The Puzzle of Property Rights Protection in China

Property rights are believed to be a critical factor fostering economic growth (North

1990). And yet, authoritarian governments often have difficulty in making credible

commitments to protect property rights, thus negatively affecting economic development

(Acemoglu et al. 2001; Weingast 1995). Nonetheless, and contrary to conventional

wisdom, China has been able to achieve an economic miracle despite the absence of

credible institutions to protect property rights. The case of China poses an intellectual

puzzle. Private ownership has been increasing dramatically without the rule of law to

overcome the commitment problem. China enacted its first law to explicitly protect

private property in 2007, but the law does not provide enough details or effective

enforcement mechanisms. With one-party communist rule and no independent judicial

system to protect property rights, private investors, especially those indigenous private

entrepreneurs, may appear to be taking a big risk.

To solve the puzzle, several explanations have been offered to account for how

China has been able to overcome its institutional deficiencies and make credible

commitments to investors. Research on property rights in China often resorts to social

networks (Nee and Opper 2012; Wang 2013; Tsai 2002; Wang 2002; Wank 1999), fiscal

federalism (Oi 1999; Qian and Weingast 1997; Weingast 1995), or the personnel control

system (Li and Zhou 2005). Despite all the efforts, we have little knowledge about why

some private firms enjoy better property rights protection than others under similar

political and economic institutional conditions. Under the incentive structure designed by

the central government, why did some local officials in some localities actively protect

private property rights more than their counterparts hence fostering economic

development?

Instead of looking for reasons of economic growth or China’s economic miracle,

which has been studied extensively by existing literature, this research is interested in the

solutions to overcome the commitment problem in China. I provide a political-economic

explanation that shows some solutions may result from strategic interactions among

political and economic actors at the local level rather than solely as a result of a

commitment device from above. Studying these questions with focus on local institutions

is not to suggest that the central government has lost its imperative grips over economic

matter. Rather, this research is to specify the mechanisms that have fostered the de facto

property rights under political institutions designed by the central government. Local

agents have reached a relatively stable equilibrium under certain conditions and with

various resources.

1.1 Local Officials and Variations in Property Rights Protection

The development of the private sector in China has gone through an uneven path of

institutional and structural changes. From the perspective of local economic actors,

market-oriented policy and 2007 law of property rights are clear signals regarding the

central authority’s commitment for the development of private economy. But with

occasional “left” and “right” ideological swing and no independent judicial system, the

government could not make that commitment credible in terms of property rights

protection.

China’s policy was favorable toward Foreign Direct Investment (FDI) not only

because China needs capital, technology, and access to the global market but also because

China wants to show its commitment to be open to the outside world. In this way, China’s

policy toward FDI as a self-enforcing mechanism addresses the

commitment problem.

Less favorable than foreign investors, however, domestic private entrepreneurs have

been facing a more difficult situation in which the commitment problem is the major one.

As with most of China’s economic reforms, policies governing the private sector have

evolved in an experimental, incremental, and sometimes contradictory manner. As a

result, private entrepreneurs can only rely on themselves in protecting their property

rights.

Although there are similar formal institutional arrangements at subnational levels in

China, each locality still enjoys a certain degree of autonomy. Generally, operations of

private firms are embedded in complex local institutions and social networks that affect

the day-to-day interactions between local political actors and private firms. While the

central government has demonstrated their commitment to a market economy and thus

reduced the political risks faced by private firms, local governments often emerge as a

major source of uncertainty for the firms. Moreover, because of the “local autonomy”

nature of the personnel control system and the moral hazard problem inherent in a

principal-agent relationship between different levels of government, whether local

governments play “grabbing hands,” “helping hands,” or “steady hands” really depends

on the individual local officials. Without an effective institutional mechanism to tie local

political actors’ hands, private investors would face a significant risk because once their

investments are in place, their bargaining power diminishes, local governments may not

stick to their promises, and local political leaders with their great deal of discretionary

power may pursue their own political and economic goals vis-à-vis the private firms.

1.2 The Theoretical Framework: A Bargaining Game

This research starts from the point that most Chinese local political actors are

supervisors of the governments (both central and local) and simultaneously principal of

their immediate subordinates at lower levels. The most powerful incentive that drives

these local agents is their concern to get more power through promotion in the

multilayered power hierarchy. The “competition for promotion” literature assumes that

the primary goal of local political leaders is to be promoted to a higher rank (Li and Zhou

2005). I relax this assumption by including economic interests. The local official is thus

assumed to be an expected utility-maximizer. His/her goals include not only promotion

(career concerns) but also monetary interests. Local political actors’ economic interests

are achieved through the pursuit of political power due to the unique career pattern in

China. Chapter 2 will show three distinct features of the career patterns of political actors

within the Chinese power hierarchy: 1) almost permanent tenure as long as secured in an

office; 2) almost no job options outside the political career once you are in; 3) age limits

for mandatory retirement (Li and Zhou 2005).

As Chapter 2 details, the Cadre Evaluation System (CES) is widely believed to be

an incentive structure designed by the central government to help control local officials in

the administrative hierarchy. It can be used to discipline local party and government

leaders and increase their compliance with the policies made by higher-level governments

(O’Brien and Li 1999; Whiting 2001; 2004; Edin 2003; Tsui and Wang 2004; Heimer

2006; Minzner 2009). The CES powerfully shaped the behavior of Chinese local officials

by linking both monetary interests and promotion incentives to their performance on the

tasks listed in the system.

Scholars identify four important factors that determine the prospect of further

promotion of local officials: 1) job performance within the jurisdiction; 2) education; 3)

age; 4) personal ties with one’s superior in charge of promotion. For some scholars, the

first one is one of the most important factors (Li & Zhou 2005), while others argue the

last one (Zhong 2003). One thing worth noting is that local officials will be rewarded

according to how well they meet the standard but rarely be punished (demoted) if they

don’t.

For building up an effective control and incentive mechanism, term limits and

rotation system were introduced that intends to solve the problem of asymmetric

information, shirking, and monitoring. Both term limits and the cadre rotation system are

expected to serve the purpose of aligning divergent preferences and reducing asymmetric

information. More specifically, the rotation system is expected to prevent tie-cultivation

in the hierarchical power structure and local protectionism (Chen and Zhao 1996;

Blanchard and Shleifer 2001; Zhong 2003).

In discussing the role of local political officials on economic growth, the existing

literature often confuses the goals of local political leaders and that of local government. I

detach political actors from government because the goals of government are not always

identical with those of political actors and hence I reconsider the role of local political

leaders on economic development in general and property rights protection in particular.

There are three players in the local economy, Government (G) is the principal, the

local political official serves (S) as the supervisor and the Private entrepreneur (P) is the

agent. In the context of China, I identify political actors as local political leaders,

economic actors as indigenous private entrepreneurs, and government includes central

and local.

I make an extremely simple assumption that the goal of government and political

actors may not be the same. Government (G), both central and local, cares about tax

revenue and the primary and foremost concern of local political leaders (S) is to stay in

office and be promoted to a higher rank. The ultimate goal of local officials, however, is

to acquire more wealth and secure their possessions. In other words, the pursuit of

political power is the means to achieve the end (wealth acquisition). The old saying

“shengguan facai” (more power more money) demonstrates the logic of career concerns

with Chinese characteristics. For the indigenous private entrepreneur (P), what he/she

wants is not only to maximize profit but also to secure property rights.

The theoretical literature indicates that the solution to the commitment problem may

result from strategic interactions among political and economic actors rather than solely

as a result of a commitment device (Weimer 2001). Chapter 2 presents a simple

bargaining game between a private firm and a local official following the literature of the

Obsolescing Bargain Model (OBM) and the Political Bargaining Model (PBM), which

explain bargaining relations between a FDI firm and a host country (Vernon 1971; Eden

et al. 2005). Chapter 2 and Chapter 3 discuss in detail the resources and constraints of

local political officials under the current personnel control system and private sector

investors, and show how these conditions and constraints determine their bargaining

power in the bargaining process.

I model the relationship as a bargaining game with conflicting goals, and hypothesize

that a firm has strong bargaining power at the time of entry when the local official, under

the pressure of the performance–based evaluation by his or her immediate superiors,

understands that the firm has other options. However, once the firm has made

sectorspecific investment, its capability to resist the official’s predatory actions relies

upon its firm-specific characteristics. Chapter 3 identifies the mechanisms that may

resolve the credible commitment problem and shows how the incentive structure

officials in dealing with private firms with a high level of Firm Specific Assets (FSAs). In

this way, the incentive structure provided by the CES, worked together with the firm-

specific characteristics, results in a stable condition for the protection of property rights.

While a firm with a high level of FSAs may possess strong post-entry bargaining power,

and thus enjoy the protection of the local official, a weak firm has to rely on other

mechanisms, such as its social networks, to overcome the hurdle.

Another equilibrium that emerges from the symbiotic relationship between local

political officials and economic agents, which creates conditions similar to secure

property rights at the local level. The degree of symbiotic relationship between the local

officials and indigenous private entrepreneurs determines the level of private property

protection. Compared to transferred officials, native local officials have fewer political

connections with higher level officials and therefore have less chance to be promoted in

the power hierarchy. This condition makes them seek the support of local economic

actors for their political survival. Moreover, native local political leaders who were born

in their jurisdiction have lower transaction costs, and therefore a symbiotic relationship

between native local officials and local private entrepreneurs is feasible and easier. The

chances were high that the native leaders would have close ties to local economic actors

and face more strict social constraints; therefore, they were more likely to protect

property rights.

1.3 What Is Property Rights? An Operational Definition

The term “property rights” has two traditions in the economic literature. One is

defined as the ability to enjoy a piece of property (Alchian 1965, 1987; Cheung 1969).

The other older definition stresses that “what the state assigns to a person” or the

enforcement of rights (Ellickson 1991; Barzel 1997). Barzel calls the first “economic

property rights” and the second “legal property rights.” He argues that “economic rights

are the end (that is, what people ultimately seek), whereas legal rights are the means to

achieve the end” (Barzel 1997: 3).

I use the definition that includes both economic rights and legal rights with focus on

legal rights and the enforcement of rights. This is especially relevant as China is still a

socialist state despite decades of economic reform. The Chinese Communist Party (CCP)

tried very hard to eliminate private property rights since it seized power in 1949. Before

the Reform era starting in 1978, private property was strictly forbidden. Anyone who ran

a private business would be severely punished, including being arrested and persecuted.

Only in 2007, China enacted its first law to explicitly protect private property rights, but

it still does not provide enough details for the enforcement of the law.

There are two theoretical traditions that identify the threat to private property rights.

In the view of Hobbes, the main threat to property rights is from private actors, and

therefore requires strong state institutions as a remedy. Another line of argument lies in

the tradition of Locke, which sees the threat to private property rights within the state

itself, and therefore implies limiting state power to reduce arbitrary behavior in private

property rights. At any rate, preventing the threats from both private actors and the state

requires the rule of law.

In addition, the theoretical literature on the interaction of political and economic

institutions shows that there is an inherent paradox on the interaction between the strong

state and economic development. The problem is that any government strong enough to

specify and protect property rights is also strong enough to seize them for its own benefit

(North and Weingast 1989). How government can provide a credible commitment to its

people is crucial for economic growth to occur in an authoritarian regime. The logic is

that unless the government can provide a credible commitment to the population that it

will not act in its own short-term interests by seizing property, the population will not

invest. If there is no investment, there will be little economic activity, hence no growth. In

order to generate economic growth, the government must not only establish the set of

rights but also must make a credible commitment to the population.

The core interest of this research is to identify the mechanisms to overcome the

commitment problem in China. For this purpose, it will focus on the threats from the state

to private property rights. Basically, there are two types of predatory actions that may be

taken by the state: direct and indirect taking of property. Direct taking of property can

take various forms, ranging from outright nationalization on a sectoral basis to the seizure

of a firm by the government to outright confiscation of the property (Zheng 2007). In the

case of China, indirect expropriations are a common practice manipulated by local

officials, which may involve arbitrary fees and fines collected by local governments, or

even “charitable contributions” to government-sponsored projects (Nee and Opper 2013).

1.4 Research Contributions

It is often argued that countries without the rule of law can rely only on other

mechanisms to overcome the commitment problem. The current literature identifies

several solutions to the credible commitment problem. While the authoritarian system is a

big problem for potential investors who are concerned about political risk, dictators with

a long time-horizon have encompassing interests and therefore may undertake proactive

actions to improve economic institutions in order to raise sustainable tax revenues (Olson

1993; 2000; McGuire and Olson 1996). My study contributes to the literature on how

authoritarian governments may be engaged in institution-building to encourage

investment and hence to promote economic growth (Olson 1993, 2000). In particular, this

research shows how the incentive structure set up by the central government in China

constrains the local officials’ predatory activities in dealing with private firms with an exit

option.

Second, my work is also related to the studies on selective protection of property

rights. Both Greif and Haber et al. show how autocratic rulers enforce property rights

selectively as a private good (Greif 2006; Haber et al. 2003). These rulers used different

strategies, trading the property rights protection of private owners for political support.

Similarly, Robinson (2003) and Treisman (2003) demonstrate how the reformers of

modern Russia, Argentina, and Brazil made similar deals with special interest groups to

promote their reform agendas. Greif (2006) shows how the commitment problem can be

solved through reputation or collective reputation, while Haber et al. (2003) focus on the

third-party enforcement. Bueno de Mesquita et al. (2003) provide other examples and

build a theory of a non-democratic government that is accountable to a selectorate, a

group that has the power to determine the fate of the incumbent. Still other scholars

suggest that political institutions like legislatures, parties, and even elections could work

in a way to “credibly tie the dictator’s hands” against predatory actions, at least against a

small group of elite (Gandhi 2008a; Gandhi and Przeworski 2007).

In this research, I provide evidence for the selective protection of property rights in

another authoritarian regime, China, where the incentive structure designed by the central

government creates conditions for secure property rights. My study reveals that, though

facing the same institutional constraints of the CES, different types of local officials may

act differently in dealing with private investment with dissimilar firm specific

characteristics. Firms with high FSAs may possess strong post-entry bargaining power

over local officials, and thus enjoy better protection of the local officials. Those native

local officials who have less chance to be promoted are more likely in protecting private

property rights, trading the property rights protection for their political survival.

Third, there is heated debate on whether behaviors of Chinese local states are

developmental, corporatists, entrepreneurial, and predatory in terms of economic

development, or whether economic performance results from inter-jurisdictional

competition or factional politics at the center (Li and Zhou 2005; Cai and Traisman 2006;

Shih 2004; Shih et al. 2012). This study contributes to the debate by specifying the

conditions under which local officials may play “grabbing hands” (predatory activities),

“helping hands” (developmental orientation) (Shleifer and Vishny 1998), or “steady

hands” (stable and credible protection of property rights). In particular, this research

specifies conditions under which private property rights may be protected in an

authoritarian regime. The study proposes a political-economic explanation of secure

property rights, where the local political leaders protect private rights when symbiosis

between local officials and private entrepreneurs is feasible.

Fourth, in the study of China’s economic development, scholars emphasize China’s

political centralization in reducing risks of local protectionsm and competition for rents

(Blanchard and Shleifer 2000), and central coordination and enforcement capability in

excersing macro-economic control over excessive and destructive local autonomy (Huang

1996; Li and Lian 1999). My work shows how the discretionary power resulted by the

“local autonomy” feature of the CES led to the positive effects of local protectionism.

Native political leaders tend to protect private property rights because they have less

chances to be promoted in the power hierarchy and need the support from local economic

actors for their political survival.

The study is also related to the literature of evaluating political connections in which

the benefits are captured by economic actors with strong connections with political

leaders (Fisman 2001; Faccio 2006). But this study also stresses the interdependent

relationships between political and economic actors.

Finally, this research touches on the issue of corruption. Most studies suggest that the

existing corruption levels are detrimental to development (Shleifer and Vishny 1993); yet,

some argue for efficiency-enhancing corruption, the effects of which may be positive

(Leff 1964; Huntington 1968; Li and Wu 2010). Hopefully, this paper will shed some new

light on the coexistence of rapid growth and rising corruption in China (Li and Wu 2010;

Wademan 2012). Some studies further distinguish among different types of corruption

(Shleifer and Vishny 1993; Sun 2004; Wedeman 1997; Manion 2014). This study will

emphasize the mutually beneficial exchange nature of corruption.

1.5 Research Design

This research mainly uses sub-provincial level comparisons combining both

qualitative and quantitative approaches. Sub-provincial comparisons can put macro

institutional factors under control. Most studies on the role of local officials focus on

provincial level officials. However, in countries like China there exists vast regional

variation in fiscal arrangement, legal environment, and political and economic conditions.

Therefore, it is not an appropriate context to study the empirical puzzling questions in this

research. Sub-provincial studies in this research can put the institutional arrangements

factor under control.

Sub-provincial level studies will also enable us to see processes such as economic

reform or the cadre evaluation system as shown in this research, often have varied effects

across the territorially-defined subunits of a political system. Studies on China’s

economic development often focus on the variation in economic performance between

provinces, which does not explain the vast intra-provincial variation.

As for empirical studies, one of the biggest challenges of this research is to gauge

variation in property rights protection in China, as there is not much research available to

refer to and no indicators ready to use. I use arbitrary fees and fines paid by private firms

and collected by the local government as an indicator to measure the degree of property

rights expropriation. Chapter 3 provides discussion to justify the measurement.

I also use private investment in fixed assets as an indicator to measure the security of

property rights. This is a good proxy for the security of property rights because this kind

of investment requires significant immediate costs with only promise of future revenue.

