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Chinas Economic Transition, 1978-2000
An Alternative Institutional Analysis

by

Stanley Zhao-xiong Yang

A dissertation submitted in partial fulfillment of the

requirements for the degree o f

Doctor o f Philosophy

(Sociology)

at the

University o f Wisconsin-Madison

2002

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UMI N um ber: 3072729

Copyright 2002 by
Yang, Stanley Zhao-xiong

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Committee's Page. This page is not to be hand-written except for the

A dissertation entitled

C h i n a ' s Economic T r a n s i t i o n , 1 9 7 8 - 2 0 0 0 An A l t e r n a t i v e
I n s t i t u t i o n a l A n a ly sis

submitted to the Graduate School of the


University of Wisconsin-Madison
in partial fulfillment of the requirements for the
degree of Doctor of Philosophy

by

S t a n l e y Z hao-X iong Yang

Date of Final Oral Examination: December 18, 2002

Month& Y ear D eg ree to be awarded: Decem ber 2002 May August


Committees Page. This page is not to be hand-written except for die signatures

Approval Signatures of Dissertation Committee

Signature, Dean of Graduate School

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Abbreviations:

PRC - People's Republic of China


FSU -- Former Soviet Union
FEE -- Former Eastern Europe
CCP -- Chinese Communist Party
RCP - Russian Communist Party
CPSU -- Communist Party of Soviet Union
SOE - State-Owned Enterprise
COE ~ Collectively-Owned Enterprise
TVE - Township and Village Enterprise
TVP -- Township, Village, and Private Enterprise (cf. Qian and Xu 1993, p.141)
HRS -- Household Responsibility System
M-form -- Multiple-Divisional Hierarchy Form
U-form - Unitary Hierarchy Form
RMB - Ren-min-bi, i.e., people's currency in China
NIE -- New Institutionalist Economics
NICA - Newly Institutionalist Comparative Analysis
MNC - Multinational Corporations
SSB - State Statistical Bureau of China
EBRD - The European Bank for Reconstruction and Development
OECD - Organization for Economic Cooperation and Development (18
industrialized countries, including US, UK, Japan, Australia, Canada,
350 rmany, Spain, France, and Italy).

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ii

Centennial Chronicle of China, 1900-2000

World Events:
1900 1900: Invasion of China by Eight Countries & the
Boxer Movement
Start of W W I (1914)
1911: Overthrown of Qing Dynasty and
Russian Revolution (1917) Founding of ROC
End of W W I (1918)
1920 1919: May Fourth Young Students Movement

1921: Founding of C CP

World Depression 1927: Founding of PLA


1930
1931: Japanese Invasion of Manchuria
Roosevelts New
Deal (1935)
1937: Start of Sino-Japan W ar
Establishment of United Front of CCP and KMT
Start of W W II (1939) 1940

1945: Surrender of Japan


End of W W I I (1945)
1949: Founding of PRC

1950
Korean W ar (1950-53)
1956: Mao's Challenge to FSU

1958: Great Leap Forward

1960 1959-61: Three Years Severe Famine


Cuban Crisis (1962)
Vietnam W ar (1964-75)
1966: Start of Cultural Revolution

1970 1972: Nixons Visit to China


World Oil Crisis (1973)
Nixons Resignation (1974) 1976: End of Cultural Revolution

1978: Start of Chinas Economic Reform

1980 1978-85: Reform Priority of Economic Efficiency

1979: Introduction of Rural Household Responsibility System

1985: Start of Overall Institutional Reforms


Collapse of FSU and FEE . 1989: Tiananmen Square Event
(1989-) 1990 1992: Southern Tour of Deng
1997: Reversion of Hong Kong to China (1999: Reversion of Macao)
Asian Financial Crisis 1997
Global Information Age Jan. 2, 2002: Chinas official joining of the W T O
(Start of 1990s)

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Chinas Long March to the 21st Century

Apr. 1348 China becomes signatory of the GATT.

Sept. 1949 CCP takes power in Beijing.

Mar. 1950 Taiwan announces withdrawal from GATT.

1957 CCP launches a campaign of anti-rightest intellectuals.

1958-1961 Mao launches Three Red F la js : General Routes to Socialism," Great Leap
Forward, and Peoples Communes.

1966-1976 Cultural Revolution.

1976 Gang of Four arrested, China begins its new regime.

1978 China embarks on transition and reform.

July 1989 Chinese students protest in Tiananmen Square.

1991 FSU and FEE collapse.

Mar. 1994 China asks to join WTO.

May 1994 US de-links most favoured-nation status for China from human rights concerns.

Dec. 1994 China fails to gain GATT entry.

July 1995 China receives WTO observer status

Nov. 1995 Chinese President Jiang Zemin announces sweeping trade reforms. US gives
China Road-map for WTO negotiations.

Oct. 1997 Jiang Zemin visits Washington. China cuts industrial tariffs.

Apr. 1998 First EU/China summit.

June 1998 US President Clinton visits China.

Apr. 1999 Chinese premier Zhu Rongji visits Washington, unsuccessfully proposes wide
ranging concessions.

May 1999 Beijing suspends WTO talks following NATO bombing of Chinese embassy in
Belgrade, Yugoslavia.

July 1999 China reaches bilateral WTO accords with Japan and Australia.

Sept. 1999 US and China resume bilateral WTO negotiations.

Nov. 1999 China-US reach deal on WTO terms.

Jan. 2, 2002 China officially becomes a WTO member.

Source: adapted from Financial Times, p. 13, Tues. Nov. 16,1999; ibid. p. 32, Mon., Dec. 10, 2001.

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iv

Table of Contents

Preface vii

Chapter 1: Introduction - Analyzing China's Transition 1

1.1 China prior to its transition

1.2 Chinas economic growth during its transition: 1978-2000

1.3 Structure of this study

Chapter 2: Theories and Models of Chinas Transition 27

2.1 Theories of state socialist economies between the 1950s and 1980s

2.11 Theories of state socialist economies in the 1950s and 1960s


2.12 Theories of state socialist economies in the 1970s and 1980s

2.2 Nee: Chinas hierarchy-market dilemma

2.21 Nees 1992 empirical thesis on China's hybrid economy


2.22 Nees non-marketized state-owned sector
2.23 Nees marketized non-private sector
2.24 Nees private sector

2.3 Boisot and Child: The emergence in China of a new economic order -
network capitalism

2.31 Boisot and Childs description of Chinas transition


2.32 Boisot and Childs thesis of Chinas network capitalism

2.4 Qian and Xu: Chinas M-form hierarchy in transition

2.41 Qian and Xus comparative study of the organizational structures in


different transitions
2.42 Qian and Xus account of Chinas M-form hierarchy
2.43 Chinas M-Form hierarchy and its hybrid economy in transition

2.5 A brief comment on institutional models of Chinas transition

Chapter 3: Criticisms of the Three Institutional Models 156

3.1 A brief review of the three institutional models

3.11 Summary of the three institutional models


3.12 Transition as social action

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3.2 Limitations of the three models

3.21 Limitations of Nees model


3.22 Limitations of Boisot and Childs model
3.23 Limitations of Qian and Xus model
3.24 Transition as social construction: Institutions as social actors
3.25 Transition as historical derivative: Generality (convergence) vs.
particularity (divergence) across transitional economies

3.3 Summary of the shortcomings of the three institutional models

Chapter 4: Research Methodology and Assumptions Regarding Transitions 247

4.1 Historical-institutional comparisons - Research methodologies and


assumptions

4.2 Transitions and expectations, depth of history, and thickness of institutions

4.3 Two modes of transition

Chapter 5: Chinas Transition and Expectations, Depth of History, and Thickness of


Institutions 392

5.1 The initiation of Chinas transition

5.11 The turnabout of Chinas social expectations: From the pursuit of a Maosit
Utopia (1949-1976) to its period of transition (1976-2000)
5.12 Chinas economic transition (1976-2000)

5.2 China's institutional reforms during its transition

5.21 Historical perspectives of institutional reforms: State activism, divergent


momentums, and characterizations
5.22 Profile of China's institutional reforms in transition: Chronicle and taxonomy

5.3 Strategies for rebuilding institutions in China's transition

5.31 Bringing social choice back in: the social structure of institutions in China's
transition
5.31.1 Markets, hierarchies, and networks as alternative coordinative
arrangements
5.31.2 Chinas decentralization reforms - From a perspective of firm
hierarchy
5.32 Chinas hybridization
5.32.1 Chinas hybrid economy
5.32.2 The feasibility of a hybrid economy for rebuilding institutions
5.32.3 Hybridization, decentralization, and the Xia-Gang system
5.33 An oveiview of China's hybridization: Toward a quasi-market economy

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5.4 Summary

Chapter 6: Transition as an Historical Spiral: Chinas Prospects 633

6.1 Dilemmas and reciprocities between background modes and constitutive


modes

6.2 Chinas transitional movements

6.3 China in the information age

6.4 A dialectic view of Chinas prospects

6.5 Concluding remarks.

Bibliography 743

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vii

Preface

I n the early 1980s, as a young junior research fellow of the Chinese Academy o f Social Sciences

(CASS), I attended several sessions of the unofficial Conferences on Chinas Strategies o f Social and

Economic Development. Most of the attendees were ordinary natural- and social-science researchers like

myself. However, there were also a number of well-known leading scholars, government officials, and elite

state plannere, most of whom sided with the nations reform-minded intellectual avant-gardes.

These conferences dealt with big ideas about Chinas reforms and strategies. A major concern was

howto realize the Four Modernizations (i.e., modernization in industries, agriculture, defense, and sciences)

set by the Chinese Communist Party (CCP) in the 1950s to make economic development the nations priority,

a priority that was reaffirmed in the early 1970s by Zhou En-lai, then-popular Premiere and chief architect of

the C C Ps pragmatist strategies. The conference sessions dealt with such topics as how to streamline

Chinas state bureaucracy and how to enhance the states economic efficiency, while acknowledging the

bureaucratic inertias of state institutions. Even today I can remember how vivid, enthusiastic, bold, free, and

candid those discussions were, though most of the audience could barely understand the breadth of the

issues, and much of the discussion was imbued with party ideology. Those discussions touched upon just-

embarking agricultural reforms, soon-impending urban enterprises reforms, later reforms of the state sector,

future social dilemmas facing peasants, workers, intellectuals, and state functionaries, and lessons to be

learned from other transitional economies (particularly in Hungary and Yugoslavia). In the end a broad

consensus reached was reached to allow market forces to streamline the economy. The charms of the

market had been rediscovered in China.

More than a decade later, I came to realize that conferences like the one I attended in Beijing played

an important role in Chinas early transition, setting the tone for Chinas economic transition toward a market

driven future. The point I want to make here is that China's early economic transition was institutionally well-

planned. Later on the transition snowballed into Chinas structural transformation, a transition that

accompanied sustained rapid growth for virtually two and half decades.

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I chose Chinas economic transition, 1978-2000 as the subject for my dissertation since I feel, in

the beginning of this new millennium, that few events are more spectacular than Chinas great

transformation and its significant impacts on the rest of the world. My Chinese-American heritage has

nothing to do with my choice. However, I believe my background in business provides me with

perspectives that are missing among many of todays politicians and scholars of social sciences, and

even some intellectual avant-gardes. Trying to do business in China reveals more about a transition than

arguing about theory. Business firms cannot afford to make many misjudgments in different cultural

environments. An overestimate of targeted markets or an undervaluation of a price could make all the

difference between a business thriving and a business going under. I believe it is not a bad idea to start

from empirical observations of business practices in order to explore further the complexities of different

sociological perspectives.

In terms of acknowledgements, from the very bottom of my heart I give full thanks to my major

advisor, Professor Joseph W . Elder. Joe has been extremely patient in editing and trimming my lengthy

dissertation drafts. Through his editing and instructions he has contributed many enlightened insights to how I

have structured my dissertation, while inspiring me to keep this dissertation going on to its successful

completion. I would also like to thank the other members of my committee - Professors J. Zeitlin, G. Green, J.

Gilbert, and D. Bromley. They have all spent considerable time reading my dissertation and offering helpful

comments and references. Without their generous supports and guidance I cannot imagine how I would have

finished this dissertation.

R eproduced w ith perm ission o f the copyright owner. Further reproduction prohibited w itho ut perm ission.
Preface

I n the early 1980s, as a young junior research fellow of the Chinese Academy of Social Sciences

(CASS), I attended several sessions of the unofficial Conferences on Chinas Strategies of Social and

Economic Development. Most of the attendees were ordinary natural- and social-science researchers like

myself. However, there were also a number of well-known leading scholars, government officials, and elite

state planners, most of whom sided with the nations reform-minded intellectual avant-gardes.

These conferences dealt with big ideas about Chinas reforms and strategies. A major concern was

howto realize the Four Modernizations (i.e., modernization in industries, agriculture, defense, and sciences)

set by the Chinese Communist Party (CCP) in the 1950s to make economic development the nations priority,

a priority that was reaffirmed in the early 1970s by Zhou En-lai, then-popular Premiere and chief architect of

the CCP's pragmatist strategies. The conference sessions dealt with such topics as how to streamline

Chinas state bureaucracy and how to enhance the states economic efficiency, while acknowledging the

bureaucratic inertias of state institutions. Even today I can remember how vivid, enthusiastic, bold, free, and

candid those discussions were, though most of the audience could barely understand the breadth of the

issues, and much of the discussion was imbued with party ideology. Those discussions touched upon just-

embarking agricultural reforms, soon-impending urban enterprises reforms, later reforms of the state sector,

future social dilemmas facing peasants, workers, intellectuals, and state functionaries, and lessons to be

learned from other transitional economies (particularly in Hungary and Yugoslavia). In the end a broad

consensus reached was reached to allow market forces to streamline the economy. The charms of the

market had been rediscovered in China.

More than a decade later, I came to realize that conferences like the one I attended in Beijing played

an important role in Chinas early transition, setting the tone for China's economic transition toward a market

driven future. The point I want to make here is that Chinas early economic transition was institutionally well-

planned. Later on the transition snowballed into Chinas structural transformation, a transition that

accompanied sustained rapid growth for virtually two and half decades.

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X

I chose Chinas economic transition, 1978-2000 as the subject for my dissertation since I feel, in

the beginning of this new millennium, that few events are more spectacular than Chinas great

transformation and its significant impacts on the rest of the world. My Chinese-American heritage has

nothing to do with my choice. However, I believe my background in business provides me with

perspectives that are missing among many of todays politicians and scholars of social sciences, and

even some intellectual avant-gardes. Trying to do business in China reveals more about a transition than

arguing about theory. Business firms cannot afford to make many misjudgments in different cultural

environments. An overestimate of targeted markets or an undervaluation of a price could make all the

difference between a business thriving and a business going under. I believe it is not a bad idea to start

from empirical observations of business practices in order to explore further the complexities of different

sociological perspectives.

In terms of acknowledgements, from the very bottom of my heart I give full thanks to my major

advisor, Professor Joseph W . Elder. Joe has been extremely patient in editing and trimming my lengthy

dissertation drafts. Through his editing and instructions he has contributed many enlightened insights to how I

have structured my dissertation, while inspiring me to keep this dissertation going on to its successful

completion. I would also like to thank the other members of my committee - Professors J. Zeitlin, G. Green, J.

Gilbert, and D. Bromley. They have all spent considerable time reading my dissertation and offering helpful

comments and references. Without their generous supports and guidance I cannot imagine how I would have

finished this dissertation.

