalism. First, budgetary increments grow in proportion to economic growth as measured in GNP (gross national products) or GDP (gross domestic products), which constitutes the base for annual expansion in government spending. Allen Schick, a well- known scholar in this field, compares budget outlays with growth in GNP to indicate incrementalism. In his
"Incremental Budgeting in a Decremental Age," Schick (1992) discovered that the economy in the United States in the
1970s did not grow fast enough to accommodate the demands on the budget. While the economy had 3 percent annual growth, the federal budget was growing at a 4 percent rate. The
U.S. economy was stagnant during the 1970s, but the momentum of incrementalism could not be slowed down because of sluggish growth. Since the budget process was programmed for growth, it could not easily adapt to the changed circumstances. Although the difference between these growth rates seems small, over the course of the decade it impelled a substantial shift in resources from the private sector as well as big and persistent deficits.
Second, increments come from the redistribution of resources. The size of government expenditures changes in relation to other sectors, which are defined by the source of flow as consumer, investment, and foreign trade balance.
Using the first letter of these four sectors, the equation should go like C (consumer) + I (investment) + G (government expenditure) + F (foreign trade) = GNP. Resources can be redistributed so that a particular sector can be enlarged at the expense of other sectors. This is what is called
"zero-sum" game in which the gains for one sector must come from some other sectors. Obviously, redistribution does not constitute incrementalism because it is not based on economic growth proportionately. According to Schick, incrementalism is distributive, not redistributive.
As a word of caution, "incrementalism is an extraordinarily elastic and elusive concept. It can be made to fit just about every budgetary circumstance" (Schick,
1992:410). Nachez and Bupp (1973) claimed that incrementalism could coexist with decline in particular programs, as long as total spending increased. Dempster and
Wildavsky even redefined incrementalism in terms of the regularity or irregularity of change, not the absolute amount of change (1979:375). Anyway, "if incrementalism is defined as growth-oriented budgeting, then the size of change is less important than the direction" (Schick,
1992:422). All these considered, this study follows suit of and is consistent with Schick's use of budget in the percentage of GNP for incrementalism, for "it has more to say about the base than about the increment" (Schick,
1992:411).
Along the line of the above description, incremental budgeting should be logically seen in an expanded economy, and it has been commonly found in the rich countries.
Budgeting might be altered if it lacks increments. To the contrary of incrementalism, budgets decrease as a result of economic adversity or decline or poverty. This budgeting is usually seen in the poor countries, thus labeled as decremental budgeting. Decremental budgeting is more clearly identified and elaborated in the poverty-uncertainty model developed by Caiden and Wildavsky (1974, 1975, 1986).
This model of poverty-uncertainty argues that budgets tend to be disappearing and shrinking because of no increments or expanding economy. Budgeting, under this circumstance, is uncertain and decremental. The solution to decremental budgeting, therefore, lies at elimination of poverty. As economic growth translates into increments, the budgetary problems caused by poverty can be solved or eased. Further, with the economy providing abundant resources, budgeting could be a predicable process in which the national government is able to allocate increments to claimants.
Although the Caiden and Wildavsky model has been widely used to describe, explain, and predict budgeting in developing countries, the impressionistic nature of poverty as an explication of budgetary problems creates a difficulty in achieving a clear overview of Chinese budget making process in its era of reform and decentralization. This difficulty casts serious doubt to the simplistic extrapolation of this model of the 1960s into the reality of the 1990s.
Important decentralization reforms were introduced in several countries of Africa, the South Pacific and Southeast
Asia in the 1970s and 1980s. In 1978 China began a process of economic and financial reforms that have brought about a series of changes over the nature of governmental revenue and expenditure structure, and the capacity of its governmental systems to manage those changes. One consequence of these changes is a trend toward decentralizing the financial responsibilities from the national level to the provincial level. Since then China has been experiencing growth and decay simultaneously,
though it sounds paradoxical.
China's spectacular economic expansion is
unprecedented. Deng Xiaoping deserves credit for this
dramatic development, and the ruling party, the Chinese
Communist Party (CCP), derives some measure of legitimacy
from it. But the outcomes this reform has brought about are
undermining its rule and eroding the state authority in
China. The results are twofold. First, economic take-off
spurred rapid democratization which exposed so much of China
to the outside world that it enhanced the provincial
officials' notion of self-determination. Meanwhile, the
decentralization of budgetary authority gave them the
initiatives to get ahead in defiance of egalitarianism of
the Maoist Era. Second, fiscal decentralization has
bestowed more opportunities than resources on local
governments (Wong, 1991). That is, although the central
government did not provide provinces with increased
financial resources to match the decentralized
responsibilities, it did provide them with ample
opportunities to acquire funds outside the central budget.
This cushion of "extra-budgetary" funds in turn permitted
provinces not only to pursue their own policy preferences
but also to become less sensitive to the policy demands from higher levels and detract from the central budget. All these have changed the unitary relations between the center and the provinces.
These changes are reflected in the share of the economy that goes into the central government coffers. One striking phenomenon is that before decentralization was decreed in
1978, the government sequestered 38.7 percent of GNP in revenue. By 1990, the central government's revenue share of
GNP made up only 16.6 percent. In other words, China's public sector and budget have shrunk in the wake of a growing economy (Denny, 1990:190). It is important to point out that although the state's budget indeed increased annually at margin, these increases happened in a decreasing ratio with GNP. Further, the growing economy did not create predictability of the national budget. On the contrary,
China's budgeting became more and more uncertain in terms of its revenue generation, as provinces retain more and more revenues in defiance of the center's coercive power. Why decremental budgeting in an incremental era? Why uncertainty amid higher economic growth? Clearly, some components of the Caiden and wildavsky model need to be reconceptualized.
The aim of this study is to clarify some of the issues involved in what constitutes decremental budgeting and 8 examine the applicability of the Caiden and Wildavsky model
in the case of China. There are two things that need to be
heeded. First, this study is not so much about
incrementalism or the incrementalist model of decision
making. Rather, it is about the base and cause of
incrementalism. "In sum, budget incrementalism was financed
by an expanding economy" (Schick, 1992:414). It proposes
that China's decremental budgeting results not from poverty
but from its weakened central state capacity to extract
revenues from its provinces. Second, this study is not so
much about the expenditure side of the budget. Rather, it
is about the revenue side of the budget. It also proposes
that the uncertainties in China derive not so much from
poverty as from wealth. Uncertainties are embedded within
the process of generating revenues from the provinces. This
process is influenced by many competing forces whose
interests are at stake, thus making it unpredictable. The
inevitable consequence of the weakened state capacity is
adverse to and erosive of the China's unitary control. The
tendency toward a confederate pattern of provincialism turns
out against the center's original intention of
decentralization.
Revenue extraction in the United States is about
transferring control over resources from the individuals and private sectors to the public sector via taxation. Resource extraction in China is primarily about fund transfer from the provinces and the state-owned enterprises to the center.
In the United States, the federal government raises more revenues than all state and local governments combined.
Among the shares of government revenue, federal government accounts for 59 percent and the state and local governments
41 percent (Patterson, 1994:55). Moreover, the federal government depends almost entirely on personal and corporate income taxes, that automatically increase revenues as the economy expands.
In China, the central government adopts a unified budget and presides over a budgetary process that includes the budgets of the central government, the provinces, and sub-provincial units. Until the 1980s the center relied upon the provinces for three-fourths, or 75 percent, of its revenues. These revenues were channeled to the central government through revenue sharings. It means that all or most revenues of the provincial governments are remitted to the national government. However, the share that goes to the center has been reduced greatly. Wealth are accumulated in the hands of the provinces. The source of uncertainty therefore stems from the conflict (the tug-of-war) between the central government's effort to maximize its collection 10 and the provincial governments' efforts to minimize their contributions.
The questions of interest are: first, how valid is the
Caiden and Wildavsky model of poverty-uncertainty commonly used for the developing countries to the situations in
China? Second, why is China's budget decrementalized at the same time when China's economy booms and grows faster than ever before, beginning with the 1980s? This study focuses its attention on the changes in the economy, finance, and budget of China. It seeks to understand how they are affected by reform, on the one hand, and how they affect the direction of reform, on the other. In other words, it seeks for patterns of the Chinese national government's revenue-generating practices and the central-provincial relationship before and during the era of fiscal decentralization. It tries to understand its meaning and implications to China's future.
Organization of the Study
The first task is to review the works by Caiden and
Wildavsky and the literature of development and uncertainty reduction within an analytical framework. This task is fulfilled at the second chapter. As this study mainly seeks to examine Chinese budgetary revenue maximization, the 11 literature of state capacity will be reviewed and the proposition will be raised, i.e., the weakened revenue-generating capacity rather than poverty leads decremental budgeting in China.
The aim of the third chapter is to introduce the 1978 decentralization in China and identify the important concepts, assumptions and ramifications of this significant reform. The fourth chapter will present some initial changes brought about ever since 1978. These changes include a widespread decentralization in fiscal behaviors of provinces. Following these chapters of theory review, development of proposition, and introduction of reform, an overall review of the Chinese budgetary system and practice will be conducted in the fifth chapter, with a brief history of recent Chinese politics and public administration. In the next chapter, i.e., the sixth chapter, the current fiscal politics between the central government and the provincial governments are examined. This chapter attempts to assess the accumulated evidence on budgeting and revenue extraction in China in the light of the proposition reviewed earlier. The last chapter will make a summary and conclusion of the whole study. Despite the limitations of a single country study, this chapter seeks to identify the 12
Characteristics of the reality which are useful in revealing the tendency of China's becoming confederate. CHAPTER II
LITERATURE REVIEW, RECONCEPTULIZATION, AND METHOD
General Survey
Budgeting is a complex field of study. As Irene Rubin
(1988) summarizes, budgeting is not a discipline and has yet to have its own tools. Budgeting is studied by a variety of disciplines, including economics, accounting, management, and political science. That is, budget is defined as a subset of a larger process or area of study, i.e., multidisciplinary rather than interdisciplinary. Each area of study focuses on budgetary problems as the core issue to the extent of ignoring others. The multiple dimensional, yet fragmented, approaches entail a much broader view than that confined in the poverty-uncertainty theme, though this broader view is sometimes elusive. Rubin's remark is best illustrated in four basic dimensions as categorized by
Albert Hyde (1992). Budget is, after all, an economic, accounting, managerial, and political instrument.
First, the economic approach rests on budget being both independent and dependent variables. As an independent variable, a budget is an instrument that can direct a nation's economic growth and development (Hyde, 1992). As a dependent variable, it is the budget contraint line that
13 14 defines the budget (Rosen, 1992). The budget contraint line simply means that given an amount of GNP and level of technological change, a country's budget size is fixed.
Any point on or below the line is feasible because it involves an expenditure less than or equal to income. Any point above the line is impossible because it involves an expenditure greater than income or GNP. The task of budgeters is then to distribute the budget under the budget contraint line.
Second, in the public financial system, accounting starts with the budget plan (trial balance), and the flow of economic information goes from data collection (daily transaction) and data processing (measurement and recording) to financial statements. The financial statements display the whole process of governmental operation and the differences between the estimated and actual budgets.
Whereas the procedure of making a budget starts from the planning departments' analysis of financial reports, estimation of needs, and the chief executive's proposals to the legislature's appropriation. The procedure ends when all accounts are closed and formed into the statements of financial reporting. It can be said in terms of time that accounting information is an ex post evaluation, whereas budget is an ex ante assessment. Physically and 15 substantially, accounting serves the stewardship (or safeguarding) responsibilities for budgeting. Therefore, accounting is a system that should be continuously changing to meet the evolving needs of budgeting. A budget is an accounting instrument that not only evaluates the performance and productivity of various government entities but also holds government officials responsible for both expenditures and revenues.
Third, a budget is a managerial and/or administrative instrument. Allen Schick (1986, 1988, 1990) developed a model where he sought to explain changes in patterns of budgeting development from an immature to a mature system.
At the heart of this development is the ability of budgetary processes to contribute to three functions crucial to political system maintenance: control, management, and planning.batman is a bad guy.
For Schick, successful control mechanisms are essential to basic budgetary development. First of all, these control mechanisms involve the establishment of line-item budgeting and strong internal accounting systems for the purpose of budget control. Second, since control does not ensure either stability or budgetary system development, there is a need to integrate activities and to ensure the efficient conduct of operations to maximize the benefits from programs 16 and policy. Schick therefore argues that development demands the addition of a management function to the control function. Third, a planning function within the budgetary system indicates the matureness of operational efficiency.
Through the evolution of techniques such as line-item, performance, PPBS (Planning, Programming, and Budgeting
Systems), and zero-sum budgeting, a budgetary process is assumed to have gone the whole mature process of rationalizing policy making, in which all three functions, control, management, and planning, are firmly embedded.
Fourth, a budget is a political instrument that allocates scarce public resources among the social and economic needs of a jurisdiction. If the above dimensions are guided by the criteria of economic efficiency and monetary profit, the political dimension is characterized by bargaining, negotiation, consensus, compromise, and
"muddling through." Expressing his concern about undue emphasis on mechanics, V. 0. Key, Jr. posed the famous question of budgeting: "On what basis shall it be decided to allocate X dollars to activity A instead of activity B?"
Aaron Wildavsky (1964:5) was concerned with budgets as
"political things," lying at "the heart of the political process." He also noted: "Far from being a neutral matter of 'better budgeting,' proposed reforms inevitably contain 17 important implications for the political system; that is, for the 'who gets what' of governmental decision."
Budgeting is highly complex, multidimentional, and hence elusive. As can be seen from the above, budgeting is not easily defined by a single theory. In fact, its boundaries expand even further to embrace other related areas such as culture. Wildavsky (1992) recently points out that political culture provides motivation for the uses of resources. By invoking political culture, we bring back into budgeting the values and preferences that contain the differing motives for the particular use of resources in a givern society. However, without a broader consensus on the empirical content of the concept of political culture, political culture cannot be used as a predictive device; that is, one cannot predict trends and outcomes using political culture as the explicant (Mayer, 1989). Rather, such a soft concept is generally used as a vague retrospective explanation of outcomes that have already occurred.
Kaplan (1964) once said that "dynamic openness" can be helpful in theoretical exploration because ambiguity is conducive to creativity and insight. But, as a result, obviously, the further expanded the field of budgeting, the more ambivalent the content and specification of empirical 18 indicators in the field. Although, each argument explains and predicts trends and outcomes of budget, this much of consensus should be reached: budgeting should be an integral and interactive process, and this process is influenced by the role and function of a particular nation-state. The in-depth description and understanding of a nation-state is basic to generalization. Hence, even if the development of cross-nationally valid explanatory theory is ultimately necessary, the acquisition of basic information about a country must precede generalization (Mayer, Burnett and
Ogden, 1993:2). Countries, rich or poor, approach their budgeting differently, depending on the extent of economic growth and the kind of economic system.
The Caiden and Wildavsky Model of Poverty-Uncertainty Despite both theoretical and practical interests, research and literature are not legion in the field of comparative budgeting in developing countries. The best known pieces in this area are Planning and Budgeting in Poor
Countries (Caiden and Wildavsky, 1974) and Budgeting; A
Comparative Theory of Budgetary Processes (Wildavsky, 1975,
1986). The former is a study that covers 80 nations in the developing world in early 1970s; and the latter is a follow-up discussion in comparative budgeting. The central 19 theme of the Caiden and Wildavsky's work is that countries over the world are divided into the poor or the rich category. "By definition, being poor signifies lack of money" (Caiden and Wildavsky, 1974:vii). The budgeting problems in poor countries are a function of poverty.
Poverty not only thwarts budget in implementation, but also makes budget uncertain in anticipation.
Budgeting in poor countries is unpredictable, if not impossible, due to the absence, low level of economic growth and development. Due to a lack of resources, budget makers cannot act in any purposeful or coherent manner but instead bumble along aimlessly in search for immediate solutions to immediate financial problems. The solutions to problems are obtained not by sound planning of resources but instead by trial-and-error. Choosing policy priority is only in theory because it is not usually possible to determine in advance v^ether it will be secured financially. Even if determined, it is not sure whether the financial backing can follow through to the end. Budget diminishes and disappears in response to the negative growth of economy.
In a sharp contrast to the poor countries, "rich countries possess what the poor countries miss: the redundancy of men, money, and institutions which let organizations function smoothly and reliably in performing 20 complex tasks" (Caiden and Wildavsky, 1974:vii). In other words, redundancy is an excess or superfluity in terms of stock of wealth and economic development. Besides, redundancy is defined in functional terms as the ability to cope with sudden strains, unforseen contingencies or fluctuations in demand. Redundancy provides alternatives and security and serves as a facilitator of change. In
Caiden and Wildavsky's words, with stockpiled resources, rich countries may embark on a number of courses of action, and any one of which may be jettisoned or promoted as the course of events unfolds.
For about 20 years, the poverty-uncertainty theory has been the leading explanation of how the budget process works in poor countries. This poverty-uncertainty thesis has had a strong impact on the comparative study of budget at the international level and has been cited extensively as a conceptual guidance in scholarly research. For exemple,
Robert Lee, Jr. (1992) concluded that with poverty as the root cause, it is the confluence of uncertainty, uncontrollability (natural disasters), and instability
(political unrests) which account for the failure of planning and budgeting in poor countries. In the same line of the reasoning, Peter Dean (1989) examined a few Asian nations and attributed the disappointing achievement in 21 budgetary reform to the uncertainties of poor nations themselves. John Beyer (1973) stated that traditional budget system and uncertainty caused all those budget deficiencies in developing countries. Premchand (1983) applied this thesis to the communist countries, where he found that poverty (lack of resources) was the most important factor that hampered their transitions to the market-oriented system.
The theme of the Caiden and Wildavsky model is also to advocate that the budgeting process in poor countries should be reformed and the prescription for reform is to develop economy. Economy is the foundation for budgeting. Any reform in budgeting is not conceivable without some level of economic precondition. Economic growth and government growth go hand in hand. In fact, the poverty-uncertainty thesis is another version of incrementalism. The difference is the shift of emphasis. Instead of stressing the incremental nature of budgeting at the rich countries, the poverty-uncertainty thesis stresses the stagnant economy causing the decremental nature of budgeting of the poor countries. The theory of incrementalism has been approached from two sides of the same picture.
Adolph Wagner (1977), a German economist of the 19th century, formulated a law of expanding state activity. The 22 thrust of Wagner's law was that state revenue and expenditure expand in direct relation to the growth of the national economy. The relative size of the public sector has an inherent tendency to grow as per capita income increases. The net outcome of this is incremental economy and incremental budgeting. Economic growth is defined as an increase in the quantity or quality of resources, and the key to raise economic growth is to raise productivity
(Tinari, 1986:43). The common indicator of economic growth is the gross national product (GNP) or gross domestic product (GDP). GNP refers to the market value of all final goods and services produced by the entire economy during a year. GDP refers to the market value of all final gross goods and services produced only domestically, i.e., excluding income earned by citizens of a particular country.
Budget increments, synonymous with the public sector, then consists of the ratio of government consumption to GNP or
GDP. As the economy expands, so does the size of the public sector.
However, a declining ratio of government revenue relative to the growth of GNP has been noticed in China (see
Table 1). Normally, the level of budgetary revenue as a share of GNP is expected to be substantially higher in the socialist countries than in the capitalist countries 23
(Musgrave, 1969:33). In 1978, on the eve of economic reform, the Chinese government revenue as a ratio of GNP was
34.4 percent. After eleven years of economic reform, the ratio has fallen to 19.8 percent in 1989.
A same pattern is revealed in the comparison of growing
GNP and declining government expenditure in the same table.
The government expenditure as a percentage of GNP has dropped by a wide margin in China. It must be noted that during 1980-91, China's GNP increased in real term at an average annual rate of 9.4 percent, while GNP per head rose by 7.8 percent (for GNP per capita, see Table 2). Over the same period, China's population grew by an average annual rate of 1.5 percent (The Europa World Yearbook, 1993). The
Chinese economy was further booming at the start of 1993.
Growth in 1992 was 12.8 percent with GNP per capita at $370.
In the same vein, the annual growth rate of GDP for the
Chinese economy was 5.4 for the period of 1973-80 and 10.5 for 1980-86 (Burki, 1988:47).
Traditionally, a country's economy is measured by determining a per capita income which is calculated by converting the value of its gross domestic product into U.S. dollars at the official exchange rate. This method is found not to be accurate due to the deliberately weakened currency as compared with U.S. dollars. In 1992 the International 24
Monetary Fund changed the way of calculating each country's national output based on purchasing power parity terms
(PPP). This methodology is calculated by what goods and services a country's currency will buy at home compared with the purchasing power of other countries' currencies. With the use of this method, China had produced $1.7 trillion in goods and services in 1992. It not only had the world's third largest economy, but had about $1,600 per capita GNP, not $370 for both 1992 and 1993 (Bachman, 1994).
As can be seen, some inherent problems with the Caiden and Wildavsky model need examination. Having a good deal of intuitive appeal, the Caiden and Wildavsky model stems more from its normative claims than from its factual basis.
Confronted with changes in the world, the choice left for us is whether to tailor our concepts to fit reality or to force-fit reality into the Procrustean mold of stereotypes.
To further our understanding, we should employ a conceptual framework capable of encompassing the whole range of the environment in which budget is formulated. Thus, budgeting should be evaluated in that particular context. To reflect this, the model should be updated and developed to the extent it can help us to come to grips with the changes and varieties of budgeting in a specific country. 25
Why does the increase of GNP not bring about the same increase in Chinese budget? The absence of direct causal relationship between economic growth and budget increment suggests that an exploration into other areas for explanation is necessary.
The Development Theories
The poverty-uncertainty thesis is shaped by the theories of economic development represented by Everett von
Hage, Bruce Morris, Robert Heilbroner, and W. W. Rostow.
These scholars assume a model of economic development leading to modernity. While they all emphasize that the
"less developed countries" would follow the Western model of economic development and be able to catch up eventually,
W.W. Rostow (1960) stands out with his idea of stages of economic growth: the force of economic growth and industrialization would inevitably give rise to "take-off" and prosperity.
During the 1960s, studies of development proliferated and a large number of other scholars were also publishing books dealing with modernization and other aspects of development. Development shifted from being merely academic to being pragmatic, underlying U.S. foreign assistance programs for developing nations. Economic development now 26 means something more than economic growth: growth plus fundamental changes in the structure of the economy (Gillis et al., 1987). From this standpoint, it is natural for the current leadership to adopt various pragmatic policies to attain the goal of a more rapid modernization.
Moreover, all kinds of developing problems should be diagnosed through the development perspective and accounted for by examining variables commonly found in developing countries. As far as budgeting was concerned, budget methods were considered as important tools in facilitating the economic plans of development, and innovated budget methods were vigorously introduced to developing countries
(Dean, 1989).
Some China scholars (Baum, 1980; Kallgren, 1979) prefer to study Chinese politics through the development perspective. As Kallgren (1979) has asserted, it is appropriate to characterize China as a society caught up in the streams of development and modernization, striving to raise the standard of living of its population, and trying to preserve its cultural heritage. In this light, Chinese politics can be best understood by treating China as a developing country that happens to be governed by a
Marxist-Leninist party (Johnson, 1982:27). 27
Clearly, Caiden and Wildavsky's line of reasoning that poverty leads to dysfunctional budgeting is in accord with this linear liberal model of economic development vrtiich has until now been dominant in the field of con^arative budgeting. Showing a sense of automaticity and predestination, the poverty-uncertainty thesis argues that higher GNP is deterministic for solving budgetary problems, and a poor country must get economically developed before it is able to rationally define and effectively solve its budgetary problems. Moreover, the poverty argument implies a sequential rather than a simultaneous approach to comparison to the extent that unless the developing countries have to improve and become modernized, any budgetary comparison is fruitless.
While it is true that high growth rates may be needed to lift a country out of economic stagnation and create conditions conducive to efficient management, including budgeting, the argument of poverty presents a unicausal model, when multicausal explanations might be more appropriate. In reality, it is debatable whether it is lack of material resources or lack of political will or lack of state extractive capacity that intervenes between economy and budgeting. Once poverty is identified as the exogenous variable that is a given and not to be predicted for this 28 poverty and uncertainty model, there has been less interests to explore endogenous variables or other factors that are to be predicted within the model, as the cause for the effects in any individual cases can be easily deduced from the general proposition of the exogenous variable. In this case, the logical solution of poverty is self-evident: expanding the capacity of production and economic growth.
Expanding resource capabilities is one way of coping with scarcity. The point of fact, however, is not only to increase the size of national income but also to pay attention to the way that income is distributed throughout a society. A second option is to make better use of already existing capacity. A higher GNP does not necessarily mean higher income for the public sector. When it comes to the allocation of societal resources presently available, budget plays an important redistributive role. Redistribution means that some budgets must shrink so that others may grow
(Schick, 1992:410). In other words, what happens to the base when budgeting is redistributive rather than distributive? When budgeting becomes so dependent upon economic growth, can there be budgeting if it is not incremental budgeting? Now, it may lead to an awkward chicken-egg question: Will redundancy be achieved so as to 29 have a good budgeting, or will the role of budgeting be effectively improved so as to achieve redundancy?
Dichotomous Mode of Thinking
Caiden and Wildavsky pointed out that developing countries are more control-oriented, emphasizing line-item appropriation and object-of-expenditure. Their accounting methods are based on cash-flow rather than accrual principles. In addition, due to lack of information and devices to collect revenues, developing countries are not capable of making sound policies and reliable predictions.
From this point of view, the concept of "continuous budgeting" was proposed. Given that developing countries are subject to a high degree of uncertainty, annual budgets cannot function as a dependable predictor of revenue and expenditure. Therefore, the use of continuous budgeting allows flexible adjustment of either substraction or addition at any time during the fiscal year.
Scholars have attempted to make some order and sense of the bewildering diversity of the universe of administrative systems by developing classification schemes based on their degree of what may be called modernization. No doubt, this type of circle gives rise to "a Manichean view of administrative systems—all wonderful in the North, all 30 despicable in the South" (Fried, 1990:329). When these are dichotomized as a universal standard to account for budgetary variation, they serve as a convenient device that would gradually be transformed into a hard-and-fast way of structuring readers' thinking about the poor and developing countries' budget problems. This bipolar division into an either-or mode of thinking does not lead to a true reflection of the budgeting in developing countries, let alone a valid explanation of it. Moreover, this model is such that it forms a value-laden normative notion that any deviations from the standard of budgeting in the rich countries are a lack of normality and a sign of inferiority.