Chapter 4 details the justification of the identification as compared to the common use of

Gross Domestic Product (GDP) growth rate or GDP per capita measurement in the study

of economic development.

The detailed case study provides additional evidence to support my theory. The

materials of case study are collected from my fieldwork in Xiamen, China from 2014 to

2015. For the basic facts of policymaking case, I use government reports, news reports, as

well as interviews. It is noteworthy that interviews only serve as supplementary sources

of information. The validity and reliability of constructed interviews may be questionable

with its intervening nature, particular when informants consciously and unconsciously

make sense of their research. The examination of media reports and government reports

will help to restore an original context that seeks to make concrete reasons state agents

give for their actions. My interviewees included officials, B&B business owners,

chairmen of B&B associations, journalists, and scholars in Xiamen. To the purpose of

methodological reliability in the interviews, I tried to ask the same questions of different

people to find common answers.

For the unit of analysis, all the administrators between the central government and

the village level are middle level supervisors, and should be included in the pool of

observations. But for theory building and empirical studies, I locate the research at the

prefecture municipality level. The municipal cities are the third level of China’s political

hierarchy. The top leaders at the municipal city level are the city Party secretary and the

city mayors. This reflects the dual presence of communists Party and government organs

at each level of China’s political hierarchy.

Moreover, officials at various levels of government may behave differently in

accordance with the resources they have in the face of the same incentive structure. For

example, provincial officials are not “local officials” in a strict sense because though

provincial leaders are the local supervisors immediately under the central government,

many of them hold central positions simultaneously, like seating in the Politburo, or the

Central Committee of the CCP. This arrangement demonstrates that they are under tight

political control by the central government and share more common interests with the

Center than lower level officials. Therefore, the behavior patterns of provincial officials

with regards to local economic affairs cannot be applied to lower levels’ officials.

Finally, prefecture-level governments enjoy more discretionary power over local

industry policymaking than county level governments. Also, municipal city leaders have

authority in managing fixed investment, land development, price setting for land lease,

and even tax collection, and therefore enjoy more autonomy than those at lower levels of

authority.

1.6 The Structure of the Dissertation

In this introductory chapter, I first discuss the empirical puzzle, and then outline the

research question driving this project and offer my theory. I also address the theoretical

contributions of my study and its methodology.

The property rights protection in China to a large degree results from a bargaining

game between private investors and local officials conditioned under the political and

personnel control system. The next chapter provides the theoretical model for arguments

made throughout subsequent chapters. I first briefly review the existing literature on the

Chinese economic miracle and commitment problem. Then I examine the dual nature of

Cadre Evaluation System (CES) and political control system that determine a local

official’s career with a brief review of the competing views on the effects of CES on

economic growth. With their one-sided conclusions, previous studies are unable to tell on

what conditions the CES can provide property rights protection (constrain or induce

property rights predatory behaviors). I suggest a bargaining game under the

principalagent model by looking into how the CES shapes the prospect of further

promotion of local officials—the most important incentives of Chinese officials. I

conclude this chapter by arguing that the resources and constraints behind the bargaining

power of private investors and local officials could provide property rights protection

from rational choice perspective.

Chapter 3 discusses the bargaining game between private investors and local officials

with focus on the examination of the private sectors’ resources and argues that a private

firm’s features determine its post-entry bargaining power with local officials and

therefore affect local officials predatory behaviors over private property rights. Finally,

this chapter provides two types of empirical evidence to test the proposed hypotheses

quantitatively.

Chapter 4 examines the bargaining game under principal-agent model with focus on

local officials’ resources and argues that native local officials with fewer connections and

more constraints have weakened bargaining power in relation to the local private sector

and therefore are more likely in protecting private property rights in exchange for their

support. In other words, all else being equal, native local political leaders who have less

chance to be promoted in the power hierarchy have lower transaction costs, face more

social constraints, and gain extra benefits in establishing symbiotic relationship with local

private entrepreneurs and therefore tend to protect private property rights more than those

transferred ones. This chapter also tests the proposed hypotheses by providing systematic

empirical evidence from Guangdong province both cross-sectionally and over time by

investigating the characteristics of 263 prefecture-level local political leaders between

1992 and 2008, and find that native political leaders promoted substantially higher level

of private investment—the proxy for the protection of private property rights. The results

are robust to various alternative specifications, including a model that accounts for

heterogeneous regional characteristics, initial economic conditions, and socioeconomic

factors.

Chapter 5 studies local industry policymaking in Xiamen. This detailed case study

shows how local industry policymaking affects property rights protection. More

importantly, it examines how policy choices of local officials in consideration of officials’

promotion endeavor conditioned with their resources (no connection). It demonstrates

that other things being equal, compared with transferred officials, native local officials

with less resources are more likely to promote private sector hence increase the level of

property rights protection.

In the sixth and concluding chapter, I reiterate my theory of political economy of

property rights with main empirical findings. Then I provide several general conclusions

about property rights in China. Finally, I suggest areas for future research.

CHAPTER 2

LOCAL OFFICIALS, INCENTIVE STRUCTURE, AND SECURE PROPERTY

RIGHTS

This chapter starts from a brief review of the property rights and commitment problem

and locates the contribution that this research hopes to make to existing literature. I then

provide a game-theoretical explanation under principal-agent framework for arguments

made throughout subsequent chapters by examining the Cadre Evaluation System (ganbu

kaohe zhidu), which determines local officials’ careers through appointment, promotion,

tenure, and removal from the 1980s to present. This is followed by a discussion of term

limits and the rotation system in Chinese bureaucratic system. These systems are very

powerful, because they have shaped local officials’ behaviors, incentives, and ways of

pursuing the benefits contained in the incentive structure. Following the theoretical

framework, I propose a bargaining game between local officials and private investors

under the principal-agent relationships and show how resources and constraints of both

parties have affected the bargaining power, which determines the security of property

rights at local level. The following chapters will be empirical studies and a case study to

test the major hypotheses.

2.1 The Existing Studies of Property Rights

The current literature identifies several solutions to the credible commitment

problem in countries without the rule of law. Theoretically speaking, the authoritarian

system is a big problem for potential investors who are concerned about political risks.

But dictators with a long time-horizon have incentive to improve economic institutions

for sustainable tax revenues (Olson 1993; 2000; McGuire and Olson 1996). However,

dictators are under constant threats from their challengers and always worry about

immediate political concerns (Svolik 2012; Wintrobe 1998). In the case of China,

political leaders face constant factional power struggle as a result of party-state system

where “collective leadership” rather a single dictator is in charge. Moreover, the

introduction of compulsory retirements in 1980s and the rotation system in 1990s

significantly shorten political leaders’ time-horizon and produced shortsighted behaviors.

Similarly, some scholars suggest that political institutions like legislatures, parties,

and even elections could work in a way to credibly constrain the dictator’s predatory

actions (Gandhi 2008a; Gandhi and Przeworski 2007). The logic is that these formal

institutions can help enhance governance, addressing the commitment problem by

imposing self-constraints. These institutions have been served as political signals making

a credible commitment to potential investors that their investment will not be easily

expropriated one day in the future (Gehlbach and Keefer 2009; Magaloni 2008; Myerson

2008; Svolik 2012). Bueno de Mesquita et al. (2003) provide other examples and build a

theory of a non-democratic government that is accountable to a selectorate, a small group

that has the power to determine the fate of the incumbent.

However, empirical studies show authoritarian countries with these institutions do

not perform well economically than countries without such institutions (Gandhi 2008b;

Wright 2008). This is especially the case in China, where the Party-state has enjoyed

unprecedented economic growth for the past three decades without the rule of law and

aforementioned institutions. More importantly, China’s contemporary history

demonstrates no institutions really deter the Party to honor its promises to its supporters

and population as it kept breaking its promises through a series of ideological campaigns.

Another way to solve the credibility problem is to rely on an exogenous

commitment device that raises the costs of expropriation. These mechanisms neither

require the rule of law nor a stable polity. What they require is credible threats of

retaliation by investors (Haber et al. 2003). Scholars show how autocratic rulers enforce

property rights selectively as a private good (Greif 2006; Haber et al. 2003, Robinson

2003; Treisman 2003). Both Robinson (203) and Treisman (2003) illustrate how these

rulers used divide-and-rule strategies, trading the property rights protection of private

owners for political support. Greif (2006) argues how the commitment problem can be

solved through reputation or collective reputation, while Haber et al. (2003) focus on the

third-party enforcement. However, these credible threats may only work in the countries

where the government is weak and unstable. In countries like China, neither intervention,

nor financial hostage, nor the third party can be placed upon it.

As China has achieved the amazing economic miracle for almost four decades,

several explanations have been offered to explain how China has been able to overcome

its institutional deficiencies and make credible commitments to investors. A popular view

is to attribute economic development to market-reform policies and institutional changes

since 1978 (Shirk 1993; Huang 2008). It has been, for example, argued that fiscal

decentralization has created an environment for local governments to protect local

businesses, and hence to promote economic growth. That is, to compete for investment

with other localities, each local government has an incentive to demonstrate credible

commitment to maintaining an environment favorable to economic growth. In other

words, the competition among local governments for revenue growth could help to limit

government’s predatory behavior in China (Oi 1992; 1999; Montinola et al. 1995; Qian

and Weingast 1997).

While fiscal decentralization provides useful insights on the commitment problem

in China, it cannot explain why there exists tremendous regional variations in economic

growth. Empirical studies suggest great variations among local governments in their

attitudes towards the private sector, which can be developmental and predatory at the

same time (Blecher and Shue 2001; Saich 2002; Tsai 2003). In particular, these studies

did not elaborate why private entrepreneurs view the political and policy signals as

credible in the face of frequent ideological swing between “socialism” and “capitalism.”

In fact, we have little knowledge about why some private firms enjoy better property

rights protection than others under similar political and economic institutional conditions,

and why some local officials in some localities are more likely than their counterparts to

support the private sector and protect private property rights.

More importantly, fiscal extraction at local levels can be worked in a way of

property rights expropriation by local government. This is especially the case after the

fiscal reform of 1990s, which has greatly weakened local government’s ability to

implement policy tasks set from above (Tao and Yang 2008; Yang 2006). Local

governments are under tremendous pressure and actively pursue extra-budgetary revenue

in the disguise of fees and fines from private sector to satisfy the policy tasks from

higher-level governments due to their limited autonomy in local taxes and revenues for

local development.

Unlike the top-down perspective, other literature focuses on coping strategies of

the private entrepreneurs or local officials to bypass the restrictions imposed by the

unfavorable formal institutional setting (Tsai 2007), such as “wearing a red hat” by

private firms whereby private businesses disguised themselves as collective firms (Oi and

Walder 1999; Tsai 2007), raising funds via underground finance (Tsai 2002), and

participating in politics to obtain political patronage (Li et al. 2006).

One line of argument focuses on social networks or flexible clientelism that has

been used to substitute for legal protection and to secure business opportunities for

foreign and domestic investors (Wank 1999; Wang 2002; Tsai 2002; Nee and Opper

2012). However, these arguments tend to overemphasize the rent-seeking relationship

between local political actors and private sector actors. In addition, the coping strategies

and informal connections that provide the mechanism to overcome the commitment

problem with regards to private property rights are unstable and may easily fall apart.

Furthermore, these informal coping strategies might have worked in the early years of the

Reform era, but as the Reform has gone deeper, especially the privatization in 1990s and

the clarification and lawmaking of private property rights in 2000s, private firms with

these strategies found themselves in big trouble. Empirical evidence in Chapter 3

demonstrates that “red hat” firms are easily involved in property rights disputes with local

government, and therefore are more vulnerable to government-related property rights

expropriations.

The emerging literature suggests that local governments are not homogenous in

responding to the incentives created by the central government (Whiting 2001; Segal

2003; Donaldson 2011). To explain regional variation, many scholars studied different

local geographical conditions and other social and cultural features in explaining the vast

variation in local economic performance (Liu 1992; Parris 1993; Forster 1990). However,

these accounts mainly focus on inter-province variation, which cannot explain the vast

intra-provincial variation. Still other researchers emphasize the importance of historical

legacy, such as patterns of state investment inherited from the past (1950-1978), working

together with other institutional and non-institutional factors, in shaping the incentives,

capacities, and constraints of economic actors after 1978 (Qian and Xu 1993; Whiting

2001; Oi 1995; Xu and Zhuang 1998; Yang 1996; Perry and Wong 1985). But this

literature cannot explain variations at the same locality over time. In addition, some

empirical works suggest great variations among local governments with regards to the

private sector, which can be developmental, corporatist, entrepreneurial, and predatory

(Blecher and Shue 2001; Saich 2002; Tsai 2003).

Another influential explanation for inter-provincial variation examines personnel

control systems designed by the central government to direct local government officials

to promote economic growth. Huang (1996) argues that despite economic

decentralization, the central government’s control over personnel allocation plays a

critical role in its ability to control local investment and thus runaway inflation (Huang

1996). This line of empirical work argues that the chances for a provincial leader to be

promoted to a higher-level position are significantly and positively correlated with the

GDP growth rate of the local official’s jurisdiction (Li and Zhou 2005). However, these

findings have been challenged. One group of scholars, for instance, demonstrate that

personal connections associated with factional competition in the central government play

a critical role in promotion and therefore encourage economic growth in their

jurisdictions (Cai and Traisman 2006; Shih 2004; Shih et al. 2012).

The incentive structure designed by the central government in the CES does play a

role in influencing local officials’ behavior towards economic growth. But the CES alone

does not solve the commitment problem and protect the property rights. This line of

argument assumes that local officials under the CES will automatically protect private

property rights. However, it isn’t necessarily the case. In particular, as this study will

show, local officials under the CES with different resources and constraints may behave

very differently with regards to private sector.

Also, self-interested and promotion-oriented local leaders tend to pursue their own

political goals in addition to the policy targets listed in the CES, taking advantage of

asymmetric information they possess over the upper level governments. To make the

situation even worse, local leaders may collude with private firms at the expense of the

government, as corruption in the form of theft indicates (Shleifer and Vishny, 1993).

More importantly, local officials as individuals may have goals different from

those of the local governments they serve. Under the current institutional arrangements,

local leaders possess a great deal of discretionary power, thus allowing them to pursue

their own political and economic interests strategically in dealing with private investment.

As a result, individual local officials rather than the governments (central or local)

become a major source of uncertainty for private firms in China. Thus, how local

government disciplines and monitors local officials’ behavior becomes a critical issue in

ensuring that local officials will pursue the same goals as those of the local governments.

2.2 The Nature of the Cadre Evaluation System

The Cadre Evaluation System (CES) is widely believed to be an incentive structure

hierarchy. The CES is one of the most important government personnel control systems in

China. It assesses local party and government leaders based on performance criteria set

by their immediate superior level of government. The CES powerfully shaped the

behavior of Chinese local officials by linking both monetary interests and promotion

incentive to their performance on the tasks listed in the system.

Before the Reform Era, the most important factor that determines Chinese political

actors’ promotion is political royalty or political affinity (Zhong 2003). In addition to

political affinity, three new elements were introduced to the evaluation process since the

Reform Era. Officials have to be of a young age, have good education, and above all,

have the ability to promote local economic growth. The last one has become one of the

most important criteria for higher-level officials to assess the work of their subordinates

(Bo 2002; Huang 1996; Landry 2008; Shih 2004; Li & Zhou 2005).

Also, as the study of factionalism in Chinese politics, social connections are believed

to play a critical role in one’s promotion (Nathan 1973; Dittmer 1995; Zhong 2003; Shih

2004; Bo 2007; Shih et al. 2012). If so, the question then become whether economic

growth still matters for promotion once social connections are account for (Opper and

Brehm 2007; Shih et al. 2012). Some scholar argue that the connections and economic

growth are complements for political leader’s promotion (Jia 2012). At any rate, if a local

leader has social connections with his/her superiors, he/she will become a strong

candidate and his/her promotion prospect will be significantly enhanced. Since political

affinity is easily to perform and has become less important during the Reform Era, it is

safe to say that four important factors determine the prospect of local officials’ promotion.

The decentralization process of China’s personnel management has transformed

the personnel control system from “two-level down” to “one-level down” administrative

hierarchy. Under the current system, the CES operates in a one-level down fashion

That means each level of local government has full

(O’Brien and Li 1999; Landry 2008).

authority to evaluate the leading officials of the immediate subordinate level. For

example, provincial governments have full authority to assess prefectural party

secretaries or mayors without approval from the central organization departments.

Prefectural governments and county governments are authorized to evaluate their

immediate subordinate level of party secretaries and heads of government without

seeking approval from higher-level organization department. Working in this way, the

final decisions are actually made in a centralized way by a handful of people leading the

party committee at each level. Therefore, local political leaders enjoy a great deal of

leeway to pursue their own objectives in appointing local leaders (Wang 2013).

Some scholars argue that the discretion of local leaders is an unintended

consequence of the CES due to conflicting priorities or due to the moral hazard problem

inherent in a principal-agent relationship between central and local governments (Edin

2003; O’Brien and Li 1999; Whiting 2001; 2004). O’Brien and Li’s (1999) study shows

that local officials possess a certain amount of discretionary power to implement policy

selectively in accordance with their own preferences. By studying governments at the

prefecture and county levels, Wang (2013) argues that in addition to the top-down

control, the CES is also characterized by a high degree of local autonomy that enables

local leaders to bargain with the higher-level government over the specifics of evaluation

standards.