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1

Chapter One

Introduction -- Analyzing China's Transition

1.1 China prior to its transition

t has been estimated * (Angus Maddison 2000: Monitoring the World Economy 1820-1995) that

I in 1820 Chinas gross domestic product and China's proportion of world trade exceeded those of

any other nation in the world (i.e. Chinas GDP comprised 28.7% of the world total in 1820 at

1990 PPP level; see Table 1.1). During the next 130 years Chinas GDP remained more-or-less constant

or stagnated in comparison with other nations (see Figure 1.1). Then, beginning in the second half of the

twentieth century, Chinas G D P started to grow. By 2000 it equaled almost half that of the United States

(i.e., Chinas G D P comprised 10.7% of the world total - $3,983bn -- in 1998 at 1990 PPP level). During

the 1990s alone, Chinas economic size (as measured by its G D P level) grew 2.28 times (cf. Financial

Times, p. 19, Wed. Oct. 11, 2000) [1].

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2
Table 1.1: World GDP in 1820 and 1998

GDP 1820 GNP1998 GNP1998


At 1990 PPP A s% of At 1990 PPP A s % o f At Market A s% of
($m) World Total ($bn) World total Values ($bn) World tc

1. China 199.2 28.7 1.U S 7,922 21.7 1. US 7,922 27.4


2. India 111.0 16.0 2. China 3,983 10.9 2. Japan 4,089 14.2
3. France 37.4 5.4 3. Japan 2,928 8.0 3. Germany 2,122 7.4
4. UK 36.2 5.2 4. Germany 1,708 4.7 4. France 1,466 5.1
5. Russia 33.8 4.9 5. India 1,660 4.5 5. UK 1,263 4.4
6. Japan 21.8 3.1 6. France 1,312 3.6 6. Italy 1,166 4.0
7. Austria 13.5 1.9 7. UK 1,218 3.3 7. China 928 3.2
8. Spain 13.0 1.9 8. Italy 1,163 3.2 8. Brazil 758 2.6
9. US 12.4 1.8 9. Brazil 1,021 2.8 9. Canada 612 2.1
10. Prussia 12.0 1.7 10. Mexico 785 2.1 10. Spain 553 1.9

Top Ten Total 490.0 70.5 Top Ten Total 23,705 64.8 Top Ten Total 20,882 72.4
World 694.8 100.0 World 36,556 100.0 World 28,862 100.0

Source: Angus Maddison Monitoring the World Economy 1820-1992; OECD 1995; IMF; World
Bank; cit. Financial Times, p. 24, Economics, in Markets 2000, Jan. 1, 2000

Figure 1.1: Global Growth since 1870

Million 1990 international (purchasing power parity) dollars


Semi-log scale

10,000,000

5,000,000

1,000,000

500,000

. USA
. China
100,000 Japan
USSR'
50,000 India
Brazil

1870 80 90 1900 10 20 30 40 50 60 70 80 90 99

Note: * Russia after 1992;


Source: Angus Maddison Monitoring the World Economy 1820-1992, updated from 1992/1994 to
1998 using IMF Growth Rates in constant price GDP; cit. from Financial Times, p. 24,
Economics, in Markets 2000, Jan. 1,2000

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3
In the minds of recent Chinese generations, China had two defining turnarounds in the second half of

the twentieth century. One was the founding of the Peoples Republic of China in 1949; the other was the

transition toward Chinas integration with the world economy after 1978. The first turnabout was followed by

an inward search trying to eradicate all forms of private proprietorship linked to social inequality and global

capitalism. The second one was followed by an outward search reverting to an economy with private property

and links with the global community [2],

In 1911 Chinas Qing Dynasty was overthrown by the so-called Republican Revolution, led by Dr.

Sun Yat-sen. In the 1910s and 1920s, in the wake of the Republican Revolution, some Chinese youths

craved for more liberal reforms and institutional learning from the outside world. They believed that only

institutional reforms through learning could wake up China, a sleeping giant. Two options for the future stood

before them: one was toward the capitalist world, Chinas old nemesis, that had exploited China during the

preceding centuries. The other was toward the Soviet Union, a rather fresh and attractive alternative to the

capitalist world that had recently emerged from a feudal social formation similar to that of China. Those

looking to the capitalist world were inclined toward gradual evolution, involving a closer alliance with Western

powers. In time they were represented by the Kuomintang (KMT) regime in China headed by Chiang Kai-

shek. In the 1930s Japan invaded China, not withdrawing from China till 1945, leaving China in shambles. By

then the thought of Chinas old landlords and capitalists repositioning themselves in power in collusion with

foreign imperialists did not resonate well with the Chinese masses. Mao Zedoing and his red army forced

Chiang Kai-shek and the Kuomintang out of mainland China to the island sanctuary of Taiwan. By 1949 the

future of China lay with MaoZedong, the Communist Party of China (CCP), and the new economic strategists

of the Peoples Republic of China. Hundreds of millions of Chinese peasants, laborers and intellectuals

supported Mao Zedong and his socialist society committed to benefiting the majority of Chinese people.

Initially China tried to imitate the socialism-constructing strategies of the Soviet Union. However, it soon

became clear that China's economy differed from that of the Soviet Union and that strategies that appeared

to work in the Soviet Union would not necessarily work" in China. In time, China evolved its approach from

its own strategic culture f3], planning the details to suit the basic features of Chinas economy.

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4
Many of China's economic practices under its planned economy actually reflected then-power-

struggles among the inner circles of the CCP. For the ordinary people, socialism was defined as equivalent to

patriotism. During this period the CCP informed the people that the imperial world had enriched itself by

draining wealth from the exploited world. Marxism-Leninism predicted that moribund and rotten capitalism

(V. Lenin 1917) and imperialism could not survive in competition with multiple socialist states, and that world

socialism would eventually triumph. However, by the late 1970s, Chinas optimism regarding a future socialist

world had begun to fade. China's highly-erratic-5% GDP growth rate, relative to the more steady 8% growth

rate of its immediate East Asian neighbors, was unimpressive, even though Chinas growth rate was

considerably greater than the growth rate of such South Asian countries as India and Pakistan. Chinas

Great Leap Forward" (1958-1960) and its Cultural Revolution (1966-1976) had devastating impacts on

Chinas economic development (see Figure 1.2.1, Chapter 1). After 1978 China became increasingly

willing to learn advanced technologies and practical managerial skills from capitalist countries, to make efforts

to attract their capital investment, and even to borrow loans from them to accelerate Chinas economic

development. China began to expand its commercial ties with the rest of the world I4]. Pragmatism replaced

socialist utopianism.

After Chinas Cultural Revolution had ended, one of Chinas major concerns was to reintroduce

social order. By the late 1990s Chinas economy could no longer be called a planned socialist economy. It

was an economy incorporating trial-and-error experiments with marketization and hybridization.

Hybridization (or "building socialism with Chinese unique characteristics" in China's official parlance; cf.

Zhao Ziyang 1987) was one way in which China could still maintain it was adhering to its earlier Marxist

principles while experimenting with various non-Marxist policies. In this way China launched its transition

into greater participation in the global market economy. This dissertation focuses on Chinas efforts to

carry out that transition.

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5
1.2 Chinas economic growth during its transition: 1978-2000

To understand Chinas transition, we need an overarching vision of Chinas economy in the global

arena, based on wide-ranging economic information. Our data in this chapter are drawn chiefly from

Statistical Yearbook o f China 1999, World Development Report 2000, and other major secondary

literature, such as The Economist, Financial Times, The Wall Street Journal, The N ew York Times, etc.

W e have used trend analyses to compare China with such countries as Russia, Hungary, India, Japan,

South Korea, the US, and the UK. To overcome the limits and the fragmented nature of the available

statistics and data, we sometimes used a combined method to integrate the data drawn from multiple

sources into our tabulations I5].

Two words describe Chinas growth during its transition: fast and sustainable. Figure 1.2.1

illustrates trends of the world economy in the second half of the last century. As the figure shows, in the

early 1960s Japan emerged and experienced double-digit growth for two decades before going into a

decline. In the 1970s the four tigers in East Asia emerged with their so-called miracles" until the late

1980s; after which, their performance became mediocre (Figure 1.2.2 here). In the 1980s arid 1990s,

China underwent its transition and led the world economy in growth I6]. W hat follows for the remainder of

this chapter is evidence of Chinas economic performance during its transition. An overarching question

will be: How did China establish and maintain its high rate of growth that has sustained much longer than

any other country? A secondary but equally interesting question will be: How did China make such a rapid

transition from a former planned economy into the world marketplace, while other former socialist

economies, such as the former Soviet Union (FSU) and former Eastern Europe (FEE), failed to make

similar successful transitions into the world marketplace.

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6
Figure 1.2.1: Differing growth rates in the world economy since 1950

Fast-double-digit-growth: 1960s-70s: Japan; 1970s-80s: 4 East Asian Tigers (with


growth rates close to double-digits);1980s-90s: China

By GDP Growth (%)

15

10

-10

-15
1950 1960 1970 1980 1990 2000
Label:
Case A: moderately slow ------------ OECD
Japan
Case B: moderately f a s t East Asian Four Tigers ; ------------- India
.............. SEA
Case C: Fast China
Case D: Negative Growth .............. Former Soviet Union (Russia after 1991)
Source: Combined sources from World Development Report 200 1 , from various issues of
Financial Times, The Economics in recent years, as well as from Kornai et al. 2001, etc. Chinas
data drawn from SSB, 2000

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7
Figure 1.2.2: Economic growth of China and the Four Tigers, 1993-2001

Real GDP
Annual % Change

15.0

12.0 China
Singapore
South Koreaf .
9.0
Hong Kong

6.0

3.0 Taiwan

-3.0

- 6.0

93 95 97 99 01* 93 95 97 99 01* 93 95 97 99 01* 93 95 97 99 01*

Source: DGBAS, Quarterly National Economic Trends; cit. Financial Times, p. I, Wed. Nov. 24, And p.
5, Fri. Nov. 2 6 ,1 9 9 9 ; Statistical Yearbook o f China, 1998; The Economist, p. 38,Dec. 2 3 rd,
1999; * estimate, ibid. cit. The Economist, p. 128, Oct. 14th, 2000, and Financial Times, p.
VII, South Korea 7 , Thurs. Oct. 19, 2000.

During the fifteen years following 1978, prominent swings occurred in both the Chinese and the

Russian economies. Previously the swings in Chinas economy were mainly the result of catastrophic

events like the Great Leap Forward (1958-60) and the Cultural Revolution (1966-1976). Russia in the

1990s underwent its own turbulence similar to Chinas Cultural Revolution only three decades later. After

Chinas Cultural Revolution, especially after 1978, China's economy grew steadily except during the

unsettled years 1989-90 following the student demonstrations in Beijings Tian-an-men Square. Additional

testimony to the sustainable robustness of Chinas economy has been the relatively minor way in which

the Asian economic crisis of the late 1990s affected China. This is partially attributable to the fact that

Chinas economy was a continental economy and remained not fully subject to the world market

movements in magnitude and direction (see Figure 1.2.3).

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The remaining figures in this chapter provide multiple forms of evidence of how Chinas economy

performed in the 1980s and 1990s, the two decades of its transition. Figure 1.2.4 compares Chinas

GDP% growth with the G D P% growth of seven countries. O f the selected countries, Russia fared the

worst, compared to China, the best.

Figure 1.2.3: The emerging market access Index*, 2000

0 20 40 60 80 100

Singapore
Chile
Hong Kong
Estonia
Slovenia
Lithuania
Taiwan
Latvia
Romania
Israel
Mexico
Hungary
Argentina
Turkey
Czech Rep
Philippines
Poland
South
Bulgaria
Thailand
Slovakia
Russia
Indonesia
Brazil
Malaysia
Ukraine
India
China
Uzbekisan

Source: Tuck School of Business, Dartmount, New Hampshire; The Economist, p. 114,
June 10th, 2000; * "market access index" refers to the ratio of marketized sectors to
the country's economy.

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Figure 1.2.4: Comparison of Chinas economy and the world economy, 1960-99

By GDP % growth

-10

-20

-30
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999

China - - Japan South Korea Russia Hungary India U S UK

Source: World Development Report 2001.

Figure 1.2.5: Chinas real GDP growth, 1978-2000

Real GDP Growth


Annual% Change

16

14

12

10

0
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Source: SSB, China, Table 3 -3 ,1 9 9 9 .

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Figure 1.2.5 presents the performance of Chinas economy from 1978 to 2000, based on China's

statistics by the State Statistical Bureau (SSB). Figure 1.2.6 provides detailed illustrations of the recent

strength of China's economy. It shows that Chinas G D P total at purchasing-power parity (PPP) in 1998

was $3.8 trillion, compared to the US with $8.0 trillion, and to India with $2 trillion. Yet Chinas G DP

growth rate in 1998 was 8.6%, relative to the US at 2.7% , and to India at 4.9% . Figure 1.2.7 shows a

steady increase in Chinas per capita income between 1977 and 2001. Figure 1.2.8 shows how Chinas

annual average percent of real G D P growth changed from 1990 to 1999, compared to that of eleven other

countries (including the United States, Japan, and Russia). Figure 1.2.9 shows what percent of the

worlds G N P at purchasing-power parity level China possessed in the year 2000. Figure 1.2.10 compares

Chinas purchasing power parity between 1985 and 1998 with that of seven other countries, showing that

Chinas purchasing power parity was second only to that of the United States. Figure 1.2.11 compares

China with the nations of the Organization for Economic Cooperation and Development (OECD, which

refers to the industrialized country grouping, including the US, UK, Japan, Canada, Germany, Spain,

France, and Italy) in terms of annual percent increase of G DP, percent increase in consumer price index,

percentage of unemployment in the labor force, and balance of payments. In each instance Chinas

performance matches or exceeds that of the O ECD nations. Figure 1.2.12 shows that there was an

average annual 5.5% growth rate in real wages in Chinas urban areas between 1983 and 1999. Figure

1.2.13 shows the growth of average per capita real income in thirteen countries between 1965 and 1998.

China is second only to South Korea in its growth of average real income per head. Figure 1.2.14 shows

the marked increase in foreign direct investment in China between 1984 and 200 [7]. Figure 1.2.15 shows

Chinas growth of industry and merchandize export between 1984 and 2001. Figure 1.2.16 shows the

steady growth of Chinas exports as a percentage of Chinas gross domestic product between 1952 and

2001. Figure 1.2.17 shows Chinas monthly trade surplus from January 1998 to August 1999. Figure

1.2.18 shows China bimonthly foreign exchange reserves between November 1997 and 2000. Figure

1.2.19 shows China's percentage export growth between January 1998 and August 1999 [], Figure

1.2.20 shows the annual percentage changes in Chinas gross domestic product between 1990 and 1999.

Figure 1.2.21 shows the foreign direct investment confidence in eighteen countries in January 2001,

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calculated on a three-point scale. China is second only to the US in its foreign direct investment

confidence climate. And figure 1.2.22 shows Chinas overall trade balance between 1990 and 2001.