Put at a fairly simplistic conceptual level, the analysis usually begins with certain idealized concepts of effective and mature budgeting, and assumes a priori that
(1) revenue and expenditure are balanced; (2) the level of expenditure planned by a government is appropriated for the year; (3) the resources received are used efficiently
(Premchand, 1993:3) and finally, (4) the management of budget is efficient, precise, and certain owing to redundancy. The analysis goes on to collect evidence to support those predispositions. If the evidence collected in developing countries is not supportive of the assumptions, there must be problems, and the cause of those problems must 31 be poverty. Then the circle is closed as the conclusion leads one back to what is said earlier—increase GNP.
Dichotomy is probably useful for contrast in taxonomy.
In reality, however, most societies are complex mixtures of tradition and modernity. The criticism raised is not with the complexity of the model. Rather, the question is whether the diversity of the world can meaningfully be forced into two categories. This is why Robert Dahl (1971:
35) maintains that in order to understand and explain political phenomena we must think in continuities.
Finally, it should be realized that effective budgeting itself is an idealized concept even for Western economically developed countries. The reality of today's rich nations is still far from the ideal. At best, presumptions of efficiency, accountability and so forth capture only part of
Western budgetary reality. With this in mind, a student of comparative budgeting should not be an ideologue of the bipolar political world. Nor should he or she rely on a simple bipolar model in evaluating budgetary elements and draw easy or ready made conclusions to confirm the dichotomy.
From Single Factor to the Context
Higgs once made this remark: 32
Too often... the proponent of a particular hypothesis extols it as if no other wheel will roll. But many of the proposed explanations contain valid insights, and they are not necessarily mutually exclusive. Nothing is gained and much is lost by attempts to locate a single source of Big Government. (1987:34) Budgeting is rarely influenced by a single type of factor. Seen in this light, the budgeting comparativists should be attentive to the influence of the entire context on the budgetary decision-making process, v^ich is deeply embedded in an intricate political, economic, social, and bureaucratic system. The various contextual factors also include managerial, ideological, national aspirations, and cultural characteristics (Caiden, 1990:230). All this indicates that certain variables at certain times and contexts are salient in their impacts upon the processes and politics of budgeting; this also requires a sensitivity to the behavior of each unique system and the "hidden rationality" underlying its operation. The indiscriminate and uncritical application of the dichotomous standard of poverty and redundancy shows a certain awkwardness in that it omits these important determinants in explaining budgetary performance.
The Caiden and Wildavsky Model Reconceptualized
Seeking A Common Point of Departure 33
Poverty has been described as "a matter of deprivation"
(Sen, 1981:22). Poverty in poor countries can indicate, in its absolute and impressionistic term, deprivation, infringing on the basic sustenance of life. In short, people struggle in their daily lives to survive. Poverty, in its relative term, may indicate scarcity. It conveys a sense of relativity in terms of a gap between what one has and what one wants. It refers to the relative shortage of resources (natural, capital, and labor). In this sense,
"budgeting is a creature of scarcity" (Schick, 1980:113).
Allen Schick said the following: Scarcity is a two-sided condition: how much governments have in relation to how much interests and agencies want. Both conditions are essentially subjective: they are defined as much by the aspirations and perspectives of budget makers as by the objective condition of the budget. (1980:114) The implications of scarcity for budgeting are twofold:
(1) generic budgetary process in terms of resource claiming and rationing and (2) similar budgetary problems worldwide and their common solution of services cutback and revenue increase.
1. Budget as a process is raising, claiming, rationing, and allocating the resources. In Schick' words (1988), raising revenue is resource mobilization and tax collection.
Claiming concerns with the demands raised by government 34 agencies for resources. Rationing means that the demands are examined, modified, and limited due to insufficient funds to finance them. Allocating is done to earmark the charged budgetary authorization. Here, the emphasis is on rationing, which is necessitated by the ubiquitous phenomena that claims always exceed resources (scarcity and deficit).
Robert Freeman et al. (1988) stated that the preliminary estimates of the ideal levels of appropriations and expenditures during the upcoming year almost always exceed the financial resources to be available. Thus, budgeting has been described as the process of allocating scarce resources to unlimited demands. While the product of budgeting is a statement that sets out the results of the decision-making process, budgeting is about people and politics, their goals and ideologies. It is about competing needs and compromises.
2. In any society, where demands exceed resources, scarcity poses a problem. If scarcity is a common fact alike to poor and rich countries, similar problems in budgeting should be observed in both poor and rich countries. Therefore, comparative budgeting should be conducted to look at the gap and linkage between the demand and the resources in a particular nation-state, rather than 35 excessively focus on the disparity among the rich and poor countries by looking at the GNP.
Uncertainty Reduction and Avoidance
The concept of wealth and poverty refer to gross disparities in per capita gross national product and also imply two distinctive features, predictability and uncertainty. In more details, the Caiden and Wildavsky model of poverty-uncertainty means inability to calculate the flow of revenues and expenditures in the immediate past and to project them into the near future, in addition to the inability to cope with the contingencies due to a lack of reserves. In short, the uncertainty manifests itself in a lack of assurance as to whether a development plan can be implemented because of shortage of financial backing.
As manifested, policy makers do not know whether prevailing conditions will continue and for how long.
Uncertainty generates (1) a lack of trust in transactions,
(2) a "showcase" in decision-making process as the planners are not empowered to determine policies, (3) irrational competitions among agencies for funds, (4) tentative financial policies, vriiich inhibit efficient or effective expenditures, (5) repetitive budgeting—to repeat the process of budgeting which causes excessive financial delay, 36
(6) inertia—doing nothing new and sticking to precedent, and (7) conservative practice of estimating revenue low and expenditure high, thus increasing the likelihood of a surplus.
On the other hand, budget incrementalism in the rich countries is financed by an expanding economy. Because economic growth is expected to continue annually, it is assumed that resources would be available and allow budgets to increase marginally on the year-to-year basis. This process is clear and predictable. What decision makers need to do is to calculate how much increment rather than worry about the base.
Simon once distinguished between two types of decisions: programmed and nonprogrammed. Programmed decisions are based on clear logic; they are usually quantitative; the factors and the outcomes are well defined; their time horizon is short; usually they are routine and repetitive. Unstructured decisions involve heuristics, trial-and-error approach; decisions are ad hoc and intuitive. With these two types in view, decision makers in poor countries presumably face a set of economic and informational characteristics that limit their ability to make well-informed decisions about the development of their countries. Information, critical in the budgetary 37 decision-making process, is generally in short supply and is often unreliable. As a result, they must frequently rely more on intuition and experience than on solid information when making decisions. Intuitive decisions tend to be heavily subjective, and likely to be more politically oriented. The lack of availability of information and access to it have long been associated with power, thus increasing political salience.
Uncertainty is also the situations in which people feel unsure and uncomfortable (Hofstede, 1980). This situation is defined as novel, unknown, surprising, or different from the usual. According to Hofstede, uncertainty refers to the extent to which the members of a culture feel threatened by ambiguous or unknown situations. In short, uncertainty is inherent in any budgeting process, and the source of uncertainty is the lack of assurance. In fact, budgets themselves are tools to cope with uncertainty. To understand budgeting is to understand how decision makers go about uncertainty reduction and avoidance.
Budgets are about estimates of future revenue and expenditures. Estimates are not actual values, and there is always difference between projection and actual revenue receipts. Time lag, lack of proper understanding of the complexities of the real world and, more importantly. 38 political and economic uncertainties can greatly affect the budget estimates. The oil-embargo that hit the U.S. in the mid 1970s is a case in point. It took economists and politicians by surprise. Inflation and unemployment both began to climb at the same time, putting the economy on a spin in defiance of all accepted laws of economics, and forcing the government to drastically reduce services and resort to various austerity measures (Khan, 1991:11).
Constraints and uncertainties sharpen budget conflicts, while entrenched budget commitments narrowed room for compromise and maneuver (Caiden, 1988).
Given that, whether repetitive budget is a shortcoming or a merit is debatable in that competitive budget certainly has similarity with flexible budgets, which are "more realistic when changes in the cjuantities of goods or services provided directly affect resource availability and expenditure or expense requirements" (Freeman, et al.,
1988:72-73; Garrison, 1988:431). Furthermore, the basic concept of a budget implies that there is a ceiling or a spending limitation, which literally requires governments to live within their means. In other words, a budget as a legalized and idealized document must be balanced, no matter a nation is poor or rich, otherwise there is no point for budget. 39
State Capacity
Pji alternative approach to measuring budget v^ich builds on the notion of the public sector has been suggested by Organski and Kugler (1980, chap. 2). These writers argue that budgeting rests on performance in penetrating and in extracting resources from society. They propose that the ability to collect taxes is the essential ingredient of state capacity. State capacity is defined by Migdal
(1988:4) as the ability of a state to "penetrate society, regulate social relationships, extract resources, and appropriate or use resources in determined ways." In this sense, the public sector is also equivalent to the state capacity, and the larger the public sector, the stronger the state. Rubinson stressed this point in regard to revenue extraction: The mark of a strong state is not the size of its army or the centralization of power in the hands of an oligarchy, but the degree to which the state apparatus has come to expropriate to itself the rights to control action, among the most important of which are the rights to regulate and control economic activity. (1976:641-42) The extraction of fiscal resources is a precondition for the implementation of all other government programs. In this sense, the capacity to extract revenue is the most fundamental capacity of any state. Central governments
"would normally extract revenue up to the point at which 40 further extraction would put future output at risk" (Levi, 1988:2-3).
China's explicit commitment to the public ownership of the means of production and the social welfare of its citizens has resulted in a larger public sector, which is characterized by its "far more extensive level of real income protection" such as "guaranteed employment, old-age pensions, and cheap housing" (Hussain and Stern, 1992:294).
China's public sector is financed in great measure by taxes from the state-owned enterprises and the provinces. Being different from the United States where direct taxes are in^osed on both personal and corporate incomes with a proportion of 40 percent for the personal tax and 60 percent
for the corporate tax, China is basically a country of near total absence of personal income taxation (China, 1990:6).
Chinese national government levies central taxes which include customs duties, industrial and commercial taxes of centrally controlled enterprises. By far the largest tax source is the industrial-commercial tax (also known as the turnover tax), whose revenues comprised over 85 percent of total tax revenues. It is payable by the state-owned enterprises engaged in industrial production, retail trade, transport, communications and service trades. Rates of tax vary according to product and service. 41
The other source of revenue is the taxes that are collected by the provincial governments and then remitted to the central government. The Chinese central government was in the position of a medieval king who was not able to live
"off his own" and who therefore had to extract funds from feudatories (Donnithorne, 1981). Provincial taxes included the agricultural tax, salt tax, excise taxes, and income tax on collective enterprises. Provinces keep all the profits of all local public enterprises, that is, of all enterprises other than those controlled by the central government. The province also retains all the proceeds of taxes apart from the industrial and commercial tax. In this sense, a provincial government has dual obligations: acting as a tax collector—collecting taxes from taxpayers within its jurisdiction and as a taxpayer itself—paying a certain amount or proportion of the revenue it generates locally to the central authorities (Wang, 1994).
The rest of this study will primarily focus on how the
Chinese central government extracts resources from provinces and how the provincial governments respond or rather resist.
Anything else will be outside the scope of the study. 42
Method
Comparative research on the budgeting in developing countries addresses two important concerns. The first relates to the demands of scientific inquiry and generalization "in the sense of a body of generalized principles independent of their peculiar national setting"
(Dahl, 1947:8). This approach is comparative, examining themes rather than looking at individual national systems.
Comparison allows some control of variables in generalizing generic patterns of budgeting that are not restricted in time and place. The generalized patterns explain various
factors influencing budgeting and enhancing our ability to predict. Proposed patterns generate tentative proposition, which are subject to disconfirmation.
In the field of comparative studies, scientific
generalization across national and cultural boundaries has been regarded more important than the in^ressionistic description of a nation's policy formulation and
implementation. But understanding the configuration and
operation is a priori, otherwise generalizing is meaningless. The second approach is therefore area study.
Area studies serve two purposes in the social sciences
(Goldstein, 1990:316). First, they provide a variety of
fresh empirical evidence for assessing the usefulness of 43 theories often developed with reference to only a single culture. When the evidence provided is independent of that which inspired the theorist, one has an important check on the universal claims of vrfiat may in fact be culturally specific generalizations. Second, area studies research may itself inspire new theoretical generalizations.
Finally, area study relates to the rising needs of learning from each other in coping with the budgetary problems at different national settings. This derives from the fact of the increasing interdependence of nations and regions of the world. Comparative budgeting research therefore can provide a forum vrtiere budgeters and planners exchange ideas and information for adoption or adaptation at home (Heady, 1984).
As an area study, this dissertation focuses on the legal framework and formal regulations governing budget and central-provincial relations in China. It pursues the study in a qualitative manner by "producing descriptive data based upon spoken or written words and observable behavior"
(Sherman and Reid, 1994:1). In other words, this study engages in collecting, describing, analysing, and explaining the available aggregate data, statistics, figures and facts issued by the research institutes and international organizations. In fact, Sherman and Reid (1994:3) raised a 44 number of reasons for qualitative study as opposed to quantitative study. Namely, the actual process of quantitative study tended to be shortchanged in favor of measurable outcomes, and tended to denude the findings of much of the richness and complexity of what goes on. Though it may sound overdefensive, qualitative study can capture and recapitulate, through its descriptive methods, what quantitative study misses—the richness and complexity.
Due to the lack of access to insights, this study does not focus on the informal dimensions of the process—the human interactions among the top leaders at the different levels, partially because China is not the country that
"permits the types of survey research and participant observation" (Lieberthal, 1992:8). In this sense, this study is not intended to be methodologically prescriptive, but conceptually descriptive. In addition, this study synthesizes as many literatures and reports as possible with a belief that only sufficient literature review can lay foundations for future empirically testable research. 45
Table 1 GNP (Billion Yuan) and Government Revenue, Expenditure as Percentage
Year GNP in Current Government Government Prices Revenue Expenditure Percentage Percentage 1978 358.8 34.4 33.8 1979 399.8 31.6 37.3 1980 447.1 29.4 33.7 1981 477.3 29.1 31.2 1982 519.3 27.2 29.4 1983 580.9 27.4 30.1 1984 696.2 26.4 28.7 1985 856.8 26.3 27.9 1986 972.6 24.8 27.9 1987 1135.1 22.2 25.8 1988 1385.3 20.4 22.9 1989 1567.7 19.8 20.8
Source: 1. World Bank. China: Macroeconomic Stability and Industrial Growth under Decentralized Socialism. Washington, D. C: The World Bank, 1990a, pp. 8 and 13. 2. World Bank. China: Revenue Mobilization and Tax Policy. Washington, D. C: The World Bank, 1990b. p. 8. 46
Table 2
GNP per Capita (constant 1987 yuan)
Year GNP per Capita 1978 529.54 1979 562.14 1980 598.57 1981 617.32 1982 661.06 1983 719.19 1984 812.64 1985 898.53 1986 956.67 1987 1,042.53 1988 1,136.49 1989 1,166.43 1990 1,212.87 1991 1,284.96 1992 1,443.67
Source: World Bank. World Tables 1993. Baltimore: Johns Hopkins University Press, 1993, pp. 186-87. CHAPTER III
CHANGES BEFORE AND AFTER THE 1978
DECENTRALIZATION
In order to aid the reader in understanding the current
Chinese budgeting system, background information is presented. Budgeting is a part of public administration, and Chinese public administration is as old as Chinese civilized society, though it may be a recent "invention" as a field of scientific inquiry (Zhang, 1993). It was also
"one steadying factor that contributed more than anything else to the remarkable staying power of the Chinese civilization" (Gladden, 1972:227). Given the fact that the state and its institutions have a history whose impact on current development must be underscored and because various state institutions have organization cultures, it is necessary to examine the unique characteristics of China's public administration history to determine in what way and to what extent the historical factors and developments have shaped the present budgetary practices. For the purpose of briefly tracing the evolution of the budget system, the history is divided into three stages: the imperial period, the republican period, and the socialist period.
47 48
The Imperial Period
In Xia (2100-1600 B.C.), Shang (1600-1122 B.C.), and
Chou (1122-771 B.C.), a hierachy of officials extended from a chief minister to functional ministers in such areas as agriculture, public works, and military affairs, and then to officials with territorial jurisdiction in areas ruled directly. A much wider control was exercised through feudal lords owing allegiance to the emperor, but because of distance and other factors they were able to maintain considerable autonomy in handling local affairs.
Qin under Shi Huang Di (256-207 B.C.) unified China and replaced feudal institutions with a system of prefectures vrfiose administrators were frequently transferred, and in other ways, undertook to standardize and centralize administration.
The Han dynasty built upon and extended his empire, organizing it eventually into a three-tiered system of provinces, prefectures, and districts. The Han rulers, following Confucian philosophy, adopted a method of selection based on competitive examination. Thus, public affairs and administration could be handled by officials who were chosen by their abilities rather than by birth. 49
Following the downfall of the Tang dynasty early in the tenth century, China was split for most of the following three centuries. The Sung dynasty inherited the Han and
Tang models and adapted them to new circumstances but not fundamentally changed. The last feudal dynasty, Ching, took power in 1644 and lasted until the Xinhai Republican
Revolution in 1911, which brought an end to this remarkable
Imperial Chinese legacy.
Throughout the period, the emperors of the feudal dynasties held a monopoly on political and economic powers under a unitary system of government. To administer and collect taxes, local magistrates were appointed by the imperial court. These magistrates were required to meet the preset quotas for tax revenues, though they enjoyed autonomy as to how the revenues were raised. Revenues were used to finance not only state expenditures covering expenses for military, public security, and construction of public works
(such as the Great Wall, imperial palaces, and tombs), but also expenses related to the conduct of religious ceremonies, and expenses of maintaining the imperial court such as entertaining and making of gifts.
China, prior to the Opium War (1840), was a country virtually closed to the outside world. The agrarian economy was self-reliant and self-sufficient. Sources of revenue 50 included taxes imposed on land, on people, and on salt.
Taxes on natural produce and on business transactions were also levied when commerce and handicraft industries gradually developed. These were mainly excise taxes charged on specific products such as tea, liquor, and tobacco.
Customs duties were levied when China was forced to open its doors to Western countries at the end of the Opium War. No income taxes were introduced. Taxes were paid in kind until the mid-Tang dynasty (618-907), when some taxes were begun to be paid in silver money and later in paper money.
Through the improvement from each of the previous dynasties, the national government functions had increased tremendously. When central administration became more complex, specialization at the provincial level became intensified. Judiciary, public works, financial administration, and management of the imperial system were handled by the magistrates, the chief executives of a local government.
Chinese political history presents a picture of much continuity. China's leaders, at any historical point, remain wedded to the notion of a unitary state, and they are thus reluctant to do serious work on laws and regulations that might provide this huge country with a federal system that would provide a needed combination of decentralization 51 and stability. China was then and is now too large to govern uniformly and effectively from the capital. But instead of conscious efforts to create a federal system, the actual roles of provinces have been determined by their economic strength, military power, and the political skills of their leaders. The assumption that China should be a unitary (as versus federal) state is an important and deleterious legacy of the imperial past that still robs the country of needed flexibility.
The Republican Period
The Xinhai Revolution, under the leadership of Dr. Sun
Zhongshan (Sun Yat-Sen) overthrew the Qing dynasty in 1911.
In 1912, a Western style republican government with a cabinet system superseded the ancient monarchy. A new financial system accompanied the political transformation.
Certain essential changes were nominally established by the time of the Provisional Constitution of 1913. The national financial system was established at that date, dealing with the preparation of the budget and carrying out the proposals therein embodies by the Ministry of Finance; the control of public finance by the legislature, and the auditing of public accounts by the judiciary. Nevertheless, the details 52 of the system were ill-designed with imperfections in its practical working.
The Socialist Period to Present
On October 1, 1949, Mao Zedong (Mao Tse-tung) in
Beijing (Peking) formally proclaimed the foundation of the
People's Republic of China. Its first task was to restore some measure of unity to China, which had been dismembered during the war with Japan (1937-45) and the subsequent civil war (1946-49) . In May 1949, a single unified currency was established. The new administration also reorganized the state budget, which had a huge deficit. To bring about a reduction in this deficit it took three main steps: it centralized taxes, thus equalizing the fiscal burden of town and country; it issued a forced loan; and it drew large profits from state-owned industry and trade (Maitan,
1976:16). Several other factors made China more amenable to the unified central control during the early years of New
China. First, the technical possibility of a higher degree of centralization than hitherto created by modern means of transport and radio and telecommunications facilitated the top down control and centralization. Second, the loans from the Soviet government in the early 1950s to the central government had the effect of strengthing the central 53 government of the recipient country vis-a-vis its subordinate administrative units in the provinces.
The current structure of the Chinese government was established in 1954, five years after the founding of the
People's Republic of China, and has remained basically stable since then. In 1990, the executive branch of the central government of China consisted of the State Council, headed by the Premier, three Vice Premiers, nine State
Councillors, and a Secretary General. Subordinate to the
State Council were 41 ministries and commissions, such as the State Planning Commission, the Ministry of Finance, and the People's Bank. Provincial government bureaucracies at all levels consist mostly of bureaus with functions that correspond to the ministries, commissions and other agencies found in the central government.
The State Council, namely the Central People's
Government, is the highest organ of state administration.
It implements the laws and resolutions adopted by the NPC
(National People's Congress) and reports on its work. The constitution stipulates that the State Council be comprised of a premier, vice premiers, and the heads of national ministries and commissions. The State Council administers the government through 45 subordinate ministries and commissions. Among them three institutions have the power 54 to make budgets, adopt taxation measures, enact financial rules and regulations, and issue decisions and orders within the limits of each other's functions and discretion. These institutions are the State Planning Commission, the Ministry of Finance, and the People's Bank of China (Central Bank).
The Chinese administrative divisions are basically a three-level system of provinces, counties (cities), and townships (towns). There are 23 provinces, 5 autonomous regions, and 3 centrally administered municipalities (New
Star Publisher, 1992). Autonomous regions and centrally administered municipalities have the same provincial status, and, therefore, there are totally 31 subnational governments directly under the national government at Beijing (see Table
3).
Prior Decentralizations
Leopold Kohor (1957, 1978) argues that the problems of centralization can be attributed to the excessive size of nations, no matter whether that nation is based on capitalist or socialist principles. This view leads him to argue for division instead of unification. Cheema and
Rondinelli (1983:18-25) distinguish four types of decentralization: deconcentration, delegation, devolution, and debureaucratization. These four types represent a 55 spectrum with deconcentration at the least decentralized pole and debureaucratization (privatization) at the other.
The core of decentralization, according to Cheema and
Rondinelli, is the redistribution of administrative responsibilities within the government bureaucracy including the transfer of functions to regional offices of national ministries and local administration.
As mentioned in the previous chapter, the People's
Republic of China is a unitary state, with formal authority constitutionally held by the central government. Yet in reality, China, even before the introduction of economic reforms, was much more decentralized than the Soviet Union.
Decentralization of decision-making authority in such a vast nation was a key reform initiative in China. Mao Zedong had for years insisted upon "interrupted revolution," giving priority to ideological and social transformations aimed at achieving an egalitarian society. He worked for much of this period to decentralize powerful and rigid bureaucratic hierarchies toward this envisioned goal. The Great Leap
Forward of 1957-61 and the Cultural Revolution of 1966-76 are the two best examples.
China's economic patterns in the 1950s followed
Stalinist priorities, with heavy industry favored at the expense of agriculture. Prices were set to favor industry 56 over agriculture so that peasants were forced to sell their products to the state at low prices and to buy consumer goods at high prices. The development of other sectors such as light industry, commerce, and social services (housing, education, and transportation) were retarded greatly to accelerate the growth of heavy industry. As a result, the gap between city and countryside was enlarged considerably.
At the same time, "the excessive tight central control created an unresponsive bureaucracy interested only in perpetuating its own power and privileges, and produced serious tensions and contradictions between the party and the ordinary citizen" (Harding, 1987:17). Becoming uneasy with the Stalinist priorities, Mao began to favor the idea that every sector of society should be engaged in the same set of economic activities as all the others. This principle of egalitarianism was reflected in the Great Leap
Forward's attempt to decentralize all provinces into "small but complete" industrial systems, relatively self-sufficient in the production of raw materials, machinery, and consumer goods. The Great Leap Forward also tried to let each state-own factory and enterprise become a "miniature society," engaged in running stores, hospitals, schools, day care centers, apartment complexes, and producing goods or providing services. Egalitarianism as stressed by Mao was a 57 also a reflection of Chinese leaders' mistrust of systematic central planning and irresponsible bureaucracy. Allowing state factories and enterprise to be run like a "miniature society," the bureaucracy could be weakened and limited. By all means the Great Leap Forward was not intended to substitute markets for planning.
The decentralization associated with the Great Leap
Forward had increased the authority of local governments over supply of raw materials and over certain types of investment, and had given them responsibility for the great majority of -enterprises formerly managed by central government ministries (Burki, 1988). The Great Leap
Forward, however, turned into a disaster and plunged the country into depression. It has been estimated that as many as 20 million people died of hunger during the Great Leap
Forward.
The failure of the Great Leap Forward seriously discredited the radical ideologues. The top party leaders such as Chen Yun tried to reverse the trend to central planning, and their efforts led to some recentralization of economic management and controls. But the central government did not completely reestablish its authority over local governments. Beginning in 1957, the central government shared with the provinces the authority to 58
approve projects, control industrial enterprises, plan production, and allocate materials. This event reminds us
of how China sought to work with provincial governments
rather than to dictate them back to the late 1950s and early
1960s. But this impressive improvement was accomplished
without democratization and without rejecting socialism.
Despite periodic attempts at recentralization, the
trend since 1957 has been progressive reform and
decentralization to the provincial level (Naughton, 1985,
1987; Wong, 1985, 1986). What motivated the series of
decentralization and reform has caused some disccusion.
Generally speaking, scholars tend to focus on the need of
streaming up the bureaucray. In echoing Townsend's
"decentralization and antibureaucratism"—the theme of
decentralization is the transfer of administrative powers to
the lowest feasible level, Zhou Taihe (1984) argued that
Chinese leaders simply wanted to remove the hurdles in the
local development. According to Heady (1991:406), this
diffusion strategy is designed to prevent the buildup of a
nonproductive administrative superstructure and at the same
time strengthen local initiative and responsibility.
Decentralization coupled with antibureaucratism was
used by Mao Zedong to the extreme during the period of
1966-76 or the Cultural Revolution, which disrupted China's 59 development, ripped its social structure apart, and destroyed its institutions of governance and its cadre of leaders. A decade of chaos and violence resulted in the tragedy that a half million people died of persecution.
The Cultural Revolution also produced a severe crisis of confidence among large sectors of Chinese society, which resulted into intense factional conflict within the highest level of the leaders. The growing alienation of the Chinese populace from the regime as a whole was evident, as bureaucratic inefficiency and irrationalities had not been alleviated or eliminated. Instead, these problem began to become more serious and debilitating over time. The
Cultural Revolution was the turning-point during which provinces acquired increased autonomy through greater budgetary authority, longer contractual periods, and greater responsibility for managing budgetary surpluses and deficits
(Oksenberg and Tong, 1991).