With regards to the commitment problem, the central government has a strong

incentive to keep its promise on private investment, but it is not easy to fulfill the task

without local governments’ compliance. Because local autonomy is inherent in the CES,

local officials have choices to formulate local policies and implement policies selectively

to suit their own goals. Moreover, officials at various levels of government may behave

differently in accordance with the resources they have in the face of the same incentive

structure.

2.3 Term Limits and Rotation System

In addition to the CES, two more systems have been introduced to be a

mechanism in shaping incentives, capacities, and constraints of local political officials.

Since the 1990s, China has developed a control system that intends to solve the problem

of asymmetric information, shirking, and monitoring. Both term limits and the cadre

rotation system are expected to serve the purpose of aligning divergent preferences and

reducing asymmetric information. The two systems largely shorten the career horizon of

local leaders and many economic targets are often out of control of the local officials, and

the provision of local public goods has reinforced the revenue extraction pressure facing

local leaders.

The system of compulsory retirements was introduced in 1982. The main feature

of the system is to set the age limits to retirement for local officials. The practice on

mandatory stepping down at age 65 for provincial governors was established. A recent

policy regulates that for a provincial party secretary, if he/she ends up at the age 63 after a

five year term, he/she would not be allowed to serve another round. Mayors of

prefectures are usually required to retire at the age of 60. Under this system, young and

well-educated officials are favored for further promotion.

The rotation system was originally to rotate provincial officials across provinces

and positions beginning in 1990. For some reasons, there was a different policy before

1990, which encouraged localization of governors (Zhang and Gao 2008). More

specifically, the rotation system is expected to prevent tie-cultivation in the hierarchical

power structure and local protectionism (Chen and Zhao 1996; Blanchard and Shleifer

2001; Zhong 2003). Those who support the rotation system argue that the system reduces

corruption and faction formation in local governments (Chen and Zhao 1996) and

promotes regional economic development (Liu 1998; Pu 1999). Others are skeptical by

focusing on the negative effect of shortsighted rotated officials on local economic

development (Gu 2006). The empirical study suggests the positive impact of rotated

governors on local economic growth in the eastern provinces (Zhang and Gao 2008).

There are no uniform rules on which who should be included in the rotation

system. However, it is discouraged that the key local officials, mostly the “first hand”—

the Party secretary, “at the provincial and prefecture levels serve in his or her native

province and prefecture (Zhong 2003, p. 118).”10 Right now, the governments both

central and provincial have sped up rotating local officials between localities in order to

prevent intense tie-cultivation and local protectionism. This system has reinforced the

short-time pressure for local officials to generate impressive economic growth in only 2

to 3 years, so as to impress their superiors to win promotion.

The local officials face great pressure and incentive to satisfy the policy targets

assigned by upper level government. This situation on the one hand does motivate better

performance from the local officials, which helps to explain the rapid growth in the past

to a large degree. But the pressures also produce other unintended consequences from

them. Shorter time-horizon in each locality also causes short-term behaviors of local

officials eager for instant success. Chapter 5 details that local leaders are fanatic in the so

called “achievement projects,” like investing in a symbolic project in the city at the cost

of hurting private sector.

In summary, the CES worked with the term limits system has created a distinct

career pattern in China’s power hierarchy. First, unlike politicians in democratic regimes,

in the case of China, once a person becomes a cadre, he/she will enjoy cadre status until

retirement. He loses his position only when he gives up voluntarily, or becomes a

convicted felon. Therefore, no mater what job performance he achieved, his position is

secured as long as he got there. It is very rare to demote an official because he/she did not

meet the targets assigned by the upper level government. Second, because of the almost

permanent tenure in an office, there are almost no job options outside the political career

once you are in (Li and Zhou 2005). Finally, the age limits have been set to compulsory

retirement for local officials.

2.4 The Theoretical Framework

In this section, I present a simple bargaining game between a private firm and a local

official following the literature of the Obsolescing Bargain Model (OBM) and the

Political Bargaining Model (PBM), which explain bargaining relations between a Foreign

Direct Investment (FDI) firm and a host country (Vernon 1971; Eden et al. 2005). The

major concerns of the multinational corporations’ (MNCs) investment decisions in a

developing country include the returns on an investment and the political risk associated

with it. One of the risks as shown in the Obsolescing Bargain Model is that the initial

bargain favors the foreign investors, but the bargaining power shifts from MNCs to the

host countries once the investment is in place. The host governments have incentives to

impose higher taxes to squeeze FDI firms’ profits or expropriate their assets completely

by changing policies at any time. The possibility of direct or indirect expropriation is

often the major political risk for MNCs investing in an authoritarian regime.

Private firms in China face similar risks as MNCs do in their investment decisions.

More importantly, in the case of China, domestic private enterprises are the most

vulnerable in terms of property rights protection as compared to the state-owned

enterprises (SOEs) and foreign invested enterprises (FIEs) since the central government

sets up a package of preferential policies exclusively for the latter types of firms. As

discussed in the previous sections, individual local officials rather than the government

(central or local) become a major source of uncertainty for private firms in China. Under

the current institutional arrangement, local political leaders possess a great deal of

discretionary power, allowing them to pursue their own political and economic interests

strategically in regard to private investment.

Before formalizing the bargaining game and the symbiotic logic of secure

property rights, I identify the players and their preferences as follows. There are three

players in the local economy, Government (G) is the principal, the local political official

serves (S) as the supervisor and the Private entrepreneur (P) is the agent. I detach political

actors from government because the goals of government are not always identical with

political actors. In the context of China, I identify political actors as local political

leaders, economic actors as indigenous private entrepreneurs, and government includes

central and local.

I make an extremely simple assumption that the goal of government and political

actors may not be the same. Government (G), both central and local, cares about tax

revenue and the primary and foremost concern of local political leaders (S) is to stay in

office and be promoted to a higher rank. The ultimate goal of local officials, however, is

to acquire more wealth and secure their possessions. In other words, the pursuit of

political power is the means to achieve the end (wealth acquisition). The old saying

“shengguan facai” (more power more money) demonstrates the logic of career concerns

with Chinese characteristics. For the indigenous private entrepreneur (P), what he/she

wants is not only to maximize profit but also to secure property rights.

There exist nested games between the three players in the local economy. The

principal-agent problem is inherent between different levels of government, as well as

between governments, both central and local, and local officials. It is assumed that there

exist information asymmetries between the government, local political leaders, and

economic actors. In other words, the activities of local political leaders and economic

actors cannot be observed by the government, and indigenous private entrepreneurs

cannot perfectly monitor the impact of the government’s actions or policies upon their

property rights. As Figure 2.1 shows, local political leaders engage in the bargaining

game with indigenous private investors within the principal-agent relationships between

the government and local leaders, and upper level leaders and lower level leaders.

The third assumption I make is that indigenous private entrepreneurs do not necessarily

demand efficient property rights. In fact, it is not clear that an individual private

entrepreneur should always demand that the government protect everyone’s property

rights. According to Haber et al. (2003), an indigenous private entrepreneur can receive

utility from the secure and efficient property rights, because this makes her asset more

liquid, and therefore more valuable. However, if selective enforcement grant the

indigenous private entrepreneur more comparative advantage in the market, then it may be

more profitable to demand less than universal enforcement. Between these two

possibilities, it is assumed that indigenous private entrepreneurs care first and foremost

about their own property rights. Any profit-maximizing actor would readily accept the

exclusive protection of her property rights, providing that it produced better benefits to that

actor.

Finally, the model assumes that local officials are potential predators and private

investors are their prey. The predator and prey interact strategically in the context in

which the central government or superiors level officials evaluate the subordinate local

officials on the basis of the cadre performance evaluation system.

Figure 2.1 A Bargaining Game under the Principal-Agent Relationships

To provide a systematic understanding of the bargaining process between local

political actors and private sector investors, I will first describe local political actors’

goals and their resources as well as the constraints under the current personnel control

systems. Then, I will discuss private sector investors’ goals and resources in the

Central

government

Provincial

government

Prefecture

City

government

Resources

. connections

. young

. well educated

Constraints

.performance

.age limits

.no connections

Resources

.employment

.export market

. technology

Constraints

.resourc

e seeking

.domestic market

Prefecture city

Party secretary &

Mayors

Goals:

.Promotion

.Wealth

Private Investors

Goals:

.Profits

.Property

rights

Central political

leaders

Provincial Party

secretary & Governors

bargaining game with local political leaders. Finally, I delineate the bargaining process

between local political actors and private sector investors, and propose theoretical

hypotheses.

The local political officials’ goals, resources, and constraints

While both central and local governments hope to accomplish broad social,

economic and political objectives, local political leaders, in direct contact with private

firms, may intend to achieve their personal goals through bargaining with private

investors. One of the major goals of the government at both central and local levels is to

attract investments, which will generate GDP growth rate, tax revenue, and employment.

But for many local political leaders, other goals may be involved in dealing with private

investment.

The “competition for promotion” literature assumes that the primary goal of local

political leaders is to be promoted to a higher rank (Li and Zhou 2005). I relax this

assumption by including economic interests. The local official is thus assumed to be an

expected utility-maximizer. His/her goals include not only promotion (career concerns)

but also monetary interests.

Although it may be clear that the CES plays a significant role in forming a local

political leader’s preferences, an individual’s background and resources influence his/her

goals and strategies toward private investment. As discussed in the previous section, three

elements are important for local officials to be promoted to a higher rank: youth,

education, and the ability to promote economic growth. Youth became a critical factor in

determining one’s political career when the age-based mandatory retirement rule was

implemented in 1982. So if a local leader is near retirement age, then he/she will have

nearly zero chance to be promoted despite his/her expertise in local economic growth. As

a result, his goal towards private investment will not be the same as the goals of those

who are young and/or well-educated. Quite likely, the near-retiring officials may be more

interested in monetary fortunes than in prospects for promotion.

Also, as discussed in previous sections, according to career concern studies, it is

not clear whether job performance measured by GDP growth rate, political connections,

or a mix of performance and connections matters most for one’s promotion. From the

perspective of “faction politics”, those who have connections with provincial leaders, will

be promoted no matter what job performance they achieved. For those who don’t, there

are several strategies to maximize their likelihood of promotion, such as bribery to their

superior or simply buy an office (Zhu 2008). Chapter 4 will show how these resources

and constraints affect local officials’ behaviors in the bargaining relationship with

indigenous private investors.

Private investors’ goals, resources, and constraints

Private firms in China are more vulnerable than the State-Owned Enterprises

(SOEs) and Foreign Invested Enterprises (FIEs). The development of the private sector in

China went through an uneven path of institutional and structural changes. Before 1978,

private businesses were strictly forbidden. Anyone who ran a private business would be

severely punished, including being arrested and persecuted. Between 1978 and 1988, the

private sector was not allowed officially except for “individual entrepreneurs” (getihu)

engaging in small businesses with less than eight employees. The 1988 regulations

allowed businesses with more than eight employees to be registered as “private

enterprise” (siying qiye), but the Tiananmen Incident of 1989 dashed the inception of

private businesses. Deng Xiaoping’s “Southern Tour Talk” in early 1992 and the

introduction of the Company Law in 1993 reignited and accelerated the development of

the private sector during the 1990’s. However, discrimination against the private sector

continued until the 1999 Constitutional Amendments accorded private enterprises legal

status. It was only after the 2004 Constitutional Amendments that lawful private property

was protected and equal legal status was offered for private firms and state-owned

enterprises. In 2007, China enacted its first law to explicitly protect private property, but

it does not provide enough details or effective enforcement mechanisms.

The major goal of a private sector investor is to secure business opportunities and

make profits. But if the profits will be expropriated by the government, investors will not

invest. Therefore, the security of property rights is also under consideration. In general,

private sector investor’s choice to invest in a particular place is determined by a variety of

objectives and considerations. Business opportunities, market expansion, social networks,

tax incentives, fiscal subsidies, cheap land, labor force, and legal environment are all

factors that private investors will take into account in their investment decisions. Which

factor is weighted more heavily than others depends very much upon post-entry

bargaining power, referring to the relative bargaining power vis-à-vis the local

government after the investment is made. And a private sector investor’s post-entry

bargaining power is in turn determined by firm specific characteristics and the degree to

which he/she will need from the local government, such as licensing requirements,

permissions, resources, domestic market, and public-goods provisions.

The literature on international business shows that firm-specific advantages affect

multinational corporations’ investment decisions in different host countries (Helpman

1984; Markusen 2002; Hansen et al. 2005; Zheng 2007). In particular, the OBM literature

indicates that OBM may only be applied to the natural resources sector such as copper

mining and the oil industry (Vernon 1971; Gilpin 1975), while manufacturing industries

may be less vulnerable to the risk of expropriation because of their ability to adjust to the

local environment and to renew production technologies to balance against the erosion of

bargaining power. Some scholars find that the multinational corporation’s bargaining

power with the host country does not obsolesce for the high technology sector (Kobrin

1987), while others suggest that in some capital-intensive manufacturing such as the

automobile industry, a firm’s ability to establish an industry cluster and its technological

assets could enhance its bargaining power (Bennett and Sharpe 1979).

As the critics of OBM question the usefulness of the model, scholars propose the

political bargaining model (PBM) to revitalize OBM by incorporating post-entry political

strategies with host government through iterative bargaining (Eden et al. 2005). The

PBM argues that the competitive advantage of MNCs comes from their Firm Specific

Assets (FSAs) or resources “if they are rare, hard to imitate, have no direct substitutes,

and enable companies to pursue opportunities or avoid threats” (Eden et al. 2005, p. 12).

In the case of China, as a general rule, labor-intensive, export-oriented

manufacturing firms and high technology firms enjoy competitive advantage, while

resource-intensive and local market seeking firms are in a disadvantageous position in

bargaining with local governments. I will come back to this point and discuss firms’

characteristics extensively in Chapter 3.

2.5 The Bargaining Game

Initially, the relative bargaining power favors private investors vis-à-vis local

officials because, first, local officials are trying to attract investment under the pressure of

the performance-based evaluation, and second, investors may have other options even for

resource-intensive firms. After a decision is made, the relative bargaining power may

shift. That is, once an investor has made firm-specific investment in a locality, his/her

resources may be held hostage by an opportunistic local official. The local government

would then be in a position to impose new requirements on the firm, which might more

than offset the initial incentives. Moreover, in the context of China, private entrepreneurs

risk not only outright expropriation but also a host of other predatory actions taken by the

local government in the guise of fines, taxes, and/or “charitable contributions” to

government-sponsored projects (Nee and Opper 2012).

However, if a private investor’s post-entry bargaining power is strong, he/she will be

able to protect his/her bargains. The degree to which the investor will be able to do so

depends on the level of Firm Specific Assets (FSAs) and the degree to which he/she will

need from the local government for, say, licensing, permissions, resources, and

publicgoods provisions. In particular, private firms with an exit option will enjoy

sufficient protection because they possess high levels of FSAs. The outright

expropriation of this type of firm does no good to the government or to the local political

leaders. Political and social considerations at both central and local governments with the

incentive structure embedded in the CES have thus set up relatively stable conditions for

these types of investment, which appears to facilitate a self-enforcing solution to the

commitment problem. In this situation, everyone benefits and no one has the incentive to

deviate.

On the one hand, both central and local governments have strong incentives to keep

their promises since these firms can generate higher GDP growth, tax revenue, and

employment. Although private firms in general may have an incentive to conceal real

profits and hence decrease the taxes they pay to the government, it is more difficult for

labor-intensive, export-oriented manufacturing firms and high technology firms to do so.

On the other hand, due to relatively short tenure in office (e.g., less than three years,

on average, for local mayors), local officials are under enormous pressure to show their

ability to produce economic growth quickly (Pei 2012). Thus, local political leaders have

strong incentives to maintain a collaborative relationship with these firms because it is an

easy way to demonstrate their job performance. Also, knowing that this type of firm has

an exit option even if it is expensive for them to do so, and that the worst scenario of

resistance to predatory actions will severely damage their reputation, local political actors

will restraint their predatory behavior.

For investors with rapidly obsolescing post-entry bargaining power, however, there is

no self-enforcing commitment. Private firms without an exit option such as

resourceintensive and local market seeking firms are in a disadvantageous position to

overcome the commitment problem. This type of firms’ FSAs is low as its firm-specific

assets are common, easy to be imitated and substituted, and hard to transfer. They need

more government-related resources for their projects. Investors may prefer a better legal

environment to constrain the predatory activities or rely on personal networks (guanxi) or

bribing local officials to protect their investments.

For local officials, the political risk of direct expropriation of private firms without an

exit option may be low due to the moral hazard problem. For instance, the predatory

actions may not be seen as personal. It may be done in the name of the local government.

In addition, a local official could assign his/her protégé to take over the firm and to run

the business as usual. After the outright expropriation, the local government still retains

GDP growth, tax revenue and employment opportunities. Moreover, the local official

receives private benefits from the outright expropriation as well. No matter who is going

to take over the firm, the new owner will owe a favor to the official, and will pay back in

some form of revenue. Therefore, private investors who engage in low-level FSAs

investments without an exit option will, from time to time, rely on their personal

networks (guanxi) or bribery to protect their property rights.

If the local official chooses not to expropriate directly but to be engaged in indirect

expropriation such as collecting fees, fines, forced apportionment of funds (tanpai), or

forced contribution of government sponsored projects, the firm with no exit option has

little bargaining power and has no choice but to give in with either direct payments or

bribes. In this case, the local official receives both higher merit and private benefits with

no risk of the exit of the firm. Chapter 3 presents the model that illustrates the prisoner’s

dilemma situation in the bargaining relationship between local officials and private

investors, and test the hypotheses statistically.