Figure 1.2.6: A global comparison of GDP growth at purchasing-power parity (PPP)

(1) GDP at PPP, 1998$trillion

Annual
us 2.7
average GDP
CHINA 1.6
growth 1965-
JAPAN 4.3
98 (%) (i.e.,
INDIA 4.9
figures
GERMANY |2.5
attached to
FRANCE I 2.6
the bars)
BRITAIN
j ' 2 -1
ITALY I 2.7
BRAZIL I 4.3
RUSSIA -4.8*
MEXICO J 3.9
CANADA
SPAIN __ I : .0
1.1/
SOUTH KOREA _ 1 8 1
INDONESIA ^ 6.:

Source: World Bank; cit. The Economist, p. 106, May 13th, 2000;
* USA Today, 1B, Fri. Apr. 23,1999

Figure 1.2.7: Chinas estimated GDP per capita (by market value, not by PPP level)
$1,168
1200
1000

800
600
400

200

0
'77 87 '97 '98 '99 2000 2001

Source: World Bank; US Commerce Department, cit. USA Today, 15A, W ed. Feb. 16, 2000; Financial
Times, p. xii, Mon. Nov. 13, 2000

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Figure 1.2.8: Real GDP growth, annual Figure 1.2.9: % of world GNP
average % change, 1990-99 At PPP ($38,804.9bn in 2000)

-6 -4 -2 0 2 4 6 8 10 12 China Japan
10.6%
China
India
21.5% 5.5%
Germany
Brazil
4.7%
Mexico
France

Germany

Brazil
Rest of 2.7%
. . .S . Russia
world . . Mexico""-
Canada*- 2.4%
Source: World Bank; c it FlnanclalTime, 31.2%
1.9% %
p. 13, Mar. 14, 2001

Figure 1.2.10: GDP at purchasing-power parity in comparison 1985-98 ($bn)

10000 2000

9000 1800

8000 1600

7000 1400

6000 1200

5000 1000

4000 800

3000 600

2000 400

1000 200

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

US (left axis) China (left axis)


-Japan (left axis) India (left axis)
South Korea (right axis) -Russia (right axis)
Hungary (right axis) UK (right axis)

Source: World Development Report 2000\ USA Today, 2A, Thurs. Apr. 12,2001

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Figure 1.2.11: Comparison of China with OECD - Some major economic indicators

GDP % Increase over previous year, Consumer prices


1996-2001 % increase over previous year,
1996-2001

12.0 10.0

8.0
China
6.0

4.0

OECD. 2.0

0.0
Chil
i------------------------1---------------------- 1----------------------- 1------------------------1----------------------- 1 o .O 1 - 2.0
96 '97 '98 99* 00** 01" '96 '97 98 '99* ' 01* *

Unemployment % of labor force, China's balance of payments


1996-2001 $bn, 1996-2001

60
OECD
------------------------------------------------------------ 50

Balance of payment
China

2.0

Current account balance


i-------------------1------------------- 1-------------------1--------------------1-------------------1 0 . 0 i__________ i__________ i__________i__________ i__________ i o

96 97 '98 '99* '00** '01** 96 '97 98 '99* '00** '01**

Source: OECD, cit. from The Economist, p. 90, August 12th, 2000; China Statistical Bureau, SSB, 1999;
Financial Times, p. xii, Mon. Nov. 13, 2000

* Estimate
** Forecast

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Figure 1.2.12: Average % annual growth in real
wages in China's urban areas, 1983-1999

- - - Nominal

30.0 Real
25.0
20.0 Linear
15.0 (Real)
10.0
5.0 Average annual 5.5% change of
0.0 real wage in China, 1983-1999

83 85 87 89 91 93 95 97 99

Source: Financial Times, p. ii, China 2, Mon. Nov. 13, 2000

Figure 1.2.13: Growth of average per capita real


income in thirteen countries, 1965-98

Source: Financial Times, p.


South Korea 6.6 ii, Mon. June 12, 2000
* Chinas data are for
China*
average real income per
Thailand 5.0 head, 1983-1999 as above.
Malaysia 4.1 ** U S s data refer to growth
Portugal 3.2 rate of US G D P per head
in 1960-99, cf. The
Indonesia 2.7
Economist, p. 19, The
Italy
llL_ New economy survey,
Greece 2.4 Sept. 23rd, 2000
US** 12.4
Brazil 2.2
France 2.1
Turkey 2.1
Mexico 1.5

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Figure 1.2.14: China net foreign direct investment (FDI) influx and current account,
1984-2001, $bn

$bn
50
45

40

35

30
Current account *
25
Net FDI inflow
20
15

10

0
1984 1986 1988 1990 1992 1994 1996 1998 2000

Source: Statistical Yearbook o f China, SSB, 1999; figures in 1999-2001 forecasted, cit. Financial
Times, p. XI, Fri. Sept. 22, 2000 ft; * Current account refers to net trade of goods and services
[ ft .

Figure 1.2.15: Chinas growth of industry and merchandize export, 1984-2001


(1984=100)

1200
1100
1000
900 Industrial growth
volume
800
700
Merchandize export
600 volume
500
400 GDP growth volume

300
200
100
1984 1986 1988 1990 1992 1994 1996 1998 2000

Source: data rebased from Tables 3 -2 ,1 3 -4 ,1 7 -3 , SSB, China, 1999; also cf. Financial Times, p. xii.
Mon. Nov. 13, 2000.

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Figure 1.2.16: Chinas export trend, as% of GDP, 1952-2000

30

25

20

15

10

0
1952 65 78 82 85 88 91 94 97 '00

Source: Financial Times, p.21, Wed. Nov. 8, 2000; Tables 3 -3 ,1 7 -3 , SSB, China, 1999.

Figure 1.2.17: China's monthly Figure 1.2.18: China's foreign


exchange reserves ($bn) bimonthly,
trade surplus ($bn),
Jan. 1998-June. 2000
Jan. 1998-Aug. 1999

6 170

165
5
160

4 155

150
3
145

2 140

135
1
130

0 125
J F M A M J J A S O N D J F M A M J J A
1998 1999

Source: CLSA Global Emerging Markets; State Statistics Bureau', cit. Financial Times, p. 4, Wed.
Dec. 2 9 ,1 9 9 9 ; ibid. p. 6, Thurs. Jan. 18, 2001

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Figure 1.2.19: China's % export Figure 1.2.20: China's GDP


growth, Jan. 1998-Aug. 1999 annual % change, 1990-1999

16 ---------------------------------------------------------------------
20
14 ------------- ==-------------------------------------------
15
12 -------------------------------------
10
10 ------- JFt----------------
5
8 ===
0 6 -----

-5 4-- -----

2
-10
0 uuuuu11U11UU

-15
90 ^ l * 2 'SS "35 96 *97 ^99 '00
J F M A M J J A S O N D J F M A M J J A

1998 1999

Source: Ibid.

Figure 1.2.21: Foreign Direct Investment Confidence


Climate,
Top 18, Jan. 2001, index values calculated on a 0-3 scale.
The higher the value the higher the confidence

US ' ' ........................ 1

Brazil
UK .............. 1
Mexico __________ ... ........................ 1
Germany ........ ................................................ 1
India ........... ........ ...... ..........1
Italy . . ............................................ 1
Spain ................. .................................... 1
France 1
Poland 1
Canada 1
Singapore ' 1
Thailand ' 1
Australia . 1
Czech Rep.
South Korea
.. .............. ; i
Netherlands i
0.0 0.6 1.0 1.5 2.0 2.5

Source: Fiancial Times, p. 6,"Foreign direct investment," in


"International economy," Feb. 19, 2001.

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Figure 1.2.22: Chinas overall trade balance since 1990s ($bn)

43.6
40.4
33.7
29.0 30 0

16.7
12.2
8.7 8.1
4.4 54

nx
V
- 12.2
1990 91 92 93 94 95 96 97 98 99 '00 '01

Source: cit. Financial Times, p. xii, Mon. Nov. 13, 2000; ibid, p. 14, Fri. Dec. 1, 2000; also cf. Institute for
International Economics- cit. Financial Times, p. 15, May 17, 2000.

As illustrated in different ways in each of the figures in this chapter, Chinas economic growth

following its 1978 policy changes was strong and consistent. W hereas other former planned economies

have faltered, especially those of the former Soviet Union (FSU) and former Eastern Europe (FEE). China

has persistently moved forward in an impressive transition from a planned economy to an economy linked

effectively with the global economy.

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1.3 Structure of this study

My dissertation includes 6 chapters in which I attempt to analyze what has actually happened in

China so far in its transition from a planned economy to an increasingly market-oriented economy. My study

focuses on China's institutional reforms. At times I compare China with its FSU and FEE counterparts, trying

to acquire sociological insights on the unique strategies of Chinas transition.

Chapter 1 gives a general statistical account of Chinas recent economic performance during its

transition since 1978. These basic facts provide quantitative evidence of Chinas changing reality through

institutional reforms.

Chapter 2 reviews earlier studies of China's post-Maoist transitional economy and antecedent

literatures on the state socialism, including such writers as Komai and Nove. It focuses on three institutional

models about Chinas transition in detail: Nee (1989, 1992), Qian and Xu (1993), and Boisot and Child

(1996).

Chapter 3 criticizes three institutional models for their methodological reductionism, their focus on

market-hierarchy dilemmas, their neglect of transitions as historically derived and socially embedded, and

their failure to capture important dynamics of transition.

Chapter 4 identifies three dilemmas (market vs. hierarchy, ideology vs. strategic rationality, and

reality change vs. regime change) that have puzzled mainstream scholarship on transitions. In search of a

sociologically-grounded institutional account, I propose a mode of transition built on three dynamic sources:

expectations, depth of history, and thickness of institutions. I then examine two contrasting transitions in

Russia and China.

Chapter 5 provides a sociologically-grounded institutional account of Chinas transition process. It

provides historical evidence for those assumptions and methodologies I proposed in Chapter 3. Section 5.1

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outlines how Chinas changing expectation initiated Chinas transition and how its political process earned out

those changes. Section 5.2 examines how China inaugurated its institutional reforms on a substantial scale

and how the state government played a strong role in facilitating the reforms and encouraging

entrepreneurship. Section 5.3 explores the dilemmas facing China in its economic governance (such as

market vs. hierarchy dilemmas) and the methods China used to tackle the dilemmas through decentralization

and hybridization, according to the so-called Xiagang' system.

Chapter 6 extends above institutional search to those regime change issues. It raises questions

about Chinas future direction. It sees Chinas transitional upgrade occurring in three sequential phases,

associated with construction of rule of law and social democracy. It asks if Chinas transition is reducible

to digital management (so-dubbed digital democracy), since that could help perpetuate the paradox

between instrumental rationality and humanitarian endeavors and thus impede Chinas reform efforts.

Lastly, it envisions Chinas prospects of integration into the global community through Chinas historically-

grounded and socially-embedded institutional reconstruction of its future.

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Endnotes of Chapter 1:

1. But while China once had its economy in the groove in the world history, people might legitimately
question why China had a big setback around the turn of the last century and how it brought its
momentum back resuscitating in the late last century. A reminder: its modernizing since the mid-last-
century just started from a position with virtually semi-feudalist and semi-capitalist conditions. Yet China
has managed to catch up those mid-income level economies in the world by the dawn of this century at a
pace even faster than the rest of East Asia and other emergent economies in the last two decades.

See Meisners vivid portrait of Chinas backwardness in the turn of the last century, compared to the
Russia, cf. M. Meisner 1996, pp. 21-23: ...in China the objective forces favoring a capitalist-type
revolution were far stronger than they had been in Russia and the socialist content far weaker. At the time
of the Communist victory in 1949 China was a much more backward country than Russia had been at the
time of the Bolshevik triumph. Czarist Russia, of course, was a backward and undeveloped country in
comparison with the industrialized capitalist countries of Western Europe. But it was far in advance of
China. In pre-1949 China, wit a population of 500 million, there were fewer than 3 million industrial
workers (many of whom labored in small shops lacking mechanical power), whereas in pre-Revolutionary
Russia there were 6 million industrial workers among a population of approximately 125 million. On a per
capita basis, industrial output in China, even in the best of pre-1949 years, was less than one-eighth of
what it was in Russia in 1917. Chinese agriculture compared even less favorably. Whereas the Russian
agrarian economy traditionally produced surpluses for export, Chinas pre-Revolutionary farm economy
yielded endemic famines which, decade after decade, took a staggering toll of lives. Between 1850 and
1930, an average of 4.5% of each generation died from famines. The famine of the late 1920s in the
sparsely populated provinces of the Northwest, for example, resulted in some 5 million deaths, killing one-
third of the population of Shensi province alone. Even in normal times, observers estimate, per capita
agricultural production in pre-1949 China was only about one-fifth of that in czarist Russia. And even after
Stalins assault on the Russian countryside during the First Five Y ear Plan, as Carl Riskin noted: 'Soviet
foodgrain production per capita in the disastrous year of 1932 was actually some 45% higher than the
comparable figure for China in the average year of 1957. Laboring under a primitive technology, and with
nearly a quarter of humanity dependent on no more than 6% of the worlds arable land, Chinese
agriculture was a precarious enterprise even in the best of times, capab'e of providing little more than
bare subsistence for the great majority of the Chinese people. Beyond the enormous human costs and
suffering this inevitably entailed, it also meant that the potential surplus that could be extracted from the
countryside to finance modem industrialization would be far smaller in China than in Russia. Chinas
backwardness in industry and agriculture, as compared with Russia, was exacerbated by backwardness
in a variety of other areas: much less developed railroad, transportation, and communication systems
(and ones that had been built primarily to serve foreign imperialist interests); a population burdened by a
substantially higher rate of illiteracy and a considerably lower level of education; and a country far more
lacking in modem scientific and technological knowledge."

2. cf. USA Today, 8A, Oct. 8, 1997: In a country where public proximity to leadership is a test of one's
stature, two officials came off well...Jiang lauded the incoming body as "another step forward toward
revolutionizing, rejuvenating...and professionalizing the party's central leadership...'Deng Xiaoping
Theory, a code for pragmatic, market-oriented reformism was set on a pedestal alongside 'M ao Tse-tung
Thought in the Communist Party canon.

3. cf. Jepperson et ai. 1996 on Variations in state identity, or changes in state identity, affect the national
security interests or policies of states (pp. 60-1): ...Johnston argues...that Chinas strategic culture in
the Maoist period was based on a zero-sum view of the world, a division between 's e lf and 'other that
generated specific strategic commitments. Classical Chinese conceptions were reinforced by contacts
with the European state system: nationalism and Marxism-Leninism provided themes o f class war and
anti-imperialist war that could be grafted onto traditional constructions. Historical variations in the
structural conditions of the Chinese empire do not account wel! for the constancy in strategic culture: the
relation between 'anarchy and realpolitik depicted by neorealism, Johnston suggests, is in this case

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22

spurious. Rather it is Chinas strategic culture that drives its real politik. Ibid. p. 62: ...Chinas strategic
culture and Japans and Germ anys politico-military culture have stronger effects on national security
policies than international structure does. Accordingly, the follow analysis of contemporary Chinese
history is based on such a perspective of Chinas strategic culture and tradition that drives its realpolitik
(Ibid. 61).

