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The Institutional Foundations of China's Market Transition

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  • Yingyi Qian
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    Abstract

    April 1999 This paper intends to properly account for China's two decades of market transition by examining its institutional foundations. The journey of transition is analyzed as a two-stage process. In the first stage (1978-93), the system was reformed to unleash the standard forces of incentives, hard budget constraints, and competition, but the underlying institutional forms and mechanisms are far from conventional: reforming government through regional decentralization; entry and expansion of nonstate (mostly local government) enterprises; financial stability through "financial dualism;" and a dual-track approach to market liberalization. In the second stage, China aimed to build a rule-based market system incorporating international best practice institutions but proceeded in its own way. Major progress was made in the first five years (1994-98) on the unification of exchange rates and convertability of the current account; the overhaul of the tax and fiscal systems; reorganization of the central bank; downsizing of the government bureaucracy; and privatization and restructuring of state-owned enterprises. To complete its transition to markets, China still faces serious challenges, especially in transforming its financial system and state-owned enterprises and in establishing the rule of law. The paper concludes by reflecting on the economics of reform and institutional change from the Chinese experience. The main lesson learned is that considerable growth is possible with sensible but not perfect institutions, and that some unconventional "transitional institutions" can be more effective than the best practice institutions for a period of time because of the second-best principle. Specific lessons include: incentives, hard budget constraints, and competition should apply not only to firms but also to governments; reforms can be implemented without creating many or big losers; and successful reforms require appropriate, but not necessarily optimal, sequencing.

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    Bibliographic Info

    Paper provided by Stanford University, Department of Economics in its series Working Papers with number 99011.

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    Date of creation: Apr 1999
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    Handle: RePEc:wop:stanec:99011

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    Cited by:
    1. Полтерович В.М., 2006. "Стратегии Институциональных Реформ. Китай И Россия," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 42(2), апреÐ.
    2. Kang, Young-Sam & Kim, Byung-Yeon, 2012. "Ownership structure and firm performance: Evidence from the Chinese corporate reform," China Economic Review, Elsevier, vol. 23(2), pages 471-481.
    3. Jing Jin & Heng-fu Zou, 2005. "Fiscal decentralization, revenue and expenditure assignments, and growth in China," CEMA Working Papers 212, China Economics and Management Academy, Central University of Finance and Economics.
    4. He, Dong & Wang, Honglin, 2012. "Dual-track interest rates and the conduct of monetary policy in China," China Economic Review, Elsevier, vol. 23(4), pages 928-947.
    5. Huang, Yasheng & Di, Wenhua, 2004. "A Tale of Two Provinces: The Institutional Environment and Foreign Ownership in China," Working papers 4482-04, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    6. Yasheng Huang, 1999. "The Institutional Foundation of Foreign-Invested Enterprises (FIEs) in China," William Davidson Institute Working Papers Series 264, William Davidson Institute at the University of Michigan.
    7. Milanovic, Branko & Hoff, Karla & Horowitz, Shale, 2008. "Political Alternation as a Restraint on Investing in Influence: Evidence from the Post-Communist Transition," MPRA Paper 11829, University Library of Munich, Germany.
    8. Li, Minqi, 2004. "Aggregate Demand, Productivity, and "Disguised Unemployment" in the Chinese Industrial Sector," World Development, Elsevier, vol. 32(3), pages 409-425, March.
    9. Allen, Franklin & Qian, Jun & Qian, Meijun, 2005. "Law, finance, and economic growth in China," Journal of Financial Economics, Elsevier, vol. 77(1), pages 57-116, July.
    10. Yang, Qing Gong & Temple, Paul, 2012. "Reform and competitive selection in China: An analysis of firm exits," Structural Change and Economic Dynamics, Elsevier, vol. 23(3), pages 286-299.
    11. Xiaogang Wu & Yu Xie, 2002. "Does the Market Pay Off? Earnings Inequality and Returns to Education in Urban China," William Davidson Institute Working Papers Series 454, William Davidson Institute at the University of Michigan.
    12. Polterovich, Victor, 2006. "Стратегии Институциональных Реформ: Перспективные Траектории
      [Institutional Reform Strategies: Promising trajectories]
      ," MPRA Paper 22000, University Library of Munich, Germany.
    13. Sonja Opper, 2001. "Dual-track Ownership Reforms: Lessons from Structural Change in China, 1978-1997," Post-Communist Economies, Taylor & Francis Journals, vol. 13(2), pages 205-227.
    14. Ehtisham Ahmad & Li Keping & Raju Jan Singh & Thomas J. Richardson, 2002. "Recentralization in China?," IMF Working Papers 02/168, International Monetary Fund.

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