Local political leaders’ decision of whether or not prey on the private sector is

determined by a firm’s resources and constraints. However, as discussed in previous

section, local officials are also under strict constraints within the personnel control

systems. If the local official is near 55, or less educated, or has no political connections,

he/she will desperately need the private sector’s support for political survival. This

symbiotic relationship between native local political officials and private entrepreneurs

creates conditions similar to secure property rights at the local level. The degree of

symbiotic relationship between the local officials and indigenous private entrepreneurs

determines the level of private property rights protection.

Native local officials have lower transaction costs and therefore a symbiotic

relationship between native local officials and local private firms is easier. Compared to

rotated local leaders, native local political leaders have more incentives to protect private

property rights in order to get political and economic benefits as well as none-material

rewards. I will show how these resources and constraints created by the political control

systems affect local officials’ behaviors in the bargaining relationship with indigenous

private investors and test the hypothesis in Chapter 4.

2.6 Summary

This chapter briefly reviews the existing studies of property rights with special

attention on the personnel control systems including the cadre evaluation system, term

limits, and rotation system, and provides a game theoretical explanation to the property

rights protection in China. I theorize the endogenous property rights as a bargaining game

between a private investor and a local official. Resources and constraints of both actors

affect their bargaining power in the bargaining relationship and hence determine the level

of property rights protection. Private firms with high levels of FSAs and especially with

an exit option possess strong post-entry bargaining power, and thus enjoy better property

rights protection, but weak firms are vulnerable to the local officials’ predatory activities,

and therefore needs to rely upon other mechanism, such as their social networks or

bribery, to overcome the commitment problem.

Another source that could overcome the commitment problem emerges from the

symbiotic relationship between the local officials and indigenous entrepreneurs. Native

local political actors, who are less favorable to the promotion prospect, are more likely to

protect private property rights. The logic is that compared to transferred officials, native

local officials have fewer political connections with higher-level officials and therefore

have less chance to be promoted in the power hierarchy. This condition makes them seek

the support of local economic actors for their political survival. Moreover, native local

political leaders who were born in their jurisdiction have lower transaction costs, and

therefore a symbiotic relationship between native local officials and local private

entrepreneurs is feasible. The chances were high that the native leaders would have close

ties to local economic actors and face more strict social constraints; therefore, they were

more likely to protect local property rights.

CHAPTER 3

THE GAME OF PROPERTY RIGHTS: CREDIBLE COMMITMENT IN CHINA

This chapter explores the resources and constraints of private firms under the institutional

arrangements by examining the firms’ characteristics. According to the theoretical

framework presented in Chapter 2, these conditions will determine the bargaining power

in the bargaining relationship with local officials in terms of property rights protection.

Then, I test the effects of firms’ characteristics on the security of private property rights

quantitatively.

As discussed in Chapter 2, I theorize the endogenous property rights as a

bargaining game between a private firm and a local political actor. I model the

relationship as a one-shot game with conflicting goals, and hypothesize that a firm is in a

strong bargaining position at the time of entry when the local official, under the pressure

of the performance–based evaluation by his or her immediate superiors, understands that

the firm has other options. However, once the firm has made sector-specific investment,

its capability to resist the official’s predatory actions relies upon certain firm-specific

characteristics. More specifically, in the post-entry situation, the availability or

unavailability of an exit option for a private firm affects the local political actor’s

behavior with regard to the protection of private property rights. These hypotheses are

supported by a statistical analysis of a nationwide firm-level survey on privately owned

enterprises and the data I collected from the media reports of government-related property

rights expropriation cases.

The remainder of this chapter is organized as follows. The next section provides a

close examination of firms’ resources and constraints created by their characteristics

under the current institutional arrangements. Section 2 provides a simple bargaining game

between a private firm and a local official with hypotheses that guide the empirical

analysis. Then, I present a model that illustrates the dominant strategies for different types

of private firms and local officials. Section 4 describes the data. Section 5 discusses the

research design and provides empirical tests. Section 6 presents the analysis of media

reports of government-related property rights expropriation cases. Section 7 concludes.

3.1 Firms’ Characteristics as a Source of Property Rights Protection

As the discussion of the Cadre Evaluation System (CES) demonstrates, local

officials are under the pressure of the performance–based evaluation by their immediate

superiors. They have to show their ability to accomplish the tasks listed in CES, which

include Gross Domestic Product (GDP) growth rate, employment creation, and tax

revenue. Labor-intensive, export-oriented manufacturing firms and high technology firms

can create more jobs, contribute stable fiscal revenue, and generate higher economic

growth. All of these are major political tasks on the basis of which local political officials’

job performance is evaluated. If these firms choose to relocate their investment elsewhere,

local governments will lose all the benefits they can get, and local political leaders will

also fail in cadre evaluation which is closely tied to their future career. As one of the fallen

local political leaders in Southern China bitterly complains, “Some firms always threaten

to relocate their headquarters. Let them leave. See if they could move to heaven.” Indeed,

the availability of an exit option, even if unused, can be a powerful tool that greatly

enhances a private firm’s bargaining power vis-à-vis local political actors.

Labor-intensive, export-oriented manufacturing firms even in the period of labor

shortage can retain their advantage. For example, many Chinese factories have struggled

to find enough people to operate the assembly lines since the labor shortage first occurred

in 2004. Labor shortage was so acute in 2012 that it forced many firms to turn to the local

government for help. However, this does not seem to decrease the bargaining power of

these private sector actors vis-à-vis the local governments. Rather, in order to attract and

retain the investment, many local governments promise to help to recruit workers for

them (Lin 2013).

However, if labor-intensive firms in resource-intensive and local market seeking

sectors, such as mining industry, or steel industry, even if they generate the same benefits

for local governments as the above-mentioned labor-intensive, export-oriented

manufacturing firms do, they may lose their advantage. The key factor is that these firms

have no option to relocate their businesses. If they choose to exit, they will lose all.

Like labor-intensive, export-oriented manufacturing firms, resource-intensive and

local market seeking firms can contribute to employment creation, fiscal revenue, and

economic growth. But this type of firms relies heavily on government-related resources.

More importantly, without an exit option, local political actors may gain more bargaining

power over private firms in protecting their properties. Knowing that these firms have no

place to relocate their investment, local political actors tend to prey on them as compared

to those firms with an exit option.

Traditionally, capital-intensive firms are vulnerable to political risks because these

firms involve a large amount of capital for machinery and infrastructure, and therefore

need longer time to make a profit. But if these capital-intensive firms are in labor-

intensive, export-oriented manufacturing sector or high technology sector so as to provide

them with an exit option, they will be able to retain their advantage. If capitalintensive

firms are in resource-intensive sectors, such as oil industry, energy industry, or real estate

industry, which leave them no option to exit, they will lose their advantage.

In summary, firms with resources that are hard to substitute in regard to skilled

labor force, access to foreign market, or technology know-how are considered to be

highlevel Firm Specific Assets (FSAs) firms, and will be in a better position to bargain

with the government. In particular, it is the availability of an exit option that, to a large

extent, determines the post-entry bargaining power of private sector actors over local

political actors in protecting their property rights.

3.2 A Bargaining Game

As discussed in Chapter 2, the relative bargaining power at the time of entry

favors private investors vis-à-vis local officials because, first, local officials are trying to

attract investment under the pressure of the performance-based evaluation, and second,

investors may have other options even for resource-intensive firms. However, once an

investor has made firm-specific investment in a locality, the relative bargaining power

may shift to local officials. In the post-entry situation, his/her investment may be held

hostage by an opportunistic local official. The local government would then take

advantage of it so as to impose new requirements on the firm, which might more than

offset the initial incentives. Moreover, in the context of China, private entrepreneurs risk

not only outright expropriation but also a host of other predatory actions taken by the

local government in the guise of fines, taxes, and/or “charitable contributions” to

government-sponsored projects (Nee and Opper 2012).

However, a firm’s specific characteristics can greatly empower its bargaining

power, and if a private investor’s post-entry bargaining power is strong, he/she will be

able to protect his/her bargains. The degree to which the investor will be able to resist

local officials’ predatory actions depends on the level of Firm Specific Assets (FSAs) and

the degree he/she will need from the local government for, say, licensing, permissions,

resources, and public-goods provisions.

As discussed in previous section, private firms with an exit option will enjoy

sufficient protection because they possess high levels of FSAs. The outright

expropriation of this type of firm will hurt the government or affect the local political

leaders negatively in terms of performance based evaluation measured by real figures like

tax revenue, employment creation, and GDP growth rate. Political and social

considerations at both central and local governments with the incentive structure

embedded in the CES have thus created relatively stable conditions for these types of

investment, which appears to facilitate a self-enforcing solution to the commitment

problem. In this situation, everyone benefits and no one has the incentive to deviate.

Governments, both central and local, have strong incentives to keep their promises

since these firms can generate higher GDP growth, tax revenue, and employment.

Although private firms in general may have an incentive to conceal real profits and hence

decrease the taxes they pay to the government, it is more difficult for high level FSAs

firms, such as labor-intensive, export-oriented manufacturing firms and high technology

firms to do so.

For local officials, due to relatively short tenure in office (e.g., less than three

years, on average, for local mayors), they are under enormous pressure to show their

ability to produce economic growth quickly (Pei 2012). Thus, local political leaders have

strong incentives to maintain a collaborative relationship with these firms because it is an

easy way to demonstrate their job performance. Also, knowing that this type of firm has

an exit option even if it is expensive for them to do so, and that the worst scenario of

resistance to predatory actions will severely damage their reputation, local political actors

will restrain their predatory behaviors.

However, there is no self-enforcing commitment for investors with rapidly

obsolescing post-entry bargaining power. Private firms without an exit option, such as

resource-intensive and local market seeking firms, are in a disadvantageous position to

overcome the commitment problem. This type of firm’s FSAs is low as its firm-specific

assets are common, easy to be imitated and substituted, and hard to transfer. They need

more government-related resources for their projects. Investors may prefer a better legal

environment to constrain the predatory activities or rely on personal networks (guanxi) or

bribing local officials to protect their investments.

More importantly, for local officials, the political risk of direct expropriation of

private firms without an exit option may be low due to the moral hazard problem. For

instance, the predatory actions may not be seen as personal responsibility. It may be done

in the name of the local government. In addition, a local official could assign his/her

protégé to take over the firm and to run the business as usual. After the outright

expropriation, the local government still retains GDP growth, tax revenue and

employment opportunities. Moreover, the local official receives private benefits from the

outright expropriation as well. No matter who is going to take over the firm, the new

owner will owe a favor to the official, and will pay back in some form of revenue.

Therefore, private investors who engage in low-level FSA investments without an exit

option will, from time to time, rely on their personal networks (guanxi) or bribery to

protect their property rights.

If the local official chooses not to expropriate directly but to be engaged in

indirect expropriation, such as collecting fees, fines, forced apportionment of funds

(tanpai), or forced contribution of government sponsored projects, the firm with no exit

option has little bargaining power and has no choice but to give in with either direct

payments or bribes. In this case, the local official receives both higher merit and private

benefits with no risk of the exit of the firm.

Given the above discussion, I come up with two hypotheses:

Hypothesis 1: All else being equal, private firms with an exit option and high

level of FSAs enjoy sufficient property rights protection.

Hypothesis 2: All else being equal, private firms with no exit option and low

level of FSAs are vulnerable to local officials’ predatory activities.

3.3 The Model

As noted earlier, the situation in which a resource-intensive and local market

seeking firm on the one hand, or a labor-intensive, export-oriented manufacturing firm or

a high technology firm on the other may find itself being treated differently. The major

difference between the two lies in the fact that the former does not have an exit option

while the latter does. The situations can be illustrated by the Prisoner’s Dilemma game.

The traditional prisoner’s dilemma is a game that shows why two purely

“rational” individuals might not cooperate, even if it is in their mutual interests to do so.

In the one-shot game, a private investor and a local official may find themselves in a

situation very much like the prisoner’s dilemma. Table 3.1 shows the two players’ payoff

matrix. By cooperate, I mean actors play by the rules. Defect means actors evade the

rules. In this case, for the firm, evading the rules means the firm conceal real profits so

that decreases the taxes it pays to the government, as well as it decides to relocate its

assets. For the local official, evading the rules means he/she preys on the firm ranging

from outright taking of investment to arbitrary fees and fines collected by the

government, or forced “charitable contributions” to the government projects. Table

3.1 Payoffs of a Private Firm and a Local Official in a One-shot Game

3.1 The situation involving a private firm with low level of FSAs and no exit option

Scenario 1:

In this scenario, suppose that both the firm and the local official choose to comply

with the rules—explicit or implicit—governing normal market transactions. Then, the

payoffs of the two players in a one-shot game are as follows. The firm will get net profit

B1 after deducting the cost and tax paid to the governments. The local official will get the

bundle benefits B2 he/she intends to achieve as an official including the policy tasks such

as GDP growth rate, tax revenue, and employment creation, assigned by higher

governments for the political survival and the monetary interests consist of wages and

pensions.

A local official

A private firm

Cooperate

Defect

Cooperate

Scenario 1

, B

Scenario 2

Defect

Scenario 3

Scenario 4

, C

Scenario 2:

In scenario 2, suppose that the firm complies with the rules, but the local official

decides to exploit. The payoffs change to as follows. The firm will get D1, in which net

profit deducts the loss of property exploited by the local official ranging from part of the

expected profit to all of the investment as well as many types of fees, fines, and

“contributions.” The local official will get A2 that includes the bundle benefits plus the

benefits from the exploitation and deducting the cost of the probability of being caught

for any wrongdoings with a penalty. Generally, the probability of being caught is very

small. And the predatory action is often done in the name of the government or the

“public.” Thus, there is also a moral hazard problem.

Scenario 3:

Scenario 3 is the situation in which the firm tries to evade while the local official

decides to abide by the rules. The payoffs thus become as follows. The firm will get A1

that includes net profit plus the extra benefits for evading the rules, and deducts the cost

of the probability of being caught with a penalty. The local official will get D2, in which

the bundle benefits deduct the loss of tax revenue and other benefits as a consequence of

the firm’s choice.

Scenario 4:

In scenario 4, suppose that both the firm and the local official choose not to

comply with the rules. The payoffs may then turn out to be as follows. The firm will get

C1, in which the net profit deducts the loss of property exploited by the local official plus

the extra benefits for evading the rules, and deducts the cost of the probability of being

caught with a penalty. The local official will get C2, in which the bundle benefits plus the

benefits from exploitation for the firm, and deduct the loss of tax revenue and other

benefits as a consequence of the firm’s choice and the cost of the probability of being

caught with a penalty.

The payoff relationship is as following:

A>B>C>D

Therefore, each player has a dominant strategy, and the game has an obvious

solution as follows.

For the firm, scenario 3 is better than scenario 1 if the extra benefits for evading

the rules deduct the cost of the probability of being caught with a penalty is bigger than 0.

Scenario 4 is better than scenario 2 if the extra benefits for evading the rules deduct the

cost of the probability of being caught with a penalty is bigger than 0. The strategic

choice made by the firm would be this:

scenario 3> scenario 1> scenario 4> scenario 2

For the local official, scenario 2 is better than scenario 1 if the benefits from

exploitation for the firm deduct the cost of the probability of being caught for any

wrongdoings with a penalty is bigger than 0. Scenario 4 is better than scenario 3 if the

benefits from exploitation for the firm deduct the cost of the probability of being caught

for any wrongdoings with a penalty is bigger than 0. The strategic choice made by the

local official would be this:

scenario 2> scenario 1> scenario 4> scenario 3

Thus, if the chances of being caught are sufficiently small, both the firm and the

local official will choose the dominant strategy that is to evade the rules in the one-shot

game, and therefore end up in scenario 4. This is a prisoners’ dilemma game. Clearly, in

the payoff relationship A>D, scenario 1 is better than scenario 4.

Given that the probability of being caught for the firm is bigger than the firm’s

extra benefits for evading the rules deducting the level of exploitation by the local official

and the probability of being caught for the local official is bigger than benefits from

exploitation for local official deducting the loss of tax revenue and other benefits as a

consequence of the firm’s choice, or chances of being caught are sufficiently high, the

choice of complying with the rules by both players will be the “common interest.” Then,

in an infinitely repeated version of the game, the “common interest” may be realized if

both players choose to play, for example, a trigger strategy.

3.2 The situation involving a private firm with high level of FSAs and an exit option

This game is similar to the previous one except that the firm has an exit option,

that is, as the exploitation becomes intolerable, the firm may opt to leave the market so as

to minimize the costs. Thus, we need to add additional terms in the payoffs for each

player under the second and fourth scenarios mentioned above. Let us call this the benefit

of exiting for the firm as r, (e.g., recovering the whole or part of the investment and

receiving potential gains from outside opportunities, minus the loss of relocation) and the

cost of losing a valuable asset for the firm to stand for as e. Then, the new payoffs are as

follows. Table 3.2 shows the new payoff matrix for the two players.

Table 3.2 Payoffs of a Private Firm with an Exit Option and a Local Official in a Oneshot

Game

Scenario 2:

Scenario 2 is the situation where the firm chooses to comply with the rules, but the

local official decides to exploit. For the firm, it will get the net profit D1 deducts the loss

of property e exploited by the local official. For the local official, the bundle benefit A2

plus the benefits from exploitation and deduct the probability of being caught.

Scenario 4:

Scenario 4 is the situation where both the firm and the local official choose not to

comply with the rules, and the firm also chooses to relocate the investment for recovering

the severe expropriation. For the firm, the net profit C1 deducts the loss of property e

exploited by the local official, plus the extra benefits for evading the rules, deduct the

probability of being caught, and plus the benefit of exiting r. For the local official, the

bundle benefits C2 plus the benefits from exploitation, but deduct the loss of tax revenue

and the loss of other benefits as a consequence of the firm’s choice, the probability of

being caught and the cost of losing a valuable asset for the firm e.