4. cf. Strategic investors take a shine to China - The countrys political commitment to capitalism and its
expected entry into the World Trade Organization attract a huge share of capital inflows into the region
by John Thornhill in Financial Times, p. ii, Tues. May 8, 2001: One glance at the headquarters of the
municipal administration of Shunde is enough to confirm the towns reputation as the most experimental
region in the most experimental province in China...Shundes openness to new ideas has rapidly turned
the former agricultural commune into one of Asias investment hot-spots. On a visit to the southern
Chinese province of Guangdong in the 1980s, the diminutive Communist leader, Deng Xiaoping, urged
Shunde to be bolder and dare to forge ahead. It is a message that Feng Run Sheng, the no-nonsense
mayor of the town of 1m people, has taken very much to heart. 'The government does not intervene in
every aspect of business. It only functions as a facilitator for businesses. Profits return to the people who
run them, he says, in a display of capitalist rhetoric that is still somewhat startling in Communist China.
So now I hope that China will quickly join the W T O [World Trade Organization] and we will be more
integrated into international capital flows and management concepts....It is the success of towns like
Shunde that explain why China is drawing such strong investment flows...Moreover, the latest slowdown
in the US economy appears to be spurring more multinational companies to lower their production costs
by shifting manufacturing capacity to Asia

Also cf. W ake-up call comes amid reform fatigue - As banks continue to grapple with problem loans and
the region again starts to show signs of weakness, the financial focus is beginning to switch to China by
John Thomville. Ibid. p. I: ...T h e word biggest investment banks are now targeting China as by far the
most promising long term opportunity in Asia. 'From a regional perspective China is the most important
market and the lead focus for Merrill Lynch, says M r Li. He believes that future share offerings - and
lucrative investment banking mandates - will come from Chinese power companies, the railway network,
the postal service, and even the media. But it is not just investment bankers and fund managers who are
currently fixated with China. Foreign strategic investors are also pouring money into the mainland
economy. At 30bn, the current stock of foreign direct investment in China is third in the world after the UK
and the US. Other Asian countries are slowly waking up to the awesome challenge that Chinas economic
development poses for the region. And many banks and companies in the smaller countries are now
scrambling to gain the scale and prominence needed to achieve greater operational efficiencies and to
attract the attention of the worlds fund managers. The most striking example of the trend is in Singapore
where the islands biggest bank, DBS, has just launched a $5.4bn bid for Dao Heng bank in Hong Kong
as part of its quest to become Asias leading banking group. 'You cannot be the best bank in Asia without
gaining a certain size, says Phillippe Paillart, D BSs chief executive...The consolidation bandwagon
seems certain to gather pace as more Asian companies evolve from being national, closely-controlled,
private or state businesses into bigger, more transparent, and increasingly internationally-minded public
companies. That trend only promises more excitement for investors and more business for bankers. As in
so many other fields swept by the forces of globalization, Asias financial markets are increasingly subject
to the winner-takes-all mentality. International fund managers, seeking sizeable, liquid investments, are
most likely to invest their money in the 50 biggest companies in the region and will ignore the more
opaque, marginal markets. Those countries that do not match the demands of this new era and complete
structural reforms run the danger of being marginalized.

5. As Cao et al. 1999 emphasized (107), Date limitations imply that we must rely on anecdotes, case
studies, and survey results rather than systematic data. Therefore, although our evidence is informative, it
should not be interpreted as systematic."

6. cf. All together now? - The worlds economies are much more in sync now than ever. But they still
dont move as one" by in The Wall Street Journal, R3, Mon. Oct, 14, 2002: ...The Chinese economy
grew by more than 7% last year and is on track for the same this year, according to economists, replacing

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23

Japan as the provider of regional economic ballast. Massive public investment projects, low-priced
exports and its gigantic consumer market kept the Chinese economy chugging through last years global
downturn. As a result, investors are increasing their exposure to A sia...

Also cf. An Asian Stampede by Shahid Javed Burki in Financial Times, Mon. p. 13, June 11, 2001:
...Between 1870 and 1913, the US overtook Britain and became the leading would economy. Between
1950 and 1973, Japan caught up with Europe and the US to become the worlds second largest
economy. The third catch-up period, from 1975 to 1997, saw the narrowing of the gap between several
tiger economies of East Asia and the developed world. The next phase is likely to shift the center of the
world economy from the Atlantic ocean to the Asian mainland. It will change the composition of world
output and world trade, the way the world uses resources and the make-up of populations of Europe and
the US. It will almost certainly create severe tensions with todays leading economies as they are
challenged for global economic dominance. The US and Europe currently account for about two-fifths of
the global economic output of $40,000bn. By 2025, the overall global figure may increase two and half
times, to $100,000bn. China and India may account for about two fifths of that. China, with a G D P of
$25,000bn in 2025 measured in terms of PPP - will probably by the worlds largest economy followed
by the US at $20,000bn and India, in third place, at about $13,000bn. These projections are based on
what I consider feasible, long-term rates of growth; it is not beyond China's capacity to grow at 6% a year
for the next 25 years. After all, it has grown at a much faster rate over the past 25 years...For the first
time in history, two of the three leading economies will also be among the world's poorest countries in
terms of the incidence of absolute poverty. China and India will have a combined population of nearly 3bn
people by 2025, of which 500m may still be living below the poverty line. They will require vast amounts
of food and other essentials. To meet their needs, both countries will continue to put an emphasis on
industry and agriculture. Instead of becoming lighter, the worlds output will start to get heavier."

Also cf. Asian economies: Reliable prosperity comes to an end - Chinas inexorable growth is sucking
investment away from the once dynamic tigers by John Thornhill in Financial Times, p. VI, World
Economy, Fri. Sept. 27, 2002 (emphasis mine): Fro several decades, East Asias economies appeared
to be models of predictable prosperity. First Japan, then Hong Kong and Singapore, then Taiwan and
South Korea followed by South-East Asia and China recorded prolonged bursts of dynamic economic
growth that collectively became known as the Asian economic m iracle...

7. cf. China draws foreign investors by Chris Giles in Financial Times, p. 1, Mon. Sept. 23, 2002: China
has for the first time supplanted the US as the most attractive destination for foreign direct investment,
according to a survey of senior executives of the worlds largest companies. Chief executives and chief
financial officers are attracted by the size of chinas market, the vibrancy of its economy, and the
perception of few competitors with entrenched positions. But they are also disillusioned with the US as
the worlds most dynamic economy, according to the annual survey by A T Kearney, the consultancy.
After the surge of foreign investment into the U S in recent years, executives who responded expressed
growing concerns over the security of US investments...In 2001, China attracted nearly $50bn of FDI,
compared with $125bn in the US. But while foreign investment levels in China were growing, he level of
FDI in the US was down from $30bn in 2 0 0 0 ...

8. cf. China exports hit global industry in The Wall Street Journal, A8, Thurs. Oct. 10, 2002: ...China
makes more than 50% of the cameras sold world-wide, 30% of the air conditioners and televisions, 25%
of the refrigerators. A private Chinese company Guangdong Galanz Enterprise Group Co., now accounts
for 40% of all microwave ovens sold in Europe. The city of Wenzhou, in eastern China, sells 70% of the
worlds metal cigarette lighters. Chinas entry into the W T O late last year accelerated the trend toward
exports. By forcing down trade tariffs, W TO membership cuts production costs and removes obstacles to
selling overseas. That is drawing more investment into China, funding new factories and leaving industry
after industry groaning with overcapacity. What's more, as the Chinese government relaxes its export
rules, a new generation of nimble Chinese companies - particularly private enterprises - is beginning to
focus on overseas sales as well. (The investment boom also is reviving an old economic nemesis: a real-
estate bust...China's growth as a production base has followed a consistent pattern: A new product is
introduced, usually by a foreign company. Within months, numerous local Chinese manufacturers also

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24

start cranking it out. Prices slide and producers, both foreign and Chinese, start looking for new markets,
increasingly overseas. Helping drive this competitive cycle is the flood of foreign investment into China -
more than $600bn during the past two decades - and the introduction of modem manufacturing
techniques. Foreign technology has powered productivity gains across the economy, and a nationwide
entrepreneurial zeal has sprouted from the shambles of central planning. Low wages have slowed
Chinas transition to a consumption-driven economy but the pool of cheap labor remains deep, allowing
companies to control costs and often to cut them dramatically. Some of the foreign companies that have
expanded their focus from the local Chinese market to exports include: General Electric Co., Toshiba
Corp. of Japan, Siemens AG of Germany, Samsung Electronics Co. of South Korea and personal
computer maker Acer Inc. of Taiwan. General Motors Corp. is exporting family wagons from its $1.5bn
joint venture factory in Shanghai to the Philippines and says it may also begin exporting minivans it
makes in China to other areas in Asia. Foreign investment in China is on pace to hit a record $50bn this
year. Motorola Inc. says its total investment in China will reach $10bn within four years, up from $3.7bn
now. Toshiba is building one of the worlds biggest laptop factories outside Hangzhou, with output next
year projected at 750,000 units and growing to 2.4million in 2004. The bulk of that is destined for export.
Feeling the effects. The US, the worlds biggest market, feels the effects more than most. Since May,
Americas monthly imports from China have consistently outstripped those from Japan. After decades of
exporting mostly low-end products, such as textiles and toys, china has moved into more sophisticated
goods, such as computers and DVD players. In July, exports to the US of China-made electronic products
hit $1.2bn, up to 12.5% from the month before. Chinas high-tech exports to the US, are now growing
faster than any other category of Chinese export, up 47% in the first seven months of this year from a
year earlier. Exports from China to the US affect most industries. Televisions and audio equipment rose
at a 13% annualized rate between 1998 and 2001 to $6bn in 2001; tools and hardware were up at a 23%
annual rate to more than $1.5bn in 2001; sporting goods rose at a 16% to $2bn. And as imports from
China are rising, US retail prices in many of these categories are falling. TV-set prices have declined on
average by 9% each year since 1998, according to Labor Department data; tool prices have fallen 1%
each year on average; sports-equipment prices have dropped at a 3% annual rate. To be sure, other big
changes in the global economy are driving prices down. The North American Free Trade Agreement and
European economic integration have boosted the flow of goods around the world Gains in technology
have spurred productivity, helping damp prices. The slowdown in the US economy has added to the
global glut of goods. But Chinas export juggernaut is a leading source of deflationary pressure.T h o u g h
the flood of cheap Chinese imports has translated into some lost jobs for US workers who compete
against Chinese manufacturers, it has been a boon for American consumers. Amatsia Salomon, who
operates a New York Limousine service, spent $48 at Home Depot on a combination ceiling fan and light
fixture made in China. Mr. Salomon, 63 years old, says: 'Years ago, we would say, 'M ade in China, we
dont want to buy it, because its very cheap quality. Then he adds, 'Today, this looks good...and its
inexpensive. In Japan, China's low-price exports are reinforcing deflation that has plagued Japan in
recent years. Matsutake mushrooms, prized for their delicate aroma, used to be considered such a luxury
that they appeared only in minuscule quantities in Japan, either sliced in soup or cooked in rice. But
matsutake mushrooms grown in China under contract with Japanese companies for export cost a tenth of
the price of Japanese-grown mushrooms and account for almost two-thirds of the matsutake mushrooms
sold in Tokyos biggest wholesale markets. Competitive prices also forced Xerox and its Asian joint
venture, Fuji Xerox Co., to refocus their energies on Chinas export market...The auto industry is one of
the best examples of the growing focus on new exports industries. Honda Motor Co. is setting up the
countrys first export-focused auto factory as a joint venture with Guangzhou Auto corp. and Dongfeng
Motor Corp., Chinas second-largest auto maker. Nissan Motor Co. announced last month that it plans to
spend about $1bn to buy a 50% stake in Dongfend Motor and begin mass production of a wide range of
cares and trucks. The Japanese company said recently that the joint venture could be exporting in one to
two years. Ford Motor Co. announced last month that it plans to boost its purchases of auto parts in
China to as much as $1bn annually starting in mid-2003. GM has already purchased more than $1bn in
Chinese spare parts in the past five years, and says it plans to increase that figure in the years ahead... In
the past decade, Asimco has acquired and revamped 1 '5 auto-parts plans across China that now bid for
manufacturing business around the world through Internet auctions. They often win contracts from US
auto-parts companies desperate to pare costs...Mr. Perkowski [a former Wall Street banker] is convinced
that will expand, as more auto-parts companies shift low-margin production to China and car

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25

manufacturers themselves buy parts from China to save money. For large U S retailers such as Target
Corp. and W al-Mart Stores Inc., China has become a huge spigot of supply. W al-Mart has been buying
goods in China to stock its stores for more than 20 years. About $10bn in Chinese-made merchandize
makes it to W al-Mart stores every year, either directly from manufacturers in China or from other suppliers
that tap sources in the country. In February, W al-Mart set up a new independent sourcing unit, based in
the southern city of Shenzhen, to buy directly from Chinese factories, with most of the goods going to the
US, executives say. General Electric, which posted sales in the local market of $ 1 .6bn last year, expects
purchases from China - both parts and finished goods - to hit $5bn annually within the next three years.
The goods include GE-brand refrigerators made by independent Chinese manufacturers, and parts for
G E s gas-turbine engines, used to generate electricity. Phillips has witnessed the unfolding of this
massive factory floor since the company made the switch from local to overseas targets. O f 23 factories it
operates, six are wholly owned and 17 are joint ventures. The company still pursues the local market,
where competition has forced Philips to adjust its strategy. Several years ago, David Chang, the 54-year-
old head of Philips's China operations, was strolling through an electronics exhibition in Shenzhen when
he was shocked by yet another round of price cuts in color T V sets. Growing numbers of these sets also
were being exported. The result was a new partnership Phillips formed with a major competitor. TCI Ltd.,
one of Chinas biggest T V makers, mainly for domestic sales. But Philips still seeks to wring more exports
from its China interests. Last month, the company broke ground on a $77million factory that will make
module displays, pr screens, for notebook computers, monitors and televisions. The majority of the
displays will be exported overseas - inside a Philips electronics product. If the factory is successful,
Philips says it may set up other such display plants in China and gradually shift the industry away from
South Korea, where the screens are now made. Ultimately, Philips says the goal is to turn China into a
global supply base from which the companys products will be exported around the world. Last year, 20%
of everything Philips made world-wide came from China, and executives say the figure is rising quickly.
Several products, such as the drivers for C D and D VD players, are now made only in China.

9. Chinas influx of foreign direct investment (FDI) is supported from another source that "By 1998 the
stock of FDI was $1 bn and 3.3% of G D P in India, against $261 bn and 23.5% of G DP in China." cf.
Financial Times, p. 20, W ed. Oct. 1 3 ,1 9 9 9 (underlining mine).

Also, see a comparison of the Top 10 global recipients of foreign direct investment, 1999:

($bn) (%)

US 720 20.86
UK 274 7.94
China 217 6.29
France 174 5.04
Belgium/Lux 143 4.14
Germany 137 3.99
Canada 137 3.97
Netherlands 127 3.70
Brazil 126 3.65
Austria 126 3.25

World Total 3,455 62.83%

Source: UNCTAD, cit. from Financial Times, "Inward Investment into the UK 2 , Thurs. Oct. 1 4,1 99 9 .

Also cf. The Economist, p. 80, Feb. 24th, 2001: ...the point about FDI is that it is far more than mere
capital: it is a uniquely potent bundle of capital, contacts, and managerial and technological knowledge.
It is the cutting edge of globalization.

10. Balance of payments includes current account, capital account, financial account, and net errors and
omissions, as well as reserves and related items. Current account refers to net trades of goods and

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26

services, current transfers (credit and debit)). Capital account refers to credits and debts. Financial
account includes direct investment abroad, portfolio investment assets (equity securities and debt
securities), other investment assets and liabilities. Reserves and related items include reserve assets, use
of fund credits and loans, exceptional financing, cf. Taiwan Statistical Data Book, 2001, by Council for
Economic Planning and Development, Republic of China, June, 2001.

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27

Chapter 2

Theories and Models of China's Transition

his chapter will review a number of scholarly explanations for the exceptional growth China has

T experienced during its transition from a planned economy to an economy relying increasingly on

market forces. Three of these explanations - by Nee, Boisot and Child, and Qian and Xu - will receive

my special attention.