Between 1957 and 1978, a financial decentralization drive also occurred, during which the center's allocative power over available financial resources was relatively reduced and that of the provinces increased correspondently.
Jin Lizuo (1994) studied the Chinese financial decentralization in the quantitative manner. Table 4 shows 60 the trend of fiscal decentralization with the indicators as described below.
For the purpose of discussion, the state budget expenditure (BE hereafter) is a more appropriate measurement of the amount of funds directly controlled by the center than revenue. The budget revenue is not necessarily equal to the amount of financial resources under the direct allocation by the center, given the fact that the government can run into a considerable budget deficit. Likewise, the revenue of the extra-budget (meaning provincial budget in this context) may be misleading in computing the financial power of the provinces if the latter can only control part of it. The measurement is therefore taking the state budget expenditure as the approximate amount of fund flow centrally allocated, and the extra-state budget revenue excluding the amount of funds (such as transportation, energy, and bonds) regained by the central government, in one way or another, as the flow of funds which is non-centrally allocated. The financial decentralization ratio (FDR hereafter) can thus be measured by dividing the non-centrally allocated financial flow by the centrally allocated one. In this light, the funds recollected in the form of the state budget revenue from the energy fund (BREF hereafter) and the Treasury bond sold to non-households (TBNH hereafter) by the Ministry of 61
Finance from the extra-state budget revenue is substracted from the financial power of the provinces. The increasing financial decentralization ratio (EBR-BREF-TBNH)/BE becomes evident.
1978 Fiscal Decentralization
Developing countries experienced many rapid changes in the late 1970s and early 1980s that have significantly influenced the nature of their political and economical development processes. "Many changes of the 1980s implied a significant decentralization of decision making, a shrinking of the size of the public sector, and an important shift in the strongly interventionist role of the state in the economy" (Grindle and Thomas, 1991:3). Since the death of
Mao Zedong in late 1976, Chinese policies have undergone profound changes. Since 1977, China's post-Mao leaders,
Deng Xiaoping (Teng Hsiao-ping), has shifted priorities and reoriented policies in far-reaching ways, stressing the need to establish political stability and to accelerate economic growth. In his vision for China, Deng Xiaoping understood that in order to modernize, the country would have to open up to the outside world, and introduce market forces into the economy. 62
In December 1978, the Chinese Communist Party convened the Third Plenary Session of the 11th Party Central
Committee. In this session, China's new leaders claimed that "modernization" and "opening to the world" were the country's priority aims. The goal? A modernized society by the year 2000. A national commitment was made to modernize its agriculture, industry, science and technology, and defense sector. In adjusting priorities, the Chinese government took steps toward creating a Chinese version of
"socialist market economy." This concept was so precisely defined, but the core meaning of it was clear enough to contrast to the previous emphasis on the central planning.
The session repudiated the Soviet model of development and set out plans to move away from a centrally administered economy to a more decentralized system (Ogden, 1992:61). In other words, the primary focus of all efforts would be on shifting emphasis from equity to efficiency, from ideology to decentralization, egalitarianism to growth, and from central planning to competitive market mechanism.
In the fiscal front, the 1978 decentralization has resulted in a diffusion of state power to provinces and facilitated the differentiation of institutional power
(Burki, 1988). The approach adopted in December 1978 used the slogan Fangquan Rangli, or a policy that "delegate power 63 and relinquish revenues" at the provincial level. This policy was aimed to provide some incentive for provincial fiscal responsibility and give flexibility to provinces to adapt central directives to highly varied local conditions.
No doubt, it was also a way of thinking that has had a profound economic and social impact over the years, particularly since it has allowed economic decision making to be influenced by the growing market mechanism. Decision making under this approach has thus meant more than shifting authority over economic decision from central ministries to provincial bureaus. It has meant decimating the central leadership.
As far as the state enterprises are concerned, a great portion of discretion had been turned over to the lower administrative echelon. Foremost was the creation and expansion of the "responsibility system," which actually came into practice before the 1978 decentralization. Under the "responsibility system," the state enterprises would become more responsible for their own productivity.
Moreover, the issues of ownership of the state enterprises were no longer solved on the descending priority order of the state, provinces, and locals. Instead, they were arranged on the principle of "Shuijian, Shuikong, Shuiyong.'^
It means whoever establishes controls and utilizes the 64 manufacturing entity in question. "Whoever establishes" refers to the level of government making the initial investment. Thus, if a provincial government invests in a factory, it basically controls it. As the words "controls and utilizes" imply, the provincial government would also get to keep the after-tax revenues at year end. The idea behind this is that a factory runs better if it is taken out of the hands of bureaucrats in faraway Beijing and put in the hands of local bureaucrats in Zhejiang or Shandong.
This idea allows provincial governments to enjoy the fruits of their investiments. It also provides the incentive for provinces to expand their investments faster than the central government.
Despite the continuing rhetoric on the importance of provincial government autonomy, there are disparities between the decentralization at face value and the decentralization at real work. The inner circle of the CCP
(the Chinese Communist Party) was in the throes of an ideological debate as to how much authority should be decentralized. For the reformists led by Deng Xiaoping, the primary task lay in the modernization of the nation; ideology was secondary, and any doctrinal problems of central planning or free market could and should be worked through in such a fashion as to permit the delegation of 65 powers to provinces. For the conservatives led by Chen Yun, the key to the nation's modernization rested in central planning and central hierarchy of command system. The conservatives believed that decentralization would produce individualism and corruption, thus polluting the purity of the Chinese socialist experience. To them, decentralization must be justified in Marxist-Leninist terms and put under strict control of the party. Generally speaking, the ideological debates, sometimes not so quietly, were not too divisive or passionate, as they all were convinced that reform and decentralization were necessary to convert China into a modern country. At least, the ability of different provinces to try different things at their own comparative advantages was worth of experiment. And this was consistent with Deng Xiaoping's call for promoting market-driven economic growth while preserving the political status quo
(Perry, 1993). Chinese leaders are now less appreciative of ideological commitment to Marxism-Leninism. In fact, they cannot even mobilize support through ideology. Instead, they share a consensus that the legitimacy of the party rests on its ability to deliver economic prosperity and providing concrete benefits, without forfeiting political security or causing political instability. 66
It must be noted that from the very beginning of the reform to the present day, the real issue is not ideology but party control, and the party has never had the intention to loosen its political control over society (Gong,
1993:313). This can be seen from the statement made by Deng
Xiaoping: The purpose of reforming the system of party and state is precisely to maintain and further strengthen party leadership and discipline, and not to weaken or relax them.... Without such a policy, our country would split up and accomplish nothing. (1980:324) This proclamation indicates the party's reserved attitude toward decentralization and its reluctance to accept any challenge to its monopoly. From the vantage point of both sides, reformists and conservatives, decentralization would test the limits of the party control, if it would not run the risk of threatening party legitimacy. Especially a too rapid progression of decentralization would entice an economically better-off province to question the soundness of socialist sacrifices.
Since democratization was taken by the authorities to mean the adoption of classic aspects of Western democracy such as election and multiparty system, decentralization sprung from such trend of democratization must be limited by "democratic centralism" or limited democracy under the leadership of the 67 party, with a stress on safeguarding central authority and forcefully implementing the party line.
Unlike the federal system of the United States, the
Chinese Constitution does not define the reserved or residual powers to the provinces. The decentralization
Chinese style thus does not give a high degree of legal fiscal autonomy or "home rule" provisions to the Chinese provinces. Further, there is no institutional mechanism making the center accountable to the provinces.
The Chinese fiscal decentralization since 1978 is, in nature, not so much as a voluntary concession by the central leadership. Rather, as a deliberate policy, the decentralization of functions and, concomitantly, a centralization of authority serve as the pressure valve to ease the political, personnel, and budgetary tensions between the two levels that accumulated during the Cultural
Revolution. No matter how much freedom is granted to provinces, the provinces can never be expected or tolerated to go beyond the boundary of their subordinate status. The pressure valve would be turned on to provide outlet when the boundary line is threatened.
Pragmatism also plays a major role. Pragmatism is possible only when ideological passion dies down. When pragmatism prevails, the central policy makers would only 68 mind the "costs" inherent in centralization. These costs are generated through the inefficient and ineffective operations of bureaucracy and state enterprises.
Decentralization has long been regarded as a means to cope with red-tapes, rigidness, and wastefulness. Since the state enterprises had not been profit-oriented for a long time, the center began to depend on a myriad of taxes on provinces. It is only when the costs can be offset by the
"benefits" of decentralization, will decentralization be deemed necessary. In this sense, centralization, decentralization, and recentralization are at the central disposal based upon the cost-benefit calculation.
Unfortunately, the central disposal is, from time to time, tantamount to the rule of man at the expense of policy credibility and consistency.
The financial decentralization is certainly not intended to permit the provincial initiatives to pursue their own interests free of control. The keen interest of decentralization is not to favor provinces but the center's budget. The fiscal decentralization is to allow provinces to become rich so that the central authority will still remain paramount in the throne of the imperial emperor. As the emperor, the center can expect to receive the provincial extractions from a larger base, and a massive shift of 69 resources would be in favor of the national programs.
Unlike previous reforms that were simply used to be optional to central planning, Deng Xiaoping chose this decentralization as the basis of his central reform programs and expansion projects (Zuo and Song, 1988). But all this portended problems for the future at the onset. "Deng has compounded the uncertainty by grounding China's new economic growth in a strategy of regional development" (Segal,
1994:45), which is incompatible with the party control as originally conceived. Now, has China achieved its goal of decentralization as intended or, in Aaron Wildavsky's words
(1987:62), "policy as its own cause," which only resulted in economic polarization and political fragmentation?
Changes After The 1978 Decentralization
The Chinese modernization program began to make progress. China's economic performance in the 1980s and
1990s was a success by most measures. An initial step in the modernization of agriculture established local free markets where the farmer could sell for profit his production above state quotas. Increased productivity soon made China a net exporter of grain (McDonald 1990:xx), and doubled the incomes of China's farmers, winning the support of over 800 million people. Agricultural reform made a good 70 start and provided the impetus for the rest of the society.
It led the economy with a one third share of GNP, accounting for between 40 percent and 60 percent of GDP growth during
1979-82. Agricultural reform also facilitated the rise of a class of small-scale entrepreneurs and stimulated the takeoff of light and medium industry, thereby helping shift the focus of policymakers toward industry.
Since China has been an agricultural society for most of its history, industry in general was not established as the leading sector in terms of both development and future potential until the mid-1980s. Industry also underwent a major transformation. Direct control by central planning authorities gave way to less intrusive regulatory mechanisms. The resulting decentralization was designed to simulate market conditions in which prices and profits gradually replaced mandatory production quotas. According to China's own timetable, a great majority of the enterprises should have become solely responsible for their own profit and loss by 1990 (Barnett, 1986:38). A World
Bank report (1990a) says it well that by allowing the state-owned enterprises to retain a much larger share of profits; by enlarging their latitude in the disposition of resources; and by introducing contracting into the field of industry, the government unequivocally committed itself to 71 the immense task of industrial reform. Nevertheless, industrial reform and decentralization presented a two-edged sword. On the up side, the state enterprises would gain latitude as said above. On the down side, however, that very same latitude, if not properly applied, could result in disaster due to the withdrawal of state protection.
In short, in this period of reform, the economy grew at an annual average rate of slightly over 7 percent during
1979-83. It expanded by over 11 percent in the period
1984-88. One-third of the growth in 1983 stemmed from agriculture, but only 9 percent in 1988. On the contrast, the GDP growth rate for industry increased from 10.9 in 1980 to 20.7 in 1988, and the industry contribution to GDP also incresed from 79.9 percent to 96.37 percent in 1988 (see
Table 5) . Living standards and consumption were more than doubled, and for most of the period inflation was kept under control. By the end of the decade, China's foreign trade had more than tripled and China had become an important player on the global economic stage. In 1989, China was the world's 13th largest exporter and total trade was equivalent to about one-fourth of its gross national product.
But strains were already evident at the beginning of the reform and decentralization. In agriculture. 72 warehousing, transport, milling and marketing facilities could not accommodate the avalanche of grain, part of which went to waste. In the consumer industries, the surge in demand for goods was far ahead of the capacity of production and imports. General industrial sectors began experiencing serious problems. Rapid industrial growth intensified shortages of energy and raw materials, and led to transportation bottlenecks.
An austerity program was implemented in 1988 to cool the overheated economy and to control inflation which had been accelerating since 1985. Restrictive policies, including sharp cutbacks of credit and added price controls, were formulated to dampen inflation. In the process, reforms were put on hold and in some cases reversed; economic growth slowed to about one-third the average for the earlier part of the decade, and unemployment increased.
While sustained hyperinflation was avoided, the underlying causes of inflation remain: weakness of the banking system and a tendency in normal times toward excessive growth of credit, protection of inefficient state enterprises, and the distortions caused by the price system.
Similarly, Beijing extended the austerity program to the foreign sector. To rein in the growth of trade, trading authority was recentralized and a larger share of exports 73 and imports were subjected to controls. The Tiananmen crisis in 1989, though it did not derail the train of economic reform, resulted in reduced resource flows from abroad, accelerating the deterioration in the current account balance and the rise in debt service requirements that were already underway. For example, tourism declined sharply, foreign investors postponed projects, and there was a drop in commercial lending. However, these repercussions proved to be temporary.
As the decentralization goes deeper, the Chinese leadership appears unwilling to loosen its rein over the traditionally centralized budget. Despite of it, physical planning of production and centralized allocation of resources at the fixed prices have been marketed to the most extent. According to a report in the Beijing Review
(1993a), government mandatory planning now accounts for only
10 percent of industrial production, compared to 40 percent before 1992. In retail sales, commodities whose prices are set by the state account for only 10 percent. About 70 percent of total industrial material sales are now subject to market forces. As far as the central-provincial relation is concerned, in the chain of unitary command system, provinces have never been considered as independent entities, but as the political extensions of the national 74 government. As such, they are expected to function as the intermediaries between the center and grass-roots work units, with a very limited decision-making role for themselves. Along the hierarchical order of command, provinces are expected to defer to the instructions from the top down, but not take their own initiatives from the bottom up. Meanwhile there is little horizontal communication and coordination among equals at the provincial level.
However, no matter what intention China's leadership had in mind and no matter what mix of market and planned economy China adopted, the ongoing dealignment of central-provincial relations, especially in terms of fiscal arrangements, has produced unintended consequences. Deng
Xiaoping did not seem to understand or underestimate that the 1978 decentralization would inevitably give rise to an increasingly independent, pluralist society that the party could not fully control. The tendency toward the decentralization of fiscal resources from the center to provinces has greatly weakened the central authority of enforcing its leadership and central capacity of collecting contributions from the subnational governments and, therefore, left a huge amount of financial resources to 75 provinces. This not only has tipped the power balance but also precipitated the provinces' centrifugal force.
The Decline of Extractive Capacity
The decentralization has transfered more resources to local governments and left a much larger share of revenue in the hands of provinces (Oksenberg and Tong, 1991; The World
Bank, 1990). A measure of economic performance, the net value of all material producing sectors (factories, mills, and plants), is called net material product (NMP). As measured by per capita NMP, substantial progress is shown in the rates of provincial economic growth from a southern rich province Zhejiang's 14.9 percent per year to a northern poor province Heilongjiang's 7.1 percent (see Table 6). As a whole China grew rapidly during the decade, even the slowest growing Chinese provinces turned in an economic performance that most countries would envy (Denny, 1990:188).
Despite of it, however, the decentralization in China has led to consequences of an increasing visibility of fiscal decline to the center not anticipated by the reformers. As a proportion of NMP, the central government's extraction of fiscal revenues declined from 37.3 percent in
1977 to 22 percent in 1988 (Denny, 1991:190). A look at government revenue, expenditure in proportion to GNP reveals 76 this pattern (refer to Table 1). As can be seen in Table 1, the absolute decline in the central government's fiscal revenues and the expenditures are very obvious during the period of 1978-1989. The central government's expenditures also declined in relation to provincial governments. In his research on the Chinese provinces' spending, Denny
(1991:192) revealed that the rate of growth of central government expenditures during the same decade of 1978-1989 was 7.1 percent as compared to the 10.7 percent growth of provincial government expenditures. The low growth rate of national spending means the reduced national obligations and the increased financial burden on the provinces.
Another comparison is between the state budget as percentage of national income. As can be seen, the state
(national government) budget accounted for 41.5 percent of
I the national income in the year of 1978, but in 1989, the percentage was 24.7. A chronological record is presented in
Table 7.
This decline in revenue-generating capacity has led to concerns that the Chinese government will be unable to continue to fulfill such traditional functions as funding large infrastructure investment projects and transferring budgetary resources from richer to poorer provinces. The 77 decline in the central government's fiscal expenditures hit the poorer areas particularly hard. For example, the
official estimates of the provincial distribution of fixed
asset investment shows a substantial decline in the share of
national investment funds going to the poorer provinces in
the deep interior regions such as Gansu and Qinghai (China
State Statistical Publishing House, 89:23). In short, not
only the capacity of Chinese national government is eroded
in generating revenues, but also the resources to be
transfered down from the provinces to the localities are
considerably lessened.
Fiscal Decline as a Result of Decentralization
The decline of the central government budget shows
itself as a decline in both the ratios of government revenue
and expenditure to GNP. Over the 15 years from 1978 to
1992, the government revenue ratio has fallen by around 15
percentage points. The government expenditure ratio has
tracked the revenue ratio but with a lag. As a result there
has usually been a budget deficit in the post-1978 period.
The shrunk share of the provincial contribution is not
the only reason for the central government's fiscal decline
in the post-Mao period. Fiscal decline becomes evident when
its own source of revenues runs dry. The primary cause of 78 it is slow growth in industry's contribution to the state budget, despite of the fact that the industrial growth rate was higher than that of agriculture.
Though China was primarily an agrarian country, the state ownership of industry was the main pillar for the government's control of the economy and public finances in the pre-reform period. The pre-reform fiscal system in
China was directly modeled on that of the Soviet Union and adopted during the early 1950s. It shared a common feature, i.e., a heavy reliance on profits of state enterprises for government revenue. In this case, administrative prices are set to discriminate against agricultural and raw materials producers in favor of industry, and surpluses from agricultural and extractive sectors are transferred to the industrial sector, where artificially high profits are created. These profits are in turn captured for government coffers through a combination of taxes and "eminent domain," i.e., simple expropriation in the name of state ownership.
Before the beginning of reforms in 1978, the state enterprises turned over all their profits to the central government and the province enterprises to the provincial budgetary authorities. After 1978, the enterprises could keep some of profits for their own use. 79
However, the state enterprises lost their competitiveness (see Table 8). As mentioned at the beginning of the chapter, the latitude gained by the state enterprises could be a two-edged sword. As far as the down side goes, without the cloak of state protection, many enterprises lost money, some were forced to shut down, and others went bankrupt. In the fall of 1986, the city government of Shenyang in northeast China announced that a debt-ridden factory had been allowed to go bankrupt, and this is the first bankruptcy in the nation's 37-year history.
Whereas only a decade ago, state enterprises acounted for 78 percent of China's industrial output, with collective contributing 21 percent and the private sector a mere 1 percent, at present the state's contribution has been reduced to 53 percent while collective and private production have grown to 36 percent and 11 percent, respectively. As of November 1993, 37.3 percent of the state-owned enterprises were in the red. From January to
November, the state enterprises lost a total of 29.2 billion yuan, a 20.1 percent increase over the same period of 1992
(Beijing Review, 1994). State enterprises are now more a burden than an asset to the Beijing's coffers. State enterprise deficits are substantial and grew fast in the 80 late 1980s. Being a burden to the national budget, the state industrial subsidies took up 38.85 billion yuan (4.55 billions dollars) or 8 percent of the 1993 national budget.
This trend can be reflected in Table 7. By the year 2000, it is anticipated that the state will account for less than a third of industrial output.
According to Christine Wong (1991), several factors explain the decline in industry's contribution to the budget. First of all, industrial profitability had declined in the reform period due to a significant realignment of relative prices. Since 1978 agricultural procurement and primary energy prices have been raised in several rounds, thus redistributing the much-needed income to the rural and mining sectors and having raised production costs in industry. In addition, economic liberalization allowed local entries into many sectors previously monopolized by the central government, and the growing competition has also contributed to realigning relative prices and eroding profits, by putting up the prices of raw materials and bringing down the prices of finished goods.
Prices of other factor inputs have also risen, especially wages and benefits. Increases in wage costs generally outstripped productivity increases during the reform decade, allowing labor to capture a greater share of 81 net output. The cost of capital has risen as well; with two-thirds of new investment in the reform period financed by bank credit in place of free grants, enterprises are now paying a non-zero, though still small, cost for capital in the form of interests and amortization payments.
Depreciation allowances have been raised slightly, also raising the cost of capital to the enterprises. Moreover,
Chinese government sometimes overpaid the workers and managers of the state enterprises to appease dissentiment.
In 1992 the overpay was higher than the 13 percent economic growth. All these measures have cut into industrial profitability.
In the United States, certain spending programs of welfare are effectively immune to budget reduction because they have been enacted into law and enshrined in entitlements. These programs represent uncontrollable outlays to the needy. In the same token, as can be seen, the central government was unable to rely upon state enterprises for revenues due to the enterprises' money loss, but it had to continue making "entitlement" payments.
Today, the monster problem confronting the Chinese leaders is how to revamp 100,000 loan-addicted state enterprises without wrecking a fragile banking system or jilting 110 million workers. 82
A state enterprise is a "small society," meaning it provides not only employment, but also medical care, retirees' pensions, children's education, workers' training, police guard, and even court. The distinction between the public and private sector is not clear-cut. The principal source of the blurred boundary is the commitment on the part of government to keep state enterprises afloat. The cost to the public finances of this commitment takes two forms: subsidies from the state budget to loss-making enterprises and bank lendings to enterprises at the behest of the state.
The central government had to make outright subsidy or
"loans" from state controlled banks, a disguised subsidy that will never be repaid, to many of the loss-making enterprises. "In China, letting such enterprises go under would have much more devastating consequences...because all the principal social services, which in America are provided by the government, would collapse along with the enterprises" (Overholt, 1993:64). Rescue and subsidy certainly enlarged the government budget deficit even further, though China was able to subsidize with one of the world's largest savings market. To make up this loss, the central government turned around to ask for more income from the provinces. 83
Action-Reaction Syndrome
For every action on the part of government, there is a reaction on the part of the affected party. Then the government attempts to counter the reaction with another action, which starts the cycle all over again (Schmidt,
Shelley, and Bardes, 1993:538). The decentralization policy is both the cause and effect of national fiscal decline. It created the unprofitable state enterprises, which ate away a big portion of the state budget in subsidy. To turn back the trend, the central government had no choice but to rely upon provinces for revenue.
Two points are noteworthy. First, centrally controlled enterprises tend to be in heavy industry such as the national defense and military sector. Provincially controlled enterprises tend to be in light industry such as textile and clothing. High profits usually grow out of light industries. Provincial governments are evidently enjoying greater discretion vis-a-vis Beijing as enterprises of light industry under their jurisdiction experienced unprecedented growth. Beginning in 1978, provincial industrial systems were allowed to retain 60 percent of the profits of newly established factories. The central government tries to tap on this resource by taxing the provincial authorities, but this often is easier said than 84 done because of resistance from the provinces. The result of this is a network of powerful alliances of provincial governments that sap the strength of the command economy.
Second, China lacked an effective system of central taxation. In 1993, the central government only received about 30 percent of overall tax revenues. It depended for revenues on a foreign-administered customs apparatus and on a domestic tax on agriculture. China, as of 1990, still does not directly collect central taxes from individuals and units. Instead it farms out tax collection to the country's
30 provinces and autonomous regions and negotiates revenue agreements with each of them (Lieberthal, 1991). In this sense, provinces are the de facto tax collection agents for the central government—the principal. While the principal argues that the entire economy should be like a chessboard to be managed or at least guided from the center, the agents would turn a deaf ear or only pay lip service to central directives. Provinces have become independent players.
Instead of waiting passively for instructions from the
center, they have begun to bargain and search for powers on
their own. They not only take initiatives but also possess
the resources to do so. 85
Table 3
China: Administrative Divisions
Provinces Population in 1,000 Capital Sichuan (Szechwan) 107,218 Chengdu (Chengtu) Henan (Honan) 85,510 Zhengzhou (Chengchow) Shandong (Shantung) 84,393 Jinan (Tsinan) Jiangsu (Kiangsu) 67,057 Nanjing (Nanking) Guangdong 62,829 Guangzhou (Canton) (Kwangtung) Hebei (Hopei) 61,082 Shij iazhuang (Shihkiachwang) Hunan (Hunan) 60, 660 Changsha (Changsha) Anhui (Anhwei) 56, 181 Hefei (Hofei) Hubei (Hupeh) 53, 969 Wuhan (Wuhan) Zhejiang (Chekiang) 41, 446 Hangzhou (Hangchow) Liaoning (Liaoning) 39, 460 Shenyang (Shenyang) Jiangxi (Kiangsi) 37, 710 Nanchang (Nanchang) Yunnan (Yunnan) 37, 973 Kunming (Kunming) Heilonggiang 35, 215 Harbin (Harbin) (Heilungkiang) Shaanxi (Shensi) 32,,88 2 Xian (Sian) Guizhou (Kweichow) 32,,39 2 Guiyang (Kweiyang) Fujian (Fukien) 30,,04 8 Fuzhou (Foochow) Shanxi (Shansi) 28,,75 9 Taiyuan (Taiyuan) Jilin (Kirin) 24^,65 9 Changchun (Changchun) Gansu (Kansu) 22,371 Lanzhou (Lanchow) Hainan (Hainan) 6^557 Haikou (Haikou) Qinghai (Tsinghai) 4^457 Xining (Hsining) Autonomous Regions Population in 1,000 Capital Guangxi Zhuang 42,246 Nanning (Nanning) (Kwanggsi Chuang) Nei Monggo (Inner 21,457 Huhehot (Hohhot) Mongolia) 86
Table 3. Continued Autonomous Regions Population in 1,000 Capital Xinjiang Uygur 15,156 Urumchi (Urumqi) (Sinkiang Uighur) Ningxia Hui 4,655 Yinchuan (Yinchuen) (Ningshia Hui) Xizang (Tibet) 2,196 Lasha (Lhasa) Municipalities Population in 1,000 Capital Shanghai (Shanghai) 13,342 Beijing (Peking) 10,819 Tianjin (Tientsin) 8,785
Source: Europa World Yearbook 1993. Europa Publications Limited, p. 750. 87
Table 4
Indicators of Financial Decentralization
Year BR DE EBR BREF TBNH 1952 173.92 176 13.62 0 0 1955 249.24 269.3 14.23 0 0 1960 572.3 654.1 117.78 0 0 1965 473.3 466.3 75.56 0 0 1970 662.9 649.4 100.94 0 0 1975 815.2 820.9 251.48 0 0 1980 1042.2 1212.7 557.4 0 0 1985 1776.6 1844.8 1530 146..7 9 21.82 1988 2357.2 2706.6 2270 185..9 3 34.87
Note: BR: the state budget revenue excluding borrowing; BE: total state budget expenditure; EBR: the extra-state budget revenue; BREF: the state budget revenue from the key energy and transportation fund; TBNH: the Treasury bond sold to non-household; FDR: financial decentralization ratio = (EBR-BREF-TBNH)/BE.