A local official

A private firm

with an exit option

Cooperate

Defect

Cooperate

Scenario 1

, B

Scenario 2

, A

Defect

Scenario 3

Scenario 4

, C

Solution:

As a result, for the firm, scenario 3 is better than scenario 1 if the extra benefit for

evading the rules is bigger than the probability of being caught, and scenario 4 is better

than scenario 2 if the extra benefit for evading the rules is bigger than the probability of

being caught. The strategic choice made by the firm would be this:

scenario 3> scenario 1> scenario 4> scenario 2

For the local official, scenario 1 is worse than scenario 2 if the benefit from

exploitation for the firm is smaller than the probability of being caught plus the cost of

losing a valuable asset for the firm, and scenario 4 is worse than scenario 3 if the benefit

from exploitation for the firm is smaller than the probability of being caught plus the cost

of losing a valuable asset for the firm. The strategic choice made by the local official

would be this:

scenario 2> scenario 1> scenario 3> scenario 4

That is, if the cost of losing a valuable asset for the firm is sufficiently large, there

exists a pure strategy equilibrium in which the firm chooses to evade while the local

official abides by the rules, as scenario 3 demonstrates.

It is also likely that business transactions for this type of firm may be transparent

to the extent that it is difficult for them to evade the rules. Consequently, the extra benefit

for evading the rules is 0; so is the probability of being caught. Then, in addition to the

previous equilibrium, there is another pure strategy equilibrium in which both players

abide by the rules, as scenario 1 shows.

At any rate, both scenarios indicate the better property rights protection, which

addresses the commitment problem at the local level. The two games demonstrate that

firms’ characteristics affect the local officials’ behavior with regards to their treatment of

the private firms.

3.4 Data

The quality of data is a major challenge for studies on the political economy of

contemporary China since local officials can easily manipulate the statistics. In this study,

I rely upon two kinds of evidence. The first type of data comes from a nationwide survey

of private firms conducted in 2012 jointly by the All-China Federation of Industry and

Commerce (ACFIC), the State Administration of Industry and Commerce (SAIC), the

United Front Work Department (UFWD), and the Institute of Chinese Private Economy at

the Chinese Academy of Social Sciences (CASS). Appendix A discusses the survey in

detail and the potential weaknesses. The survey collected information on 4,747 firms

from thirty-one provinces. Since there are some missing responses for almost every

question, I kept only 3,397 observations in which data on basic financial indicators, such

as sales revenue and total number of employees, were available.

The second type of data we use is the media reports of government-related

property rights expropriation cases involving local officials and private firms, which were

collected from major news media in China. Appendix B provides more information on the

collection of cases in greater detail and the limitations of our cases.

3.5 Empirical Test and Research Design

In this section, I test hypotheses generated from the model by analyzing the data

of a nationwide survey of private firms in 2012. I first discuss the research design and

variables, and then I present the main empirical results.

Research Design

Before I precede the analyses of empirical evidence, I first discuss briefly my

main dependent variable—government-related property rights expropriation. Basically,

there are two types of predatory actions that may be taken by local political actors: direct

and indirect taking of property. Direct taking of property can take various forms, ranging

from outright nationalization on a sectoral basis to the seizure of land or a firm by the

government to outright confiscation of the property. In the case of China, indirect

expropriations are a common practice manipulated by local officials, which may involve

arbitrary fees and fines collected by local government, or “charitable contributions” to

government-sponsored projects (Nee and Opper 2012). In my statistical analysis of

firmlevel survey, I use arbitrary fees and fines collected by local government as a proxy

to measure the level of local political actors’ predatory actions. As for the media reports

of government-related property rights expropriation cases, the 279 expropriation cases I

documented between 1992 and 2010 are exclusively direct taking of property.

Following existing literature, I use one indicator to measure my dependent variable—the

level of local political actors’ predatory actions (Nee and Opper 2012).

First, I use the information on all sorts of arbitrary fees and fines collected by local

government in addition to taxes in 2011. Then I created a new variable coded as ratiofees,

which calculates the proportion of arbitrary fees and fines collected by local government

on firm’s total sales revenue. Arbitrary fees and fines is a perfect indicator of

government-related property rights expropriations because firms must pay these fees and

fines at the local level even though the central government has issued several orders to

stop them.

The key independent variable is the firm characteristics. What I am looking for is

the availability of exit option a firm has. The survey listed eighteen industry sectors and

asked firm owners what sector your firm’s business is in. The full list of industry sectors

in the survey includes agriculture such as farming, forestry, livestock husbandry, and

fishing, mining, manufacturing, energy such as electricity, gas, and water, construction,

transportation, information services, retail, hotel & restaurant, finance, real estate, rental

& commercial services, science & technology, public infrastructure, resident services,

education, public health, and culture & sports. There is one sector named others, which

means that firms are not clearly specified their business type in the survey thus I am not

able to identify the availability of exit option. Therefore, I omitted this sector in my study.

Also, it is worth noting that firms in manufacturing sector include both those have an exit

option and no exit option. Finally, I choose agriculture sector as the baseline category in

the model.

A host of control variables, mainly including economic conditions and variables

both at firm and entrepreneur levels, are also involved in the model (Dickson 2008). With

respect to economic conditions, I first use firm’s postcode to identify which province a

firm is in. Then I code the top ten GDP per capita provinces as a rich region and the

lowest 10 as a poor region according to the China Statistical Year Book of 2012. Finally, I

created the first dummy variable Region1 identifying whether a firm belongs to a rich

province (rich=1, otherwise=0). The second dummy Region2 was created to capture

whether a firm belongs to a poor province (poor=1, otherwise=0).

Firm-level variables include firm size measured by the total number of employees

in 2011, and the historical ties between the sample firm and the local government of its

locality measured by a binary variable indicating whether the firm was transformed from

an SOE.

At the entrepreneur level, I control for firm owners’ political backgrounds,

measured by Chinese Communist Party (CCP) and minor Democratic Party membership,

a binary variable indicating whether owners used to be public officials, and a dummy

variable indicating whether owners are legislative members including members of

People’s Congress and People’s Political Consultative Conference at both national and

local levels. I also control for entrepreneurs’ education attainment.

Table 3.3 provides a statistical summary for all variables.

an exit option. However, the firm with exit option is not that easy to classify because the costs will be take into account.

For example, a firm in manufacturing or hotel & restaurant sector may have an exit option but with heavy costs.

Therefore, I classified firms with an exit option only conditioned with slightly costs, such as firms in IT services. Those

with heavy costs fell into the third category.

Table 3.3 Statistical Description of Variables

Obs. Mean Std. Err. Min. Max.

Firm level

Ratio-fee

3784

0.0302384

0.2294989

11.76471

Arbitrary fees and fines

4031

66.44514

485.6483

19041

Total sales revenue in 2011

Numbers of employees in

4691

14271.65

134599.8

6761939

2011

4952

218.5971

1135.873

53000

Former SOE status

Entrepreneur level

4988

0.058741

0.2351628

Education

4980

3.949799

1.116389

CCP membership Democratic

party

4886

0.3401555

0.4738098

membership

4886

0.3964388

0.4892076

Legislative member

4835

0.422544

0.4940152

Former government official

4861

0.3953919

0.488985

Source: Survey on Privately Owned Enterprises in China, 2012 (see Appendix A) Note:

The unit for all financial variables is 10.000 RMB yuan.

Main Empirical Results

I employ a simple linear regression model to estimate the effects of firms’

characteristics on the level of local political actors’ predatory actions on firms’ property

rights. Table 3.4 presents main empirical results. Using the proportion of arbitrary fees

and fines collected by local government on firm’s total sales revenue as the dependent

variable, after controlling for economic conditions and firms’ and entrepreneurs’

backgrounds, I find the value of R-square is quiet low, suggesting arbitrary fees ad fines

are not that arbitrary as the public has perceived. However, two sectors indeed show some

unfair treatment with regards to arbitrary fees and fines. Mining and construction industry

has a significant and positive effect on the proportion of arbitrary fees and fines collected

by local government on firm’s total sales revenue, suggesting if a firm has no exit option,

then this firm had higher arbitrary fees and fines collected by local government. Mining

industry is clearly a resource-intensive sector and construction industry is a local market

attached sector. These two industries share the same feature of no exit option. A firm in

either these two sectors if choose to relocate its business will lose everything; therefore it

is more likely to be subjected to local political actors’ predatory actions.

Table 3.4 OLS Regression Results

The proportion of arbitrary fees on firm’s total sales revenue

Ratio-fees

Mining 2.3**

（0.022）

Manufacturing -0.82

（0.41）

Energy -0.12

（0.906）

Construction 2.28**

（0.023）

Transportation 0.39

（0.689）

Information service 0.19

（0.851）

Retail -0.41

（0.681）

Hotel & Restaurant 0.17

（0.867）

Finance -0.17

（0.865）

Real Estate 0.12

（0.904）

Rental & Commercial services 0.44

（0.658）

Science & Technology

0.03

（0.973）

Infrastructure

0.15

（0.878）

Resident services

-0.2

（0.843）

Education

-0.13

（0.896）

Health

-0.33

（0.741）

Culture & Sport

0.27

（0.79）

Region1

-1.03

(rich=1, other=0)

（0.305）

Region2

0.96

(poor=1, other=0)

（0.336）

Number of employees

0.01

（0.995）

Former SOE status

-0.54

(yes=1, no=0)

（0.589）

CCP membership

0.07

(yes=1, no=0)

（0.947）

Democratic Part membership

-0.8

(yes=1, no=0)

（0.426）

Legislative mebers

0.87

(yes=1, no=0)

（0.386）

Former officials

2.15**

(yes=1, no=0)

（0.032）

Education attainment

-2.71***

（0.007）

Constant

3.4***

（0.001）

3300

0.0097

F-value

1.23

Notes: p-values are in parentheses. *p < 0.10, **p < 0.05, ***p < 0.01

Among the control variables, firm owner’s political background has a significant

and positive effect on arbitrary fees and fines collected by local government. Firm

owner’s education attainment has a significant and negative effect on the proportion of

arbitrary fees and fines collected by local government on firm’s total sales revenue. This

means that if a firm owner’s education level is lower, then the firm had higher arbitrary

fees and fines collected by local government. In other words, the level of firm owner’s

education attainment affects local political actors’ predatory actions on its firms’ property

rights.

In general, the regression results confirm the theoretical predictions. The positive

correlation between the availability of firm’s exit option and the level of local political

actors’ predatory actions on this firm suggests firm’s characteristics have a far-reaching

influence on local political actors’ predatory behaviors. Since the firms without exit

option have no place to move out their business, this feature greatly weakens the private

firms’ post-entry bargaining power vis-à-vis local political actors and makes firms

vulnerable to the local officials’ predatory activities, and therefore need to rely on other

mechanisms, such as social networks or bribery, to overcome the commitment problem.

3.6 Analysis of Media Reports of Property Rights Expropriation Cases

This empirical investigation relies on media exposure of government-related

property rights expropriation cases involving local officials and private firms. I

documented a total of 279 cases based on news reports from major newspapers,

magazines and news portals in China. Appendix B discusses the collection of cases in

greater detail and the limitations of the cases.

That being said, the 279 cases we documented between 1992 and 2010 are

adequate to test the two hypotheses: (1) private firms with a high level of FSAs and an

exit option, such as labor-intensive, export-oriented manufacturing firms, and high

technology firms, enjoy sufficient property rights protection; and (2) private firms with a

low level of FSAs and no exit option, such as resource-intensive and local market seeking

firms are vulnerable as the targets of local officials’ predatory activities.

As table 3.5 shows, 243 out of 279 outright expropriation cases are in the energy

industry (including the coal industry, petroleum industry, and electrical power industry),

14 in real estate development, 14 in manufacturing industry, 4 in transportation and

construction, and 4 in the retail and service industry. A total of 92.12% of outright

expropriations are resource-intensive and local market seeking firms, a result confirming

my hypotheses.

Table 3.5 Media Exposure of Government-Related Property Rights Expropriations

Expropriation

Cases (%)

1988-1998

1999-2010

Energy Industry

243

(87.10%)

243

Real Estate Development

14 (5.02%)

Manufacturing

14 (5.02%)

Transportation and Construction

4 (1.43%)

Retail and Service

4 (1.43%)

Total

279

(100.00%)

271

Source: Compiled by author.

My cases also reveal that the number of government-related expropriations has

increased sharply in the natural resources sector after 1999. This may have something to

do with the national government’s change of policies toward the coal mining and oil

industries since the 1990s. Before 1999, both the central government and the various

provincial governments encouraged private investment in the coal mining and oil drilling

industries. Afterwards, the national government decided to take over or shut down small

mines and drilling firms in the name of mining safety or the restructuring of the oil

industry. The process of nationalization on these two natural resource sectors provided

opportunities for local governments to engage in direct expropriation or creeping

expropriation activities. As a result, a large number of property rights disputes has

stemed from the policy changes in coal mining and oil sectors.

Due to the nature of government-related property rights expropriation in the coal

mining and oil industries, I exclude the cases in the energy industry to test the hypotheses.

As shown in table 3.6, 38.89% of expropriation cases are in the manufacturing industry,

and a total of 61.11% of expropriations are resource-intensive and local market seeking

firms, again confirming our hypotheses.

Table 3.6 Media Exposure of Government-Related Property Rights Expropriations

(Without Energy Industry)

Expropriation

Cases (%)

1988-1998

1999-2010

Real Estate Development

14 (38.89%)

Manufacturing

14 (38.89%)

Transportation and Construction

4 (11.11%)

Retail and Service

4 (11.11%)

Total

(100.00%)

Source: Compiled by author.

With respect to the manufacturing firms, table 3.7 shows that 7 out of 14 cases

were “red-hat enterprises”, 4 involved privatizing SOEs or collective-owned enterprises

(COEs), and 3 were in the food industry. Among the food-manufacturing cases, one was

related to land acquisition, in which the local government used forced eviction to seize

the factory building for real estate development; and another involved the crackdown on

“organized crime” in Chongqing, in which the private entrepreneur was sentenced to

capital punishment with a penalty of 100 million RMB. Although these food firms can be

characterized as labor-intensive manufacturing firms, they are all local market seeking

with a low degree of FSAs. My cases show that there are no governmentrelated

appropriation cases involving labor-intensive, export-oriented manufacturing firms, and

high technology firms.

Table 3.7 Media Exposure of Government-Related Property Rights Expropriations

(Manufacturing Industry)

Expropriation

Cases (%)

Red-hat

7 (50%)

Restructuring SOEs or COEs

4 (28.57%)

Food Industry

3 (21.43%)

Total

14 (100.00%)

Source: Compiled by author.

Summarizing the cases of government-related property rights expropriation, it is

evident that labor-intensive, export-oriented manufacturing firms, and high technology

firms enjoy sufficient property rights protection, and resource-intensive and local market

seeking firms are vulnerable as targets of local officials’ predatory activities. Therefore,

the empirical evidence lends support to what I would expect from my model.

Interestingly, despite the external policy shock imposed on the mining and energy

industries, my cases still show that the number of government-related expropriations have

increased sharply after 1999, the turning point in the development of private property

rights, when the Constitutional Amendments affirmed the legal status of private

enterprises. The improvement in the legal status of private businesses does not seem to

offer sufficient protection of private property rights. This provides further evidence to

support my thesis that local political officials enjoy great leeway in choosing to abide by

the rules and implement the policies.

Another interesting phenomenon as shown in these cases is that compared to other

manufacturing firms, “red-hat” firms are most vulnerable in terms of property rights

protection. Indeed, it is easy for this type of private entrepreneur to get into a property

rights dispute with local governments. This happens as a consequence of the very nature

of this type of enterprise. They are private firms, but their owners disguised their private

ownership and registered as public-owned firms in the early years of market transition in

order to evade the “eight employees” restriction. After 1988, when businesses with more

than eight employees could be registered as private enterprise, many owners of the

“redhat” firms intended to take off the hat. But since the property rights of such firms

were vaguely defined, these owners often found themselves in dispute with local

governments.

The ownership change of manufacturing firms through the privatization of SOEs

and COEs also makes such firms vulnerable. The issue involved in this kind of property

rights dispute is the drain on state owned property. The process of privatization in China

was often accompanied by the drain on state assets because of the agency problem. The

local government may want to secretly privatize SOEs under its control or even

encourage spontaneous privatization (Qian 1996). Under such circumstances, local

officials can easily manipulate the value of the firm and its ownership structure, and

facilitate the illicit asset transfer of such enterprises (Smyth 2000). The problems in the

process of privatization of SOEs and COEs also set the stage for disputes over property

rights.

3.7 Conclusion

This study provides a game-theoretic model to study the political economy of

property rights in China, that is, a bargaining game between a firm and a local political

official following the literature of the Obsolescing Bargain Model. The model assumes

that local officials are potential predators and private firms are their prey. The predator

and prey interact strategically in the context in which the central government evaluates

the local officials on the basis of the cadre performance evaluation system.

I identify the mechanisms that may resolve the credible commitment problem. I

show how the incentive structure provided by the Cadre Evaluation System, together with

the firm-specific characteristics, results in a relatively stable condition for the protection

of property rights for private firms. While firms with strong post-entry bargaining power

enjoy a high level of credible commitment from the local government, weak firms are

vulnerable to the local political officials’ predatory activities, and therefore need to rely

on other mechanism, such as social networks (guanxi) or bribery, to overcome the

commitment problem. In particular, the availability of an exit option greatly enhances the

private firms’ post-entry bargaining power over local political actors in protecting their

property rights.