2.1 Theories of state socialist economies between the 1950s and 1980s

2.11 Theories of state socialist economies in the 1950s and 1960s

In the 1950s and 1960s, in the midst of the cold war between the West and the Soviet Union and

Eastern Europe, some Western scholars had already developed an array of alternative theories regarding

state socialism. Initially these earlier scholars had challenged the mainstream critics of Leninist doctrine of a

dialectical relationship between the base and the superstructure that viewed historical development as an

unfolding progress of productive forces [1], They had also challenged the mainstream critics of Stalin's

dogmatist totalitarianism that viewed communism as the polar opposite of capitalism (cf. C. Friedrih and Z.

Brzenzinski. 1956: Totalitarian Dictatorship and Autocracy, Adam Ulam 1963: The N ew Face o f Soviet

Totalitarianism) [2],

Modernization theorists about socialist economies emerged in the West who challenged those

critics of totalitarianism for being unable to answer questions about industrial growth under state socialism

(R. Richta 1969: Civilization at the Crossroads: Social and Human Implications o f the Scientific and

Technical Revolution] R. Lowenthal 1970: "Development vs. Utopia in Communist Policy"; M. Montias

1970: Types of Communist Economic Systems. M. Field 1976 ed. 1976: Social Consequences o f

Modernization in Communist Societies; T. Baylis 1974: The Technical Intelligentsia and the East German

Elite; R. Bahro 1979: The Alternative in Eastern Europe; J. Bielasiak 1980: "Modernization and Elite

Cooptation in Eastern Europe, 1954-1971"; F. Parkin 1982: "System Contradiction and Political

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28
Transformation") I3]. Some modernization theorists argued that Communist party ideology and the forces

of modernization in planned economies could reinforce each other rather than have one (e.g.,

modernization) subjugated to the other (e.g., party ideology) (cf. R. Lowenthal 1970, p. 50: The

Communist Dilemma: Utopia vs. Modernity and p. 108: Uses of limits of the Totalitarian Model) f4].

According to these modernization theories, even under state socialism society would undergo its

own modem/industrial progress with a diminishing role of communist ideology. Implicit in their theories was

a mechanist logic of industrialization that assumed that industrialization, whether in a socialist or capitalist

society, could automatically expedite the spread of modem values and an efficient technology, and could

even help a rational bureaucracy to develop. According to such theorists, certain values, efficient

technology, and rational bureaucracy were benchmarks of modernization, irrespective of given historical

contexts and institutional conditions. According to R. Lowenthal (1970):

The very success of economic development [in the socialist economies] tends in the long
run to strengthen the forces of spontaneous, self-sustaining change, which are typical of
modem societies everywhere, while making the cost of further imposed revolutionary
change not only higher and more obvious, but less likely to be recovered by a new upsurge
of enthusiasm...[It thus] suggests the existence of a long term trend toward the victory of
modernization over utopianism (p. 54).

In this sense,

...a powerful, recurrent urge to utopian-motivated revolutions from above gradually loses
momentum with the progress of economic development (p. 108);

and

No longer able to justify its rule as a dictatorship of the proletariat needed to achieve full
Communism, it [the Communist party] claims that its guardian role is necessary to assure a
steady growth of production and welfare (which will eventually lead to Communism), to
prevent the penetration of foreign influences hostile to the countrys socialist achievements,
and generally to maintain national unity, independence, and greatness...the renunciation of
further revolutions from above and the acceptance of the primary need for continuous
economic growth lead to a strong emphasis on rationality, not only in the running of the
economy but in the methods of bureaucratic government (p. 115) (emphasis and brackets
mine) f t .

In the late 1970s, when several socialist economies began their transitional experiments to

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29
incorporate elements of market forces, modernization theorists in the West were already beginning to rethink

the dilemmas of market-state/hierarchies and to redefine them more often locally and dynamically at the

micro- or meso-institutional level.

2.12 Theories of state socialist economies in the 1970s and 1980s

In the mid- and the late 1970s several dramatic events occurred including the oil crisis in the Middle

East, Japan's fast growth, moderate development in the capitalist countries, and a widening gap between the

North and South. During this same period, the state socialist countries and the previous planned economies

experienced protracted economic stagnation. China's planning economy had seriously suffered from its

Cultural Revolution, with a drastic drop in social production after the 1960s. Socialist state planners began to

seek alternatives. At this point, Hungary became a focus of attention (cf. X. Richet 1981) I6].

Why was this so? It may have been because Hungarian reforms seemed to provide a promising

model for other ailing planned economies (cf. Nina P. Halpem 1985) [7], The Hungarian economist Janos

Komai identified a number of factors he felt contributed to the problems of the socialist economies,

particularly those in Hungary f t . He maintained (1956/[1959]) that the problem of shortages was a central

and unavoidable feature of any kind of planned economy f t . Komai stated (cf. Komai 1986a, pp.: 6-7):

In my opinion, all the above-mentioned symptoms spring from the sam e root; in the final
analysis they can be traced back to common main causes. W e are faced with various
concrete manifestations of the same general phenomenon...The 'reproduction [of
shortage] of the title refers to the fact that we are not faced with temporary, provisional,
occasional events but with a complex of phenomena that constantly reproduces itself
under specific circumstances. It is not simply a case of 'shortage breeding shortage
although such self-movement and self-generation can also feature. Shortage is
continually reborn out of social conditions and certain characteristics of the economic
mechanism about which we shall speak in a moment.

Ibid. p. 10: ...shortage and slack are not mutually exclusive phenomena, considering the
whole of production and a long period, but are necessarily concomitant.

Komai in 1992 offered a systemic comparison between a socialist shortage' economy and a

capitalist counterpart as follows (cf. 1992. Table 12.2, p. 291),

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Table 2.12a: The shortage syndrome: Komais comparison
between capitalist and socialist systems

Criterion for comparison Capitalism Classical socialism

1. Market regime Buyers market Sellers market

2. Dominant deviation Surplus Shortage


from market
equilibrium

3. State of labor allocation Labor surplus Labor shortage

4. Effective constraint Demand-constrained Resource-constrained


system system (administrative quota,
supply constraint, physical
input constraint)

Komai thought that the problem of shortages in socialist economies was rooted in the mechanism

of budgetary constraints facing state-owned companies. Komai called these "soft budget" constraints

under the policy of socialist redistribution [10J. According to Korai, these shortages cause the inefficiencies

of socialist economies and impede their growth (see Figure 2.12a for comparisons of the economic

performance in the former socialist economies prior to and following their transitions, 1961-2002) [11J.

Figure 2.12a: Economic performance of some socialist economies before and after their
introduction of market reforms: former Eastern Europe, former Soviet
Union, and China, 1961-2002

G D P Growth %
16
12
8
4 ^ L .
-/ , /+ " "
0 V v if ' *
-4 W\ /
-8 v
-12
-16

tf? o f? o f? o f? o f? J? o f? d f? o f? d f?
"P r< *? cJ?

Bulgaria - Czech Republic Hungary


Poland Romania Russia
East Germany China

Source: Komai 1992, Table 9.10, pp. 194-5; Komai et al. 2001, p. 78. Table 3.1, p. 269, Table A.1;
World Development Report 2000; Financial Times, II, Investing in Central and Easter
Europe, Mon. July 2,20 01 ; The Economist, p. 90, July 21st, 2001; the rest as same as of
Table 1.21b (2), Chapter 1.

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Komai stated (1986a, p. 8):

W e shall center attention on the producer firm, dealing exclusively with the short-term
behavior of the firm. It is presumed that the firm strives for increasing production, and we
shall not question its motivation, i.e. whether its impetus comes from the command of
superior authorities, from its own voluntary decision (with a view to increased profit), or
from bonuses promised to the managers, or from the urgings of customers, etc. The
question is the following: what are the constraints limiting efforts at increasing
production? Constraints are divided into three large groups: 1. Resource constraints...2.
Demand constraints... 3. Budget constraints: Financial expenses of the firm cannot
exceed the amount of its initial money stock and of its proceeds from sales...Which of the
three constraints is effective is a defining characteristic of the social system...It is always
the comparatively narrower constraints that are effective, for these conflict with the
endeavor to raise production. Relatively looser constraints are not effective (emphasis
mine).

As a further revelation, Komai later on developed a system-to system comparison of the short

term behavior of the firm (1992, p. 264, Tables 12.1) with the following features:

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32
Table 2.12b: Komais system-to-system comparison: the short term behaviors of
capitalist firm and socialist state-owned firms

Competitive private
firm under capitalism State-owned
within framework of firm under
Main feature imperfect competition classical socialism

1. Interest Primarily increasing profits Primarily recognition


from superior organizations,
chief criterion: performance of
instructions.

2. Entry and exit Determined by the market. Bureaucracy decides on all


Free entry. Business failure leads entries and ail exits.
to exit.

3. Budget constraint Hand Soft

4. Price responsiveness Strong W eak

5. Price determination Firm sets selling price. Price Price authority sets selling
higher than marginal cost. price, but firm has influence
on it. Relationship of price to
marginal cost is arbitrary.

6. Information on Firm unsure of demand Firm sure of demand


demand

Producer-seller Does not expect notional Expects notional excess


Hypothesis excess demand. Quantity demand. Quantity sold does
sold depends on own efforts. not depend on own efforts.

7. Notional excess Would like to sell more at price Would not like to sell more at
supply set than buyer buys. There is price set (approved) by price
notional excess supply and authority than amount it deems
notional excess capacity. its production limit. There is no
notional excess supply or
notional excess capacity.

8. Demand for inputs Constrained Inclined to run away [12].

Komai further distinguished the effective profit-making in socialist economies (through soft budget

constraints) from the effective budget constraints in capitalist market economies (through hard budget

constraints):

...The budget constraint is soft, if the growth of the firm is not tied to its present and
future financial situation. In this case there is no failure; the firm survives even when
investment entails grave losses. W hat I call here the hardness of the budget constraint is
not identical with what is called profit incentive of the firm in disputes about economic
management reforms in socialist countries. Profit incentive - e.g., profit sharing of

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33
managers and workers - is compatible with a soft budget constraint. In such cases
managers of the firm ask superior authorities for financial support exactly in order that
workers (and maybe also the managers) can get their usual profit share even in the case
of losses. Hard budget constraints are effective in the sense we have explained. They
constrain action and the freedom of choice. W e can spend only as much money as we
have. If we invest badly, we shall die of it. Soft budget constraints are not effective. The
financial situation of the firm does not constrain action. Money has only a passive role.
Let it cost what it may. The main thing is to acquire material and capacity, and money
for it will be found in some way. Once we have a contractor, we shall not stop the
investment just because we have no money. If there is a loss, the state budget will take
it over. The preceding stereotypes of common thought in business circles suggest that
the hardness or softness of the budget constraint reflects an attitude. It must not be
mistaken for the book-keeping category of the balance sheet of the firm. The latter is an
ex post identity. It is a relationship which holds all the time: the difference of the terminal
and the initial money stock is identical with the difference of incomes and of expenses. As
opposed to this, the budget constraint - if hard and thereby effective - is an ex ante
behavioral regularity, which exerts an influence on the firms decision. Exactly because it
is an ex ante constraint, it is related to the firm managers expectations...beyond a certain
limit, the manager can expect almost with a 100% certainty that the survival of his firm is
guaranteed; it can stand every loss and investment financial failure. If the overwhelming
majority of firm managers have this expectation for the future, it can be said that the
budget constraint is soft. In the 'classic' form o f socialist economy the budget constraint
is soft (1986a. pp. 13-15; emphasis mine).

The softness of the budget constraint decreases the elasticity of demand of all alternative
inputs, of all factors; diminishes the firms sensitivity toward the interest rate, exchange
rate and so on (cf. 1986b, p.9) [13].

Komai's major contribution herein was his observation that "it is not only market economies that

have an 'invisible hand, the economies of state socialism, too, have self-reproducing institutional

mechanisms" (cf. Nee and Stark 1989, p. 11; also cf. Komai 1980: Economics o f Shortage, Vol. A,

Chapter 9: The investor: Institutional framework, pp. 189-215) Furthermore Komai suggested that the key

remedy for ailing socialist economies would be to end the separation of production, enterprises, and

organization of socialist societies from market competition, financial constrains, and incentives; and this

would require a transition toward market economy [14] (also cf. P. Hall 1986: Chap. 2). Komais study was

acclaimed as a great theoretical breakthrough. It renewed the interests of Western academics in the

enduring institutional problems of the state socialist societies with their planned economies (cf. Komai

1980, 1986b, 1990).

With Komai's work as a start, new projects emerging in the late 1970s and the early 1980s began

to investigate the economic institutions in the socialist societies and their reforms. Alec Noves 1983

volume The Economics o f Feasible Socialism (1983a) can be regarded as one of the more fascinating

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34
subsequent presentations. Nove concurred with many of the insights Komai had addressed [15J. But he

did so on his own by reexamining Marx's theories of value as the fundamental premises accepted in

socialist societies for counting valuations and prices [16]. According to Nove, one flaw of socialist societies

was their common adoption of Marx's misconception of labor value that separated the value of a

commodity from the price of that commoditys production. According to Marx, value is calculated only on

the basis of labor time, excluding other factors such as scarcity of resources and of marginal production

other than labor costs, which Marx treated as value-in-use. In the meantime the price of a commodity was

to be stated according to its market values in money terms. Thus in planning economies value was

related only to the cost of production or production for use. It was de-linked from demand utilities, money

factors and market relations. As Nove uttered, this economic reductionism became a principal guideline

for inefficient resource allocation and deficient competition. In Noves vision (cf. Nove 1983a, p. 30)

Marx had little that was relevant to say about computation of costs under socialism. Marxists
who have tried to adapt his theory of value tend wrongly to use "valuations in terms of
(direct) labor-cost alone, which, so far as efficient resource allocation is concerned, is plainly
inadequate, as it ignores scarcity of production factors other than labor, and neglects use-
value...Labor-time can be measured in hours, but it is far from clear, unless one assumes
the existence of money, how other elements of cost can be computed and added to a sum
of labor-time.

Nove explained (ibid. pp. 25-6) that:

For Marx, the presence of use-value is a pre-condition for value, but there is no recognition
in this context that some things have greater use-value than others. There is total abstraction
from quality unless it requires more labor-time to achieve it. Marx certainly knew that
exchange-values and use values will tend to be brought into line with each other in a
competitive capitalist market...Market forces so guide profit-making capitalists that they do
not knowingly hire labor-power to make goods which yield below-average profits, or no
profits at all. But what happens if there is no market? Its absence removes the link -
imperfect, no doubt, but still a link - between effort and result, between the quantity of labor-
power utilized and the use-value it produces... if goods are valued in labor time...there is a
total absence of any connection between this valuation and use-value...Throughout Soviet
history, both theory and practice have suffered from this disjunction between value (or cost-
based price) and use-value.

Nove went on to criticize Marx's theories of values:

values (=sodally necessary labor time) [themselves] underlie prices; the former are
essence, the latter are appearance (ibid. p. 29; parentheses original; brackets mine).

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35
Hence according to Nove, Marx analyze the values instead of price, while he obviously ignored that

the price of production is the rules when capitalism develops (ibid.) [17].

As Nove stressed (ibid. p. 30), labor value in itself incorporates many other factors, such as who

provide tools, materials, means (e.g., parts, facilities), and how they are organized and distributed, etc. [18].

That is, labor value cannot supersede these factors such as society, market, and utility in accounting for

price [19]. In Marx's theories, value in use is basically neglected: "Demand (utility) does not 'fit' into either

the theory or the practice of price-fixing" with the assumption that "materials and energy are

inexhaustible" (ibid. p. 30). Moreover, in the context of deciding valuations and price, market values are

jettisoned as subjective factors that ought to be excluded [20]. Marx's theories of value and labor value

barely counted on money terms, since any valuation in money terms would be an imperfect appearance,

exclusive of the essence. Thus in state socialist and/or planned economies, labor values were measured

only by hours of labor-time, and that presumably determined production costs. As Nove explained, in

socialist economies, anywhere, everywhere production is [only] for use," and thus the real "value" is

linked with use value and likened to it (ibid. p. 27),

in contrast to the real world of capitalist commodity production in that the products of
labor [as exchange values] are related to one another through the market (ibid.; brackets
mine).