Source: Lizuo Jin. 1994. "Effects of Financial Decentralization on Industrial Growth in China, 1952-88. In China's Economic Reforms by Qimiao Fan and Peter Nolan (eds.) St. Martin's Press. P. 162. 88
Table 5
Sectoral and Demand Linked Sources of Growth, 1980-88
Sector Year 1980 1981 1982 1983 1984 1985 1986 1987 1988 ^DP 6.4 4.9 8.3 9.8 13.5 13.1 8 10.5 11.2 growth rate Agricu -1.8 7.1 11.7 8.5 13 1.7 3.7 4.8 3.2 Iture Indus- 10.9 1.7 6 9.8 14.9 19.6 9.6 14.3 20.7 try Servi- 14.06 10.01 7.31 12.93 10.64 20.66 11.83 10.03 -3.28 ces Contri bution to GDP in % Agricu -10.96 52.09 51.74 32.83 36.02 4.83 15.49 14.7 8.71 Iture Indus- 79.9 16.97 34.27 46.4 51.21 70.28 59.61 68.65 96.37 try Servi- 31.05 30.94 13.99 20.76 12.76 24.89 24.9 16.65 -5.06 ces
Source: World Bank. China: Macroeconomic Stability and Industrial Growth under Decentralized Socialism. Washington, D. C: The World Bank, 1990a. p. 6. 89
Table 6 Provincial Per Capita in 1977 and Average Annual Growth Rates, 1978-88
Province Per Capita NMP in Growth Rate 1977 1978-1988 Shanghai 1,918 7.95 Beijing 927 9.06 Tianjin 873 7.96 Liaoning 560 7.96 Heilongjiang 437 7.09 Guangdong 297 12.05 Jiangsu 289 12.51 Qinghai 287 8.4 Jilin 284 9.92 Ningxia 273 9.09 Gansu 271 7.64 Hebei 267 8.73 Hubei 261 10.23 Shandong 246 10.46 Xinjiang 239 10.37 Zhejiang 237 14.91 Nei Monggol 237 8.76 Shanxi 236 8.74 Shaanxi 226 7.31 Hunan 219 8.02 Jiangxi 217 8.35 Anhui 198 10.56 11.23 Fujian 190 7.55 Guangxi 186 10.25 Henan 184 90
Table 6. Continued
Province Per Capita NMP in Growth Rate 1977 1978-1988 Yunnan 168 9.71 Sichuan 166 9.24 Guizhou 127 8.87 National Average 290 9.09
Source: Denny, David L. 1990. "Provincial Economic Differences Diminished in the Decade of Reform." in China's Economic Dilemmas in the 1990s: Problems of Reforms, Modernization, and Interdependence. Submitted to the Joint Economic Committee Congress of the United States. Washington: U.S. Government Printing Office. 91
Table 7
State Budget Share of National Income, 1952-8 9
Year Budget National Budget as % Revenues Income income 1952 17.4 58.9 29.5 1953 21.3 70.9 30.1 1954 24.5 74.8 32.8 1955 24.9 78.8 31.6 1956 28.1 88.2 31.7 1957 30.3 90.8 33.4 1958 38.1 111.8 34.1 1959 48.7 122.2 39.9 1960 57.2 122.1 46.9 1961 45.9 99.6 46.1 1962 40.7 92.4 44.1 1963 40.7 100.1 40.7 1964 45.4 116.6 38.9 1965 52.9 138.7 38.1 1966 59.4 158.6 37.4 1967 47.1 148.7 31.6 1968 36.1 141.5 25.5 1969 52.7 161.7 32.6 1970 72.1 192.6 37.4 1971 81.9 207.7 39.4 1972 85.3 213.6 39.9 1973 90.8 231.8 39.2 1974 91.1 23d.8 38 .8 1975 94.6 250.3 37.8 1976 94.1 242.7 38.8 1977 101.5 264.4 38.4 1978 124.8 301.1 41.5 335.1 37.7 1979 126.4 92 Table 7. Continued
Year Budget National Budget as % Revenues Income income 1980 130.1 368.8 35.3 1981 130.2 394.1 33.1 1982 140.9 425.8 33.1 1983 160.7 473.6 33.9 1984 184.3 565.2 32.6 1985 229.7 702.1 32.7 1986 244.7 785.9 31.1 1987 257.6 931.3 27.7 1988 280.4 1,173.8 23.9 1989 324.5 1,312.5 24.7
Note: Revenues and national income are in billion yuan. Source: Zhongguo Tongji Nianjian, 1990, p. 34. 93
Table 8
Sources of Revenues by Sector (%)
Year Industry Commerce Agricul- Transpor- Construc- ture tation tion 1950 34.37 44.56 18.69 1.74 0.63 1951 38.13 30.82 25.59 4.73 0.72 1952 41.11 24.47 27.56 6.31 0.56 1953 46.32 19.46 25.84 8.18 0.21 1954 47.41 19.28 25.27 7.61 0.45 1955 50.26 17.39 23.33 8.23 0.79 1956 49.73 14.76 25.95 8.89 0.67 1957 52.14 13.57 24.95 8.84 0.51 1958 58.97 11.41 18.86 10.19 0.58 1959 63.02 8.83 16.22 11.58 0.38 1960 64.98 6.34 16.71 11.41 0.59 1961 54.96 8.29 24.96 12.35 -0.55 1962 61.45 10.13 17.66 11.22 -0.45 1963 70.64 9.78 9.52 9.77 0.28 1964 72.71 9.08 9.16 8.71 0.37 1965 76.17 7.52 6.93 9.24 0.14 1966 76.71 7.01 7.26 8.89 0.14 1967 72.39 8.59 12.11 6.78 0 1968 69.48 9.85 14.35 6.96 -0.64 1969 72.29 6.63 13.63 7.61 -0.16 1970 74.51 5.37 12.69 7.53 -0.09 1971 75.85 4.64 11.91 7.61 0.01 1972 76.07 4.14 11.81 7.98 0.01 1973 75.82 3.06 13.42 7.73 -0.03 1974 73.52 4.31 14.88 7.47 -0.17 1975 79.45 3.81 8.73 8.16 -0.14 1976 80.02 3.93 8.09 8.11 -0.15 1977 77.75 3.22 11.45 7.72 -0.14 1978 77.02 2.88 12.49 7.43 0.17 94 Table 8. Continued Year Industry Commerce Agricul Transpor Construc ture tation tion 1979 83.74 3.08 4.96 8.18 0.03 1980 88.12 3.25 1.62 6.91 0.11 1981 89.59 3.89 0.33 6.31 -0.11 1982 93.98 4.91 -4.16 5.13 0.14 1983 95.48 6.11 -8.82 6.32 1.02 1984 86.71 4.53 -0.93 9.23 0.47 1985 76.36 5.59 9.18 8.39 0.48 1986 69.41 4.41 18.14 6.72 1.34 1987 71.95 6.45 14.55 6.59 0.47
Source: Wong, Christine P. W. (1991). Central-Local Relations in an Era of Fiscal Decline: The Paradox of Fiscal Decentralization in Post-Mao China. The China Quarterly. December 1991, No. 128, pp. 691-715. CHAPTER IV
CHINESE BUDGET SYSTEM AND PRACTICE
Budget System: A General Introduction
According to the Chinese Constitution, China's political system and fiscal administration are unified. The central government is dominant, at least in theory, over fiscal policy, budgetary authority, and various fiscal management systems. Based on a summary by Zhao Suisheng
(1994), the central planning system functioned through three networks: (1) physical planning of production, (2) centralized allocation of materials, and (3) budgetary control of revenues and expenditures.
The central government adopts a consolidated budget document that combines both national and provincial budgets.
The Chinese national budget is not, however, the same as the central government budget. One of the practices which China borrowed from the Soviet Union in the 1950s was to include not only items of revenue and expenditure of the central government but also those of provincial authorities. Thus the national budget is the grand total of budgetary revenue and expenditure of both central and provincial governments
(Donnithorne, 1981:8).
95 96
In the same token, the provincial budget is the grand total of budgetary revenue and expenditure of both provincial and county governments. The central government is empowered to promulgate national economic goals and decide the appropriation of resources at the national level, and make fiscal, budgetary, and accounting and auditing policies and regulations. It also presides over a budgetary process that includes the budgeting of the central government, the provinces, and sub-provincial units. In this sense, although each province has its own budget, provincial budgets must be made under central guidance. The center reserves the right to formulate the central fiscal policies and rules on budget making, which are supposedly implemented and obeyed by the provinces. The amalgamation of provincial budgets into the consolidated budget document is also for accounting convenience, but at the expense of detailed information on provincial incomes and outlays.
Accounting is shaped by the environment in which it operates. Accounting as we know it in the United States is not like accounting in other countries like China. Since the Chinese government still owns most productive resources and supplies most capital needs, the primary function of its uniform accounting is to accomplish macroeconomic policies, taxation, and to compile government statistics. In contrast 97 to the United States, the basic inputs to production in
China's public sector and state enterprises are not purchased on open markets. The governments allocate resources (raw materials, equipment, and staff) and the enterprises are expected to produce a predetermined level of output. Success is not measured by the amount of income earned, but by the production quotas (Mueller, Gernon, and
Meek, 1994).
Unlike the United States where accountants prepare accounting data and information for "decision usefulness," the Chinese accountants are basically responsible for fund, cost only; planning and budgeting are the responsibilities of the State Planning Commission and the Planning Department at various provinces. The separation of accounting and budgeting has therefore become a major concern of fiscal and financial management in the public sector of China. Also, there is no public accounting board in China that is charged with setting up standards and supervising practices, i.e., something like G7\SB (Governmental Accounting Standards
Board) in the United States.
In China, a specialized agency, the Department of
Commerce and Trade under the Ministry of Finance, is responsible for financial accounting in the state-owned enterprises, while the People's Bank of China is responsible 98 for that of banks. Though consistent with international standards in some areas, the Chinese accounting system does not comply with the "generally accepted accounting principles" (GAAP) in many important areas. The presentation of budgetary accounts in China differs from that found in most other countries. China continues to present its budget in prose rather than tabular form. This alone makes it hard to compare its performance from one year to the next.
Furthermore, revenue in the Chinese definition includes all proceeds from domestic borrowing such as treasury bill issues and domestic bank financing as well as foreign loan proceeds, whereas these are more typically classified as domestic and foreign financing in the United States.
Similarly, repayments to retire principal and interest on these borrowings are included as a form of expenditure rather than as a negative financing item in the reduction of obligation.
The Chinese fiscal year is from January 1 to December
31, and its currency is called Renminbi (RMB) or Yuan
(China, 1990) . The annual budget is prepared by the
Ministry of Finance. It is responsible for budget making and has broad authority over the power of the purse in
China. The Ministry of Finance is also a major source of 99 information about the day-to-day functioning of the economy.
This control over information along with its mobilization of expertise gives the Ministry of Finance a strong voice in policy deliberations (Bachman, 1989:170). Once the budget is proposed by the Ministry of Finance to the State Council, the State Council studies, revises, and presents the finalized budget request to the national legislature—the
National People's Congress for approval. The National
People's Congress or its related Standing Committee approves, authorizes, and appropriates the budget.
Components of Budgetary Receipts
The Chinese budgetary revenue primarily concerns with collection of revenues to meet budget outlays. In other words, tax in China is not used significantly to accomplish some of other objectives such as making the tax burden more equitable for taxpayers or controlling economy by raising or lowering taxes. Basically, the Chinese budgetary revenue relies upon (1) taxes and (2) borrowing. For the sake of discussion in this study, taxes are divided into central, local, and shared taxes. Borrowing is divided into internal and external borrowing. 100
Taxation John Marshall, Chief Justice of the U.S. in the early nineteenth century, said that the power to tax involves the power to destroy. But taxes are necessary to provide
governmental services and to help finance the production of
public goods and those goods causing external benefit.
China does have taxation, and its tax policy is a crucial
element in determining China's ability to carry out the
macroeconomic policies and stabilization programs. China's
taxes consist of the largest component of budgetary
revenues. The irony is that the Chinese tax system is at
one and the same time the most ancient and also the most
recent in the world. Records of land taxes in China go back
almost four thousand years. Yet when the People's Republic
of China was declared in 1949, the tax system had almost
completely broken down, a result of several decades of
continual warfare (Li, 1991:iv) .
After the founding of the New China, Marxist tax
theories were closely related to the socialist concept of a
non-commodity economy. According to Karl Marx, taxation is
an instrument used by governments to exploit labor. At the
same time, the Chinese government was heavily influenced by
Soviet "non-tax" theory. Although taxation did exist at the
beginning of the republic, the necessity of taxation under a 101 centrally planned system was not widely recognized. From
October 1949 to the end of 1978, China had a command economy. During this period, taxation was purely an administrative measure, lacking any regulatory function
(Yeh, 1993). It was not until a policy of economic reform was adopted in 1978 that taxation began to be used as an economic lever. Taxation has now become an important means of generating revenues.
In the late 1960s and early 1970s China's goal was to simplify the tax system as much as possible, and the tax system was subsequently simplified several times. Within industry and commerce, for example, the number of taxable items fell from 108 to 44. The tax rates also fell, with reportedly only 16 in use. Most enterprises paid only one tax (Guojia Shuiwu Ju, 1989:9). Simplification was also regarded as necessary to administrative control and oversight over enterprises through the planning mechanism.
In 1983 China's tax system was further reformed. The main feature of this tax reform was that state enterprises began paying industrial and commercial taxes instead of remitting profits. This so-called "changing profit to tax"
(Li Gai Shui) will be further discussed later. A striking difference between China and the United States is the near total absence of any personal income taxation, although to 102 some extent in China wage and subsidy policies are akin to personal taxes. In most market countries, direct taxes are imposed on both personal and corporate incomes; on average, about 40 percent of direct tax revenues derive from the former and 60 percent from the latter. In China, almost the entire explicit burden of direct taxation is on the enterprises. As for personal income tax, few Chinese were even aware of it, according to China Daily (1994), because it did not appear in China until 1986 with the passage of the first law on income taxes.
In January of 1994, China instituted its new income tax brackets. Those who earn over 800 yuan or $90 per month must pay tax on their income, while the growing ranks of the nouveau riche must pay as much as 45 percent of their earnings, an unheard of percentage in a country with no previous record of tax collection on individuals. What follows is a glimpse of three major types of taxes in China based upon the description by Chinese tax expert Jinyan Li
(1991) .
Central tax revenues include revenues from the income taxes on state enterprises under central control: Business
Tax levied on enterprises under the Ministry of Railways, banks and insurance companies, and on enterprises producing petroleum, electricity, petroleum chemical, and nonferrous 103 metals; Special Oil Burning Tax; Customs Duties; Product
Tax, Value Added Tax (VAT), Cigarette Tax, and Business Tax collected by customs on goods imported and exported;
Consolidated Industrial and Commercial Tax; and income taxes charged on foreign enterprises engaged in offshore oil exploration.
Local tax revenues include revenues from the income taxes levied on state enterprises under provincial and local control: Collective Enterprise Income Tax, Agriculture Tax and Animal Husbandry Tax, Vehicle and Vessel Tax, Slaughter
Tax, Livestock Transaction Tax, Market Transaction Tax,
Contracts Tax, Urban Maintenance and Development Tax, Land
Use Tax, and Urban Real Estate Tax.
Taxes shared by central and provincial governments are the Product Tax, VAT, Business Tax (with the exception of those allocated to the central government exclusively), Salt
Tax, Resource Tax, Construction Tax, individual income tax.
State Enterprise Bonus Tax, Consolidated Industrial and
Commercial Tax, and income taxes levied on foreign enterprises, except those engaged in offshore oil exploration. Due to the limited space, the following descriptions will focus on how taxes are collected from where and by whom. 104
Central Taxes
The state enterprises are the primary source for the central business, industrial and commercial taxes. The state enterprises include entities in industry, commerce, communication and transportation, grains, foreign trade as well as banking. Before economic reforms began in 1978, the state enterprise accounts were part of China's public finance budget, and were made compatible with plan targets.
At the year end, enterprises contributed nearly 100 percent of their profits to government revenue, and the enterprise remittance of profits made up a larger share of government revenue than did taxes.
State enterprises in pre-reform China disposed of substantial sums of money, but they had little or no incentive to improve performance or economize on production outlays, for they had no direct interest in the profitability of their operation. In order to change this situation, Chinese leaders introduced a profit-sharing plan in 1979. This program basically rested on the establishment of a percentage of total profits (or increased profits) which could be kept by the enterprises and used for worker bonuses, or other benefits. In 1981, the focus shifted to an explicit mandate "profit-and-loss contracting" (Yingkui
Baogan), in which enterprises agreed to remit a certain 105 absolute quantity of profit to the budget, and were in turn
authorized to keep a very high proportion (typically 40
percent or more) of profit realized above this sum. At the
same time, they were responsible and liable to their own
losses. Also known as a profit retention program, this
meant that these factories had to begin to operate on a
profit-and-loss basis rather than plodding along, all
"eating from the same pot"—a Chinese saying on job security
irrespective of performance. These profit-and-loss
contracting systems vary substantially in the way in which
they calculate the amount of profits to be retained, for the
amount of profit for an enterprise to retain is determined
on the individual basis. It depends on the public relations
and negotiations between the enterprise and its supervisory
body. Unlike taxation as a legal means to raise revenue,
profit remittance is a transfer of resources through
administrative directives. This leaves some room for
discretion and bargaining in terms of how much profit to be
reported and remitted. Since enterprise managers can now
disburse part of their earnings as bonus payments to workers
or for production expansion, profit after tax is a big
incentive to both managers and workers. Moreover, with
enterprises operating more like Western firms, enterprises 106 begin to have independent economic interests and rights to protect.
In practice, the supervisory bodies typically had a paternalistic interest in their subordinate enterprises, therefore profit sharing regulations were drawn up in such a way as to allow each enterprise to retain a "fair" sum of profit. Enterprises which ran into difficulties frequently found that special circumstances could be invoked to justify a more generous profit sharing arrangement, given the close and generally paternalistic relations between individual factories and their supervisory bodies. As a result, nearly all enterprises retained substantial profits, and a large portion of budgetary revenues slipped out of the control of central planners. By 1981-2, industrial enterprises were holding on to about 15 percent of their profits; if we include the less profitable commerce and construction enterprises in our calculations, by 1981, enterprises were retaining fully 24 percent of total realized profits.
The large volume of profit retained by enterprises, about 17 billion yuan in 1982, quickly boosted worker living standards by funding bonuses and, above all, funding the surge in housing construction so apparent in today's China.
But profit retention programs were not successful in their primary aim of dramatically improving the efficiency of 107 enterprise operation. In fact, the profit retention programs did not discriminate effectively between well and poorly run factories. They could all survive either by making profits or by seeking paternalistic protection.
In 1983 the state enterprises began paying industrial and commercial taxes instead of remitting profits, and this is referred to as Li Gai Shui (changing profit to tax). The purpose of the Li Gai Shui is to reward enterprises by allowing them to keep after-tax profits that are earned as a result of better management rather than as a result of public relations. Li Gai Shui established taxation as an indirect "lever" to influence managers' decisions.
Moreover, profitability, rather than fulfillment of planned targets, has become a chief indicator for performance.
Profits have become the most important objective for state enterprises in a sense that funds for consumption such as bonuses and reinvestment would no longer be provided through the state budget. The gradual transition to market prices has both forced and induced them to cope with economic forces rather than just negotiating or lobbying the government for a better deal.
With Li Gai Shui being implemented in 1983, enterprises paid a profit tax of at the rate of 55 percent. But this was not enough. The state enterprises, in some cases, still 108 needed to remit a portion of after-tax profits. Although taxation is becoming a major allocative force in the economy, the government still keeps the legitimacy and power to draft the after-tax profits. Government, with its supremacy over enterprises and control of primary capital supply, can force enterprises to transmit the retained profits after tax or even change tax rate when deemed necessary. This more or less dampens the incentives and prompts employees to meddle through the opportunities of making profits. They only work hard enough to get what is anticipated in advance.
On the other hand, however, state enterprises in general still receive considerable government subsidies, no matter whether they make or lose money. It is a small wonder that the collapse of a state enterprise means job losses and social discontent. The Chinese government has threatened to halt energy and raw material supplies to some ailing and money losing state enterpriese. But it has seldom happened, for it would mean that factories would have to stop production and stop handing out salaries, and workers would be sent home with partial or no pay.
Economists estimate one-third of the state enterprises' 100 million-strong work force is extraneous (The Wall Street
Journal, 1994). All this strikes a fear of social 109 instability in the minds of the Chinese leaders, who would rather shy away from bankruptcy as a solution. (A note of interest: only about three hundred enterprises have been forced into bankruptcy after a bankruptcy law was in effect for several years.) Despite its shrinking contribution to industrial output (78 percent in 1978 and less than 50 percent in 1993) and its growing losses, Merrill Lynch notes that state enterprises got 70 percent of total investment in
1993, up from 61 percent in 1989. The private sector's share dropped during the period to 12 percent from 25 percent. The collective sector got 18 percent in 1993. In one word, the state enterprises still claim a growing share of investment capital.
The goal of replacing enterprise profit remittance with industrial and commercial taxes separates state enterprises from the government budget. In theory, taxation of state enterprise profits would reduce the difference between state and collective enterprises. In reality, the government's protection policies are more weighted on the former.
Collective enterprises are an intermediate form of industry usually found at inner cities, counties, towns, and villages. Unlike state enterprises, collectives have always paid profit taxes and have been responsible for losses if they occurred. The budget has subsidized collectives to 110 some extent, but the operation of collectives has not been part of the budget's function. It means that collectives operate in competitive markets with little governmental protection, but, at the same time, with little bureaucratic constraints. Therefore, one significance of separating state enterprises from the budget would be to put state enterprises as separate legal entities in competition with collectives for inputs and customers, although the latter is not treated on equal footing. The industrial growth by ownership in 1991 shows that the collectives actually grew faster (at 16 percent) than the state enterprises (at 8 percent) (Overholt, 1993:74). The collectives did much more better than the monopolistic state enterprises owing to their entrepreneurial initiatives.
On the other hand, the government still has a tight control of business licenses, capital supply, and credit.
This fuels the patron-client relationship between enterprises and bureaucracies. For enterprises, the inability to secure licenses, capital supply, and credit can mean disaster. Therefore, as subordinates, they are reaching out for political connections and alliances. As patrons, the bureaucracies use their jurisdictions to assist and protect enterprises in a hope of realizing the goal of profit remittance from the enterprises. Meanwhile, the Ill families of both groups were brought for alliance by the special advantages of their situation: they could use work connections to get special advantages at making money in the marketplace. It was through a combination of idealism, expedience, and corruption that the nation's power elite was enlisted (Overholt, 1993:39).
In addition, another revenue source is the retention of depreciation allowances. Depreciation is a sum of money vrtiich is set aside to compensate for the fact that a factory's fixed assets are declining in value over the long run, as they are worn down by continued use. In the standard Soviet-type system, these sums are remitted to the budgetary authority where they serve as an important funding source for new investment, which is in turn allocated by central planners. By 1971, however, Chinese enterprises and their supervisory bodies were retaining nearly all depreciation allowances, and this amounted to a very large sum, increasing gradually to about 13 billion yuan in 1977.
Since most enterprises could rely on a separate "major repair" fund to keep their existing assets functional, most depreciation funds were channelled into new fixed investment.
Making tax policy is one thing, collecting taxes is another. Rampant forgeries have been found in the 112 enterprises' efforts to evade tax. Forgers, sellers, and thieves of invoices burgeoned in this underground business.
The state enterprises use the fake invoices to evade or cheat on taxes. China's taxation bureau handles some 10 billion invoices each year, with buyers and sellers in separate cities handing in invoices at different times and making it virtually impossible to check the veracity of the documents. In March, 1994, China set up a private information network to crackdown on corporate and individual tax dodgers, who cost the government 10 to 30 billion yuan
(about 1.15 to 3.45 billions dollars) annually by faking invoices. The network, known as the Golden Tax Project, links all taxation offices in 350 cities around the country with the central bank's capital clearing network and unifies the collection and management system (Business Weekly of
China Daily, 1994).
Local Taxes The Chinese tax system is highly centralized. The
State Council is empowered to introduce, amend, and implement tax policies, tax laws, and regulations. It has the power to approve tax reductions and exemptions to be applied to a particular provinces. Local tax laws are also promulgated initially by the central government. Provincial 113 governments have little independence in matters of structuring their tax systems. They derive taxing powers from the central government, and the taxes that they are authorized to levy are prescribed by the central government.
In this sense, "local taxes" are really central taxes whose revenues are determined by the center for provincial governments. Since there is no mention of expressly delegated powers for the provinces in the Chinese
Constitution, the Chinese budgetary system gives less formal fiscal autonomy to provincial governments in regard to revenue raising. The limited responsibilities of raising local taxes are de facto rather than de jure.
Provincial governments do, however, have the power to adopt implementing rules with respect to the management of the budgets of their separate jurisdictions: (1) within the budget approved by the central government, provincial governments can make adjustments among different items and tax rates to suit local conditions; (2) subject to certain broad constraints, provincial governments can freely allocate their flexible funds and approve tax reductions and exemptions; (3) when implementing central policy, provincial governments can formulate detailed regulation according to native circumstances (Hsiao, 1987) . 114
Beginning in March, 1985, the revenue collected from each tax as listed above has been divided into central and local portions to ensure both levels have taxation authority and sources for revenues. This change formally granted provinces the authority to tax for provincial needs, rather than solely for the central government. The divided tax
revenue means that the central and provincial governments
have their own respective fixed expenditures and revenue
sources. The proportion in which it is divided differs from
one province to another, and is subject to negotiation. The
revenues collected from the specified taxes have thus been
designed to go to either central or provincial governments,
or to be shared at a predetermined rate. Since central and
provincial governments both have the concurrent power to
levy taxes, delineation of revenue scopes become vague.
