The Principal-Agent Problem, Economic Growth, Subjective Wellbeing and Social Instability: China

In China political control is centralised and economic management is decentralised. This gives rise to a serious principal-agent problem, in which the agents are often better informed than the principal. China also has a semi-marketised economy involving much state intervention. This intervention serves both a political and an economic function. It assists the Communist Party to remain in political command and generates formidable patronage resources. It also provides the policy instruments, including incentive structures for officialdom, to maintain a ‘developmental state’. The combination of economic decentralisation and semi-marketised economy creates a problem of weak accountability and a breeding ground for rent seeking and corruption. For a quarter of a century China’s leadership gave overwhelming priority to the objective of achieving rapid economic growth. This policy was viewed as providing political legitimacy and securing the best protection against social instability. It is argued that the leadership was able to solve the principal-agent problem in its pursuit of economic growth. By contrast, the solution to the principal-agent problem failed in other respects, giving rise to societal costs. Little attention was paid to the dramatic socioeconomic changes –including rising inequality and economic insecurity, environmental degradation, mass migration, rent seeking and corruption – which accompanied economic growth and posed new challenges. It is argued that these changes help to explain the failure of life satisfaction scores to rise over the two decades 1990-2010. They can also help to explain the rise in indicators of social instability over that period. It is to be hoped that the new leadership’s current anti-corruption campaign together with its declared policy intention to reduce state economic intervention and increase reliance on competitive markets will strengthen deterrence and weaken opportunities for rent seeking and corruption. The paper carries the implication that China’s economy cannot be well understood except through the lens of political economy.