Noves trenchant arguments could be regarded as significant supplements to Komais

extrapolations on soft budget constraints and transitions in the socialist economies, where market

mechanisms as real determinants had long been ignored or abandoned.

In the early 1980s, Victor Nee shared many of Noves observations (1983. "Between Center and

Locality: State, Militia, and Village," In Nee, Victor and David Mozingo, eds. State and Society in

Contemporary China. Ithaca: Cornell University Press). But unlike Noves focus on Marxs theory of value

and labor value in terms of cost of production, Nee presented some conventional wisdom about market

forces and competition, derived primarily from mainstream canons. However, he also addressed his

discontent with neo-classic economics for neglecting many institutional constraints on economic efficiency

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36
and a rational economic model, and described how presentations were altered through a lens of new

institutionalism that he claimed to adopt (1989) [21], His thesis, as I perceived it, was a synthetic combination

of Polanyi's redistributive economy (K. Polanyi 1944 [1957]) and Szelenyis reduction of inequality under

state socialism (cf. Ivan Szelenyi 1978, 1983; also cf. R. Manchin and I. Szelenyi 1987). Nee attempted to

develop a revised view of an economic transition, through rephrasing state-market boundaries that could

affect the transition of a former planned economy from redistributive domination to market guidance (cf. Nee

1989: pp. 167-207; see the detailed discussion below in Section 2.2). Nee assumed that markets could

provide efficient incentives to direct producers and could create new structures with more opportunities in

the market place. This process could eventually transfer decision-making from the central powers to the

direct producers and thus eliminate the central powers monopoly.

David Stark, a co-author with Nee in their 1989 Remaking the Economic Institutions o f Socialism:

China and Eastern Europe, in his "Coexisting Organizational Forms in Hungary's Emerging Mixed

Economy" (ibid.) stressed the need to compare institutional configurations in socialist economies rather

than particular elements. While concurring with Szelenyi's arguments challenging the conventional

wisdom that markets indispensably increase inequalities, Stark added that:

...behind the explicit and very specific economic goals stands another political-economic
consideration that is especially important for understanding the establishment of the
V G M s [vdllalati gazdas&gi munkakOzOssPgek, i.e. enterprise business work
partnerships"!. The [Hungarian] political leaders saw the work partnerships as, above all,
a means of maintaining the standard of living of the politically and economically strategic
core group of workers inside the large enterprises during a period in which the real wages
for the entire working class were growing little, if at all. It was hoped that the VGMs, by
providing an additional source of income, would prevent the emergence of tensions
among workers whose key position in the labor process (and whose political skills and
ability to use their dense social connections) provide a strong basis for informal
bargaining inside the large enterprises (ibid. 1989: p. 142; emphasis mine).

Hence in capitalist economies where

the firm operates in a market environment...systemic uncertainties regarding labor are


reduced through internal bureaucratic rules,

whereas in state socialist economies,

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by contrast, where systemic uncertainties are produced by a bureaucratic environment.
workers and manaaers respond through internal market transactions (Stark and Nee
1989, p. 13; emphasis mine).

In their 1989 work, Stark and Nee together stated that in state socialist economies

the 'internal labor markets of the capitalist firm are a set of bureaucratic rules whose
logic is more classificatory than transactive (ibid. p. 13; also ibid. D. Stark 1989, pp. 143-
9: Market Inside the Socialist Firm"; and also cf. D. Stark 1986: Rethinking Internal
Labor Markets: New Insights from a Comparative Perspective").

So-called classificatory logic working on capitalist conditions is here designated as a

supplemental welfare measure to remedy the defects in market relations through rules regulated by the

state and market institutions. In contrast, socialist economies under redistributive mode might need a

boost via market forces to facilitate economic production and distribution. Market forces could counteract

superfluous bureaucratic organs and functionaries and provide more space to develop a "civic" economy,

reduce inequality, and flatten out social privileges, etc. Thus an advantage in such a new comparative

institutional analysis, as Nee and Stark like to call it (1989, p. 13), was that it could help unravel in a

systemic fashion the contrasting modes of systemic institutions of capitalism and socialism before

reviewing the specific attributes of each system. Nee and Stark went on to say:

Whereas modernization theory posited the West as the standard from which to gaze at
the 'other, in these and other studies the new comparative institutional analysis provides
a vantage point from which to look back at the institutions of capitalism as the specific
features of each system are revealed in their mutual contrast (Stark and Nee 1989, p. 13;
emphasis mine).

New institutional comparison herein is posed as a systemic means whereby we can make

effective comparisons between quite divergent socio-economic systems. To both Nee and Stark, as well

as to Komai, the bureaucratic inflexibility and redundancy in state socialism had incurred economic

inefficiencies. Reducing economic inefficiencies called for rebuilding economic institutions including state

bureaucracies. As Komai et al. claimed (2001, p. 10):

The transition to a market economy opens extraordinary opportunities for enhancing


growth and improving efficiency in the allocation of resources.

In short, the early institutional explorations of socialist transitions that started in the late 1950s

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provided a systemic critique of state socialism and its associated problems in terms of market-state relations

that contrasted with capitalism [22]. This kind of critique helped unveil the deficiencies of the cold-war

theories of totalitarianism in the 1950s and the inadequacies of the modernization theories prevailing in

1960s and 1970s. The picture of state socialism was not so much one of despotism but one of bargaining

and negotiation, with a primary focus on society. A new area of interdisciplinary research had been

identified: the study of transitional economies emerging between sociology and economics [23].

Following this line of early scholarship, could a reduction of bureaucratic size or central control,

as Komai and Nee implied [24|, induce increased economic efficiency and increased governance

effectiveness in socialist economies? If so, why did a great cut in bureaucratic size and central control in

the former Soviet Union (FSU) and the former Eastern Europe (FEE) apparently generate a bureaucratic

collapse and economic depression rather than add momentum and streamline the economy [25]?

Similarly, could privatization alone bring greater economic efficiency and performance [26]? O r could

privatization be a major factor in economic efficiency and performance? If so, how could one explain the

inconsistent relationships between the degrees of aggressive re-privatization and the respective GDP

performances in China, the FSU and the FEE, as shown in above Figure 2.12a, and Figure 1.2.1k, Table

1.2.1b (2) in our Chapter 1 [27]? In examining the transition of Hungary, Komai found that

it has been exactly the nonstate sectors that have brought the most palpable changes
into the life of the economy" (cit. from Nee 1989, 22).

In the 1970s and 1980s, the expansion of non-state sectors had gone "further" in Hungary and

China than in any other socialist society (cf. Michel Oksenbeng 1983; David Zweig 1985). These changes,

albeit piecemeal, had eventually initiated structural transformations in both countries [28]. As illustrated by

Table 2.12c and Figure 2.12b below, from the mid-1970s to the mid-1980s, the non-state sectors in China

grew more rapidly than they did in Hungary (cf. D. M. Newbery 1993) [29]. But we need to add a caution

regarding the numbers in the table and figure. Currently, Chinas data are available only for its gross

industrial output but not for its agricultural output. And Hungarian data are available only for its agricultural

output but not for its industrial output. Considering that the Hungarian industrial sector occupied a large

share of its economy, much larger than its counterpart in China, we could use Hungarys data o f national

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income as a surrogate indicator of Hungary's industrial output so that we could make comparisons

between China and Hungary. Nevertheless, one must keep these differences in mind while making

comparisons I30].

Table 2.12c: State-owned vs. non-state-owned annual share of national output,

China vs. Hungary

China * Hungary **

Share of Gross Industrial Output Share of National Share of Gross


Value by Ownership (% per annum Income*** by Owner- Agricultural Output by
for selected years) ship (% per annum Ownership (% per annum
for selected Years) for selected years)

State-Owned Non-State-Owned State Non-State State Non-State

Year Year

1949 26.25 73.75


1957 53.77 46.23
1958 89.17 10.83

1966 90.18 9.82 1966 16.4 83.6


1970 87.61 12.39
1975 81.09 18.91 1975 73.3 26.7 18.0 82.0
1978 77.63 22.37
1980 75.98 24.02 1980 69.8 30.2 16.8 83.2

1985 64.86 35.14 1984 65.2 34.8 15.3 84.7


1990 54.60 45.40 1990
1991 56.17 43.83 1991 70.0 30.0
1992 51.52 48.48 1992 53.0 47.0
1993 46.95 53.05 1993 45.0 55.0
1994 37.34 62.66 1994 40.0 60.0
1995 33.97 66.03 1995 35.0 65.0
1996 28.48 71.52 1996 25.0 75.0
1997 25.52 74.48 1997

Sources:

* China: Statistical Yearbook of China, various issues from 1985 to 1992,1998; Qian and Xu 1993.

** Hungary: converted from Central Statistics Office, Hungary; cit. Nee and Stark 1989: 36 [31]; data after
1991 refer to Official Estimates of the Private Sectors Contribution to GDP" in Komai et al. eds. 2001, p.
276: Table A.5.

*** See above note in parenthesis.

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Figure 2.12b: Growth in non-state sectors: China vs. Hungary.

80%

70%

60%
China

50%

40%

Hungary
30%

20%

1975 1980 1985 1990 1995 1997

Source: same as Table 2.12a.

Labels:

Hungary: Share of non-state sectors in national income


(Percentage distribution)

- China: Share of non-state sectors in gross industrial output


(Percentage distribution) [32].

Table 2.12c and Figure 2.12c compare the growth in the non-state sectors of the economy in

Hungary and in China between 1975 and 1996. They show that China had a significant amount of small-

scale commercial and industrial activities outside the central planning economy, except for the periods of

the Great Leap Forward (1958-66) and the Cultural Revolution (1966-76). Since 1979 Chinas industrial

system has become considerably more diversified, and there has been a gradual but substantial growth

in the non-state sector share of the total national output throughout the years I33]. By contrast, Hungarys

non-state sector changed less than Chinas during three decades until 1991, when its private sector

became a major driving force in its economic transition. Since 1991 Hungary has taken much more

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radical approach to privatization of its industrial system. As regards agriculture, by the 1990s Chinas rural

reforms had gone much further than Hungarys rural reforms both in depth and breadth, having assigned

virtually all the arable lands to households since its transition [34]. Since 1978 Chinas agriculture had

provided increased incentives and opportunities for collective production, private production, and for non

state market exchanges, and these had precipitated the emergence of a hybrid economy [35]. In contrast,

Hungary had set aside only a relatively small proportion of its land as auxiliary plots by the 1990s.

Hungarian market-induced policies remained until then merely adjustment measures.

This brief comparison between Hungary and China, two pioneers in the transition from state

socialism (or centrally planned economy) toward a market economy (or a quasi-market economy),

suggests the usefulness of institutionally-based cross-national comparisons. However, China differed in

so many ways from most socialist economies that it might be useful to look at China as a unique instance

of the transition from a centrally planned economy toward a market economy. This dissertation has no

intention to ignore some of the downsides of Chinas transition, its numerous backlashes, social

aftermaths, institutional failures, and even setbacks, which have consistently haunted Chinas process of

transition. But it will try from an institutional perspective to explain China's relatively rapid economic

growth as it introduced increased market forces into its formerly-planned economy.

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2.2 Nee: Chinas hierarchy-market dilemma

Many early writers tried to explain the underlying dynamics of Chinas economic transition by

examining the binary relationships between the state hierarchical coordination and the market coordination.

By chronological order of its appearance and due to its salience to scholarship on China's transition, we

start with Victor Nee's explanation early in 1989. Some other explanations we will discuss later can be seen

as modifications of N ees explanation (e.g., Boisot and Child). Nee and Stark first presented their

explanation in an introduction to their 1989 co-edited volume defining the predominant mode of Chinas

transition and the nature of its emergent hybrid economy [36] (cf. Nee and Stark 1989: Toward an

Institutional Analysis of State Socialism," in Nee and Stark, eds. 1989. Remaking the Economic

Institutions o f Socialism: China and Eastern Europe, pp. 1-31). Another important work by Nee was his

Peasant Entrepreneurship and the Politics of Regulation in China," also in Nee and Stark, eds. 1989.

Remaking the Economic Institutions o f Socialism: China and Eastern Europe, pp. 169-207).

In his Toward an Institutional Analysis of State Socialism," Nee acknowledged two possible patterns

of transition for a socialist state: (1) A socialist state could go through a radical political transformation to

remove political obstacle from the one-party Leninist state, in which case the transition would involve a

decisive shift from bureaucratic to market coordination." O r (2) A socialist state could follow an

incremental path to rebuild economic institutions and reform socialist economies. The first pattern

involves changes of the state hierarchy. The second pattern involves changes of the society. As N ee and

Stark stated (pp. 25, 27-8),

The history of market reform in socialist economies has been marked by cycles of
decentralization and centralization, expanding markets and restoration of hierarchies, and
alternating periods of reform and countenreform...ln a one-party Leninist state, without
competing political parties, there is little scope for open debate to ensure thoughtful
consideration of alternative visions, programs, agendas, and public policies. Progress
and successes in reform typically have no secure institutional basis or
guarantees....Som e analysts believe that the concentration of political power in a Leninist
party-state without electoral accountability and public scrutiny seriously complicates, if
not ultimately jeopardizes, any attempt at market reform. There is no political penalty for
failure in the absence of genuine opposition parties capable of mounting political
challenges through electoral politics... Brus, Whyte, and Lin thus contend that the
Leninist state is the main obstacle to remaking the economic institutions of socialism. In
marked contrast, Susan Shirk argues that it is precisely the concentration of power in a

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few top leaders in setting the reform agenda, shaping the reform ideology, and managing
conflicts in subordinate agencies that provides the tools to manage the implementation
process. Far from an obstacle, the Leninist state is the instrument of reform. To support
this position, Shirk notes that although reform in Hungary and China has not brought
about a decisive shift from bureaucratic to market coordination, we should not lose sight
of the lam er cumulative trend across cycles toward the increased role of the market
mechanism in the reforming socialist economies (emphasis mine).

While introducing numerous chapters by major scholars analyzing transitions from socialism, Nee

and Stark pointed out how scholarly attention eventually focused on redrawing the boundaries between state

and society.

Redrawing the boundaries of the state is especially marked in societies with Stalinist or
Maoist legacies in which, for longer or shorter periods, a concerted effort had been made to
deny these boundaries altogether (Ibid. p. 22).

But Nee called such a reform simultaneously involving a mix of bureaucratic and market

coordination" a partial reform, holding that it merely underscored the problem of the transition from

bureaucratic to market coordination. Nee further argued that rebuilding the economic institutions of socialism

in order to shape new patterns of transaction could provide the long-run possibility that capitalism and state

socialism could eventually merge by denying those boundaries,

Market reform and its social consequences will no doubt stimulate interest in models of
convergence between capitalism and state socialism (ibid. p. 30).

According to Nee, to be effective, boundary redrawing has to be systemic, immediate, and essential

to the transitions. Explicitly, state and society, hierarchy and market, can be treated in a binary relationship.

Below is my heuristic figure of Nees major thesis regarding the convergence between capitalism and state

socialism (also see Nees further clarification about his institutional thesis on the convergence in 2001; cf. V.

Nee, 2001, p. 846) [37J.