Whenever the tax boundary line is in question, it is almost
always resolved in favor of the expanded scope of what is
designed as central revenues. As a result, purely local
taxes only cover less than one fifth of their expenditures
in 1988 (World Bank, 1990b:78).
Shared Taxes
China differs from the United states in that the
central government only directly collects central taxes such 115 as customs duties, selected excise taxes like the Salt Tax, and industrial tax paid by the state enterprises. Rather, because of the sheer size of the nation, the center relies upon provincial and local governments for collection of the bulk of shared taxes. It is the responsibility of the provincial and local governments to collect these taxes and deliver them directly into branches of the People's Bank of
China. Until the early 1980s the central government directly collected less than a quarter of total revenues, although it was responsible for 50 percent of total expenditures. The remaining three fourths of the revenues were collected and remitted by the provinces (World Bank,
1990:62). On the other hand, being responsible for collection and delivery, the provincial governments possess substantial leverage with respect to the revenues they collect. That is, if "possession is 90 percent of law," a province certainly has great discretion in claiming its slice. This makes it critical for the center to distinguish and secure its share of the revenue. The following are the major mechanisms employed over the past years by the center for collection of taxes. 116
The Coercive Draft
The rule of "uniform receipt and uniform allocation"
(Tongshou Tongzhi) was introduced in 1950, when China faced serious economic difficulties. To rehabilitate the economy, the national government needed to pool all financial resources available and to utilize them in a planned and efficient manner. This rule of "uniform receipt and uniform allocation" means that all governments below the central are responsible to collect and remit revenues to the center.
The center in turn allocates the revenue to governments at the different levels. However, to ensure all revenues to be remitted and allocated uniformally, the administrative cost is certainly high. Furthermore, as far as the provinces are concerned, there is simply no incentive to strengthen revenue collection since there is no linkage between revenue and expenditure of their own.
Revenue Sharing
Revenue sharing in the United States is a federal non-categorical aid plan using a formula based on population, tax collections, and categorical income. The federal government turns tax revenues over to the states and localities to spend as they please. Funding to state and local government has been divided so that state government 117 receives one-third of the funds and local government two-thirds. Revenue-sharing is a misnomer in the Chinese situation in a sense that revenue sharing is not a top-down flow of resource to local, but a bottom-up remittance to the center. In China, a new financial arrangement was made in
1951 to "classify revenue ownership and permit decision making at three levels—central, provincial, and local"
(Huafen Shouzhi, Fenji Guanli). The centralized budgeting was further modified in the period 1953-7 by separating the provincial budget from the central one. "Connecting revenue and expenditure, and empowering local governments" (Shouzhi
Guagou, Difeng Fangchan) was also applied. The aim of this practice is to let provinces decide revenue sharing based on two formulas: (1)"Revenue-sharing by surplus" (Zhonge
Fengchen) and (2) "Revenue-sharing by categories" (Fenglei
Fengchen).
First, "revenue-sharing by surplus" means that the sharing rates are set at levels that enable the anticipated provincial revenues to ecjual budgeted provincial expenditures. The provinces retain all or part of year-end surpluses depending upon their respective projected expenditures and then hand over any excess revenues over expenditures to the center. Provincial expenditures are thus linked to the revenues they collect. This arrangement 118 is in operation usually when both revenues and expenditures are relatively predictable, and when ownership of
enterprises is stable. For instance, a province makes
5,000,000 yuan in revenue, and its projected expenditures
account for 2,000,000 yuan, then the sharing ratio will be
40 percent for retainment and 60 percent for remittance. In
this case the leftover of 3,000,000 will be remitted to the
center.
"Revenue-sharing by surplus" allows provinces to keep a
certain portion of their revenues on the assumption of
expenditures matching revenues or "a link between local
revenues and expenditures" (Lardy, 1978:169). A province
generating more revenues could possibly spend more at its
discretion. A province that has less revenue to generate
can be exempted from remitting any income. For some poor
provinces 100 percent of local income will be retained
locally (see Table 9) . Moreover, they will get transfers
from rich provinces.
Second, "sharing revenues by categories," introduced in
1980, refers to such decision rule as retainment and
remittance to be determined by categories. The center set
compulsory financial categories and targets for the
provinces and had complete budgetary control over provincial
governmnent's revenue in accordance with these categories. 119
If certain income falls into the categories specified for retainment, then that part of income will remain as local revenue. If certain part of revenues collected by the provinces are designated as "central revenue" by categories, then they must be given to the center.
"Sharing revenues by categories" is determined pretty much in an ad hoc way rather than on some objective basis.
The central government chould substitute a category for the present negotiated and judgmental approach, to compensate for its lower fiscal capacity or greater fiscal need, or to reward for provinces' greater revenue mobilization.
Normally, the provincial governments are not aware of the sharing categories and ratio well before the beginning of the fiscal year to ensure better fiscal planning.
These two formulas were established on the basis of either one single year or multiyear implementation.
Normally speaking, one year basis does not have as much assurance for the provinces to manage their fiscal resources on the long term plan. As a result, the latter, i.e., the multiyear basis, is preferred more. The tax sharing ratios are fixed for a number of years to provide provincial governments with some certainty, and to discourage the central government from allowing the sharing ratio to become a subject of annual negotiation. 120
The effect of these reform efforts is that it dispelled uncertainties to some extent. Instead of requiring the repatriation of virtually all taxes collected, provinces agreed on their tax revenue obligations to the center following a review of their planned budgets. This was first experimented with in Jiangsu and subsequently adopted by 12 other provinces. Eight provinces and autonomous regions lying on the western periphery of China, all with large minority, ethnic groups, remained dependent on Beijing for subsidies and development funding that substantially augmented locally generated resources. Guangdong and Fujian were given the most fiscal autonomy becuase they served as testing grounds for the "open door" policy. Beijing,
Tianjin, and Shanghai had to accept the most stringent terms, retaining only 25 percent of taxes collected and having to renegotiate yearly with the center, whereas the other provinces enjoyed three-year programs. These majJ or industrial cities, which profit from the sale of manufactures to all parts of China, resemble "giant sponges, soaking up revenues from the rest of the country which the center then squeezes out for its own coffers" (Donnithorne,
1983:98) . 121
Retention System
In addition to the revenue sharing, the center also gives tax credit and reduction to the provinces with respect to how much they have collected for the center. Provinces operate under the retention system have to remit an amount of "fixed delivery quota" to the center and retain the remainder. The purpose is to give these provinces incentives to collect tax, which can provide for up to 100 percent retention of above quota collections. The basic retention formula was most recently amended in 1988. The retention rate may be either positive or negative so as to determine whether the province needs to remit a share to the center or receive a subsidy. Revenue-sharing system and retention system are the two sides of the same coin. The former stresses how much to remit, and the latter how much to retain from the taxable income. Beijing in 1987 would be able to retain 49.5 percent of its 1987 collections. A new formula is used in 1994 to calculate tax refund to provinces on the basis of their 1993 tax receipts (Far Eastern
Economic Review, 1994) . This gave an incentive to the provincial leaders to step up their tax collections. As a result, although spending far exceeded budget allocations last year, revenues kept pace. 122
As said, retention can be 100 percent for the poor or deficit provinces. The 8 autonomous regions and the provinces with heavy minority populations were singled out for special treatment. They received a subsidy equal to their calculated deficit and this amount was to be increased by 10 percent per year, a figure taken roughly to approximate needed revenue growth. Furthermore, they are allowed to retain all fixed and shared revenue collections.
In short, there has been much discussion in China on the proper division of fiscal responsibility between the central government and the provinces. A series of experiments in fiscal decentralization have been implemented over the last decade with the intention of finding the best mix of central-local revenue sharing and expenditure responsibility. The goal of these changes is not for a larger role of government per se, but only for a larger share of the center vis-a-vis provincial governments and enhanced certainty (Hsiao, 1987).
The most obvious tug-of-war between the center and the provinces is how much to be remitted to the center and how much to be retained to the provinces. There are a number of weaknesses pertinent to the revenue-sharing. First, the sharing ratios were negotiated and determined on subjective basis of the central needs. The changeable nature of the 123 ratio or a lack of rationalized known pattern of distribution provided provincial governments with less certainty so that no incentive effects might be realized.
Without a known pattern, the revenue sharing ratio became a subject of annual negotiation (World Bank, 1990:106).
Second, penalties for overspending by provincial governments were vague. Beijing was ready to entertain subsidiary requests and occasionally accede to them, so long as the particular entity had met revenue goals. Third, one important feature has remained in effect through the entire history of revenue-sharing system, that is, central revenues are never subject to sharing with provinces, and the budgeting process was still largely subordinate to the planning system. Fourth and last, information is less effectively used. Implementation of the revenue sharing system requires reporting a substantial amount of detailed fiscal data by the province and verification of accuracy by the central government. Provinces do not appear to gather detailed data from their local governments, and the central government does not have a good mechanism for monitoring available data.
It must be pointed out that all kinds of devices or
"systems" are intended to subject provinces to substantial central control and direction. Even today, provinces still 124 have little formal or legal independence in matters of structuring their tax system or deciding on the level and composition of expenditures. All tax rates and bases are set centrally and so there are literaly no truly local taxes at the provincial level. In effect, provinces are the de jure tax collectors for the central government.
To accomplish the task of macro-economic balancing and resource transfer, historically, the central government possesses four sets of controls over provincial revenues and expenditures. First, it assigns revenue sources to provinces and stipulates revenue-sharing rates. Second, it stipulates the level of local expenditure by issuing mandatory targets that set spending levels for each major expenditure category. Third, it can regulate provincial receipts and spending through revenue collection and spending schedules, financial operations and accounting procedures. Fourth, it can enact extraordinary fiscal measures such as requisitioning provincial surpluses by forced borrowing and purchase of treasury bonds, and freezing local bank account.
China intends to complete by the end of the century the drastic overhaul in the tax system that was unveiled in
January 7, 1994. This overhaul includes new value-added, turnover, and consumption taxes and is aimed to guarantee the central treasury's share from economic growth. It would 125 transfer a greater share of tax revenue to the central government. This new tax scheme would allow the center to keep 60-percent share of tax revenue, leaving provincial and local governments with a 40-percent share. The central government would then funnel back to the provinces about 20 percent of its 60-percent share (China News Digest, 1994) .
This has caused bitter negotiations and fierce resistences from provinces that are reluctant to give up revenue powers earned since 1978. The central-local shares of budget revenues is displayed in Table 10.
As stated in Chapter III, pragmatism is one factor in the center's consideration of fiscal policies. China's reform is maintained on the balance of costs and benefits, risks and opportunities. The choice of a particular central-local fiscal relationship at a certain point of time depends on how the government weights the benefits of provincial responsibility for development versus less central control. Usually, when the central leaders desire to increase provincial autonomy and incentives, they designate more revenue sources to provincial governments and tie provincial spending to expenditure so that provinces which collect more revenue can also spend more (Oksenberg and Tong, 1991). But, if the center wishes to unconstrain provinces and relax implementation of tax policy, it will be 126 less able to use tax policy to pursue macrostabilization and equalization goals. If the central government wishes to strengthen the management of the revenue system as a whole, it will need to reduce, if not eliminate, the provincial governments' s power to administer the tax system, to implement tax policy, and the discretion to give special tax concessions. This is certainly a difficult balance to be struck, one between centralizing the management and regulation of the tax system better to pursue macroeconomic objectives and increase the central government's equalizing capacity, and decentralizing to accommodate the diverse needs and preferences of the provinces. In other words, the central government needs to define and find an intermediate area that represents the zone of prosperity and stability.
Borrowing
The second category of budgetary revenue is borrowing in lieu of tax, including both international and domestic ones. Revenues raised from borrowing are counted as budgetary revenues in the Chinese accounting. Fiscal stress occurs when government spending outruns tax collections. A large discrepancy between revenue and expenditure and the unwillingness of the government to continuously raise taxes worsens fiscal stress. Allan Meltzer (1976) theorizes that 127 the growing share of national income taken by government is a result of rational behavior, working through the political process: the government grows faster than the private sector whenever the costs of government can be diffused and the benefits concentrated. Diffusing costs while concentrating benefits creates incentives for expansion and disincentives for reduction in size of government. The practice of borrowing as revenue serves the purpose of decreasing or hiding deficits (Wanless, 1985:66).
Domestic Borrowing
The most diffuse way governments can use to gain command over additional amounts of society's resources is to issue treasury bonds. During the 1960's and 1970's, government borrowings were either negligible or nonexistent.
In the early 1980s, the need to fund development projects, to finance growing budget deficits, and to absorb inflation-causing excess liquidity helped the Ministry of
Finance to win approval for the opening of bond markets and plans to link bond markets in several major cities such as
Beijing, Shanghai, and Quangzhou. As mentioned above, the national budget is prepared by the Ministry of Finance. In the borrowing process, each year the State Planning
Commission examines the outlook for budget receipts and 128 expenditures prepared by the Ministry of Finance. It then seeks ways of increasing revenues and reducing expenditures.
Once the budget is completed, the Ministry of Finance estimates what volume of bonds it will be feasible to sell to enterprises and individuals. In estimating the amount it can sell to individuals, it analyzes the income of individuals, and the amount of currency and bank deposits they hold. The State Statistical Bureau makes a separate feasibility study. The Ministry of Finance also looks at the financial position of enterprises and their supervisory ministries. The State Debt Management Department of the
Ministry of Finance is responsible for issuing the bonds.
Treasury bonds were first issued in 1981 in an amount of 4 billion yuan ($1.1 billion). By 1989, the total issuance was 54 billion yuan. The bonds were first sold entirely to government institutions and enterprises.
Purchases were mandatory, and were allocated according to purchases quotas based on each institution's net income after tax. Individuals were then made to purchase treasury bonds in 1982 through their employers. A common practice called "administrative flotation" (Xie, 1990) refers to the administrative imposition of treasury bonds on employees by making deductions from their payroll. Treasury bonds are quantitatively the most important fixed income security in 129
China's financial market. In 1981, over 85 percent of the overall budget deficit was financed with treasury bonds, and this was achieved by "administrative flotation." Beginning in 1991, the central bank began using securities companies as underwriters. The underwriting system avoided the resentment created by forced allocation.
The bonds sold to individuals are in bearer form with an identifying number on each. The maximum denomination is
100 yuan ($27) . Bonds had uniformly long maturities and low interest rates. When a bond approaches maturity, the
Ministry of Finance transfer sufficient funds to a special account at the People's Bank of China to pay off the bond and accumulated interest. By the late 1980s, a differentiated market was emerging, and interest rates were responding to market forces. Instead of ten-year bonds, the market was increasingly dominated by three- and five-year maturities. Interest rates were made responsive to inflation and rose from 8 to 14 percent per annum in 1988.
Around the same time, the bond market emerged very quickly and the government used very high interest rates on bonds to soak up the excess money supply.
The latter financial and economic developments created a need for the bond holders to trade bonds at prices reflecting market conditions as well as the face value of 130 the bonds. A secondary market thus was required to allow bonds to be traded in accordance with the rise and fall of interest rates and principal value. In April, 1988, the
Ministry of Finance set up secondary markets for bonds in sixty-one cities. Finally, China was not linked with international bond markets until the mid-1980s. China began to issue bonds in the Tokyo market in 1986 and U.S. dollar and Hong Kong dollar bonds in 1992.
Foreign Borrowing
China also has become increasingly dependent on external funding for their economic development.
Traditionally, China was not an importer of capital. The end of the First Five-Year Plan (1953-57), during which the country undertook limited borrowing to expand its industrial base, saw the end of foreign loans. This source of revenue was utilized in the early years of the Chinese government, when foreign loans were provided by the Soviet Union.
Subsequently there was no government borrowing for two decades as China adopted the policy of both no internal debt and no external debt, by following a conservative growth path with limited emphasis on trade and reliance on domestic savings to finance growth. For most of its post-1949 131 history, the China's leadership simply refused to take on debt.
However, beginning with 1979, China resumes economic relations with foreign countries and encourages the inflow of international loans. The process of economic liberalization promotes imports and permits movement of capital; therefore, it creates inherent risks of potential shortages of foreign exchange and to creditworthiness.
Since China opened its doors to the outside world, its foreign borrowing has increased considerably. By the end of
1992, the foreign debt reached U.S. $69 billion, and debt repayment is expected to peak in the first half of the 1990s
(see Table 11) .
Following the large increase in foreign debt in 1985, the Chinese authorities decided to subject all external borrowing to centralized reporting and control. As a first step, in April 1986, the State Council appointed the State
Administration for Exchange Control (SAEC) as the sole agency responsible for monitoring and controlling China's external borrowing. On 27 August 1987, the SAEC promulgated the Provisional Regulations for Statistics and Supervision of External Debt. China has proved one of the world's most conservative regimes in managing foreign exchange. With a foreign-currency reserves of $45 billion by 1994, China has 132 been very prudent to make them convertible in a fear of
losing control of its economy.
Table 12 shows China's total debt. To update the
information and illustrate the point, some figures and
analysis are borrowed from William Overholt's recent
research (1993:56-7). China's debt at the end of 1991 was
$67 billion. Of this, $13.9 billion was trade finance of
less than one year's duration: this is just a set of
guarantees that traded goods will reach their destination,
and it liquidates itself automatically when the goods do
arrive. Taking this amount out, that leaves a real debt of
$53.1 billion. Against this $53.1 billion, China had $43.7
billion of foreign exchange reserve and $4.5 billion of
gold. Taking these out, the total net debt was $4.9
billion. A direct measure of ability to pay this $4.9
billion is twofold. First, a country is considered
creditworthy if it has not committed more than 20 percent of
its export revenues to pay its debt. By this standard,
China can pay its debt service with only 12.4 percent of its
export revenues. Second, a country has sufficient reserves
of foreign exchange and gold to weather a crisis for at
least three months. China's revenues can cover nine months.
Foreign borrowing is planned centrally. The Bank of
China, the People's Bank of China, the Communication Bank of 133
China, the Investment Bank of China, and the China
International Trust and Investment Corporation are the
national-level borrowing group and within the plan to
finance five-year and annual plan projects. They are
subject to scrutiny on a loan-by-loan basis. Normally, they
have to submit financial details for their projects to the
State Planning Commission. After reviewing these plans in
cooperation with the Ministry of Finance, the State Planning
Commission recommends the overall number of projects and the
total volume of external borrowing, and the State Council
approves and controls. Table 13 presents the sources of
borrowing.
The Chinese banks are in the process of evolving from
administrative organs of the states, charged primarily with
providing financial resources to carry out the plan, to
financial institutions managed on the basis of
profitability, risk containment and efficiency. The era of
"free banking" that followed witnessed unparalleled growth
and expansion in China. The less stringent bank regulations
permitted an explosive growth in the money supply,
speculative boom periods and crashes, inflations,
deflations, defaulted loans, business bankruptcies, and bank
failures. The number of banks and bank notes proliferated.
The amount of currency circulating outside bank and finance 134 systems had risen from 40 percent to about 60 percent, weakening the role of banks as economic regulators.
Renminbi (Chinese currency) was also losing its value, with one U.S. dollar now buying over nine yuan outside banks against an official rate of one dollar to just over five yuan.
Components Of Budgetary Expenditures
Generally speaking, the central government's major areas of expenditure responsibility are economic construction, culture and education, administration, and defense. Economic construction includes capital investment and large investment projects. Culture and education includes science and health, i.e., national universities, research, and welfare. The central government gives grants to the provinces for certain investment projects, for certain categories of scientific and technical research, innovation, and modernization (including experiments in new products and the costs of trial production), for relief in major natural disasters; and, from 1980, special development funds for economically underdeveloped areas. Other items of central expenditure include national defense, foreign affairs and foreign aid. 135
Nonetheless, not all national expenditures have been cut back as the result of the decentralization policies.
The good example is China's national defence. China's top national priority of economic modernization did compel the national government to reduce the size and budget of the
Chinese People's Liberation Army (PLA). The military share of the Chinese government's budget declined steadily from
17.5 percent (U.S. $5.8 billion) in 1979 to 8.3 percent
($5.3 billion) in 1987. However, the late 1980s and early
1990s saw that China's official mlitary expenditures actually doubled between 1988 and 1993, from $3.8 to $7.3 billion (Lin, 1994).
Despite the increased spending on national defense,
China' s PLA cannot get enough money from the government' s budget. Being hard pressed for funds, PLA is raising funds on its own through business dealings. Some observers estimate that there could be as many as 20,000
PLA-established and backed businesses today, and they are mainly in construction, transportation, medical services, hotels. For example, the PLA started China United Airlines, which uses air force transport planes and military airports for commercial passengers.
In addition to the foregoing, the central government expenditure includes revenue transfers to poor provinces and 136 subsidies to loss-making enterprises. Table 14 presents where the central money went and these are to be discussed as follows.
Tax Transfer
Many countries have revenue and expenditure imbalance between levels of governments, and they try to resolve these discrepancies by redistributing financial resources in the form of transfers to lower level governments (World Bank,
1990:75). Redistribution permits the central government to retain the authority to levy taxes on the broadened and more productive resource bases, and to avoid the high administrative costs which can be associated with the local tax assessment and collection. The Chinese budget is an important vehicle for transferring. Resource transfer means inter-regional and inter-sectorial transfers which redistributes funds and resources from rich provinces and sectors to the poor with an view of not only reducing regional inequality, but also keeping inflation low, and achieving planned growth. The way of doing this is largely by administrative regulations rather than market mechanisms.
The administrative regulations include the fiscal levers of determining, adjusting the scope of provinces' revenue base. 137 revenue share, revenue certainty, spending authority, and use of discretionary and extra-budgetary funds.
Details provided by the report of the Minister of
Finance, Wang Bingqian, at the Third Plenary Session of the
7th National People's Congress in March, 1990, presents the first available breakdown of the consolidated budget into central and local portions. According to these data, decentralization raised the local share of total expenditrues from approximately 50 to 64 percent, or from
62.6 billion yuan in 1979 to 164.6 billion yuan in 1988.
In 1989, local governments collected 219 billion yuan in revenues and spent 228.7 billion on their own account, which comprised 69 and 65 percent of total revenues and expenditures, respectively. They received a net transfer of
11.6 billion yuan, remitting 44.7 billion yuan to the central budget, while receiving central subsidies of 56.3 billion yuan. In the 1990 budget, local government shares of revenues and expenditures were 68.2 and 63.5 percent, respectively. In short, the Chinese budget was decentralized greatly with provincial governments keeping more shares of budget revenue as compared to the outset of reform when they were remitting a sizeable portion of their revenue collections. 138
Revenue transfers are also equal to central government expenditure mandates. In that sense, provincial governments must promise to pay for a portion of cost on matching fund basis. The strings attached to the receipt of such transfers may help accomplish national goals. Therefore, transfer allocations can be political weapons used by the center to command compliance.
The lure of transfer has proved to be a fiscal incentive for the provincial governments that look to
Beijing for money. Nevertheless, transfers and shared taxes as given tend to make provincial governments less accountable for their fiscal decisions. Hence, there will be less incentive for them to improve the efficiency of how to best use the central money.
The Chinese fiscal decentralization with a series of reforms was implemented to put provincial governments increasingly on a self-financing basis. In their struggle for self-reliance and self-efficiency, provinces, with coastal provinces in particular, try to retain as much resources in the hands as possible, thus largely reducing the amount of revenues available for the center's collection and redistribution. Since the central government has in the past aggressively used its control over funds to transfer resources from richer to poorer provinces, the decline in 139 the central government's transfers starve the poor provinces immensely. The direct victims are the poor provinces in the interior areas that have less choices but have to rely upon the center for transfers. As a result, tension between the coast and the interior became evident and explosive after the post-1978 reform.
Interactions among equals are on a horizontal rather than on the hierarchical basis. Dissonance and friction, in the setting of Amrican federalism, have been over boundary lines, riparian rights, and competition for businesses and industries (Glendening and Reeves, 1984). There have been numerous clashes among the Chinese equals. A number of provinces have set up inspection stations along rail lines to restrict domestic imports. Hubei, Hunan, and Jiangxi have even used their own de facto currencies to protect their own industries. On the Hunan/Guangdond border, there were frequent demonstrations by Hunanese trying to stop the
"export" of Hunan's raw materials and agricultural products, including rice, to fuel the growth of Guangdong, a coastal province and Hong Kong's neighbor, which reaped all the foreign exchange benefits and enjoyed special privileges.
The incident of "rice war" originated from an argument over the price of rice imported to Guangdong from Hunan.
Hunan, a poor province to the north of Guangdong, insisted 140 on a higher rate of price for exporting rice and finally gave up, when Guangdong used the units of its military garrison to ensure access to cheap rice in interior Hunan.
For a long period, Hunan people demanded that Guangdong's special privileges be taken away. Around 1991, however, a turning point occurred. No longer did they demand repeal of
Guangdong's privileges, but rather the right of the interior provinces to enjoy all the same economic liberalization privileges. In the meantime, millions of Hunanese had migrated to Guangdong to work in the factories there and returned home with money and stories of prosperity. The growth rate in Hunan's gross economic product was 12 percent in 1992. It is a big jump from only 7 percent between 1985 and 1991.
The experiences like this greatly prompted the poor interior provinces to look for opportunities of wealth and get rid of passive dependence on transfers. The decentralization of economic and fiscal powers paved the way for every province to attempt to follow the path of growth of Guangdong, whose GDP has grown by 13 percent every year for the last 15 years. Once these provinces find a role model and the road to success, they will no longer stay at the mercy of the center. They hinge hopes on proximity to
Guangdong—a symbol of divergence and prosperity. 141
Subsidies
As far as the state enterprises are concerned, the central government have been seemingly more favorable to them than to the provinces. Every single state factory threatened by closure or bankruptcy by the economic downturn in late 1989 was quickly subsidized. A group of 234 "large and medium-sized" state enterprises received emergency injections of cash in that year. When conditions failed to improve in 1990, subsidies continued, despite the fact that the share of state enterprises losing money exceeded one-third, or was as high as one-half, according to one report in The Wall Street Journal (1994b). The central government could not discipline factories that lost money, and it lacked any incentive to change those that did not make money. In the same year, instead, about 70 billion yuan of the state budget was paid to loss-making enterprises as subsidies. These moves make it clear that state factories are too important to reform and also too dear and dangerous to the center. If China were to shut down money-losing enterprises, millions of workers would be laid off with no benefits; their addition to the 100 million-plus workers already adrift in China could be volatile and unstable. 142
The reason that China was able to defer spasmodic action on the state enterprise deficits was because it had tightly controlled pension and insurance funds. Chinese city and provincial governments control about $34 billion yuan ($4 billion) in pension and unemployment insurance funds, and the Chinese government only permits as much as 10 percent of that amount to be invested in the stock markets.
However, the sheer size of unemployment is far more than the amount of pension. Further, the banks already lent the state enterprises 4/5 of their working capital and need extra cash infusions before bankruptcies increase.