My model demonstrates that private firms without an exit option may find

themselves in a situation very much like a prisoner’s dilemma in the bargaining

relationship with local officials. Both the firm and the local official will choose the

dominant strategy that is to evade the rules in the one-shot game and end up in the worse

situation, where the firm tries to conceal real profits so that decreases the taxes it pays to

the government, and the local official tries to exploit the firm. The empirical tests both in

quantitative and qualitative study support the hypotheses generated from the model.

CHAPTER 4

THE CHINESE STYLE OF SECURE PROPERTY RIGHTS

This chapter explores the resources and constraints of local political officials created by

the incentive structure. According to the framework presented in Chapter 2, these

conditions will have an impact on local political officials’ behaviors in the bargaining

relationship with indigenous private investors in terms of property rights protection.

Then, I test the effects of different types of local political leaders on the security of

private property rights quantitatively.

The local political leaders protect private property rights when symbiosis between

local officials and private entrepreneurs is feasible. In this framework, the symbiotic

relationship between local political officials and private entrepreneurs creates conditions

similar to secure property rights at the local level. The degree of symbiotic relationship

between the local officials and indigenous private entrepreneurs determines the level of

private property rights protection. Lower transaction costs make symbiotic relationships

feasible, hence increasing the level of property rights protection. A native political leader

of a locality has lower transaction costs of symbiotic relationship, and therefore symbiotic

relationship between native local officials and local private firms is easier.

Using panel data covering detailed information for all political leaders in 21

prefecture-level cities in Guangdong province between 1992 and 2008, I test the

hypothesis and find a positive impact on the secure private property rights of native local

political leaders. 166 out of 201 political leaders at prefecture-level municipality are

native. By native, I mean those who were born in Guangdong province. Those who were

born outside Guangdong province are coded as rotated political leaders. Political leaders

include both the Party secretary (the first hand) and the Mayor of the municipal cities.

One common measure used to judge economic development and property rights is

Gross Domestic Product (GDP) growth rate or GDP per capita. GDP measurement may

be a good way to measure the overall economic performance but in an authoritarian

regime like China, it is not an accurate indicator to measure the development of private

economy, let alone the security of property rights. I use private investment in fixed assets

as an indicator to measure the security of property rights. This is a good proxy for the

security of property rights because this kind of investment requires significant immediate

costs with only the promise of future revenue. I collect a dataset on private investment in

fixed assets from 1992 to 2008 in 21 prefecture-level cities in Guangdong province.

To see if the main results and inferences are robust, I run two models and conduct

a robust regression. I also conducted the third model, which examines the effects of

nativity on the proportion of private investment in fixed assets on total investment in

fixed assets, and the results are even more robust. All of the findings suggest that having a

native political leader increase private investment substantially.

The remainder of this chapter is organized as follows. The next section sets out a

theoretical framework with a close examination of local political leaders’ characteristics

that guides the empirical analysis. Then I describe research design and the dataset.

Section 4 presents the main empirical results. Section 4 provides robustness checks.

Section 5 concludes with a summary of the study.

4.1 The Theoretical Framework

As Chapter 3 has shown, local political leaders’ decision of whether or not prey on

private sector is determined by firm’s resources and constraints. Meanwhile, as discussed

in Chapter 2, local officials are also under strict constraints within the personnel control

systems such as the Cadre Evaluation System (CES), the term limits system, and the

rotation system. If the local official is near 55, or less educated, or no political

connections, he/she will desperately need private sector’s support for his/her political

survival. This symbiotic relationship between less favorable to be promoted local political

officials and private entrepreneurs creates conditions similar to secure property rights at

the local level. The degree of symbiotic relationship between the local officials and

indigenous private entrepreneurs determines the level of private property rights

protection.

Native local officials have lower transaction costs and therefore symbiotic

relationship between native local officials and local private firms is easier. Compare to

rotated local leaders, native local political leaders have more incentives to protect private

property rights in order to get political and economic benefits as well as none material

rewards.

Those local officials who are native face different social constraints from those

rotated leaders. First, for native prefecture-level officials, they had crafted broad and

complex personal webs long before they came to this position from a county or township

level position. Some native local political leaders just don’t want to be promoted to a

higher rank if that position does not have real authority to utilize resources. As a result,

they will promote local economy in order to get economic interests, whether for their

family businesses or direct money transfers from local firms. They may provide the

public good of localized property rights protection so that they could get closer

connections with local economic elites for their own economic interests.

Second, since the loyalty-based long term relationships and regional affinity are

crucial in establishing political connections, those native local political leaders who do

not have connections but want to be promoted have to establish a new political

connection with provincial leaders. The development of the private sector will serve two

purposes for native local political leaders. On the one hand, the good performance of

local private economy proves their ability to promote local economic growth. On the

other hand, native local political leaders depend on the development of private economy

because what they have for exchange is local economic resources. They will rely on local

private firms to provide economic resources to achieve their goal of being promoted.

Third, from the perspective of local economic actors, market-oriented policy and

2007 law of property rights are clear signal regarding the central authority’s commitment

for the development of private economy. But occasional “left” and “right” ideological

swing and no independent judicial system could not make that commitment credible in

terms of property rights protection. Predatory activities may come from both public and

private actors. Having a native local political leader will be an assurance of property

rights protection because they are weak in comparison to rotated officials. Defective

behaviors and opportunism will cost them much politically, economically and socially. In

the worst scenario, for local private entrepreneurs it is much easier to utilize punishment

to native political leaders rather than rotated ones, as their tenure normally is less than

three years, on average, for local mayors. The ability of retaliation by local private

entrepreneurs creates stable conditions of property rights protection at the local level and

hence influences private entrepreneurs’ investment decisions.

Finally, local protectionism can be seen as a bad thing in the view of the central

government or provincial government in terms of central coordination, policy

compliances, and destructive local autonomy. It is true that this is the very reason behind

the introduction of term limits and the rotation system by the central government.

However, for indigenous private entrepreneurs, this is one source that helps to overcome

the commitment problem and becomes an assurance of protection for their investment.

In sum, for any local official, he/she cares about his/her own payoff that includes

his/her wages and potential transfers from the local firms, money or favors. But those

local officials who are native are more likely to protect private property rights since their

political and economic interests are intertwined more closely with the private

entrepreneurs. The credible threats of retaliation to potential predatory activities by local

indigenous private entrepreneurs creates stable conditions of property rights protection at

local level and hence encourages private investment and economic development.

As discussed in Chapter 2, I argue that those local political leaders who are native

are more likely to protect private property rights since the interests of local political

actors and economic actors are intertwined closely. Native political leaders have less

chance to be promoted and have more incentives to protect private investment in order to

get political support as well as economic benefits.

Players

Before formalizing the symbiosis logic of secure property rights, I identify the

players and their preferences as follows. There are three players in the local economy,

Government (G) is the principal, the local political official serves (S) as the supervisor

and the Private entrepreneur (P) is the agent. In the context of China, I identify political

actors as local political leaders, economic actors as indigenous private entrepreneurs, and

government includes central and local.

Preferences

I make an extremely simple assumption that the goal of the government and

political actors may not be the same. Government (G), both central and local, cares about

tax revenue. The primary and foremost concern of local political leaders (S) is to stay in

an office and being promoted to a higher rank. But the ultimate goal of local political

leaders is to acquire more wealth and secure their possessions. In other words, the pursuit

of political power is the means to achieve the end (wealth acquisition). For the indigenous

private entrepreneur (P), what he/she wants is not only to maximize profit but also to

secure their property rights. For the later goal, economic actors are willing to pay the

costs (Cp) as long as they expect some positive level of profits in compensation.

G cares about tax revenue (t).

S cares about his own payoff, which includes his wages (w) and potential transfers

from the Firms (Ts).

P cares about maximizing its own profits (r) while minimizing costs (c).

The second assumption I make is that indigenous private entrepreneurs do not

necessarily demand efficient property rights. In fact, it is not clear that an individual

private entrepreneur should always demand that the government protect everyone’s

property rights. According to Haber et al. (2003), an indigenous private entrepreneur can

receive utility from the secure and efficient property rights, because this makes her asset

more liquid, and therefore more valuable. However, if selective enforcement grants the

indigenous private entrepreneur more comparative advantage in the market, then it may

be more profitable to demand less than universal enforcement. Between these two

possibilities, it is assumed that indigenous private entrepreneurs care first and foremost

about their own property rights. Any profit-maximizing actor would readily accept the

exclusive protection of her property rights, providing that it produced better benefits to

that actor.

Finally, it is assumed that there exist information asymmetries between the

government, local political leaders, and economic actors. In other words, the activities of

local political leaders and economic actors cannot be observed by the government, and

indigenous private entrepreneurs cannot perfectly monitor the impact of the government’s

actions or policies upon their property rights.

The Costs of Secure Property Rights (Cp)

Producer (P) chooses whether or not to invest with anticipated tax rate t ≥ 0, and

expected revenue r > c >0，where r is the revenue, c the cost, and t the tax rate. To make

an investment, P needs to get connected with S to protect its property. The costs of

property rights are tolerated as long as P expects some positive level of profits in

compensation (ep). This expected compensation can be a tax discount or special market

access. To sum up,

1. Producer (P) choose whether or not to invest with anticipated tax rate t ≥ 0; r

> c > 0

2. Government (G) sets tax rate t, 0 ≤ t ≤ 1

3. Game ends with payoffs:

G: t • r

S: w + Ts

protection for her investment or not to do so. The profit for not getting connected is r-trc>

0 with the risk of being predated k. The profit for getting connected is r-tr-c-Cp+ep>0

with property protection. Parameters r and tr are known to S and P but cannot be

observed by G. To lower the risk of predation, P needs to get connected with S to get

property protection. I assume that P cannot get connected with G for property protection.

(In the real world, it is impossible to get connected with the central government and local

government because under authoritarian rule it is almost impossible to access the

government through formal institutions. In other words, it is much easier to access the

government through political actors). This assumption can be relaxed by assuming that it

is very costly to reach G for protection.

To secure property rights, P and S can cooperate by signing a contract.* In

cooperation, P pays S. However, they face some transaction costs to agree with this

arrangement. I assume that S can get part of Ts = iCp where 0≤i≤1and (1-i) Cp, which

indicates the transaction costs of symbiotic relationship.

In this context, the wage of S is a constant w. When S failed in political struggles,

she/he loses her/his wage w. The probability of being punished is mnp, where m denotes

the failure probability in political struggle and n denotes the detection probability.

if investment not made

For any potential investment,

can choose to get connected with

to get

–

)

–

if investment made

Investment Decision

For any potential investment, P can choose whether or not to invest with an

anticipated tax rate t ≥ 0. She can also choose to get connected with S to get protection

for her investment.

If she chooses not to get connected, her problem is as follows:

r-tr-c> 0 with the risk of being predated k. (1)

If she chooses to get connected, her problems become as follows:

r-tr-c-Cp+ep > 0 (2)

subject to the participation constraint of S:

Ts =iCp≥ mnpw (3)

Thus,

ep-Cp≥ mnpwi (4)

In the current framework, a symbiotic relationship is more likely for higher i and

thus the private investment growth rates are higher for higher i. This can be seen from

equation (4), as the right-hand side is decreasing in i. This simple framework generates

the main hypothesis regarding the symbiotic property protection and I will test with data

as follows.

Hypothesis: Symbiotic relationship between political and economic actors at the

local level is more likely to happen when local political officials are native and

hence the private investment growth rates are higher.

4.2 Research Design

To assess the determinants of property rights protection, the general model tested

is Private investment

= f Nativity

+ 92Private

+ 92Total

+ Region

+ Education

+ Edu1

+ Firstjob

+ Partyschool

+ Age

+ Error term

Dependent Variable

Private investment is my dependent variable and an indicator of property rights

protection. I use private investment in fixed assets as an indicator to measure the security

of property rights. This is a good proxy for secure property rights because this kind of

private investment requires significant immediate costs with only promises of future

revenue. I also created a new variable coded as ratio-private, which calculates the

proportion of private investment in fixed assets on total investment in fixed assets to

gauge the level of private property rights protection in a locality.

One common measure used to judge economic development and property rights is

GDP growth rate and GDP per capita (Liu et al. 2012). GDP measurement may be a good

way to measure the overall economic performance but is not a good indicator to measure

the security of property rights. Scholars argue that China’s economic development largely

relies on large-scale investment to facilitate high GDP growth rate. Investment can be

categorized into two types, that concerning infrastructure and real estate properties, and

that in corporate development. The high GDP growth rate does not necessarily indicate

the growth rate of private investment because this investment-led growth shows the large

part of investment are government fund infrastructure projects and real estate properties

rather than private investment. It may well be the case that the cities with higher

economic growth rates had received more economic resources from higher authorities or

borrowed money from state-owned banks to finance infrastructure projects.

Despite the contribution of previous studies, the common problem in these

empirical studies is the GDP measurement as an indicator of property rights protection.

GDP growth rate or GDP per capita does not necessarily mean the development of private

economy or the security of property rights for several reasons. First, before 1978, private

economy was strictly forbidden. Anyone who did private business would be severely

punished including being arrested and persecuted. The major contribution of GDP was

from the state sector. Between 1978 and 1988, the private sector was not allowed

officially except “individual entrepreneurs” (getihu) doing small business with less than

eight employees. This is why other literature places more emphasis on the informal and

coping strategies of the private entrepreneurs or local officials to get around the

restrictions imposed by the unfavorable formal institutions, such as disguising their

operations as collective enterprises or foreign firms in order to protect themselves (Tsai

2007; Oi and Walder 1999; Sull 2005). The 1988 regulations allowed businesses with

more than eight employees to be registered as “private enterprise” (siying qiye), but it was

only after the introduction of the Company Law in 1993 that paved the way to the rapid

development in private sector during the 1990’s. Therefore, any empirical study on the

development of private economy and property rights in China using GDP measurement

does not distinguish these three time periods will distort the picture.

Second, China is a mixed-market economy in which the state sector still plays an

important role. For example, in 2010, the private investment in fixed assets made 13.7%

of Guangdong province’s total investment in fixed assets. After including the investment

of self-employed individuals, other limited liability and share holding firms, all four kinds

of investment made 45.83% of total investment in fixed assets.

Finally, under the cadre rotation system and political officials’ relatively short

tenure in one position before promotion or rotation (less than three years, on average, for

local mayors), local officials are under enormous pressure to show their ability to produce

economic growth quickly. One way of generating quick economic growth is to borrow

money from banks to finance massive infrastructure projects. The typical way is by

selling land or using land as collateral to borrow large sums of money from state-owned

banks. The abusive land requisitions and forced evictions caused by local “land finance”

have produced great grievances among rural peasants, urban dwellers, and small business

owners. The worst example is the Chongqing model, where GDP growth rate is high and

property rights violence prevalent. During Bo Xilai’s tenure, his administration borrowed

the equivalent of more than 50% of local GDP to finance the construction projects. At the

same period, many private entrepreneurs were imprisoned and billions in private

properties were confiscated in the name of the campaign “signing red songs and

crackdown black gangs” (Changhongdahei) (Pei 2012).

Because GDP measurement is not an accurate indicator to measure the

development of private economy and the security of property rights, I use private

investment in fixed assets as an indicator to measure the security of property rights. This

is a good proxy for the security of property rights because this kind of investment

requires significant risk with only promises of future revenue in an authoritarian regime. I

collect a dataset on private investment in fixed assets from 1992 to 2008 in 21

prefecturelevel cities in Guangdong province.

Explanatory Variable

I explore the degree of symbiotic relationship between political and economic

actors by examining the biographical information of the prefecture level political leaders

in 21 municipality cities in Guangdong province. These local political leaders include

111 mayors and 92 party secretaries. I trace the careers of all the 203 political leaders of

21 municipalities between 1992 and 2008. I proxy the transaction costs of symbiotic

relationship by whether the top leaders of prefecture-level cities are native and create one

dummy variable nativity. Nativity identifies whether a mayor or party secretary was born

in Guangdong province, which takes a value of 1, otherwise its value is 0. Once a

municipality had local political leaders who were born in Guangdong province, the

chances were high that the leaders would have close ties to local economic actors and

face more strict social constraints; therefore, they were more likely to protect property

rights. In contrast, rotated local political leaders would have close ties to the higher

authorities so that they would lack the incentives to protect the private property rights.

Thus, the dummy variable I constructed would have a positive effect on the dependent

variables.

Control Variables

A host of control variables are also involved in my model. I include initial

economic variables, geographical variables, and some socioeconomic variables.

According to the literature, initial economic conditions will have positive effects on

economic development (Solow 1956). In the model with the private investment in fixed

assets from 1992 to 2008 as the dependent variable, I control private investment in fixed

assets in 1992 and total investment in fixed assets in 1992.

With respect to geographical variables, I create a dummy variable region (PRD=1,

other=0) identifying whether a municipality belongs to Pearl River Delta (PRD) region,

Eastern coast, Western coast, or Mountain area. This dummy variable is to control the

location advantage of a municipality and the effects PRD on the economic growth of a

municipality.

I create five dummy variables in order to control socioeconomic factors that may

have impacts on the dependent variable. One is education (education in Guangdong=1,

otherwise=0). This variable is created to catch the phenomenon of those local leaders who

were not born in Guangdong province but pursued their higher education in Guangdong.