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Figure 2.2:

Nees 1989 model (i.e., solid line):


Redrawing boundaries between
State hierarchy and market

(State Socialism) Welfare State


Redistribution

State/Hierarchy

Today Tomorrow
A Crbss-Systemic
CovergenceV

Market Competition
Laissez-raire Market Competition (Re-Privatization)
Market

Note: this heuristic figure is mine.


Labels: Solid line shows Nees thesis on Chinas market transition from the state socialism to a
market economy;
Dotted line shows advanced capitalist development with a long-run possibility in Nees
proposal of the convergence between capitalism and state socialism.

As above shown, Nees model emphasized that the socialist state bureaucracy is the principal barrier

to the transition. The transition can occur only through reforming political institutions and reducing the size of

the state bureaucracy:

A central contradiction of reform efforts in socialist economies derives from the reform
leaderships failure to cut back sharply or dismantle entirely the bureaucracy that managed
the command economy. This is largely because inherent in any reform effort is the fear that
the reform may fail to realize desired results...To minimize the risk of failure, reformers tend
to move gradually in carrying out organizational reforms that are aimed at sharply reducing
the size of the economic bureaucracy (1989, pp. 26-7).

Nee went on to say:

In an important sense, reforms in a socialist society, even when they do not challenge the
sacrosanct institutions of the Communist party or raise the issue of political democracy,
always involve a reconceptualization of the relation between particular and general interests.
At a basic level, genuine reforms legitimate the particular - in the sense that particular

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interests can have validity without being expressed in immediately universal terms. To take
the problem of enterprise autonomy seriously, for example, means that an enterprise
director can legitimately justify a decision on the grounds that it is good for his firm. He might
go on to make a link to general interests, adding that if it is good for his firm, it is good for the
country; but that is quite different from the earlier situation in which the argument from the
central planners usually ran the other way around; since it was good for the national
economy, it followed that it would be good for the firm. Similarly, legalization (as opposed to
mere toleration) of private ventures involves a legitimization of particular interests. Thus
remaking the economic institutions of socialism involves redefining the conceptions of
interests and redrawing the boundaries of the state and economy as well as of state and
society...the state-society boundary is not only redrawn by state policy makers; it is also
reshaped by society, the activities of peasants, manual workers, and other employees who
are not functionaries in the bureaucracy (ibid. pp. 22-3).

Thus, according to Nee, the transition from state socialism to market competition required redefining the

conception of the general/particular interests and state/society boundaries I38]. As Nee elaborated,

The penetration of the state into all realms of life did not extend a public sphere so much as
negate it, for without attachment to the party or one of its subsidiary organizations no
particular individual could make claims with any general validity. Yet at the same time, the
omnipresence of ideas about universal interests threatened to eliminate the particular as
individuals lived in fear that the simplest particularity...could be interpreted as intending to
convey a general comment (ibid. 22).

In Nees view, partial reforms in transitional economies are most problematic. They produce the

dilemma of dual dependence on both bureaucratic coordination and market coordination. Partial reform can

result in the worst ends instead of the best ends, and can reinforce or even perpetuate central control. The

solution thus has to be the complete removal of state bureaucratic coordination and a complete entry through

market reforms to market coordination. According to Nee,

Public ownership, Komai argues, fosters paternalism on the part of central planners...The
hyperactive role that comes with public ownership and the resulting multitude of direct
microinterventions on the firm have the effect of distorting the regulation of the firms survival
and growth. Moreover, central planners undertaking these interventions are disadvantaged
in making rational allocative decisions because prices set by bureaucratic procedures
cannot convey detailed information on changing conditions. These allocative inefficiencies of
central planning led early reformers in state socialist societies to advocate incorporating the
market mechanism into central planning... The outcome of market reform in Eastern Europe
has been largely disappointing, especially in light of the early reformers extreme confidence
in the harmonious, mutually correcting duality of plan and market...As Komai suggests, the
naivete of the early reformers was to believe that in combining central planning with the
market mechanism they could achieve the best of both worlds. They failed to consider fully
the possibility that partial reform would result in the worst of both worlds (ibid. 16-7).

Bureaucratic allocation encourages firms both to make exaggerated claims for resources
to strengthen their bargaining position and to hoard, actions that, when aggregated to the
economy as a whole, are reflected in excessive or limitless demand and therefore in

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permanent shortages. The existence and perception of widespread shortage in turn
necessitate continuation of bureaucratic allocation. Moreover, the same bureaucracy
entrusted by reformers to implement market reform has strong vested interests in
maintaining its power and prestige, which are based in its control over economic
transactions (ibid. 19).

On the one hand, Nee did suggest that the redrawn boundaries between the public/state and

private/society might generate hybrid and intermediate forms and enable society/private sectors to grow and

penetrate into the state/public sector

...the process of establishing the institutional framework of a mixed economy generates


pressures for bureaucratic rationalization within state socialism. As the state withdraws from
direct control over the economy, and as markets expand in scope and generate new
entrepreneurial activity in the private sector, the state must adopt a regulatory role in
specifying and enforcing rules and procedures within which economic actors operate and
which define the limits of state power...the growth of competitive markets generates
organizational dynamics that may result in greater reliance on legal-rational procedures and
indirect macroeconomic regulation to economize on transaction costs (ibid. 20).

The boundary between public and private sectors would thus be crisscrossed by multiple
strands of joint ownership forms and related leasing arrangements...Redrawing the
boundaries between private and public, between state and society, need not entail making
them more distinct and clearly defined but may mean widening the boundary zones and
blurring the distinctions (ibid. 25).

On the other hand, Nee was skeptical of partial reforms, since he doubted if any room existed in

between central planning by the state bureaucracy and market mechanism,

Instead, partial reforms both perpetuated problems of the prereform economy and created
new distortions and imbalances... The command economy was replaced by a hybrid
economy, which Komai argues[,]...operates in a condition of 'dual dependence in which the
economy is coordinated by both vertical bureaucratic and horizontal market relationships.
The essence of dual dependence, however, is the continued dominance of hierarchical
forms of coordination over the socialist firm and the debilitation of the market mechanism by
persistent and pervasive bureaucratic microinterventions. Komais analysis points to the
dilemma of partial reform, that despite giving a greater role to the market, all of the critical
decisions - entry, exit, investments, prices and wages, output, credit - still depend more on
processes internal to the planning governance structure than on the market. As a result, the
problems of the soft budget constraint, shortage economy, and investment fever of the
prereform socialist firms persist in the postreform economy. Komais analysis of the
reforming socialist economy reveals the relative weakness of the market mechanism when
confronted with an intact bureaucracy accustomed to controlling economic action. Whether
the actual mechanism of bureaucratic control is direct or indirect, the effect on the firm is to
weaken its responsiveness to the market and perpetuate the conditions of inefficiency
associated with central planning. Komai concludes from the Hungarian experience of partial
reform that without a decisive shift from plan to a structure of market governance,
characterized by hard budget constraints and market competition, there can be no escape
from the dilemma of dual dependence. The transition from bureaucratic to market

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coordination in Chinas industrial sector, Nicholas Lardy argues, has proceeded far more
slowly than the stated intentions of Chinese reform leaders would suggest...In these crucial
areas [such as pricing structure], argues Lardy, China has yet to go as far as Hungary and
Yugoslavia in changing the governance structure from hierarchical to market modes. The
difficulties of bypassing hierarchies and shifting to market coordination point to the
extraordinary staying power of established bureaucracies in charge of economic
allocation...(ibid. 17-9; emphasis and brackets mine) f39].

N ees and Komais agendas of socialist economies transition resemble each other, not only for

their similar terminologies, such as market efficiency," shortage economy, and soft budget constraints

(also, cf. Nee 1992, p. 6), but also for their similar contentions that the best way to prevent bureaucratic

hyperactive microintervention is aggressively to undertake full privatization. As Nee and Stark stated,

Just as the evolution of hierarchical organizational forms has been explained as a means to
economize on transactions costs under conditions of market failure in capitalist economies,
so the shift from hierarchies to markets should be understood as a response to
organizational failures in socialist economies. Kornais soft budget constraint, for example,
can be viewed as an organizational failure generic to centrally planned economies.
Organizational failures in state socialism are rooted in the relationship between the firm and
the state, that is. in the allocative processes of central planning (1989,16; emphasis mine).

W e have to credit Nees model for its contrast with the previous school of totalitarianism and

modernization theory I40] by including social institutions and interested groups. N ees model identifies the

social constructive nature of transition and the underlying need to redress the problems generated by the

ambiguity of property rights that comes along with China's hybrid economy and that might enable a

hyperactive state to become a regulatory state under the rule of laws. Ambiguity of property rights could lead

to considerable corruption and malfeasances.

One outcome of Nees observations was his conclusion that a new form of institutional analysis

would be most fruitful in guiding the comparative study on transitions f41]. Such an analysis could shift from a

conception of reform as mix of plan and market within the state sector to a conception of reform as the

transition to a mixed economy of public and private property forms with implications for the emergence of new

social groups and autonomous social organizations (ibid. 16).

Nee, in another work (i.e., "Peasant Entrepreneurship and the Politics of Regulation in China,"

1989), while persisting with the primary theses elaborated in his joint essay with Stark, approved the role

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Chinas peasant entrepreneurs were playing in pursuing public goals by promoting economic growth, and

by providing new workplaces for the underemployed (ibid. p. 23). To Nee, the penetration of society by

the state can also be seen as a penetration of the state by society (ibid.). In this work, Nee documented

how Chinas peasants, through their entrepreneurship, pursued their private profits within their legitimate

range (ibid. pp. 169-207).

Despite observations such as these, N ees analysis remained haunted by this binary dilemma

and its intractable nature. Many of Nees arguments appeared vulnerable to being holistic, resting chiefly on

mainstream conventions of the market economies and general economic regularities. Nee presumed that

Chinas reforming regime had retained an intact bureaucracy" inherited from the erstwhile planning system

(ibid, 17), i.e., the classical socialist economy so-called by Komei (see our Section 1.1, Chapter 1), and that

Chinas decentralized hierarchy was at most a "partial reform" that could eventually generate the worst result,

i.e., saving the "persistent and pervasive bureaucratic microinterventions" policies that impeded market

competition. According to Nee, those hybrid forms essentially weakened Chinas organizational "responses to

the market" and entrenched "the conditions of inefficiency associated with central planning" because they

reinstated such "an intact bureaucracy accustomed to controlling economic action" (ibid. 17) f42].

2.21 Nees 1992 empirical thesis on China's hybrid economy

N ee in 1989 had maintained that unless China's transition headed for a market economy, China

could not solve its "soft budget" problems related to the irrational nature of bureaucratic coordination and

the inefficient allocation of resources. Hence remaking China's economic institutions had to center on

ownership re-privatization through diminishing the role of state sector and through elevating the role of

non-state sectors that come along with market expansion f43]. N ees 1992 empirical investigation of

Chinas organizational dynamics retained his concern for ownership re-privatization. As he stressed,

The organizational dynamics growing out of disparities in economic performance and


access to resources among the state, collective, and private sectors is what drives
market transition in China (1992, p. 24).

Notwithstanding, Nee's 1992 work ("Organizational Dynamics of Market Transition: Hybrid Forms,

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Property Rights, and Mixed Economy in China." Administrative Science Quarterly Vol. 37 (1), 1992: 1-27)

cast new light on the study of Chinas transition by acknowledging Chinas considerable institutional

changes since the 1990s, affected in part by the hybrids,

The emergence of the hybrid marketized sector reflects a fundamental structural change
that is still in progress (ibid. p. 23) I44].

Here Nee treats the hybrids more positively. According to Nee (1992, p. 8),

In China at present, the marketized redistributive and private sectors sustain potent interests
in market-oriented economic growth, which is often nurtured by direct links to urban centers
and the world economy through subcontracting or 'putting out arrangements and joint-
venture projects (Su, 1992). These interests, moreover, are often supported and articulated
by local governments, which have become increasingly reliant on revenues gained from the
marketized redistributive sector [i.e., the state sector], as well as the private economy. The
new alignment of interests structured by market forces and the institutional dynamics of
partial reform has given rise to neolocalism, a form of corporatism based on a coalition
between local government, the marketized firm, and private enterprise, often against the
encroachment of the central state. Far from being unitary hierarchies, local government,
marketized firms, and private enterprise constitute a loosely coupled coalition of interest
groups, in which interests and group cohesion are continuously shifting and reconstituting
themselves in new combinations according to changing environmental conditions (Pfeffer
and Salancik, 1978) (the brackets mine).

Despite his insistence that Chinas reforms were partial, Nee now suggested that Chinas

economic hybrids provided intermediary links between the state hierarchy and markets that buffered the

tensions between them and thus were indispensable to Chinas transition (ibid. p. 3), particularly through

a booming local corporatism f45] that underscored the salient role of local governments sponsorship of

the local business communities and had little to do with the central state government j46].

In 1992 Nee also noted that Chinas hybrid economy actually adapted elements of the East Asian

development model which cannot be readily accounted for by neoclassical assumptions (ibid. 25) f47].

As Nee argued,

The East Asian development model - Japan, South Korea and Taiwan - rested on
continuous but selective state interventions (e.g., Amsden 1985; Hamilton and biggart,
1988). There, authoritarian states intervened in markets and firms to shape the course of
development, which enable these late-industrializing economies to mount and sustain
high levels of economic growth. Chinas market transition bears family resemblance to
the East Asian mode, and economic development there may in time take a similar course
(Perkins, 1986). As Biggart (1991) argued, the East Asian cultural tradition encompasses

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the deep structures that produce the distinctive institutional environments of East Asian
market economies, which cannot be readily accounted for by neoclassical assumptions.
The market has penetrated the state socialist redistributive economy and is in the
process of transforming it into a hybrid market economy characterized by strong
government involvement (ibid. 24-5; emphasis mine).

Thus we could use a heuristic figure to illustrate N ees revised scheme in 1992 (see Figure 2.21

below). It shows that China's transition through its market reforms, if on the right track, would move from a

hierarchically-dominated or state-commanding economy to a market-oriented or market-mechanism-

approached economy.

Figure 2.21: Nees 1992 perception of


Chinas transition

Hierarchy
China Prior to Reform

Reforming China

Right Track - Head for Market Economy

Market

Note: This figure is made with reference to N ees 1992 figure and table (cf. pp. 8-9: Figure 2 and Table 1).

In 1992 Nee divided Chinas enterprises into three types: nonmarketized firms (NF), marketized

firms (MF), and private firms (PF) (ibid. pp. 11-13), somewhat similar to Komais divisions (cf. Komais

1992, p. 291: Table 12.2 contrasting classical socialist firms with capitalist private firms). Nonmarketized

firms (NF) refer to those state-owned enterprises (SOEs) that are mainly large-sized and big-city-based

(also cf. Cao et al. 1999, Table 1, i.e., Table 2.21a below) I48].

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Table 2.21a: Chinas state-owned industrial enterprises by size, 1993

Number Output Employment Net value Profits and


(%) (%) (%) of fixed taxes (%)
assets (%)

Large 4.7 56.7 43.2 62.0 66.7

Medium 12.9 23.6 25.6 18.6 19.4

Small 82.3 19.7 31.1 19.5 13.9

Source: China Statistical Yearbook 1994, pp. 388-91; cit. from Cao et al. 1999, p. 108: Table 1.