Though share trading reemerged in 1984, there were only seven state enterprises listed in Shanghai that were designated to issue shares to the public. In 1992, China began to expand stock exchanges at a large scale. Thousands of China's state enterprises issued shares. Today, China has 10 million shareholders (The Wall Street Journal,
1994a), and their ranks are growing by about 50,000 a week.
On any given day, $350 million worth of shares are traded
(Naisbitt, 1994).
The rise of share trading legitimizes the market operation in the sphere of the state-own enterprises. This movement touched on the nerves of the central government, and a very sensitive issue popped up as a dilemma for the 143 leadership: the ownership of the state enterprises. The central government does not want to lose the ownership by trading the shares of state enterprises to the hands of individuals, but it needs to cut down the subsidies so as to reduce budget deficits by allowing ordinary people to buy up the shares. In response to it, the central government made a distinction between "natural persons"—ordinary people and
"legal persons"—government agencies and state enterprises.
It then confined most state enterprises to selling their shares only to legal persons. Ordinary people are not allowed to acquire more thann 49 percent of a state enterprise. Indeed, the Chinese leaders regard China's 10 million shareholders more as a potentially destabilizing force rather than as risk-takers helping to finance China's modernization.
China also decided to open the stock exchanges to international markets. After all, it is useful for the state enterprises to be able to acquire foreign exchanges for their shares. Logically, China faces the same dilemma of the state ownership. To prevent foreigners from buying up all of the country's most important and successful enterprises, the central government made another distinction between the shares to be bought by foreigners—"B Shares" and the ones by domestic buyers—"A Shares." B shares 144 require special approval from the People's Bank of China, and no invester is allowed to acquire more than 5 percent of a company without approval. Moreover, China is in the process of drafting measures to limit foreign investment for two purposes. First, a ratio must be maintained for the
Chinese economy to preserve as the mainstay. Second, state assets should not be sold off at bargain-basement prices.
The latter underscores the leadership's fear that freewheeling local officials are selling off state assets too cheaply and line their pockets with proceeds.
Provincial Expenditure
Autonomy on the expenditure side of the budget was limited for provinces. Subnational government budgets were determined as part of a consolidated central, provincial and local budget and as such must satisfy the fiscal targets laid down by higher level government. The budgetary choices of provincial governments were further limited by expenditure rules, mandates and monitoring by higher level government. Provinces accounted for slightly over 50 percent of total direct expenditures.
Since the inception of the economic reforms, however, there has been a gradual trend toward decentralizing expenditures. The decentralized expenditures typify that 145 provinces decide their own expenditures. For example, central planners try to increase the flow of investment to key bottleneck sectors, particularly energy and transport.
Provincial governments and enterprises, by contrast, tried to develop industrial with high profit rates and prospects for rapid growth in defiance of the center's directives.
Within the province, there is more room for discretion.
At the local level, provincial governments are responsible for approving the budgets and financial plans of municipal and county governments. This means they can control the spatial distribution of expenditures within the province.
The responsibilities of the provincial and lower-level authorities include their own investment projects, and most, but not all, public expenditures on education and health, local administration, culture, science and agricultural support, including irrigation, agricultural research, extension activities, and other rural expenditures. As a result, the central government's share in total outlays declined from about 50 percent of total expenditures to 41 percent. The rate of growth of central governmnent expenditures during the decade was 7.1 percent compared to the 10.7 percent of provincial government expenditures. By the second half of the 1980s a significant disparity had 146 developed between what the central government wished to accomplish and the resources at its disposal. 147
Table 9 Revenue-Sharing Rates of China's Provincial Units 1980-1983 (percent)
Province Arrange- 1980 1981 1982 1983 ment Beijing SOR 28 27 35 na Tianjin SOR 31 31 35 na Shanghai SOR 9 8 11 na Hebei DR 27 27 SOR 68 64 Shanxi DR 58 58 75 SOR 83 Liaoning SOR 30 30 30 34 Jiangsu SOR 39 37 38 36 Zhejiang DR 13 13 SOR 56 52 Anhui DR 58 58 SOR 77 76 Shandong DR 10 SOR 49 49 52 Henan DR 75 75 SOR 82 78 Hubei DR 45 45 SOR 69 64 Hunan DR 45 45 SOR 75 71 Sichuan DR 72 72 SOR Q& QZl Shaanxi DR 88 88 SOR 100 100 148
Table 9. Contined Province Arrange 1980 1981 1982 1983 ment Gansu DR 53 53 SOR 8 DR-Subsidy (169 mn)
Note: The sharing of Overall Revenue (SOR) formula calls for sharing total local revenue, which includes local fixed income, local fixed rate income, and local shared income. The Dividing Revenue (DR) formula requires the sharing of only local shared income (industrial and commercial tax).
Source: Oksenberg, Michel & Tong, James. 1991. "The Evolution of Central-Provincial Fiscal Relations in China, 1971-1984. The Formal System." The China Quarterly, March, 1991, No. 125. p. 24. 149
Table 10 Central-Local Shares of Budget Revenues (billion yuan)
Central Year Total Central Local Share % 1976-78 496.07 77.45 418.61 15.61 1979 110.33 15.78 94.55 14.3 1980 108.52 17.36 91.16 16 1981 108.95 22.47 86.47 20.63 1982 112.4 25.85 86.55 23 1983 124.9 37.21 87.69 29.79 1984 150.19 52.45 97.74 34.92 1985 186.64 70.79 115.85 37.93 1986 226.03 91.67 134.36 40.56 1987 236.89 90.58 146.31 38.24 1988 262.8 104.55 158.25 39.78 1989 291.92 108.9 183 37.31 1990 324.5 133.6 190.9 41.17
Source: Chinese Financial Statistics, pp. 58-59. Wang Bingqian, "Report," 1990, 1991. 150
Table 11 Foreign Capital Flow into China, 1979-1987 (US$ 10th)
Period Foreign Aid Direct Other Total Foreign Foreign Investment Capital 1979-81 185,668 112,069 723,373 1,021,110 (18.8) (10.98) (70.48) (100) 1982 55,634 64,972 122,673 243,234 (22.87) (26.70) (50.43) (100) 1983 78901 91,596 27,567 198,064 (39.84) (46.25) (13.91) (100) 1984 90596 41885 37971 270452 (33.50) (52.46) (14.04) (100) 1985 109064 195615 141534 446211 (24.44) (43.84) (31.72) (100) 1986 218322 224373 283135 725830 (30.08) (30.91) (39.01) (100) 1987 151304 264661 429191 845156 (17.90) (31.31) (50.78) (100)
Note: Percentages are in parentheses. Source: Chen, C. H. "Modernization in Mainland China, Self Reliance and Dependence," American Journal of Economics and Sociology, 51:1 (Jan 1992), p. 62. 151
Table 12 China's Total Debt and Debt Indicator, 1980-90
Year Total Total Total Principal Interest/ Debt (US Debt/GNP Debt/Ex and Exports $million) (%) ports (%) Interest/ (%) Exports (%) 1980 4,504 755 21.2 4.4 1.5 1981 5,797 2.1 23.1 6.9 2.1 1982 8,359 3.1 32.1 8.1 3.1 1983 9,609 3.3 35.7 10.1 3.1 1984 12,082 4.1 38.6 7.3 3.2 1985 16,722 5.7 52.2 7.7 3.7 1986 23,746 8.5 65.8 8.2 2.9 1987 35,303 11.6 78.4 8.5 4.1 1988 42,406 11.3 79.4 8.7 4.1 1989 44,847 10.7 77.7 9.8 5.5 1990 52,555 14.4 77.4 10.3 4.6
Source: Platte, Erika . "China's Foreign Debt., " Pacific Affairs,. Vol. 66, No. 4, Winter 1993-94. 152
Table 13 Sources of Government Financing (billions of Yuan)
Source Year 1, 983 1984 1985 1986 1987 1988 1989 Banks 4.3 4.5 -2.1 7.1 6.4 23.5 16 Others 4.2 4.2 6.1 6.3 11.4 7.9 5 Total 8.5 8.7 4.1 13.4 17.8 31.4 21 domestic Financ ing Foreign 1.1 1.8 0.1 5.3 6.8 11.5 12 fiancing Total 9.6 10.5 4.1 18.7 24.6 35.1 33
Source: China: Financial Sector Policies and Institutional Development . The World Bank, 1990, p.109 153
Table 14 Government Expenditure by General Categories (1,000,000 Yuan)
Year Economic Culture & National Adminis- Repayment other Construe- Eciucation Defense tration of Loans tion 1950 1,736 755 2,801 1,313 3 200 1951 3,511 1,344 5,264 1,745 42 343 1952 7,323 2,111 5,784 1,549 392 440 1953 8,743 3,244 7,538 1,972 91 424 1954 12,358 3,461 5,813 2,162 221 617 1955 13,762 3,189 6,500 2,154 656 668 1956 15,914 4,596 6,117 2,660 722 565 1957 16,304 4,642 5,511 2,270 826 868 1958 27,886 4,354 5,000 2,272 904 524 1959 38,933 5,860 5,800 3,000 969 724 1960 46,071 8,695 5,800 3,139 1,046 663 1961 21,001 6,125 5,000 2,714 1,093 769 1,962 15,264 5,173 5,694 2,191 1,037 1,166 1963 17,412 5,145 6,642 2,386 758 1,620 1964 20,999 6,609 7,286 2,622 523 1,863 1965 25,411 6,270 8,676 2,634 636 3,006 1966 30,943 6,706 10,101 2,659 391 3,356 1967 24,403 6,083 8,302 2,295 201 2,901 1968 16,603 4,788 9,409 2,291 200 2,693 1969 29,552 4,977 12,618 2,982 2,457 1970 39,261 5,222 14,526 3,200 2,732 1971 41,830 6,380 16,947 3,762 4,298 1972 43,196 7,531 15,939 3,893 50 6027 1973 46,827 8,857 14,539 3,859 50 6,796 1974 46,093 9,502 13,339 3,976 50 6,115 1975 48,196 10,355 14,246 4,181 5,140 1976 46,622 12,006 13,445 4,338 4,209 1977 49,373 11,943 14,904 4,518 3,615 1978 70,784 14,696 16,784 5,290 3,541 154
Table 14. Continued Year Economic Culture & National Adminis Repayment other Construc Education Defense tration of Loans tion 1979 76,159 17,518 22,266 6,305 5,146 1980 67,078 19,901 19,384 7,553 2,858 4,499 1981 54,443 21,146 16,797 8,263 6,289 4,559 1982 54,318 24,298 17,635 9,084 5,552 4,444 1983 63,521 28,251 17,713 10,308 4,247 5,205 1984 78,465 33,206 18,076 13,980 2,891 8,022 1985 89,500 40,843 19,153 17,106 3,956 13,920 1986 123,471 48,509 20,075 22,004 5,016 14,006 1987 125,995 50,583 20,962 22,820 7,983 16,506 1988 139,700 58,118 21,800 27,160 7,675 16,204
Source: China Statistical Yearbook 1990. State Statistical Bureau of the People's Republic of China, p. 215. CHAPTER V
A TYPOLOGY OF CHINESE BUDGETING POLITICS
Harold Lasswell, one of this century's most influential political scientist, fashioned a definition of politics that captures conflicts over scarce resources: Politics is a process that determines "who gets what, when, and how."
Based on what have been observed, a typology or taxonomy is constructed of three budgetary instruments alternately employed over time by the central government in the process of Chinese budgeting politics. The description of each of these instruments (central planning-mass movement, authoritarian-party/state, and bargaining-decentralization) presents unique pattern of budgetary control by three powerful institutions of China's bureaucracy—the State
Planning Commission, the Ministry of Finance, and the
People's Bank of China. Officially, these three national institutions are jointly responsible for decisions on
Chinese fiscal and financial policies. The State Planning
Commission has broad overall responsibility for policy formulation. The Ministry of Finance drafts, oversees, and evaluates budgets. The People's Bank of China manages the flow of money and credit. Each of these institutions reports to the State Council. To update the study of
155 156 current practices in budgeting politics, more space is devoted to the analysis of the third instrument of bargaining-decentralization.
Some government decision making models in the literature are employed to frame the budgeting process in
China. They are the principal-agent model, the patron-client model, and the fragmented authoritarian model.
Important for theory development and practical problem solving is the evaluation of the usefulness of these theoretical frameworks in China. As can be seen in the following, these three theoretical models fit quite well in the above mentioned typology.
Central Planning-Mass Movement
After the founding of the New China in 1949, the
Chinese government chose to rely on Soviet models of economic structure and development strategy due to the fact that the Korean War (1951-1953) had foreclosed the possibility of gaining technology, capital, markets from the
West. In that model, the state exercised its planning function primarily through mandatory procurement and allocation of key agricultural and industrial products and through rigid control of the prices of major goods. Within only a few years' time after the founding, a number of 157 institutions was established to carry out the Soviet-style plan. In 1950, the State Financial and Economic Commission was set up to take charge of national economic activities.
In March of the same year, the Government Administrative
Council issued a "Resolution on Unifying State Financial and
Economic Works," according to which all financial revenues and expenditures, material distribution, and cash management were highly centralized (Fang, 1982). The State Planning
Commission was established in 1952 and the First Five-Year
Plan was launched in 1953. The integrated vertical system was thereby formed during the early period of the PRC, which featured a highly centralized planned economy (Liu, 1984).
During this period, the government's sources of public finances were found on the remittances mainly from provinces and the state owned enterprises, and were spent primarily on heavy industry investment. A high rate of investment was allocated to ministries and state enterprises through a system of state grants. State control over wages and prices ensured that industrial enterprises enjoyed high profits, which were then transferred directly to the central state treasury to fund new investment (Harding, 1987:16). On the other hand, the effects of government capital spending on growth were long viewed as more important than government recurrent spending. Whenever there was trade-off between 158 capital accumulation and recurrent outlays, the issue was resolved in favor of investment, as recurrent costs of development were labeled by convention as government consumption, implying unproductive. This pervasive belief has given rise to wasteful underutilization and rapid decay of public infrastructure.
Furthermore, the central government had licensing power to approve the purchase of most goods. Money on its own had little value, for it was not automatically convertible into goods. Given this, there was little economic incentive for both the provinces and the enterprises to evade profit remittances to the center. Since wage and price were set, the central government had powerful handles for raising revenue.
Capital accumulation and investment were set by the
State Planning Commission with priority in getting support such as loans, equipment and raw material from state banks and government bodies. In most cases, fulfillment of these objectives were not regarded merely as economic, but as political tasks to be realized by mobilizing almost the entire population. Mass movement typified the essence of such kind of popular participation by education and exhortation of socialist ideologies (Ross, 1984). 159
The Chinese Communist Party, under the leadership of
Mao Zedong, won the legitimacy to the great extent by centralizing the political power of the country and initiating a socialist reconstruction of the economy. The absolute authority and public trust the CCP enjoyed during the 1950s and 1960s made almost all Chinese eager to be part of the mass movement. This popular enthusiasm made it possible for the government to procure agricultural products at low cost and to mandate savings at no resistance. As a result, capital accumulation as a share of national income peaked to a high of 44 percent in 1959, and the accumulation rate during 1960s and 1970s amounted to between 25 and 33 percent (China, 1984). The Chinese masses could be manipulated with respect to their social demands. This fundamentally affected the needs of government spending on social programs, welfares, and economy.
Mass movement, as coined by Mao, refers to the mobilized masses by the CCP (Chinese Communist Party) to support the government's leadership and implement the public policies. Meanwhile, the mass movement is used by the party to promote self-legitimation, meaning producing favorable image as the evidence of legitimacy to the CCP and the state
(Kelly, 1991:23). In this sense, mass movement is about value integration and consensus building. Value integration 160 is a good way of reducing cost, since values can provide a strong basis for integration of policy making and implementation (Lieberthal, 1992). Harding (1981) attempts to illustrate that struggle for control of the bureaucracy and adoption of organizational policies are directly related to the ideological commitment. Value integration exerted substantial impact on the operations of the Chinese budgetary system. Value consensus served tremendously to have reduced the need of the central leadership to develop additional resources to assure fidelity to its priorities and compliance with their policies.
Consensus is achieved through coercive sanction as well as value integration. But, for both of them to be effective, the center has to build elaborate mechanisms of monitoring and enforcement. Unlike the United States, however, where the federal bureaucracy has numerous regional and field branches within 50 states, China has fewer offices of that kind in the provinces, and it basically relies upon provinces to do the jobs and report themselves to the center. The center reclaimed control only when things get out of hand. The practice of centralizing all financial receipts and expenditures, which was referred to as "eating from the same stove," created a sentiment of risk sharing 161 between central and provincial governments. The principal-agent model fits this situation.
The principal-agent model focuses on incentives for reducing information and transaction costs (Morris, 1987).
It addresses the problem of the high cost of monitoring the agent in order to ensure that he is performing as required by the contract. Monitoring is costly to the principal, but is mitigated by redistribution of the burden of risk more evenly between the two parties ("risk-sharing") or through the provision of information by the agent regarding his performance.
Mass movement waxed in the Cultural Revolution and waned in the ensuing political and economic campaigns of the early 1980. One of the most significant attempts in post-Mao period was spearheaded by Deng Xiaoping to create a professional bureaucracy so as to retire the old guard of party officials (Nolan, 1994). The emergence of budgeting into prominence as an option for collecting revenue is a function of decline of the mass movement. The Chinese budget began to be handled by the cadres (ganbu)—the bureaucrats who are in leadership or administrative positions. The cadres are the elite divided into three broad general categories: state, local, and military. As a special class enjoying special privileges, planners. 162 budgeters, and decision makers in their capacity of managerial knowledge directly respond to the party and provide leadership for the masses.
Authoritarian-Party/State
With the centralized nature of the party/state's unified leadership, power relations were quite simple.
Information flowed through top-down channels. It was particularly true in the absence of a detailed, published code of laws. Political and administrative top leaders published the directives and required the organs of the party and governments at all levels to comply. The system of "directives" is a system to command compliance among provincial governments with the numbered circular notices with various security classifications. It stipulated the level of provincial expenditure in periods of central control by issuing mandatory targets that set spending levels for each major expenditure category, or in less centralized periods, by issuing nonbinding directive or reference targets.
It also regulated provincial receipts and spending through revenue collection and spending schedules, financial operations and accounting procedures. Moreover, it enacted extraordinary fiscal measures such as requisitioning 163 provincial surpluses by forced borrowing and purchase of treasury bonds, and freezing local bank account. The system of directives is not only a system of policy implementation, but also a mechanism of inducing compliance with the control of the party's "visible hand" out of fear of sanctions.
That is, provincial governments were assigned revenue targets by the center and judged by their record of collection. Their budgets were sanctioned by Beijing if they failed to live up to the target.
China's fiscal system was derived from a Soviet template. In earlier years, it was also the fiscal calculus that helped maintain a balance between expenditures and the supply of goods. Along with the State Planning Commission, the Ministry of Finance decided the portion of provincial retention and remittance and redistributed surplus of revenues obtained from the richer coastal provinces to the relatively underdeveloped central and western regions.
Budgetary regulations were authoritatively communicated and hierarchically administrated through the command system of the Ministry of Finance and its counterparts at provincial level. This top-down type of communication created an unresponsive bureaucracy interested only in perpetuating its own power and privilege, and generated serious tensions and 164 contradictions between the top (party/state) and the bottom
(provinces) .
Furthermore, since the party/state possesses the ultimate authority, there are less access points available for the outsiders to look into the process, let alone to influence it. The centralized budgetary allocation is also in the lack of transparency of funds, materials, and investment. Allen Schick (1992:415) once said that in budgeting, the most effective expenditure control is the inhibition, not the rejection, of demands. In the case of
China's budgeting, demand was inhibited by closing the budget process to outsiders. There is no public participation of whatsoever. Little was known about the next budget until it was released. As China institutionalized a Soviet-type command economy and is controlled by a Marxist-Leninist party, which stresses secrecy and democratic centralism, regime-type variables will invariably affect the nature, processes, and outcomes of Chinese political process (Chow, 1993:35).
Finally, the CCP followed closely then the line of
Marxist theories of political economics. Marxist thought places production at the heart of economic processes.
Consequently, commerce and finance are held to be subordinate to, and, seemingly, natural outgrowths of. 165 production. Since commerce and finance do not create value, the Marxist theory argues that they should not have a major impact on economic planning. Finance and commerce have remained subsidiary to productive activities. Such a viewpoint makes it difficult for the leaders of China's financial system to argue that finance should play a larger role in the regulation of the economy.
Under the great pressure of omnipresent authoritarianism, provincial officials who had a stake in politics attempted to reduce the risk by building allies with a particular faction in power at the center. They acted as clients to serve the patron not only for their portion of budgets but also for their own job security. The authoritarian-party/state model fits well the patron-client relationship. The term "patron-client" is largely confined to an exchange relationship between roles, in which an individual of higher socio-economic status (patron) uses his own influence and resources to provide protection and/or benefits for a person of lower status (client) who, for his part, reciprocates by offering general support and assistance to the patron (Scott, 1987). Further, Shu-Yun Ma
(1993) pointed it out that clientelism in China is very unlikely to form horizontal alliance, and it is established 166 on the basis of vertical coalitions linking individual inferiors to specific superiors.
Since there is no certainty as to the flow of funds and access, the needy provinces try to reduce the certainty by
"bandwagoning." The model of bandwagon (Goldstein, 1990) suggests that the Chinese political structure is hierarchically ordered where influential resources are tightly concentrated in the hands of superordinate actors
(the center). In such a setting, subordinate followers
(provinces) have a strong desire to remain attentive to seemingly prevailing factions or emerging victorious coalitions at the central government. They attempt to become valued members of such groups by contributing support early enough to make a difference. In other words, through networking with the influencial factions in Beijing, provincial officials seek to secure the channel of financial resources.
Bargaining-Decentralization: Current Fiscal Politics
It might seem somewhat paradoxical that the Chinese government of such a unitary state may need to bargain in raising enough revenue to meet its expenditure. The 1978 decentralizations dispersed functions of the center and set the stage for the intensive intergovernmental bargaining on 167 revenue sharing ratio and fixing of budgetary priorities.
Bargaining-decentralization is a phrase used to describe the current fiscal politics in China. Also called as fragmented authoritarianism by Lampton (1987) and Lieberthal and
Oksenberg (1988), the theme of bargaining-decentralization argues that the structure of authority within the Chinese bureaucracy is not the centralized, hierarchical one, but rather a fragmented one. Though this fragmentation is not entirely a post-Mao phenomenon, the post-Mao administrative and economic reforms have greatly increased it by promoting the dispersal of resources throughout the country. In other words, extensive bargaining existed under Mao, but became prevalent only after the Mao's death. There are several reasons that bargaining became more prevalent in the decade of reform: leadership became more collective, and political agendas were dominated by complex economic and development issues that reflected great interdependencies, many trade-offs, and high complexity. Perhaps even more important, the very notion of decentralization enhanced the provincial tendencies to articulate their needs, which was legitimized in the wake of Mao's death (Lampton, 1992).
National power over finance was decentralized to give the provincial governments more discretion as to their revenues and spending. "Eating from the same pot," that led 168 to waste, inefficiency, was replaced by a system of "eating from separate pots." Under this system, provincial governments were given opportunities to be responsible for meeting revenue targets and for balancing their provincial budgets.
Christine Wong (1991) made a good analysis on local responses to the decentralization opportunities in two way.
The first seeks to work within the confines of the fiscal system. This type of response is a passive one of negotiating with higher levels in the fiscal hierarchy for an adjustment in the division of revenues and responsibilities and in the hope of obtaining a more favorable revenue-sharing ratio, a bigger subsidy from the higher level, or a reduction in expenditure responsibilities. The second reaches outside the system to find solutions. This approach is quite aggressive in a sense that provinces keep two sets of books, one is part of the consolidated budget and the other is beyond the reach of the center, i.e., the provincial extra-budget.
Extra-budget is a good example of the era of bargaining-decentralization. Provinces have come out with many ways to make money off the central budget. These provinces aggressively pursued their own developmental ambitions by taking advantage of the extra-budget, which 169 left the central government uncertain as to how much money is retained by provinces and how much is available for central collection. The point is that the budget does not give a complete picture of the magnitude of public sector financial operations, unless it is adjusted for extra-budgetary transactions.
The Provincial Extra-Budget
The Chinese government controls allocation of funds mainly through the national budget, which is further divided into the central budget and the provincial budget. The central budget is directly managed by the State Council through the Ministry of Finance, whereas the provincial budget is only indirectly managed by the center. In other words, provinces make their own budgets, but their appropriations in the budgets are approved by the center.
The provincial budget consists of sources and uses of funds under direct management of the Department of Finance of each province. Although in a state of constant change, the
Chinese central government regularly made some sort of provision for stand-by or reserve funds for provincial and local governments which they could use as "extra-budget."
In other words, the Chinese central government does permit the creation of provincial extra-budgets and recognizes the 170 legitimate use of them thereof. While this is a fact, the center is certainly not willing to tolerate the provincial extra-budgets being hidden or growing too fast. Provinces, in the contrary, are aggressively reaching out to grasp any resources that could be categorized as extra-budget. For example, many items in today's extra-budgetary funds were previously budgetary items. What has happened is a shifting or channelling of these items to provincial extra-budgets through a change in category. Once falling out of the category of budgetary revenue, funds are hardly within the reach of Beijing (Wang, 1994).
A difference exists between extra-budget and off-budget. As said, extra-budget refers to two books for separate budgeting and accounting, whereas off-budget means that certain items or transactions in revenue and expenditure are excluded from the budget totals. Take the
United States for instance, off-budget activities include credit guarantees, tax subsidies, the finances of public corporations, and the shifting of costs to private parties through regulation and to other units of government through mandates (Schick, 1992:417). Congress has, by law, placed a number of important programs, especially redistributive programs, outside the annual budget process altogether.
Over 75 percent of the federal budget is regarded as 171 uncontrollable in the sense that these outlays are legislated by prior commitments (LeLoup, 1989:51-61). The government has very little discretion over these expenditures.
The Chinese statistical authorities recently published data on revenues of both the state budget and the extra-state budget. Since the onset of decentralization, budgetary revenue itself has fallen dramatically compared with national income. For example, in 1978 budgetary revenue represented 37.2 percent of the national income; in
1988, it represented only 20.0 percent. In contrast, extra-budgetary revenue increased from 11.5 percent of the national income in 1978 to 19.3 percent in 1988. Since extra-budgetary revenue is controlled primarily at provincial levels, these trends would explain the central government's growing concern over its loosened control of provincial revenues and provincial gains at the expenses of the center. Table 15 presents a comparison of extra-budgetary revenue and expenditure between the central and the provincial governments.