According to the literature of social connections, locality of origin, classmates, and job-

related colleagues are common ways to establish social networks in China (Guo 2001;

Luo 2007). Therefore, those rotated political leaders who studies in Guangdong would

have established close ties to local elites. I also created a dummy variable edu1 (college

degree=1, otherwise=0) to control local political leaders’ education attainment as an

indicator for individual human capital.

Likewise, the dummy variable (first job in Guangdong=1, otherwise=0) is to

control job-related social networks. And party school experience (Yes=1, No=0) is to

detect the common practice where local political leaders strive to establish new political

connections with higher officials during their study in party schools since the party school

is the best place to meet other political leaders. Finally, I created a dummy variable age to

control local political leaders age effect on their behaviors.

4.3 Data

I collected a dataset on private investment growth rate, the prefecture-level of

political leaders for 21 municipality cities in Guangdong province between 1992 and

2008. I focus on Guangdong province because Guangdong province is one of the most

prosperous in China with the highest GDP among all the provinces, but the disparity

within the province is larger than between provinces.

There are 21 municipality cities in Guangdong province, 9 in PRD region, 4 in

eastern coast, 3 in western coast, and 5 in mountain areas. A prefecture-level municipality

is subject to the jurisdiction of a provincial government, and directly controls some urban

districts while overseeing some counties or smaller cities on behalf of the provincial

government.

The data used in this paper comes from two primary sources: First, the data of

private investment in fixed assets between 1992 and 2008 come from Guangdong

Statistical Yearbook. It is worth noting that the data of the Yunfu municipality only covers

from 1996 to 2008 because Yunfu was a newly created prefecture-level city in

1996.

Second, the data and CVs on 203 municipality’s leaders between 1992 and 2008

come from government website of Guangdong province, People’s Daily online, and

municipality newspapers. Information on two mayors and one party secretary are missing

in this dataset. Table 4.1 presents a descriptive statistics of variables.

As shown in Table 4.1, the average length in office of prefectural level officials is

round 3 years. The average age is 51.5 years old, where the youngest local leader is at 38;

and the oldest at 66. The average of private investment in fixed assets is around 14.63

(1.463 billon RMB Yuan); the average of total investment in fixed assets is around 206.55

(20.655 billon RMB Yuan). The average ratio private investment on total investment is

0.147, which means the average percentage of private investment on total investment is

14.7%.

Table 4.1 Statistical Description of Variables

Variables Obs Mean Std. Dev. Min Max

Tenure

197

3.395939

1.891329

Age

599

51.50918

4.919027

Private investment

664

14.62557

11.11922

0.19

71.86

Total investment

665

206.5487

312.5168

7.19

2101.45

Nativity

657

0.8219178

0.3828734

Region

666

0.4324324

0.4957859

Education

413

0.748184

0.4345825

attainment

590

0.5

0.5004243

First job

532

0.862782

0.3444012

Party school

519

0.5722543

0.4952291

Ratio-private

663

0.1474508

0.1012198

0.0001476

0.4584749

Source: Compiled by author.

Note: The unit for all financial variables is 100.000.000 RMB yuan.

As a comparison, Table 4.2 and Table 4.3 present descriptive statistics on native

local officials and rotated officials. The average length in office is very close for native

mayors or the Party secretaries and rotated ones, around 3 years. The average age is also

very close for native local political leaders and rotated ones, around 51 years old.

The average of private investment in fixed assets between 1992 and 2008 is 15.13

(1.513 billion RMB Yuan) for places where have native officials, but 12.70 (1.27 billion

RMB Yuan) for rotated officials. The municipality cities with native political leaders have

higher private investment than the cities with rotated leader about 20%. In contrast, the

average of total investment in the cities with rotated leaders is 454.41 (45.441 billion

RMB Yuan), but it is only 154.61 (15.461 billion RMB Yuan) with native leader, which is

higher almost 3 times.

Table 4.2 Statistical Description of Variables on Native Prefecture-level Political Leaders

Obs Mean

Std. Dev. Min Max

Tenure

153

3.529412

1.970369

Age

482

51.66805

4.974966

Private investment

540

15.13476

11.31886

0.32

71.86

Total investment

539

154.6141

211.6711

7.19

1687.11

Nativity

540

Region

540

0.3685185

0.4828503

Education

306

0.8823529

0.3227175

Education

attainment

476

0.4390756

0.4967965

First job

421

0.9714964

0.1666044

Party school

405

0.6049383

0.4894686

Ratio-private 539 0.1615698 0.1004819 0.004481 0.4584749

Source: Compiled by author.

Note: The unit for all financial variables is 100.000.000 RMB yuan.

Table 4.3 Statistical Description of Variables on Rotated Prefecture-level Political

Leaders

Obs Mean Std. Dev. Min Max

Tenure

3.076923

1.528408

Age

117

50.8547

4.644732

Private investment

115

12.6973

10.01239

0.19

68.39

Total investment

117

454.41

524.4573

16.21

2101.45

Nativity

117

Region

117

0.7008547

0.459853

Education

107

0.364486

0.4835506

attainment

114

0.754386

0.4323511

First job

111

0.4504505

0.4997952

Party school

114

0.4561404

0.5002716

Ratio-private

115

0.0841656

0.0808905

0.0001476

0.4017234

Source: Compiled by author.

Note: The unit for all financial variables is 100.000.000 RMB yuan.

It is worth noting that the average proportion of private investment in fixed assets

on total investment in cities with native political leaders is 16.16%, but in cities with

rotated political leaders is only 8.4%. All these figures suggest that the prefectural cities

with rotated political leaders have lower private investment but much higher total

investment.

4.4 Main Empirical Results

The estimation results are presented in Table 4.4. I first estimate the correlation

coefficients between the dependent variable and the independent variable. In model 1,

the dependent variable nativity has a positive (2.14) and significant (P<0.033) effect on

private investment, which is consistent with the theoretical expectation.

Table 4.4 OLS Regression Results

Dependent variable: Private investment Ratio-private

Model 1 Model 2 Model 3

Nativity

2.14*

3.33***

3.97***

(native=1, other=0)

(0.033)

(0.001)

(0.000)

92private

6.72***

3.8***

(0.000)

92total

-3.38***

-4.91***

(0.001)

(0.000)

Region

0.17

-7.3***

(0.862)

(0.000)

Education

-1.04

1.36

(Guangdong=1, other=0)

(0.301)

(0.174)

Education attainment

3.94***

0.67

(college=1, other=0)

(0.000)

(0.503)

Firstjob

-0.85

-4.69***

(Guangdong=1, other=0)

(0.398)

(0.000)

Partyschool

2.92**

1.58

(yes=1, no=0)

(0.004)

(0.114)

Age

0.88

-2.04*

(0.381)

(0.042)

Constant

12.26

-0.16

5.25***

0.000

(0.874)

(0.000)

655

353

352

0.007

0.2184

0.4794

F-value

4.57

10.65

P-values are in parentheses.

*p < 0.05, **p < 0.01, ***p < 0.001

In model 2, after controlling for the initial economic variables, geographical

features, and socioeconomic factors, we can see that the correlation coefficient between

private investment and nativity is positive (3.33) and highly significant (P<0.001),

indicating that having a native political leader has positive effect on private investment in

fixed assets. In other words, if a city has a native political leader, then this city has higher

private investment, suggesting private firms in this city enjoys better property rights

protection.

Among the control variables, the initial economic conditions have a significant

effect on private investment. But what is interesting is that private investment in 1992 has

a positive effect whereas total investment in 1992 has a negative effect on private

investment. As for socioeconomic variables, the coefficient of education is insignificant;

suggesting whether a local political leader studied in Guangdong did not affect private

investment. However, the level of education attainment has a positive effect on private

investment. Also, party school experience has a positive and significant effect on private

investment. Those local political leaders who have higher education and those who have

party school experience promote local private economy. The geographical variable has no

significant effect, which indicates that whether a city is in PRD, east coast, west coast, or

mountain areas is not important to private investment in Guangdong province.

Overall, the regression results are very consistent to my theoretical prediction.

Native local political leaders are more likely to protect private property rights and hence

encourage local private economy. Since the native political leaders in the province had

more close ties with local economic elites, they would have more incentives to promote

the development of private economy.

4.5 Robust Test

I ran the third model, where the independent variable is ration-private, the

proportion of private investment in fixed assets on total investment in fixed assets. The

results are even more robust. The correlation coefficient between private investment and

nativity is positive (3.97) and highly significant (P<0.000), indicating that having a native

political leader has strong positive effect on private investment. However, there are

different results between the model 2 and the model 3 among the control variables. First,

the level of education has a positive effect on private investment, but has no effect on the

ratio private investment. Second, those leaders who had their first job in Guangdong have

no effect on private investment, but have a negative effect on the ratio private investment.

Third, party school experience has a positive and significant effect on private investment,

but has no effect on ration private investment. Finally, local political leaders’ age has no

effect on private investment, but has a slightly negative effect on ratio private investment.

To see if the above results and inferences are robust, I ran two models. Comparing

model 1 and model 2, we find that they are similar in terms of the effects of the

independent variables and explanation power indicating that the relationship between

property rights protection and nativity of local political leaders are stable and my

specification are robust. I also conducted the third model, which examines the effects of

nativity on the ratio private investment and the results are even more robust. All of the

findings confirm the theoretical prediction that having native local political leaders

increase private investment substantially.

4.6 Conclusion

My study tries to explore the micro-foundations of the credible commitment logic

by formalizing symbiotic logic in property rights protection and provides some empirical

evidence for it. I have shown that when there were no credible commitment to protect

property rights, native local political leaders had incentives of supporting local private

entrepreneurship for political, economic, and reputation building. Indigenous local private

entrepreneurs were more likely to invest in the localities with native local political leaders

because in a small community with dense social connections they could monitor the

potential predatory activities and provide credible threats of retaliation. The transaction

costs in the symbiotic relationship between native local political leaders and indigenous

private entrepreneurs are low, and therefore this relationship is more likely to happen. The

interactions between political and economic actors created conditions similar to secure

property rights, and hence encouraged the development of private economy. Though

property rights protection afforded by this logic is unstable and localized, in places where

secure and efficient property rights are missing, this mechanism has been effective in

fostering local economic development.

Two main challenges for this study are measurement and data quality. For the

challenge of measurement, I used private investment as an indicator to measure the

security of property rights. This is a better proxy than GDP measurement since this kind

of investment bears considerable risks with only promises of future revenue whereas

GDP growth may not require the commitment to protect private property rights, as long

as the local leaders could gain economic resources for higher authorities or state-owned

financial institutions.

Data quality is a common concern to any study on contemporary China. I test the

hypothesis of the model using various sources of data: biographies of local political

leaders, statistical yearbooks, and the media reports. Empirical results I tested in this

paper are consistent with the theoretical prediction. All the findings suggest having native

local political leaders promoted a substantially higher level of private investment. While

my study focuses on Guangdong province, the symbiotic logic can apply to other

provinces as well.

CHAPTER 5

LOCAL INDUSTRY POLICYMAKING AS A SOURCE OF PROPERTY RIGHTS

A Case Study of B&B Industry Policymaking in Xiamen

This chapter provides a case study of local B&B industry policymaking that further

support the second hypothesis generated from the model—the bargaining game between

private investors and local officials, presented in Chapter 2. It shows how different types

of local officials make very different local industry policy choices under the same

incentive structure, and, therefore, create a condition that allows for property rights

protection or expropriation.

A large body of literature has attributed China’s economic miracle to the direct

consequences of fiscal and political institutions rather than economic institutions such as

the property rights regime. Growth-driven activities pursued by local governments or

local officials were directly shaped by incentive structures, such as fiscal arrangement and

cadre performance evaluation system, designed by the central government. But the

incentive structure itself cannot explain different behaviors of local governments, ranging

from developmental, corporatists, entrepreneurial, and predatory, which led to variations

in local economic performance.

Local industry policymaking has been treated as the local states’ or local officials’

rational response to a problem, a simple strategic action to faction power struggles, or

muddling through bureaucratic politics decision-making. The role local officials play in

the local industry policy initiatives and policymaking and its effects on property rights is

not clear. Local officials may pursue very diverse industry policy choices in accordance

with the conditions and constraints placed on them. As Chapter 2 and Chapter 4 have

shown, personal characteristics of local officials under the same institutional setting as the

Cadre Evaluation System (CES) create advantages and constraints, which influence local

officials’ behaviors toward private property rights in order to achieve their career

concerns and monetary interests.

My theory argues that native local officials are more likely to respond to their local

“support” constituency’s interests in local policy making than transferred/rotated officials,

especially those who transferred from the central agencies. Whether or not local state

becomes predatory or developmental depends on what types of key local officials and

whether they are native or have been rotated/transferred from outside that locality.

Compared with native local officials, the rotated/transferred local officials tend to be

predatory to private property rights regardless of their orientations toward economic

growth as a result of the cadre performance evaluation system.

In addition to the empirical test in Chapter 4, this chapter further provides the

support by examining the role of different types of local officials in local industry

policymaking or initiative and policy changes. Taking policy changes of B&B industry in

Xiamen as an example, this chapter shows that under the current institutional

arrangements, local leaders possess a great deal of autonomy over local industry policy

making thus allowing them to pursue their own preferences, and political and economic

interests strategically in dealing with private sector. As a result, individual local officials

rather than the governments (central or local) become a major source of uncertainty for

private property rights in China even though the central government enacted the Property

Rights Law in 2005.

This chapter attempts to answer the following questions: Why and how the local

industry policy on B&B business has been made? Why is there a dramatic change in local

industry policy toward B&B business in Gulangyu? Why the change of local industry

policy is possible? How was this policy change implemented?

The case study constitutes four sections. The first section introduces the

development of the B&B sector in Xiamen. The second section demonstrates policy

change of B&B industry and shows that the problem of “doing business without license”

and “fine and detention of B&B owners” are direct consequences of local industry policy

changes. The third section presents how and why two contradictory local industry policies

took place, the logics behind such changes, and their outcomes. The fourth concludes.

5.1 The Development of the Bed & Breakfast Industry in Gulangyu, Xiamen

The bed-and-breakfast (B&B) business has been increasing dramatically throughout

the world. In China, the B&B industry emerged as a new phenomenon in the late 1990s

with the development of domestic tourism. Like elsewhere, the nature of B&B business

has resulted in a great variety of establishments, as well as what constitutes a B&B (Jones

& Guan 2011). In the most cases, a B&B often refers to a homestay, or a “family hotel”

(an English translation of the Chinese name 家庭旅馆) as it is often an owner-occupied

private home with a number of guest rooms. But increasingly, more and more Chinese

B&B hostels are under the operation of private entrepreneurs who are not owners but

entered the business through investing private capital. In either case, the B&B presents a

great opportunity for the growth of entrepreneurship in China. In this study, I use the term

B&B hostel that includes both owner-occupied “family hotels” and non-owner invested

inns or lodges.

B&B hostels in China are usually located around famous scenic spots or attractive

tourism destinations, and achieved great success (Zheng & Li 2007; Lu 2007). In general,

local government encouraged residents to operate B&B businesses to relieve the stress on

tourist accommodation and to facilitate local economic development. But as the case of

the Gulangyu B&B industry shows, local political leaders’ attitudes toward B&B industry

are very different and hence affect their policy choices on the industry’s development and

private investment.

The hotel business has been categorized as a special sector in China. Theoretically

speaking, anyone who wants to enter the hotel business should apply for a special permit

after the facility meets several requirements set by different government agencies. The

process of so-called “six licenses” of a B&B hostel takes at least six months to complete.

As a result, most B&B owners started their investment for the business when they got the

first permission from the local sub-district government. Table 5.1 shows the application

process of a B&B hostel in Gulangyu, Xiamen.

Table 5.1 The Process of Six-License Application for a B&B Hostel in Xiamen

A. Pre-permission from Gulangyu sub-district government

B. Permission from GSMC (beginning in May 2010)

1. License 1—Fire Certificate from Siming district Fire department

2. License 2—Special Sector Permission from Siming district police station

3. License 3—Industry and Commerce Business License from Siming district Administration of

Industry and Commerce

4. License 4—Tax Certificate

5. License 5—Sanitary Certificate

6. License 6—Environmental Protection Certificate

Source: Cai Changchun, “Gualngyu Shengyi zhongde Minzi ‘Ermeng’” [Private

Investment’s ‘Nightmare’ in Gulangyu’s World Heritage Application Process],

Fazhizhoume [Rule by Law Weekend], 09-04-2013.

Gulangyu is an island off the southwest coast of Xiamen city, which is an old port

city in Fujian province in southern China and has been one of five Special Economic

Zones (SEZs) since 1980. As a place of residence for Westerners during the China’s

colonial past, it is famous for its colonial architecture and for hosting more than 600

pianos, giving it the nickname of “Piano Island.” The island is on China’s top list of

National Scenic Spots and is one of the most popular domestic tourist destinations.

Administratively, it forms Gulangyu sub-district of Xiamen’s Siming district

government. However, the island is also under the administrative guidance of

GulangyuWanshi Scenic Management Committee (GSMC) that is directly controlled by

Xiamen government. Table 5.2 shows this unique nature of administrative system.

Table 5.2 The “Duel Administrative System” of Gulangyu

Source of Table 5.2: “The brief introduction of Gulangyu-Wanshi Scenic Management

Committee,” at

http://www.gly.cn/zhfxxgk/zhfxxgkml/index.htm?u=/zhfxxgk/zhfxxgkml/gwhgk/index.ht

Siming district

Government

license

, 2, 3, 4, 5,

Gulangyu

Wanshi

Scenic Management

Committee (GSMC)

permission

beginning in

May 2010

Gulangyu sub

district

pre

(

permission)

B&B

Hostels

Xiamen government

GSMC enjoys equal power but shares different administrative responsibilities with

Siming district government in the hierarchical government structure. This arrangement

can be traced back to 2003 when Gulangyu was originally a district of Xiamen but

dissolved and transferred its partial administrative power to Siming district. Under this

dual administrative system, the GSMC is responsible for Gulangyu’s scenic regulation,

preservation, construction and management while Gulangyu sub-district government is

responsible for the residents of the island.