Before the 1978 decentralization, there were two periods in which extra-budgetary funds expanded rapidly: the
Great Leap Forward period (1958-60) and the Cultural
Revolution period (1966-1976). In 1978, the size of 172 extra-budget was 31 percent as large as the size of total budget revenues. In the ten years between 1979 and 1988, while budget revenues grew 133 percent, extra-budget funds increased five-fold (Wang, 1994:99). Decentralization of budgetary authority enabled bureaucratic units at all levels to acquire funds outside of those allocated through the central budget, which they could use to pursue their own policy preferences. This cushion of "extra-budgetary" funds in turn permitted many local units to become less sensitive to the policy demands from higher levels (Lieberthal and
Lampton, 1992).
To reduce extra-budgets, in 1983 and 1988 two new taxes were levied against provinces. The 1983 tax was a 10 percent tax on extra-budgetary funds and the 1988 tax was the substitution of the profit tax on state-owned enterprises for the profit transfer system (Wulf, 1986).
These measures curbed the growing rate of extra-budget (see
Table 15).
However, the provincial extra-budget has always been more than that of central government in both revenue and expenditure from 1982 to 1987, as shown in Table 16. What follows is a description of how provinces go about building up their extra-budgets. 173
Tanpai
One of the major strategies used by provinces to augment their income is to resort to various informal levies or impose ad-hoc charges (Tan Pai) on enterprises within the provincial jurisdiction (Wang, 1994; Gordon, 1991). These ad-hoc charges are levies with no statutory basis (Wang,
1994:97). Since these ad-hoc charges are solely at the provincial discretion, the central government does not receive a penny from the revenue generated by provinces in this manner. By the late 1980s, there were literally tens of thousands of forms of tanpai. A nationwide survey conducted in 1990 found that there were altogether more than
50,000 varieties of such charges (Enterprise Management
Division, 1991:327). Among these charges local authorities extracted at least 20 billion yuan a year (Wang, 1988).
In spite of its own numerous injunctions to stop tanpai from spreading, the central government's relaxed restrictions on creation of new cities cancelled out the effectiveness of those injunctions. Creation of new cities means creation of new jurisdiction or rather new outliers beyond the center's control. The post-Mao reform has seen a bewildering array of new regional institutional reform, and one of them is the urban-based regionalization. In 1978,
China had only 190 cities; by the end of 1991, the number 174 had grown to 476, with an average of more than 20 new cities emerging each year (People's Daily, 1992). The newly created cities differed from the old ones at least in this aspec-caspect.. AccoramAccordingg to Gong Ting and Chen Feng (1994), cities were created no longer merely based upon the products of population growth; the level of socioeconomic development was taken into consideration. For example, a town could be converted into a city when its non-rural population reached
60,000 and its GNP rose to more than 200 million yuan a year. Urbanization facilitates tanpai by enlarging the tax base. The enlarged tax base enabled provinces to levy more taxes on the urban population than the rural population.
Fiscal decentralization means the elimination of the central government's monopoly over foreign trade. The "open door policy" included establishing experimental "special economic zones." Guangdong province was granted three zones, and one of them is Shenzhen on Guangdong's border with Hong Kong. Shenzhen was converted from a collection of backward villages and paddies into an industrial power center with the privileges to move faster in domestic reform and in foreign trade. To follow the suit, other provinces set up such zones by offering preferential policies to attract outside investment. In so doing, a larger share of taxes could be expected to flow to the provinces. Since the 175 amount of investment was not infinite, the contest among provinces for financial resources was severe. Provinces competed against each other to offer more favorable terms.
As a result, normally overseas investors putting fund in the zones were free of income tax for as long as five years and enjoyed tax reduction during the next three.
Decentralization has reached down to local governments, i.e., counties, townships, and villages. The establishment of regional economic zones has been flourishing. A famous ancient Chinese saying goes: "The mountain is high and the emperor is far way." This represents the typical Chinese attitude toward the central government. Even though the central authority has rules as to where economic zones can be established or where foreign trade can be made, the local governments have been setting up the zones anyway (but they do not call them the "zones"). The rapid expansion of the development zones is very much like the enclosure movement in the British Industrial Revolution. The scale of the land enclosure into development zones in China is indeed astounding. According to one estimate, by May 1993, the total size of development zones had reached about 15,000 square kilometers, or larger than the country's 517 cities combined (about 13,000 square kilometers) (Yang, 1993).
With this in mind, it would be difficult to imagine that the 176 central government has any real grip on the way provincial enterprises develop and operate. Further, the sheer size of the country, the number of people and business units are too enormous and formidable for the center to effectively control them with its limited resources. The center is either powerless or simply will not control the development.
Tanpai in China is a new source of funds for supporting the operation of public sector at the provincial level. The growing magnitude of tanpai is a sign that local governments have become strong enough to make rival claims over resources in defiance of the center's regulatory authority.
Tanpai is derived primarily from own sources. Own sources are defined as those revenues collected by provincial governments for their own use, plus those taxes unconditionally assigned or which accrue automatically to provincial governments. The similar type of levy may be found in the United States. One of the ways to avoid taxpayers' resentment is user charges and fees. The use of user charges and fees can also possibly synchronize the timing of payment and benefit. The shift from governmental fund (general revenue as approved by the legislature) to proprietary fund (user charges and fees as mandated by the executive) not only reflects the priority of the government's fiscal policy, but also indicates an expanded 177 power in the executive branch relative to the legislative branch (Chang and Freeman, 1991).
Having no such separation of powers in the Chinese situation, provincial governments have to work out a large base available for tanpai. In fact they do have a surprising amount of discretion in granting tax relief for that purpose. There are three methods of granting tax relief. First, if the provincial government wants to promote a new product or a pioneer industry, it may authorize a reduced tax rate or a tax holiday for a number of years. Second, the provincial Finance Bureau may enter into a contract arrangement with an enterprise for payment of a negotiated amount of taxes. Third, the provincial Tax
Bureau may grant ad hoc tax relief to enterprises on a case-by-case basis depending on the needs of the enterprise.
Tax reduction and relief are used to hold back as much local funds as possible from central extraction. The bottom line is: as long as funds are kept within provinces, they are within the reach of provincial governments.
Foreign Capital
A second source of provincial extra-budget is foreign capital. Traditionally, the Chinese viewed their country as a civilization unto itself and felt little need for contact 178 with the outside world. Because of this, the forcible
"opening" of China by the Western colonial powers in the
1840s was traumatic. The Chinese viewed these powers as culturally inferior even though they were more advanced scientifically, technologically, and militarily. The
Western impact contributed to the disintegration of the traditional Chinese political and social system. Since then, for a century and a half, they have been trying to answer some basic questions: should China involve itself in the world economy and modern international community
(Barnett, 1981:6)? If yes, to what extent?
Today, decentralization and liberalization have encouraged broader foreign contacts. China's fast growth is making great demands on foreign expertise and capital. For example, Fujian province, which lies across the strait from
Taiwan, wants Taiwan to invest in its downstream sector.
Shanghai has discussed a refining and distribution joint venture with the French oil company. Tianjin is completing a plant of cellular phones with American Motorola. The Far
Eastern Economic Review described, China's economic boom has made Hong Kong a mecca for capital-hungry delegations coming from as far as Heilongjiang in the north and Yunnan in the south. Like an army of travelling salesmen, they bring their projects—a power plant here, a night club there—to the colony in search of financial backers. (1994:40) 179
Foreign companies have begun to enter China's infrastructure. Airport construction, aircraft maintenance, and airlines are open to Sino-foreign joint venture, while construction of airport concourses can be granted entirely to foreign firms. In energy sector, many global firms such as Bechtel and Westinghouse are making deals to increase
China's power capacity. Serious energy shortages have prompted China for the first time to allow 100 percent foreign ownership of power stations (Naisbitt, 1994:194).
Approved in 1992, the $11.5 billion project of the Three
Gorges on China's longest river, the Yangtze River, is designed to produce $4 billion kilowatt-hours of electricity a year, or 11 percent of China's total power production.
This huge potential market has attracted many foreign businesses.
After more than half a century of isolationism, China opened its door just as wide as it can. While it needs foreign capital and knowledge, foreign companies need their
1.2 billion consumer market. World Bank research shows many provinces trading more with the outside world, while trade with domestic counterparts falls, both in real terms and as a percentage of a province's total trade. In other words, more than half of all exports and about 60 percent of 180
China's imports are determined outside the scope of the central plan.
External borrowing can also be non-plan borrowing.
Borrowing outside the plan includes borrowing by the Bank of
China for purposes other than plan projects, short-term trade credits, borrowing by provincial governments to finance their projects. Generally speaking, plan borrowing accounts for 75 percent of China's foreign debt, and non-plan borrowing makes up the remainder (Platte, 1994).
In 1987 the central government began to encourage provinces to negotiate loans directly with foreign countries (Platte,
1994). As Beijing gives more leeway to the regions, it grows harder to retain central control over the economy.
"One consequence of China's increasingly outward orientation will be the reduction of Beijing's influence over the regions most closely integrated into the global economy"
(Endean, 1991:742).
Foreign economic and financing links have also blunted the impact on coastal provinces of the economic austerity program Beijing has been implementing over the past years.
In fact, tighter domestic credit and sluggish domestic demand resulting from austerity policies have encouraged provinces to rely increasingly on global markets for their products and on foreign partners for needed investment 181 funds. All this intensified the provincial movement away from central control. This is especially true for the swiftly growing coastal provinces. Higher wages in coastal regions allow provinces such as Guangdong to buy material and labor from the hinterland, increasingly without central control. Guangdong can also buy its own oil on the international spot market and charter its own tankers
(Segal, 1994). As a result, coastal Guangdong's per capita
GNP is twice that of interior Ningxia, and Shanghai's is five times that of Sichuan.
Today, China's growth is simply not sustainable without access to foreign markets and injections of foreign capital.
The implications of Chinese regionalism extend beyond domestic politics into the international arena. Regionalism will raise the sensitive question of the integrity of the modern Chinese state. In the same token, the idea and practice of capital budgeting from foreign investments is controversial. The Chinese leaders long had a fear that a sovereign socialist country would be in danger of blackmail, if the market-oriented capitals were borrowed to finance such vital capital projects as energy and transportation.
The leaders are now aware that foreign loans are keyed to an adequate infrastructure that provides employment, domestic and international markets, and the means to sustain heavy 182 production and create a service industry. The notion of self-reliance is replaced by opportunism. The Ministry of
Energy has disappeared, leaving the state energy companies increasingly free to make many of their own commercial decisions. Despite some confusions and uncertainties caused by Tiananmen Incident in 1989, foreign trade, technology, and financing have become important determinants of China's economic growth and modernization. Century Casino Inc., a company in Denver, Colorado, and the Chinese government agreed in late 1994 to build a gambling facility in Shenyang in northeast China. All this enabled the enterprises at both the national and provincial levels to streamline production and to respond quickly to world market forces.
Bank Loans
First of all, it should be pointed out again that bank loans are accounted as revenue rather than liability in the
Chinese accounting book. The reforms in the banking areas by the end of 1993 were primarily administrative and organizational-orientod. In March, 1978, tho Pooplo's Bank of China was conferred the ministerial status on a par with the Ministry of Finance. Since then, the People's Bank of
China ceased to be an industrial and commercial bank as it was before 1978 and was organized into the central bank of 183
China. In the words of Lu Peijian (Beijing Review^ 1984) the former governor of the People's Bank of China, the
People's Bank of China exercises authority over various specialized banks and monetary institutions. For example, in order to effectively control the specialized banks (such as agricultural banks and industrial banks) which gained organizational independence, the People's Bank of China introduced the reserve requirement system. It also allowed its intermediate and local banks to adjust and differentiate their operations according to specific sectoral and local conditions. For example, the local banks were allowed to broaden the range of their lending activities and empowered to vary interest rates according to the performance of the borrowers and the policy priority of the industry by as much as 20 percent from the official rate.
All this promised greater regard for local environmental, social variations, consumer preferences, and, ultimately, market exchange mechanism, which, in return, justifies or legitimizes the independence of the banks. At the annual national conference on economic work held on
December 1, 1993, Premier Li Peng said that the People's
Bank of China will be strengthened into a full-fledged "true central bank, " which will have the capacity to decide and implement China's monetary policies, to fine-tune cash 184 supply and demand, and to stabilize the currency (Beijing
Review, 1993c).
Although the People's Bank of China at the national level (the headquarter) has been becoming more and more vocal and visible in macro-economic control of the nation's inflation, and the scope of mandatory planning has been substantially reduced, it shows serious problems at the intermediate and local levels that tremendously weaken the central bank's full exercising of monetary function as a whole. At the provincial level, for instance, banks are still subject to the provincial leaders' supervision, which continues to regulate prices, restrict labor mobility, approve bank credits, and decide who gets what essential, scarce inputs and in what cjuantities (Leeahtam,
Patrawimolpon, and Supapongse, 1991) . Clearly, the lack of a clear and independent role for the banks means that the banks lack the right to review over legislation and executive decrees. Consequently, the provincial officials may enact laws without checks from the banks, and, typically, the responsibilities of the banks are only of serving as lenders, cashier, printing press, and the financial agents for the government (Sender, 1993b).
Subsequently, the provincial banks can provide volumes of irresponsible credit and get away with it. 185
There is a close association between the rate of growth in the money supply and the rate of price inflation.
Lasting increases in the growth rate of money have been accompanied by faster-rising prices, and shortages of money have coincided with falling prices. This has been true regardless of whether the medium of exchange was gold coins or paper currency. It also is independent of the form of economic organization (DeRosa and Stern, 1981). According to Gourevitch (1986), this relationship, when reflected in the policy preference, gives rise to two different approaches from bankers and politicians. Compared to political leaders, local banks tend to be more concerned with the risks of inflation and instability and are highly averse to price inflation. Political leaders, on the other hand, are more concerned with growth and employment and are highly averse to economic stagnation. Political leaders worry that if the growth rate falls below a certain level, it will adversely affect state revenue and may cause the unemployment rate to rise. This is exactly what has happened in the provinces of China, where provincial banks tend to be conservative, but provincial political leaders tend to be aggressive. The latter are almost always the victor in the clash of interest. 186
Theoretically, the intermediate and local banks should be the pro-active agents of the People's Bank of China. One may say since intermediate and local banks are the branches of the central bank, they should be accountable to the central bank rather than provincial or local politicians.
It is, however, not so simple in reality. The central bank has little control over financial personnel at lower levels.
Local bankers are appointed by the local government.
Therefore they are more responsive to local political leaders than they are to central dictates since they know clearly who is evaluating their performance.
To fund the dramatic proliferation of new investment projects, local interests exerted pressures on local branches to issue credit. Since the real interest rate on loans were negative (partly to protect money-losing state enterprises) because of inflation, the demand for credit was virtually insatiable as more people know the credit is a tool for growth. Under this circumstance, many of China's banks have overextended themselves to meet the credit demands of booming capital investment and property speculation, leaving them with little cash on hand to meet short-term cash demands. Bank deposits dropped sharply.
The asset ratio dropped from 6 percent to 1 percent. Some foreign exports say they are being forced to wait as long as 187 six months for payment on goods delivered to customers in
China. The culprits are cash-strapped Chinese banks.
State banks are caught in a bind. They cannot lift their lending rates too far, because the majority of state enterprises are debt-ridden and are already unable to pay interest on their loans. If interest rates were increased to reflect the true cost of money, as in the informal money market, the government would either have to let many firms go under or increase subsidies to keep them afloat. The assumption that private investment is reduced by government borrowing plays a key role in the neoclassical analysis for
Western countries—crowding out hypothesis. In China, the low level governments draw on the pool of resources available for the national level investment.
Capital is the lifeblood of any economy. The direction in which capital flows in China has always been politically determined. Banking reforms now under way are aimed at transforming lending so that funds flow to the profitable rather than to the well-connected. The transition, however, is slow and painful. Banking reform has long lagged that in other sectors, precisely because control of money is so political.
All the state banks have nonbank subsidiaries which engage in leasing, securities trading and property 188 investment. Local authorities have their own nonbanks as well. Corporations, whether state-owned or private, have also discovered that lending excess funds can often be more profitable than their original core businesses. Similarly, newly listed corporations have found that they can garner more profits by lending the proceeds of their share offers than by investing in new equipment. To attract funds, non-banks offer depositors rates that are 500 to 600 basis points higher than the 9.2 percent offered at state banks.
On the lending side, these nonbanks charge rates varying from 20 percent to 40 percent, compared with 10 to 11 percent at the state banks.
Banking loans are also facilitated by the non-state credit and leasing institutions. The non-state credit and leasing institutions came into being like the mushrooms after rain to offer credits that could not be obtained from the state banks. As much as 30 percent of China's financial system is unofficial and unregulated, and they are called non-bank financial institutions (NBFI), whose credit reached
140 billion yuan in 1993 (Sender, 1993).
Rent-Seeking
Public choice theory created by James M. Buchanan is critical of government budgeting. First, it explains the 189 separate interests of politicians and bureaucrats in contrast to the interest of people. The interests of politicians and bureaucrats are to expand agency budgets, gain greater authority and prestige, and expand the power of government. Second, it holds that budgeting is self-serving, invoking the old Chinese proverb: "The appetite grows with eating." There is no rational budgeting that provides the public with true choice. Budgeting is all fiscal illusion. These activities are also collectively known as rent-seeking. In this area, the most cited economic theory of bureaucracy is that of Niskanen (1968,
1971, 1973). Niskanen assumed that bureaucrats would maximize budgets as a way of maximizing utility. Pay, prestige, power and promotion are all assumed to be positive utility sources and to be a direct function of the bureaucrats' budget. Niskanen contends that bureaucrats attempt to maximize their budgets and thereby become a political driving force for larger government.
Financial decentralization and economic liberalization gave rise to rent-seeking activities shown in several aspects. Contrary to what one might expect, though, the retreat from centralized control during the reformist decade has actually fueled even faster growth in the size of the state administration. From 1952-1978, state personnel rolls 190 increased 61 percent, for an average annual rate of 1.85 percent. But in the decade after 1978 it nearly doubled from 4,300,000 to 8,420,000, and the average annual rate of increase almost quadrupled to 6.95 percent (while population was raising 1.3 percent per year).
The expansion of government has, of course, gone hand in hand with increased administrative expenditure. Before
1979, government administrative expenditures accounted for 4 to 6 percent of total budget expenditure. For most of the
1970s, it was kept below 5 percent. After 1979, the ratio of administrative expenditure to total budgetary expenditure began a steady increase. In 1988, it reached an unprecedented 9 percent (Wang, 1994:101). Rent-seeking is also reflected in the bureaucrats' acquisition of motor vehicles, dress suits, banquets, and travel, entertainment
(Mi and Su, 1993). At the same time, individual depositors simply withdrew savings and bought gold and consumer durables. All this competed directly with the "national bonds" issued by the central government; strangled the nation's transportation and energy infrastruction; and thwarted the government function of providing the infrastruction needed by industry and business and heavily investing in education (especially vocational training). 191
The rent-seeking obviously runs against capital budgeting. Capital budgeting covers long-term capital expenditures, including investments in machines, buildings, equipments, options to buy or lease real estates, and other expenditures that have benefits extending beyond one time period. Thus it covers a wide range of business activity.
The Chinese bureaucrats are so eager to make immediate gains to take advantage of their occupancies of positions. In the
United States, as capital budgeting is the process of allocating capital for long-term investments, it is a central and critical aspect of making and implementing fiscal policy. Normally, new public capital investments spur political leaders' desire for publicity and offer political leaders best opportunities for high visibility such as ribbon cutting on the site of new projects (Pagano and Moore, 1985) . TU-l this helps these officials gain credit.
In the contrast, maintenance and repair activities have received little attention or support, and infrastructural bases of economic development are considerably ignored and decayed. This practice has tremendously weakened the build-up of the key sectors such as transportation and energy, thus causing bottlenecks. 192
China is confronted with massive infrastructure problems: insufficient communication, inadequate transport, energy shortage, and so on. Bottlenecks will likely persist for the indefinite future, for a decentralized system cannot be expected to maximize the nationwide infrastructure or social welfare. Efficiency requires that those commodities with spillovers that affect the entire country—national public goods—be provided at the national level (Rosen,
1992:539). In his report to the 1994 National People's
Congress, China's Prime Minister Li Peng announced the exemption of the enterprises from contributing to funds for transport and energy projects. The question is, however, how far and fast China is decentralized.
Reorganization and restructure created a need for fiscal consumption. According to John Wong (1994), when new responsibilities are handed down to local governments, these local governments tend to recruit more staff to handle these responsibilities. More staff creates more demands for government purchases. Furthermore, the formation of local coalitions among bureaucrats and business spawned the
Chinese social norms of guanxi (the obligatory exchange of favors derived from interpersonal relationships) for the monopoly of political resources in the granting of professional licenses, permissions, rationed materials, and 193 collection of taxes. These alliances vigorously attempted to use the political system to redistribute income toward themselves or vote themselves programs of ever-increasing size by seizing any windows of opportunities before they are closed (Yang, 1993).
Finally, the rent-seeking practice featured the inter-bank lending activities. Because of the disparity in economic development, some of the capital from the interior areas has flowed to the economically developed coastal areas with high loan interest. According to Xu Jian, an official from the Department of Financial System Reform of the
People's Bank of China, between January 1992 and May 1993,
14.3 percent of the inter-bank lending was used as work capital, loans for fixed assets, real estate and direct investment (People's Daily, 1993). Banking loans added more to the provincial treasuries so that more expenditure and spending spree are at the expense of the center's bottleneck sectors. In an effort to stimulate investments in the priority sectors of energy and transportation, extra-budgetary investments are now more tightly controlled.
The Decline of State Capacity
As described in Chapter II, budgeting rests on performance of the state's capacity in penetrating and 194 extracting resources from society, and the ability to collect taxes is the essential ingredient of state capacity.
The 1978 decentralization has devolved China to centrifugalmen in provinces. Three reasons have been identified for the decline of state capacity. First,
China's economy has been structured in such a way that central government tends to take care of national and interprovincial infrastructures, whereas provincial governments mind their own manufactures and productions.
Infrastructures tend to be long-term capital investments, and provincial productions tend to be light and consumer-oriented industries, which are more profitable than the heavy industries owned by the central government.
Second, politically, the provincial leaders' link with the center was strengthened further by their increased representation as full members on the CCP's Central
Committee from 36 percent to 43 percent (Wang, 1995:153).
In their representation, these leaders are not so concerned about the issues of national scope as much as the local or regional matters. The Central Committee, a body of national policy deliberation, has been pulled to all directions and eroded to be of coercion to provinces.
Third, administratively, China lacks an effective tax collection system. The central government does not interact 195 with tax payers directly, be it individuals or enterprises.
It entirely relies upon the goodwill of the provinces to function as both tax collectors and payers.
There are two consequences from the decline of state capacity. They are national deficit and inflation.
National Deficit
The deficit during a period of time is the excess of spending over revenues. Despite this definition, a proper measure of the extent of government deficit requires that all revenues and expenditures be taken into account. Hence, it is useful to consider the sum of the on-budget deficit and the off-budget or extra-budget deficit to arrive at the total deficit. Take the federal government of the United
States for example, many outlays (loans and debt services) in a given year do not even appear in the budgets, but they are added in the government's total debt and interest obligations (Johnson, 1992). The same thing applies to the
Chinese budget. Since the provinces fervently pursue extra-budgets and lots of income might as well be spent for rent-seeking, the provinces indeed create deficit. The deficit, however, is reported to the national budget and becomes a liability of the national government. Further,
since provincial and local governments are legally not 196 allowed to run deficits or to engage in credit-financing of deficits, these government leaders relocate deficits to make their books look good in balance. Consequently, the central government spends more than it collects and owes more than it owns (see Table 16).
In 1979, China ran a deficit of 20.6 billion yuan, almost three times as large as the previous peak of 7.1 billion in 1960. The next year saw yet another big deficit of 14.2 billion. Together, deficit in these two years was as high as 34.8 billion, exceeding the total deficit of 24.8 billion in the previous 29 years (Zuo and Song, 1988:453).
The 1992 budget deficit is 90.49 billion yuan, or approximately $16.8 billion; the 1993 budget deficit is 129 billion yuan or $14.8 billion (Far Eastern Economic Review,
1994) . The current minister of Ministry of Finance, Mr. Liu
Zhongli spelled out in his budget speech to the National
People's Congress of 1994 that the central government in
1994 will receive barely a quarter of total state revenues, but undertake more than a third of overall expenditures.
The budget deficit as percentage of national income can be seen in Table 8.
Over the years, China has aimed at a balanced budget policy, or at least for a budget deficit not in excess of net foreign capital inflow (Wulf, 1986:31). Provinces' 197 centrifugal tendency and the center's inability to restore its monolistic control frustrated Beijing's efforts to finance the national debt. The drop in foreign loans to
China after Tiananmen added to this frustration because the large investments needed by the central state sector could only come from Western financial institutions rather than the provinces.
The world picture presents a similar pattern: in developing countries, the government budget deficit widened from about 3.5 percent of GNP in 1972 to about 6.3 percent in 1985. Whereas in developed countries the deficits grew in the same period from 1.8 percent to 5.1 percent
(Premchand, 1993:54-55). According to literatures, a country can finance its public deficit in one of three major ways: borrowing from abroad, borrowing domestically, or printing money. Each of these approaches has its negative effects. Heavy foreign borrowing can lead to appreciating real exchange rates, widening current account deficits, capital flight, and growing foreign debt-service burdens.
Heavy domestic borrowing by the public sector can put pressure on domestic interest rates and crowd out private investment. Money creation can exacerbate inflation if the money supply grows faster than the demand for monetary assets. 198
China's inflation of 1979-80 started from large unexpected budgetary deficits in 1979 and 1980. The main causes of the deficits were the overrun of expenditures designed to improve the population's living standards (such as wage increases, hikes in state purchasing prices for agricultural products, and reductions in agricultural taxes). In those years, most of the deficits were financed by borrowing from the People's Bank of China in the form of overdrafts. Furthermore, in 1979 the government restorted to another potentially inflationary method of covering the deficit, a withdrawal of the accumulated past budgetary surpluses (Imai, 1985).
The burden of the debt requires that future generations either have to retire the debt, or else refinance it.
Refinancing simply means borrowing new money to pay existing creditors. The emergence of capital market is a response to refinancing. Without treasury bonds, the Chinese government could not finance its vital development projects and deficits. In either case, there is a transfer from future taxpayers to bondholders because even if the debt is refinanced, interest payments must be made to the new bondholders. The shift to refinancing through borrowing from the securities markets raised the possibility of using market controls on money supply to manage the overall 199 deficits. All this, however, runs the risk of jeopardizing financial stability and drawing resources away from other sectors in the economy.
Large amount of domestic bond sales are activated as a measure to cover the central budget deficits through provinces. After receiving the bond mandates from the central government, each provincial finance bureau calls a provincial conference of local finance bureaus to determine the allocation of bonds within the provinces. In Shanghai, for example, the finance bureau relies on its industrial bureaus to allocate bonds to the enterprises they supervise.
The allocations made in 1989 amounted to about 2.7 percent of individual wages and about 4 percent of enterprises profits. The People's Bank of China prints the bonds and distributes them to provincial banks of the People's Bank of
China. These provincial banks serve as distribution agents and keep very detailed records on sales made each day and return unissued bonds back to the People's Bank of China.
The provincial finance bureaus have considerable flexibility in scheduling the annual sales campaign.
Although all provinces are supposed to have completed their sales by the end of September each year, provinces sometimes deliberately delay the bond sale till after they collect 200 their own annual taxes. This leaves the central government's bond sale in uncertainty and limbo.
Inflation
In the first three decades after 1949, prices scarcely rose. From 1951 to 1978, the average annual inflation rate was 0.7 percent. But to any reforming socialist country in transition, inflation is catastrophic—political disillution. But inflation is inevitable, since these countries have held down the prices of basic goods below the their market value for long. Any swift decontrol of prices can trigger inflation. Realizing this, China's initial strategy was to liberalize prices of commodities in an order of priority very slowly so as to avoid simultaneous price unfreezing. Meanwhile, China deliberately slowed down the process of privatization until it had successfully liberalized prices. This strategy proved inadequate.
Prices still rose 18.6 percent in 1988. As a matter of fact, dissatisfaction with inflation was one important cause of the Tiananmen Square Incident in 1989.
A combination of overheated economy, excessive credit and investment, low interest rates, price liberalization, and an explosion of consummer demand are the major causes of the post-1978 inflations. All these would create much more 201 factor demand than there are factors available. When aggregate demand is too great for the productive capacity of the economy, prices would break loose and go up. The end result is inflation. In 1988, the inflation rate rose to
18.5 percent, and in the first half of 1989, it reached 25.5 percent. China's economy began overheating toward the end of 1992, a year when GDP grew at a rate of more than 12.5 percent. The growth rate GDP accelerated in 1993 and ended at 13.5 percent. China's per-capita GDP reached 2,500 yuan in 1993. But, the inflation in 1993 hit 14.5 percent, and that the figure was 19.5 percent in the 35 largest cities
(Beijing Review, 1994) . The inflation of 1992-94 is characterized by excessive investment in capital and fixed assets and uncontrolled investments in cjuick-buck projects such as nightclubs, villas, racetracks, and hotels. Table
16 presents the inflation rates from 1979 to 1993 in percent.
Realizing the severity of the situation, the Chinese leadership intervened with some abrupt measures. In the late summer of 1988, Chinese leaders announced a program of economic retrenchment, aimed at ameliorating the economic and political damage that excessive rates of growth had inflicted on the country's reform effort. They learned and adopted Western methods of inflation control, that is, the 202 control of money supply. Inflation requires monetary fuel, and a good fight against inflation is to dampen the fuel as well as reform the price system.
Any economic reform goes along with personnel change.
It is a common practice in China that a new replacement signals a new start of effort. In 1993, Mr. Li Guixian was removed from the post of Governor of the People's Bank of
China for his being ineffective in curbing monetary expansion and replaced him with Vice Premier Zhu Rongji, who initiated the austerity program to rein in the overheated economy. The austerity program was coupled with a series of administrative mandates to curtail budget and control credit growth. These mandates included orders to call in unauthorized loans by August 15, 1993, to control prices by local governments at their current levels for the rest of the year, to stop the spread of the issuance of stocks and bonds to finance surging investment, to forcefully sell unsold state treasury bonds due to better yields on the stock market, to make slow-selling state treasury bonds more attractive to the public by allowing the buyers of five-year bonds to cash them in after three years at a reduced interest rate, to further prevent local governments from setting up so-called development zones, to halt unauthorized 203 fund raising through the issuance of debentures at high interest rate.
What is noteworthy in the control of money supply is the change of bank loans from the government's transfers to the commercial interest-bearing loans and the emergence of a bond market. All this illustrates that the central government is able to exert control over interest rates to discourage borrowing and cool down the economy.
Governor Zhu's austerity program did show early promises. It managed to exert some limits on overproduction of unwanted goods by public sector, and to have cooled property speculation and tightened the money supply. The gross money supply in the second half of 1993 was 21 billion yuan, falling 31.8 billion yuan from the first half of the year (Beijing Review, 1994) . Despite all this, China has yet to bring its overheated economy under control. China failed to recoup Renminbi 90 billions (US$15.6 billion) worth of property loans in speculative lending and was forced to extend the deadline for calling in the loans and to continue expanding money supply by printing money (China
Daily, 1993).
This inflation resulted from conflicting perceptions of economic objectives. This can be twofold. First, the center did not have a concensus about whether China was 204 having the overheated economy until the summer 1993. In fact, the perception of runaway inflation was only confined in the center, which was not shared or recognized by the local leaders. Virtually no local leaders admitted that his province or locality has become overheated. Actually leaders in more developed coastal provinces call for full speed ahead, their counterparts in interior regions are concerned about lagging behind the coast and strive to catch up (Yang, 1993). There was little or no agreement among participants in the implementation of austerity policy at local level. There was considerable disagreement about cutting development zones.
To make things worse, there were two contradictory mandates from the center, one is the austerity program, the other is Deng's encouragement of local initiatives. During his tour to the special export zones of Shenzhen and Zhuhai early 1992, Deng openly appraise their achievements and to reiterate his commitment to rapid economic reform. In
October, 1993, the 90-year-old leader proclaimed that "Slow growth is not socialism." In 1994 Deng visited Shanghai and called for fast growth again. The contradictory nature of central mandates—one written in the circulars, the other embodied in the paramount leader Deng Xiaoping's gesture—certainly confused the officials at the lower 205 level. Moreover, it severely offset the effect of austerity program and encouraged provinces to go ahead for economic growth at the expense of price control and social stability.
As can be seen from it, while trying not to enact vague and internally contradictory policy, the central government should provide strict and clear guidelines on who should be served by what, thus preventing the local governments from taking any chances for potentially controversial decisions.
The persistent, strong inflationary pressure has presented policy makers with a serious dilemma. On the one hand, economic reform giving local governments more autonomy in making production decision have brought on a prosperity and improvement. A nationawide spending spree has been unleashed that has thus far resisted the central constraints and has threatened to result in accelerating inflation and destabilizing the economy. On the other hand, decentralization and liberalization have created a monster that can disrupt the economic reform. To strike a balance,
China is so far very careful with price liberalization and ownership privatization. It is prudent to ensure that the price of staples such as rice is not allowed to become so volatile as to threaten the people in general and rural farmers, retirees in particular. 206
Table 15 Extra-budgetary Revenue and Expenditure of Central & Local Governments (1,000,000,000 Yuan & percent) A. Revenue Year Total Central Local 1982 80.274 27.071 53.204 (34) (66) 1983 96.768 35.991 60.778 (37) (63) 1984 118.848 47.054 71.794 (40) (60) 1985 153.003 63.611 89.393 (42) (58) 1986 173.731 71.663 102.068 (41) (59) 1987 202.881 82.803 120.077 (41) (59) B. Expenditure Year Total Central Local 1982 73.453 22.705 50.748 (31) (69) 1983 87.581 30.038 57.543 (34) (66) 1984 111.474 42.024 69.451 (38) (62) 1985 137.503 56.205 81.298 (41) (59) 1986 157.837 64.094 93.743 (41) (59) 1987 184.075 74.161 109.914
Source: China Statistical Yearbook 1990. State Statistical Bureau of the People's Republic of China, p. 222. 207
Table 16
Central Government Budget Deficit and China's Inflation Rates
Year Deficit (in billion Inflation (%) yuan) 1979 -17.06 2 1980 -12.75 6 1981 -2.55 2.4 1982 -2.93 1.9 1983 -4.35 1.5 1984 -4.45 2.8 1985 2.16 8.8 1986 -7.05 6 1987 -7.96 7.3 1988 -7.86 18.5 1989 -9.23 17.8 1990 -13.96 1.6 1991 -20.27 3 1992 -23.75 5.6 1993 14.5
Source: Lieberthal, Kenneth. (1995). Governing China. New York: W.W.Norton & Company, Inc. p. 250 and 271. CHAPTER VI
SUMMARY AND CONCLUSION
The most provocative and exhaustive efforts in comparative budgeting in developing countries have been performed by Caiden and Wildavsky (1974) and Wildavsky
(1975, 1986). The Caiden and Wildavsky work evidently postulates a model of "poverty-uncertainty" as critical variables from which a host of dysfunctional budgeting practices logically follow in the poor countries. Since the poor countries lack economic growth, their budgets tend to be disappearing, cut, repetitive, and decremental.
Redundancy (using Caiden and Wildavsky's term), to the contrary, constitutes the condition for incremental budgeting in rich countries. With the economy providing abundant resources for enlarging the public sector, budgeting can be an incremental process in which the government allocates increments to claimants. Ample increments presupposes certainty of funding. As such, government agencies do not have to con^ete for scarce resources. Economic growth opens up the budget process by encouraging the demand for increases. "A government blessed with incremental resources will behave differently than one which must struggle to make ends meet" (Schick, 1980:116).
208 209
The model of incrementalism and decrementalism has since become a set of principles with identifiable attributes to explain incremental or decremental budget based on annual increase or decrease as a function of GNP growth. Although the Caiden and Wildavsky model has been dominant in the comparative budgeting, it certainly has weaknesses that need to be examined. For one thing, it offers little explanation as to how these poor countries deal with uncertainties with "who gets vy^at." In addition to its simplistic and impressionistic nature, this model does not capture the changing reality of Chinese budget in the era of fiscal decentralization: an inverse relationship between China's high, increasing economic growth and its low, diminishing share of government budget.
The proposed research reconceptualizes the Caiden and
Wildavsky model of budgeting in poor countries and zero-bases its view in light of the new economic conditions and political characteristics. The finding is that China's budgeting is decremental while its GNP is incremental. This fact provides both good news and bad news. The good news is that a central government committed to reform has been willing to take sweeping measures at great cost to its control over the economy. The bad news is that the measures appear out of control (Overholt 1993:49). 210
Unintended Consequences
The phenomenon of unintended consequences has been well noticed by social scientists. Indeed, as rational actors, human beings are able to calculate and rationalize their action and anticipate the outcome. However, unintended consequences always exist, for human "knowledgeability" is always bounded. Decision making can only be based on the existing state of knowledge which may not apply to the future. Unintended consequences may also be caused by what
Robert Merton called the "imperious immediacy of interest," when the actor's paramount concern with immediate outcomes makes him/her overlook future or other consequences which might not have been foreseen. Finally, unintended consequences may also arise from flawed policy or contradiction of co-existing policies.
When it was decided to open the door and reform, the idea of "socialist market system" was not defined clearly.
As a matter of fact, the Chinese people were encouraged to
"cross the river by feeling the water" (trials-and-errors) .
The decentralization envisaged by the central government was one that would be circumvented by the party control. Though cautiously embarking on political reform, the Chinese leaders have made it very clear that the purpose of 211 reforming the system of party and state is precisely to maintain and further strengthen party leadership and discipline, and not to weaken or relax them. Without the party's leadership, China would split up and accomplish nothing. This kind of proclamation is not just a calculated reassurance to conservative segments within the party as some scholars favoring a "factional conflict model" of
Chinese politics may suggest. It indicates the party's reserved attitude toward political liberalization and its reluctance to accept any challenge to the party's monopoly.
Thus, political reform is instrumental in nature. That is, it is merely the means of economic reconstruction.
China's decentralization efforts prior to 1978 focused on administrative restructuring. The 1978 decentralization added market mechanism on top of the acioinistrative restructuring and reorganization. Benjamin Ward is right when he points out that organizational change has long been used as an important instrument of economic policy in China, in contrast to capitalist economies which prefer indirect instruments such as fiscal and monetary policy.
Institutional reforms are aimed at accommodating the bureaucracy to the market-driven economy; the party's withdrawal from its previous deep involvement in administrative work is intended to free it from daily 212 administrative affairs and therefore concentrate on effective macro-control over society and the economy.
Though granting state enterprises managerial power in day-to-day affairs may revitalize them as the most active components of society, it is assumed by the leadership that this will not weaken the center's control, because vrtiat state enterprises are granted is not the right to own or control the means of production, but the right to manage them. This would be embodied at least in decentralization of economic managerial authority to increase efficiency, institutional reorganization to reduce overlapping decision-making, and professionalization of government cadres to accommodate them to the modernization program.
The instrumental nature of the reform becomes even clearer if one looks at the fact that the decentralization has been generally limited to administrative matters of revenue sharing and tax extraction, which would only have impacts on the provinces' initiatives to realize a substantial amount of revenues. This will eventually constitute a larger base for central extraction. Policy intention is one thing; policy implementation is another.
The relevance of policy implementation, though not discussed in-depth here, should also be taken into consideration. 213
Since the late 1970s, the actual process of decentralization has gradually gone far beyond the center's original intent. Decentralization has increased the central government's deficits, which have resulted from the guaranteed subsidies to state enterprises. The central government's inability to cut expenditures in this regard to keep pace with declining revenues created persistent budget deficits that contributed to the mounting inflationary pressures. Though budget constraints are exerted on the enterprises, they tend to be vriiat Kornai called "soft budget." A soft budget constraint merely means that the producers and buyers are provided funds by the banking system or by the state budget so they can continue their activities. Because of political and social reasons, the central government has found it necessary to devote a significant share of budget revenue to subsidies, which has thwarted the achievement of a more efficient allocation of resources and goods. The central government allowed greater financial autonomy to enterprises, without subjecting them to hard budget constraints. Therefore there is no market competition that weeds out either the high-cost and inefficient producers (Kornai, 1980).
China adopted policies that the costs imposed by any policy or institutional change will be offset by the 214 creation of a new subsidy to the group that would have to bear the cost. The Chinese economic reformers have not only had difficulty in trying to "harden" the budget constraint, they have also made this already difficult task even harder by awarding new subsidies to those groups that may be hurt by the introduction of a more rational price system and allocation of resources and goods. The resulting inflation allocates the costs of reforms, but does so in a very inequitable and inefficient manner.
Decentralization also decreased the center's control of and access to provinces, and this weakened and reduced resources that could be allocated by the central government.
The unexpected decrease in central allocation of resources and the increased extra-budgetary funds retained by the provincial governments are thoroughly an unintended product of fiscal reform. Furthermore, the consequence of China's increasingly outward orientation (open door policy) has resulted in the reduction of Beijing's influence over the provinces that are closely integrated into the global economy.
Fiscal decentralization has bestowed more opportunities. The opportunities are such that provinces outgrow the constraints of the central budget and explore for the great potentials of extra-budgets. Since provincial 215 governments are legally not allowed to run deficits or to engage in credit-financing of deficits, they set up two budget books. In other words, provincial governments have learned to live with the central constraints, on one hand, and to maximize their extra-budgets for their own favorate programs, on the other. This is true especially when local autonomy in allocating budgetary expenditures still remains limited despite the announcement in 1981 that the central government would no longer stipulate specific expenditures in local budgets as in the past (Ji and Li, 1984).
The effectiveness of decentralization is influenced by a range of factors intrinsic to the policy itself and other characteristics of the broader social and political context.
For one thing, a policy is carried out and can be reshaped by provincial and local bureaucrats and party cadres whose influence over the policy performance is far more significant than the center. Richard Elmore's "backward mapping" strategy centers on the point of service delivery rather than on the original intention: "It begins not at the top of the implementation process but at the last possible stage... It begins not with a statement of intent, but with a statement of the specific behavior at the lowest level of the implementation process that generates the need for a policy" (1982:76). Implementors are usually the ones who 216 determine the success or failure of a policy. To a large extent, the provincial implementors obstruct or even do not implement as they choose, especially if local views run contrary to the center's preference.
Decentralization and Fiscal Politics
Tremendous uncertainties have been created over the future of further decentralization. China's reformers have taken important measures, structurally and functionally, to differentiate the centralized system. The party gradually abolished within its organization those departments that duplicated government agencies. These departments had been established to supervise their counterparts in the government. The party also reduced administrative posts concurrently held by party cadres. More important, the party ideology no longer provides much political cement.
Most Chineses, including party members, are ideologically cynical. Since the party cannot mobilize support through ideology or the fear of sanction, it must mobilize it by providing concrete benefits. And the party can only provide concrete benefits by increasing efficiency rather than restraints.
Having witnessed the uncontrollable propensity at the provincial level, the center seems rather feeble and 217 permissive. Actually, the center is not without instruments to roll back. The center still has its supporters from the party/state bureaucracies, which wield great influence in the implementation of any policy. These supporters fear that reform and decentralization will diminish their power, prestige, and perquisites. Therefore, they will take any advantage of any opportunity to interpret reform in a way that preserves bureaucratic power.
Central government can constrain provincial expenditures through disbursement regulations issued by the headquarters of the People's Bank of China to its provincial branches where provincial governments deposit their funds.
The constraints also include the system of control over foreign exchange that governs the disposition of hard currency which provinces earn in international trade.
Besides, the central government can take radical enforcement steps such as withdrawing program funds and sustaining transfers. Being in control of money supply and circulation, the center can reinstate central planning when necessary.
Moreover, the central government has the power of organization and personnel. It can remove the provincial leaders from their positions. The (question is when and how to use these technicjues. In other words, the "question 218 revolves around the degree to vrfiich Beijing's authority will give way to the centrifugal pull of China's increasingly dynamic periphery" (Segal, 1994).
Diversity among provincial responses have been a constant in China's modern political life. Provincial officials also have strong cards to play back when they bargain for control of finances. For example, provincial governments control a significant share of industrial production. By 1988, provincial enterprises produced more than one-third of China's industrial output—up from one-fifth a decade ago. Moreover, they control important sources of raw materials; about 54 percent of coal was produced by provincially run mines in 1988, and more than half of China's steel and more than four-fifths of its cement were allocated outside Beijing's central plan.
Although Beijing will try to reclaim control over tax receipts from provincial governments as a ways of reducing the budget deficit and its inflationary impact on the economy, it will continue to face stiff opposition from provincial officials.
All this is even compounded by the fast emergence of private sector. According to official figures (official New
China News Agency), by the year 2000, private sector production is expected to account for 20 percent of GDP. in 219
1990, the official private-sector contribution to GDP was already 1 percent at most. Government figures also show that China, a nation of 1.3 billion people, now has 18 million entrepreneurs who employ a work force of about 42 million.
Outlook for the Future—Unitary or Confederate?
Current practices of decentralization toward provincial autonomy raise many questions about the future of China. In opening the Pandora's box, the Chinese government was perhaps ignorant of the possibility of the spill-over effect of fiscal decentralization. Or more likely, the center was overly confident in its abilities to keep the provinces under control. In fact the center assigned itself an impossible mission. John Naisbitt (1994:184) points out in his new book of Global Paradox, "The larger the Chinese economy becomes, the smaller and more powerful the parts."
Self-assertion has been let loose under the 1978 decentralization, the openness of Chinese society has left the society vulnerable, and the resultant dynamism has had destabilizing effects to the center's supremacy.
What are the prospects for further reforms? Continuity and caution are the hallmarks of the 8th Five-Year Plan
(1991-95) and the 10-year development program for the 1990s. 220
The question for 1995 and 1996 is whether rapid growth and accelerating inflation will lead to another economic crisis—and if so, what the political ramifications will be.
In the Fourth Party Plenum that ended on September 27, 1994,
China's Communist Party signaled a return to the central planning system. In its closing communique, the plenum, attended by more than 300 ranking officials from the central and provincial party organizations, invoked the worn theme of democratic centralism. It not only reflects the lessons learned from economic reforms that have fueled inflation and unemployment, but also underscores the party leaders' deep concern with maintaining stability and shoring up the party's position.
A return to the system of central planning and administrative command as discussed in the first two budgetary instruments still appeals to some at the central circle of leadership. After all, the central planning system internalizes these instability within the budget by keeping incomes, employments, prices, the balance of payment, and even the budget itself is relatively stable.
But a return to a fully fledged central planning system will be already difficult, because, having made the decision to modernize, the Chinese have progressed to the point that it would be difficult for the China ship of state to reverse 221 engines or alter course. An occasional surge of central planning with administrative command cannot order problems to be gone. It may hide them (for exan^le, price freezes that translate into suppressed inflation; or replacing open unemployment with overstaffing, that is unemployment on the job), but it will do nothing to solve the structural problem of inefficiency of which it is the parent. Perhaps it may relieve some symptoms for a while, but it is ultimately self-destructive.
The temptation of returning to central planning as a remedy for the present condition may increase with the deterioration of Deng Xiaoping's health. It reflects that the leadership does not have a coherent vision for the nation's future or a plan to solve its myriad problems, but only reacts instead to developments in an ad hoc fashion.
It may rule tenuously, but it does not govern effectively.
The old levers of control have proven a dead end and wrong-headed incentives by a combination of regional autonomy, passive resistance, and newly created wealth.
Provincial authorities have feigned compliance with
Beijing's dictates already to the extent of almost bankrupting the central government as admitted by vice
Premier Zhu Rongji in the summer of 1993. Mr. Zhu said that at the worst moment, the central coffers had only tens of 222 millions of yuan left, and he did not even know whether they could pay wages. By pursuing their own interests today, the provinces have the financial wherewithal to ignore the center. One consequence is that revenues are not being collected for the center and the central budget deficit is soaring. Beijing is losing its grip on the provinces.
On the other hand, local entrepreneurs and enterprises make their own investments irrespective of national economic concerns. Interprovincial protectionism hampers national economic integration, while independent international trading by provincial entities further restricts the center's reach. The de facto result of the emerging economic regionalism has been devolved political power to
China's provinces and localities, which contributes greatly to the erosion of state authority.
Continuity of decentralization will be taken as a given. Unable to force uniformity throughout the country, the weakened central government will no longer micromanage output levels and materials allocations in all areas. No matter how hard China is searching for policies that would reduce the huge regional differences, China seems destined to develop into a collection of powerful parts. This process is evolutionary rather than revolutionary.
Though it is not necessary to assess all aspects of China's 223 fiscal system or how the entire fiscal system may have changed over time, it is sufficient to show the irony that some of the processes that have caused the erosion of state authority are actually the product of policies intended to strengthen the party-state and ensure its hold on power.
China's national agenda is being set not in Beijing but across the country, where millions of Chinese are grasping the entrepreneurial opportunities offered to them. It is a delusion of the leadership that it controls the national agenda, much less the nation. In the central-provincial relationship in general, what is unfolding now is an unspoken agreement that "we will pretend to rule if you pretend to be ruled" (Naisbitt, 1994:224). The problems of regionalism, provincial indiscipline, popular political antipathy, and central government's financial squeeze are real to the leadership of the center. The ongoing decentralization has enabled provinces increasingly to follow their own policies with unwilling concetion from the center.
Conceding the powers to the provinces, the center would help facilitate the evolution to a market economy, but in doing so would weaken its own authority. Christine Wong
(1992) used "encystation" to describe such a process: fiscal decentralization would lead to a rapid decline in economic 224 performance and a rapid rise in political confrontation. It is quite conceivable and possible that each faction of the weakened central government looks for the support of various provinces, and such competitiona could be set off after
Deng's death. In fact, China's unitary rule has been paralyzed so many times in its history. The lack of state extractive power has historically been a key reason for the downfall of China's regimes; at least it was a fatal flaw of the Qing dynasty (Spence, 1990). Obviously, the weakening of cohesion to impose a central tax system and raise its share of central revenues has become inevitable and hard to be restored. This is true especially when a coalition of provinces that advocate self-determination is becoming too broad to be defeated.
Provinces can take protectionist measures against neighboring provinces, and they can also take any measures against the central government based upon their shared interests and consensus. In his summary of China in 1993,
Bachman (1994) warned about the dissolution of the People's
Republic of China with reference to the growing irrelevance of the central leadership and a weak confederative Chinese
state de facto in the making. In China, it is not the provinces that are dependent upon the center; it is vice versa. 225
In the formal setting of Chinese intergovernmental relationship, the same territory and people are governed by two levels of government, both of which derive their authority from the people. The lower level, however, is not protected from the central government. There is no guarantee of the autonomy of the provincial governments in their spheres. Vertical relationships are characterized with interferences constantly from the center to the locality, and the legal authority of central jurisdiction is undisputably over provinces without any expressive challenges. Power is centralized in the center, and proit^t and complete compliance with policies is expected without regard for the interests of lower levels of authority.
All these considered, a confederative China is not a legal concept, emphasizing a constitutional division of authority and functions between two levels of governments or retainment of sovereignty at the provincial level. China is not a constitutional nation-state anyway, though it has a constitution. Confederacy is stressed not on a contractual and legal status, but on its pragmatic and procedural nature. It should not be read to mean adherence to a system, but a process in the context of intergovernmental interactions, attitudes, and behaviors. 226
In spite of this, provinces are gaining and exerting more leverage. Financial strength may enhance the status of independence and claim for self-determination. In fact, provinces have gained great discretion in initiating foreign contact pertaining to trade, investment, and official exchanges. As mentioned earlier, Hubei, Hunan, and Jiangxi have even used their own de facto currencies to protect their own industries. Each province also has a close tie with the military garrison within the provincial territory.
Guangdong even used its military garrison units to ensure access to cheap rice in interior Hunan. The military enterprises, at the same time, need the civilian and provincial protections in their domestic undertakings and international outreach. It is hence not difficult to invoke the image of old war-lord domination in China around the turn of the century. The central-provincial relationships constantly change and adjust. The tendency is from once submissive, compliant, and unitary to competitive, conflicting, and confederative. Above all they are dynamic, tailored to and changing with the need and the times. They breathe life into the operations and evolution of China's budgetary policy making process, political sovereignty, and national unity. 227
Possible Contributions and Limitations
The proposed study makes two major contributions to the literature. One, it is the first study that attempts to apply the Caiden and Wildavsky model of poverty-uncertainty to the reality of China. Therefore this study will expand the reconceptualized framework of comparative budgeting.
This expansion includes broadening the view of budgetary factors in the state capacity of resource mobilization, and the impacts of fiscal decentralization. Second, this study will improve the predictability for China's fiscal future by illustrating a thorough examination of Chinese extractive and centrifugal patterns. It is also an timely study which will provide definitive information on the crutial period of the Chinese economic and political transformation.
This case study is constrained by two major limitations. First, China is a moving target: Events are unfolding fast, and it is difficult to catch up with them and evaluate their ultimate impact. Second, documentation in Chinese is fragmentary. This is partly because of relatively limited contributions from Chinese counterparts in the field, and partly because of limited access to those documentations due to either Chinese government's control or financial difficulties. BIBLIOGRAPHY
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