The so-called “duel administrative system” has been cited as a factor that affects the

development of Guangyu B&B industry (Huang 2013). However, as this essay will show

it is local political leaders’ personal policy choices, which determined the change of B&B

industry policy, and hence affected the private property rights.

Xiamen’s first private owned hostel emerged in the late 1980’s in Gulangyu. In 2006,

the first B&B hostel started business when the former German counselor’s building was

renovated and transformed into a B&B hostel. But it was only after the pass of the

“Regulations on Gulangyu B&B Industry (Trial)” in 2008 that the industry began to

develop rapidly. There were only six B&B hostels in 2008. As of 2013, privately owned

B&B hostels have increased to almost four hundred. Figure 5.1 shows the number of

B&B in Gulangyu between 2006 and 2013.

However, of the 400 B&B hostels only 126 are fully licensed. Another 130 B&B

hostels are at various stages of the six-licenses application process. The remaining 100 or

so hostels are operating without any license. Although 130 hostels only have partial

license they still pay all relevant taxes and fees, and received the “proof of temporary tax

payment” from relevant local governmental agencies. Figure 5.2 demonstrates the

distribution of licensed B&B hostels in Gulangyu by 2013.

Figure 5.1 The Number of Bed & Breakfast Hostels in Gulangyu from 2006 to 2013

Source: Cai Changchun, “Gualngyu Shengyi zhongde Minzi ‘Ermeng’” [Private

Investment’s ‘Nightmare’ in Gulangyu’s World Heritage Application Process],

Fazhizhoume [Rule by Law Weekend], 09-04-2013, and Xu Yixin, “Gulangyu B&Bs

(in Chinese).” The Summit Forum for the Development of B&Bs Across the Strait,

September, 2014.

5.2 The Change of Local Policy on Gulangyu B&B Industry

With the rapid development of B&B industry in Gulangyu, the local government

faced great challenges in managing the fast growing number of tourists and B&B hostels,

particularly in regulating the market, and providing public goods. In response to these

challenges, local government added extra procedures as a way of managing the B&B

industry in Gulangyu in May 2010. In other words, any one who wants to start a B&B

business should get approval from GSMC in addition to the six licenses in May 2010.

100

152

206

300

100

150

200

250

300

350

2006

2007

2008

2009

2010

2011

2012

2013

Figure 5.2 The Distribution of Licensed B&B Hostels in Gulangyu by 2013

Source: Cai Changchun, “Gualngyu Shengyi zhongde Minzi ‘Ermeng’” [Private

Investment’s ‘Nightmare’ in Gulangyu’s World Heritage Application Process],

Fazhizhoume [Rule by Law Weekend], 09-04-2013, and Xu Yixin, “Gulangyu B&Bs

(in Chinese).” The Summit Forum for the Development of B&Bs Across the Strait,

September, 2014.

The problem of “doing business without a license” in the B&B sector in Gulangyu is

a direct consequence of local government’s decision to stop processing all B&B

applications, no matter at what stage a B&B hostel was in the process of the six-license

application, as well as their decision to stop accepting new applications in late 2011. In

the first half of 2012, the application process was restarted but it was closed again in July

2012. Because of the long process of the six-licenses application, no single B&B hostel

was able to complete its application during this period resulting in 130 B&B hostels at

various stages of the application process. Since then, another 100 B&B hostels were

established without any license due to this local administrative decision.

partial license

without a

license 94

fullly licensed

126

Distribution of Licensed B&B Hostels in Gulangyu by 2013

In May of 2013, the GSMC issued “Gulangyu Applying for World Cultural Heritage

Improvement Projects—A Specific Plan for Gulangyu B&B Industry” (the Plan), which

aims to regulate the confusions about the development of the B&B industry in Gulangyu.

The plan was drafted by the joint work of GSMC and Siming district government, and

ratified by the Planning Department of Xiamen. As the date of the promulgation, all

applications and clearance of B&B hostels in Gulangyu should follow the guidance of the

Plan. According to the Plan, almost half of all B&B hostels in Gulangyu will be closed

down, which means nearly 10 to 20 million private investment will be under threat. The

Plan also provides practical guidance to the procedure of shutting down a B&B business.

In order to meet the cut-off numbers, the Plan urges regulatory and law enforcement

agencies to work hard in checking and closing down those B&B hostels who are “doing

business without a license”. Beginning in late 2013, many owners of B&B hostels with

partial licenses were fined and detained by local police station for 5 to 15 days.

The above description of the development of the B&B industry in Gulangyu shows

very clearly that the problem of “doing business without a license” in the B&B sector in

Gulangyu and “fine and detention of B&B owners” in Xiamen are direct consequences of

the administrative decision in 2011 and local government agencies’ orders in 2013. But

there is no doubt that the development of the Gulangyu B&B industry was a result of

local government’s industry policy introduced in 2008.

In the next section, I will show how the local industry policy of B&B sector becomes

a source of private property rights protection. A dramatic change in local industry policy

toward B&B business in Gulangyu turned out to be a way of private property rights

expropriation. The comparison of two local political leaders’ characteristics and career

pattern demonstrates how the change of local industry policy is possible and how this

policy change was implemented, as well as why that dramatic policy change toward the

Gulangyu B&B industry has been made.

5.3 Local Industry Policymaking as a Source of Property Rights Protection or

Expropriation

The origin of the B&B sector development in Gulanyu can be traced back to then the

“first hand” (number one position) political leader of Xiamen, the Party secretary He

Lifeng. Theoretically speaking, government leaders such as governors or mayors are

responsible to economic affairs. In practice, the Party secretary has the final say over

everything, including policies and personnel placement. This is because the Party and

state hierarchies are intertwined in China. In the Chinese political structure, wherever

there is a governor or mayor, there is a corresponding Party secretary, except at lower

levels where the Party secretary and the executive are sometimes the same person. The

Party secretary is usually the number one boss in the jurisdiction due to the working

structure of the Party Committee. For example, at the city level, the Party secretary leads

the city Party Committee, which consists of the mayor and vice mayors, as well as other

officials heading important departments in the Party. The Party Committee members have

a clear division of labor, where every member is responsible for certain affairs in the city.

But the Party Committee determines all the major issues in the city, and inside the

committee the Party secretary has the final say over everything, including policies and

personnel placement.

The Policymaking of the Gulangyu B&B Industry in Xiamen

As I will show in this section, the Party secretary of Xiamen, He Lifeng played a

decisive role in policy initiative and policy making of the B&B industry in Gulangyu and

deserves special notice. Born in 1955 in Xingning, Guangdong province, He went to

neighboring Fujian province as a zhiqing (sent down urban youth) when he was eighteen.

In 1978, He became a college student studying fiscal finance at the department of

economics in Xiamen University. During the school year, He joined the Chinese

Communist Party (CCP) in 1981 and continued his study in graduate school in same

discipline. In 1984, He got a master degree and started to work in the Xiamen Special

Economic Zone’s economic institute. After several years working in Xiamen government

agencies, He was appointed as Xiamen Xinglin district Party Secretary (first hand) in

1990. Two years later, He was promoted to be Xiamen’s vice mayor and stayed in that

position for three years. Theoretically speaking, He Lifeng was not a local native official

since he was born in the neighboring province and grew up in Guangdong province.

However, He lived in Xiamen for twenty years since he was 18 years old. He completed

his education and got his first job in Xiamen. In practice, He is considered as a Xiamen

local native official. In 1995, He Lifeng was rotated to Xiamen’s neighboring city,

Quanzhuo, as vice-Party secretary and the acting mayor. Following the usual rule, He

turned to be the mayor the following year. Two years later, He Lifeng was promoted to

the first hand (the Party secretary) of Quanzhuo city. After another three years as the

rotated top official in the province’s capital city at the same rank, He was transferred back

to Xiamen as the first hand (the Party secretary) native political leader.

Policy making in China often is a product of a combination of rationality, power

struggles, and bureaucratic politics. Even being a top leader in Xiamen city, to promote a

local industry policy initiative such as B&B industry development still needs a skill for

politics in the Chinese political structure to get things done. Early in 2006, the second

year of Party Secretary He’s tenure in Xiamen as the top local leader, he gave a talk at a

tourist industry development conference, encouraging local government to “promote fast

development of the emerging B&B industry”. As a result, the former German counselor

building was renovated and transformed into the first B&B hostel business in Gulangyu

at the end of that year. But nothing has really happened since then. In the following year’s

spring festival, He offered a night tour in Gulangyu to foreign friends (investors) and

found out that contrary to his thoughts very few tourists stayed on the island at night

because there were no commercial activities or nightlife. Next day, He sent a note to the

GSMC indicating that the GSMC should take “some real actions” to promote the

development of the B&B industry in Gulangyu.

Although He Lifeng made very clear both in public and private about his ambitions

for the B&B industry development in Gulangyu, B&B development was slow until 2008,

the third year of He’s tenure as a top leader in Xiamen. In May 2008, He made a visiting

tour investigating the development of tourism in Gulangyu and figured out there were

only 12 B&B hostels established in past two years since his first talk. To express his

dissatisfaction about the development of the B&B sector in Gulangyu, He made a

statement that set a clear goal of achieving 3000 B&B beds in Gulangyu by the end of

2008. At the same time, He called a “major project work leading group” meeting in order

to mobilize his colleagues to promote the B&B sector development. In November 2008,

the city Party Committee held a special meeting discussing the development of the B&B

industry in Gulangyu. In that meeting, the city Party committee discussed “Xiamen

Gulangyu B&B Management Regulations (Trial)”, which was drafted by Siming district

government. The meeting memo, as a local official document, shows that “Siming district

government, the GSMC and other relevant government agencies should work together,

make initiative moves and take proactive action, incorporating the application of World

Cultural Heritage project, which would support and encourage the development of the

B&B industry in Gulangyu.”

In December 2008, the Regulations became a formal local industry policy as Siming

district government issued “Xiamen Gulangyu B&B Management Regulations (Trial)”

publicly. At the same time, the Xiamen city Party committee and the Xiamen government

forwarded the Regulations to different government agencies as well as made a statement

indicating that ““Xiamen Gulangyu B&B Industry Management Regulations (Trial)”,

which as drafted by Siming district government had been discussed and ratified by the

city “major project work leading group” in the 46 meetings, now forwarded to your

department, please make the effort to follow and enforce the regulations.” Since the

promulgation of the Regulations, B&B hostels have increased dramatically during 2009

and 2010 and reached 152 B&B hostels in Gulangyu with the total private investment 3

to 4 hundred million. By the end of 2013, more than ten million tourists visited Gulangyu

Island and the total number of B&B hostels reached 300 including those without licenses.

The Policy Changes of the B&B Industry in Gulangyu

The development of the B&B sector turned in another direction beginning in the late

2009 as He Lifeng was transferred to Tianjin as a vice Party secretary and the succeeding

top leader Yu Weiguo was in charge. Table 5.3 illustrates the policymaking and policy

change process directed by two types of local political leaders. It is logical that as the

industry developed rapidly government authority would shift its focus from the

development policy to the regulation policy. However, the case of Gulangyu B&B shows

that local officials’ policy choices with regards to the development of a sector are

determined by individual leaders’ career concerns and their calculations which are

conditioned by their resources and constraints.

Like He Lifeng, Yu Weiguo was born in 1955. But his hometown is in Shandong

province, eastern China. Similar to He Lifeng, Yu went to a neighboring province when

he was eighteen, but became a worker in a chemistry factory in Taicang, Jiangsu

province. Yu joined the CCP in 1975 and went to China People’s University in Beijing in

1979 studying Chinese literature. In 1983, Yu started to work in a research department at

the CCP’s Central Committee Secretariat’s Office. After several years of research work,

Yu was appointed to a mishu (personal secretary) of Ding Guangen—the former Head of

the CCP’s Central Department of Propaganda in 1991. Four years later, at the age of forty,

Yu was a guazhi (temporary transferred duty) cadre to the Xiamen government as the

assistant mayor, and two years later was transferred formally to the Xiamen government.

He became vice mayor of Xiamen in 1999, and then minister of the Department of

Organization (DOO) of Xiamen in 2001 before becoming vice-Party secretary of the city

in 2002. In 2005, Yu was promoted to deputy vice-minister of DOO of Fujian, and

minister of DOO of Fujian the following year. In June 2009, Yu became the Party

secretary of Xiamen.

It is not clear if there was a faction power struggle between He Lifeng and Yu

Weiguo. What public records show is that Yu Weiguo and He Lifeng shared no

overlapping working experiences. When Yu came to Xiamen from Beijing, He Lifeng

was transferred to a neighboring city as a rotated top political leader. While He Lifeng

was transferred back to Xiamen, Yu had been promoted to the head of provincial DOO.

The only overlapping period of theses two top leaders was two and half years when they

were both provincial Party Standing Committee members between 2006 and 2009.

Tirole (1994, p. 7) introduced the theory of career concerns that argues that civil

servants and politicians “are concerned by the effect of their current performance not so

much on their monetary reward, but rather on their reputation or image in view of future

promotion.” Performance measurement for local officials in China comes form the Cadre

Evaluation System (CES), which is the major instrument that the central government has

used to manage its cadre corps. Economic growth measured by numbers of GDP growth

rate has been one of major criteria to determine whether a particular local leader should

be promoted to a higher rank (Li and Zhuo 2005). Another two important factors that

determine local officials’ prospect of promotion are personal characteristics mainly age

and education, and personal connections with their superiors in charge of promotion.

Table 5.3 The Policy Making and Policy Changes of Gulangyu B&B Industry in Xiamen

The Party secretary of Siming district

4, 5

He Lifeng administration (2005.05—2009.05)

1) Talk in a tourism industry development conference in April 2006

2) A note to GSMC indicating that GSMC should take “some real actions” to promote the development of B&B

industry in Gulangyu in February 2007.

3) A visiting tour, a statement that sets a clear goal of achieving 3000 B&B beds in Gulangyu by the end of 2008, and a

“major project work leading group” meeting in May 2008.

4) A special meeting of the city Party Committee discussing the development of B&B industry in Gulangyu in

November 2008.

5) The promulgation of “Xiamen Gulangyu B&B Management Regulations (Trial)” in December 2008.

Yu Weiguo administration (2009.06—2013.05)

1.Permission from GSMC in addition to “six-license” process of B&B hostel in May 2010.

2-1.CPC standing committee’s enquiry on “improve Gulangyu’s tourism environment”

2-2.Established “Gulangyu Scenic Improvement Work Leading Group” charged by GSMC

3.Established “Gulangyu Applying World Cultural Heritage Work Leading Group” and the former Mayor was in charge

of the group.

4. An informal administrative order that temporarily suspended the application of B&B hostel in Gulangyu issued by

GSMC

5. Open the application

6. Re-closed the process

7. Re-opened the process

8. An informal administrative order using the form of a meeting memo signed by several government agencies issued

to terminate the application

9. “Gulangyu Applying for World Cultural Heritage Improvement Projects—A Specific Plan for Gulangyu B&B

Industry” issued by GSMC

Source: Compiled by author.

Unlike He Lifeng, Yu was a typical mishu cadre sent-down from the central

organization of the CCP who lacked local government experiences. Although he worked

in Xiamen for ten years, Yu was truly a transferred official. More importantly, compared

to native leader He Lifeng, Yu had personal tie with higher rank officials both at the

center and provincial DOO who were in charge of promotion. While He Lifeng had to

respond to “support” constituency’s interests in order to secure his position, Yu just

needed to build up an impressive image in the view of party officials for future

promotion. By “support” constituency, it doesn’t mean specific constituencies within the

electorate. Rather, it means the social and commercial elite, not the political elite. In the

context of China, this means urban district level officials or local businesspersons.

Due to the term limits and rotation system, Yu faced short-time pressure to show his

ability for local governance in only 2 to 3 years so as to impress both his superiors and

the local public to win promotion. One of the best strategies for him to demonstrate his

ability was to pursue “achievement projects” for an instant success. In addition, as the

succeeding transferred top leader, Yu needed to differentiate himself from the previous

native Party secretary through his unique “achievement projects.” Yu concentrated his

efforts on building the new city image—to make Gulanyu one of the World Cultural

Heritages.

The dual administrative system of Gulangyu offered an opportunity for the new

leader to introduce his “achievement project” and to intervene in the affairs of an

evergrowing local tourism industry. In May 2010, the second year of Yu’s tenure, the

process of the six-license application of a B&B hostel added one more step—the

permission from GSMC. Since GSMC is a subordinate agency of Xiamen government

and the Party committee determines major affairs of the city, the Party secretary Yu

gained final say over the direction of Gulangyu tourism industry development,

specifically B&B development.

In January 2010, Yu acquired another top position in the City People’s Congress

(CPC) standing committee in addition to the Party secretary position, which is not normal

practice in local political structure. Yu chose to show his local governance innovation by

introducing the CPC standing committee’s enquiry on local government with regards to

specific topics. The first enquiry of Xiamen’s history was held on November 29, 2010

and the topic was about how to “improve Gulangyu’s tourism environment.” In order to

follow up the issues raised in the enquiry, Xiamen government delegated to GSMC who

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