Marketized firms (M F) refer to mid-sized SOEs, C O Es (collective-owned enterprises), and TVEs

(township-village enterprises). The mid-sized cities and urban centers are surrounded largely by mid

sized SO Es and COEs, while Chinas rural townships and villages are the locations of the TVEs. Private

firms (PF) are mainly owned by individual entrepreneurs, private firms, and private ventures, including

those joint ventures with foreign firms and the joint ventures with SOEs and COEs, depending upon the

percentage of holding shares. The SO E, COEs, TVEs, and Private Ownership are currently standard

ownership used by Chinas State Statistical Bureau. I49]. Currently, most individual entrepreneurs and

most indigenous private firms operate with small amounts of working capital relative to their SOE

counterparts. But during this period the individual entrepreneurs and private firms have expanded, while

the SO Es have shrunk. In 1992 Nee compared the organizational dynamics, managerial styles and

attributes of different types of enterprises in Chinas hybrid economy (see Table 2.21 b).

Table 2.21b: Nees 1992 comparative organizational dynamics of nonmarketized firms


(NF), marketized firms (MF), and private firms (PF) f50]

Attributes NF MF PF

Enterprise autonomy 0 + ++
Neolocalist orientation 0 ++ +
Soft-budget constraints ++ 0 0
Efficiency 0 + ++
Access to capital ++ + 0
Access to raw material ++ + 0
Access to labor + ++ +
Access to markets + ++ +
Workers compensation + ++ +

* ++ = strong; + = semi-strong; 0 = weak; Source: Nee 1992, p. 9, Table 1.

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As Boisot and Child noted in 1996 (609), Nees distinctions most overtly followed the concept of a

bifurcated economic system between market and state, albeit they also addressed the distinctions from the

perspective of management. However, Nees distinctions sensed the plurality of China's present economic

order" (ibid, 610). According to Boisot and Child [51], N ees classification could be regrouped as follows,

Table 2.21d: Boisot and Childs regrouping of Nees classification of


Chinese enterprises by ownership and marketization

Mode of Ownership/Property Rights


Coordination

State Collective Private

Non-Market 1. Non-Marketized
State Enterprises

Market 2. Marketized 3. Collective 4. Private


State Enterprises Enterprises Enterprises

Source: Nee 1992, p. 8: Figure 2; cit. Boisot et al. 1996: Table 1, p. 609 [52].

In the following sections 2.22-2.24 I will use the above regrouping of Nees classification, since, in my

opinion, it can help identify the nature of Chinas hybrid economy, and expose the strengths and weaknesses

of Nee's model. My following description is also reflective of Boisot and Childs discussion in 1996 of Chinas

emerging hybrids (610, 622).

2.22 Nees non-marketized state-owned sector (Sector 1 of above Table 2.21 d)

In the 1990s the non-marketized state-owned sector of China's economy included most core

enterprises and competent industries. Despite this sectors increasing discretion from the central government

that followed decentralization and new Enterprise Law, the governance and management of non-marketized

state enterprises remained mostly controlled by the "vertical ties to higher-level agencies" (Boisot and Child

1996, 610). They have thus retained the constraints of soft budget on efficient resource allocation inherited

from the pre-reform period I53]. A major concern here was the ambiguity of this sectors property rights with

multiplying market operations that kept it from the fully free market contracting formally required by a market

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firm for its complete autonomy I54]. Nee noted that state ownership made it difficult to delegate full authority to

the boards of directors and firm managers like most private firms could. With state ownership, only the upper

authorities could appoint most of those who were in charge of the firms governance and managerial

decision-making (ibid, 620). Ultimate state ownership would incite myriads of problems, such as those of

legal loopholes, legitimacy, soft budgets, organizational inertia, corruption, etc. These problems could further

dampen the local entrepreneurship, tamper with the activism of the economic organizations I55], and drag

down their performance. In the end, Nee holds out little hope for the non-marketized state-owned sector of

Chinas economy.

2.23 Nees marketized non-private sector (Sectors 2 and 3 of above Table 2.21 d)

The Marketized State Enterprises (Sector 2) and the Collective Enterprises (Sector 3) in Nees

above classification include most business enterprises, state-owned or collective-owned or semi-state-

owned. There is some controversy regarding whether or not these state-owned enterprises and

collective-owned enterprises (most rural collective-owned enterprises are now township-village

enterprises) actually represent private firms I56]. These enterprises of this sector act more or less as

formally autonomous entities or players, somewhat independent of the state in a legitimate sense through

marketization. Such a semi-dependent status of ownership and operation accompanies growing

discretion in decision-making [57]. Although these enterprises do not enjoy full formal discretion as the

private sector does, the effective discretion they can enjoy informally is sometimes larger than that of

private firms f58]. Private firms are actually suffering double hits not only from state interventions but also

from the very hard budget constraints of the markets invisible hand. The leverage drawing from the

duality of ownership and the associated complexities exposed to Chinas transition could really be

revealed through this marketized non-private sector I59].

If we look at N ees non-state sectors (i.e., Sectors 3 and 4 of above Table 2.21d), they are by and

large made up of mid- or small-sized, undercapitalized collectives of family businesses, and private

enterprises providing over 70% of overall industrial output (see above Table 2.12c and Figure 2.12b).

Supposedly, they are more vulnerable than the marketized non-private sectors (i.e., Sectors 2 and 3 of

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above Table 2.21d) to the double sufferings from their free market transactions and from the intervention

of local governments. As Nee explained in 1992, the non-state sectors could not escape the exactions of

local bureaucracies with which they must reach some accommodation for their survival" I60]. In the

meantime, as Nee discovered, their operations could succeed only if they were beyond the reach of the

state central bureaucracy. According to Nee, the role of the state is mostly perceived as negative,

whereas the role of market mechanisms is mostly romanticized I61]. The state role is assumed as

contradictory to marketization. Such a perception ignores the fact that many firms in the state sector have

actually leveled themselves out through subcontracting to non-state firms and through forming joint

ventures with both non-state firms and foreign partners. The distinctions between the state sectors and

the non-state sectors with respect to their property rights and operations thus become rather blurred and

ambiguous in China's transition.

Nees marketized non-private sector (i.e., Sectors 2 and 3 of the above Table 2.21d) cannot be

immune to the same dilemma related to its property rights and operation mode I62]. Nee realized in 1992

that the ambiguous role of the state in regard to the marketized non-private sector could be positive and

not always be negative I63]. Boisot and Child (1988, 1996) and Pei (1996) held even more optimistic

perspectives, particularly regarding TVEs or COEs (Sector 3). Boisot and Child assumed that this

ambiguity could allow the sector actually to enjoy both a "type of state-dependence" and a kind of semi

autonomy backed by localized intermediaries like local banks with their access to local resource and

network information I64]. Pei in 1996 explained that TVEs, in the absence of sufficient resources and

proper market regulations by the state, could become major surrogates for other alternatives in rural

industrialization. Further, the reciprocity between the state and the marketized non-private sector actually

caps the collusion with local governments. This agreed with Qian and Xu's observation that the local

agencies of the state have actually filled many roles that in the market economies would be played by

private intermediary institutions. Boisot and Child share similar findings I65]. As seen in Chinas current

transition, keeping stronger personal ties to communities and informal connections with local

governments have been conducive to the thriving of these sectors (see Figure 2.23) I66]. W hat counts

here is the actual role of state reforms and policies, whether they are supportive or repressive, and how

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their effects can be evaluated. In comparison to the ambiguity of property rights in the non-marketized

state sector (Sector 1 of the above Table 2.21d), that Nee regarded negatively, Nee regards the double-

edged nature or duality enjoyed by marketized non-private sector, particularly by TVEs, much more

positively. Today the marketized non-private sector (Sectors 2 and 3 of the above Table 2.21d) and the

private sector (i.e. sector 4 of above Table 2.21 d; see below Section 2.24) altogether constitute an

integrative marketized sector, which has taken over 85% of Chinas total industrial output in 2001.

Figure 2.23: C h in a - Industrial o u tp u t by types o f ow nership,


1952-1997

% per annum

90
80

70 State
Enterprises
60 Collective
50 Enterprises
Private
40 Enterprises
30

20

10

0
1952 1962 1970 1978 1985 1987 1989 1991 1993 1995 1997

Source: China Statistical Yearbook, 1998.

2.24 Nees private sector (Sector 4 o f the Table 2.21 d).

Most components of the marketized private sector have more unique characteristics and even close

affinities with overseas Chinese family businesses in the so-called Chinese Diaspora I67]. Following the

institutional reforms intensified since 1985, this sector of Chinas economy, consisting of those individual

ownerships and other ownerships (non-SOE and non-COE owned), as well as venture capital enterprises

(many of which mix with local SOEs, COEs, and overseas capital enterprises), has formally enjoyed greater

economic discretion than any other sector. Nee was most interested in this sector, since he thought it might

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be the sector most seeking short-termed economic efficiency, although he remained doubtful about its

capacity, in the long run, to introduce modem capitalism t68]. Indeed, in 2001 this is the sector of fastest

growth with strongest momentum I69]. Many of those private firms remain small, contingent, localized, and

undercapitalized, operating under hard budget constraints. Many of them remain rather self-reliant, diligent,

and frugal, and thus distinct from their Western counterparts as well as from giant corporations [70]. This

sector operates almost entirely exposed to the market, much more so than the TVEs or COEs, though many

private firms have co-partners in the slate-owned enterprises, or strong affiliations with them, and have even

been shaped by governmental institutions. In this way the leverage that private firms could enjoy from the

formal discretion would be less than what marketized non-private firms could enjoy with their informal

discretion. On the whole, however, the survival of this sector rests upon a private firms ability to make

dynamic and innovative decisions. Local banks and other intermediaries provided little assistance for the

private firms since they concentrated on larger state enterprises and collective firms [71],

Prior to 1990, the state had not yet stipulated full-fledged codes and stable procedures, regulating

the normative routines of those fledgling private firms, protecting their legitimate rights, and promoting their

growth. In the absence of stable institutional procedures and well-coded private intermediaries, as Boisot and

Child noted in 1996 [72J, the management of many private firms had to depend on personal connections and

local governments and trust networks to tackle the scarcity in resources and information. The legitimacy of

the private sector had been more problematic than that of other sectors. Sometimes private firms that had

registered in the name of collectively owned firms found that they enjoyed more subsidies and protections

from the local governments (cf. Pei 1996). Hence similar in some ways to the marketized non-private sector,

the property rights of the private sector were "dependent importantly upon the sanctions of local governments

and officials" (cf. Boisot and Child, p. 612).

After Dengs famous Southern Tour in 1992, the situation in China began to change. Nee published

his work before he could see that state governments had taken a series of more aggressive reforms

regarding industrial structure. The duality in private firms gradually abated in the 1990s, and their economic

leverage increased. As more and more COEs or TVEs become converted into private firms, SOEs' reforms

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were extended, and the governments policies became more relaxed. More SOEs marketized and sold out.

Private firms gained greater access to capital funds and labor [73]. The increasing sizes, employment

numbers, and growth rates of private firms contributed significantly to Chinas national industrial growth.

In summary, we can say N ees model focused on the binary distinction between state/hierarchy

and the intractable nature of the market. His 1989 works explored the transitions to market economies

from erstwhile socialist economies. Nee extended his analysis beyond the narrow neo-classical range to

include society and social groups. But while focusing on redrawing boundaries between state/hierarchy

and market and between public interests and private interests, his observations and programs of

remaking economic institutions essentially repeated essentially repeated Komais thesis regarding the

needs for market efficiency and the inept nature of the state bureaucracy in socialist economies.

According to Nee, Chinas regime remained an intact bureaucracy of a planning system; therefore its

reforms through decentralization and hybridization were doomed to be only partial reforms. His thesis

was later criticized by Boisot and Child as an example of Williamsons unidimensional market-hierarchy

continuum (see our discussion below). By contrast, Nee in 1992 provided an empirical investigation of

organizational dynamics in Chinas market transition. He put Chinas hybrids in the dynamic front of its

transition. He turned to Chinas local corporatism and cultural intermediaries to account for the

momentum of Chinas fast growth. Accordingly, Nee identified Chinas privatization of its non-state

sectors as playing a key part in Chinas economic transition and subsequent rapid growth.

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2.3 Boisot and Child: The emergence in China of a new
economic order - network capitalism

Max Boisot and John Child (hereafter B&C) presented their analysis of Chinas transition in their two joint

treatises in 1988 and 1996, in both of which they expressed their critical reservations about Nees endeavors

to analyze Chinas transition.

Boisot and Childs 1988 work (507-527) started with a critique of Williamsons theorems on

transaction costs. According to them, the current markets and hierarchies framework of transaction-cost

economics provides too limited room to account for the PRCs bureaucratic failures of economic governance

in the pre-reform as well as the economic reform periods, failures that lie beyond the market-hierarchies

typology (1988, p. 507).

In Williamson's (1975) early analysis, as well as in that of his predecessors, such as


Commons (1934) and Coase (1937), the choice was seen to fall between governance
through the hierarchical structures of formal bureaucracies or through the market
mechanism. Thus if a bureaucratic governance of transactions failed, the market was
presented as the alternative, and vice versa. While Williamson wrote with reference to the
United States, a developed capitalist economy, discussions of economic system reform in
socialist countries have also taken as a central theme the postulated dichotomy between
bureaucratic and market transaction-govemance structures (e.g.. Komai. 1986)...The
examination of the Chinese case in this article indicates, however, that Williamsons model
reouires extension to take into account other transaction-govemance possibilities that may
be more consistent with the social preferences emanating from a traditional culture and that
are also easier to support with the limited infrastructure of an economically less developed
nation (ibid.; emphasis mine).

In above paragraph Boisot and Child indicate that Williamsons theorems of transaction costs

essentially created a dilemma between hierarchy and market. To Boisot and Child, there is an area beyond

market and hierarchy structure, in which social preferences and cultural underpinnings might play salient and

crucial roles. Seen in this light, Williamsons theorems of transaction costs might need an extension,

particularly when analyzing changes in the developing worlds [74]. According to Boisot an Child, to extend

Williamson's as well as Nees analyses of Chinas transition toward market competition [75], one must know

more about institutional sources of information hold key, because it is information that frames those economic

transactions.

Information is inherent in transactions for goods and services because it is a prerequisite for

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their initiation and completion. Transactions require the production and exchange of
information. The structures through which transactions are governed differ in the ways they
express and distribute information (ibid. 507).

Implicit in Boisot and Child's view is the idea that the role of the market per se is not aimed to bring

about a price equilibrium or an optimum economy but to act as a signaling device to enable information

scattered in the economy to be brought together so that it can be used as an incentive to business decision

making [76]. Boisot and Child wrote:

Focusing on the codification and diffusion of information, it [this paper] provides a set of
concepts designed to extend the existing framework...[this] paper identifies a form of
bureaucratic failure that lies beyond the markets-hierarchies typology [e.g., N ees scheme]
and that highlights the important role played by culture and level of development in shaping
transactional preferences (ibid. 507; the bracket mine).

Boisot and Child looked at the ways in which social groups structured and shared information across

space and time. In so doing Boisot and Child further distinguished between the codification of information

(regarding the structuring of information) and the diffusion of information (regarding the extent to which

information is shared). Both the codification and diffusion of information are fashioned in social and cultural

contexts. And sets of possible combinations" of codification and diffusion in their different contextual levels

could demonstrate various information environments for transactions, environments that were dynamic in

some occasions, and repressive in others, and that varied in levels of constraints or dynamics they could

present [77]. According to Boisot and Child,

The culture space described by the dimensions of codification and diffusion posits distinctive
information environments for transactions (ibid. 508).

Following this line of reasoning, Boisot and Child concluded that any society or culture could follow

its own way of codification and diffusion to structure and share information (i.e., societies or cultures are

constructed by means of information codification and diffusion); and any society or culture could have its own

special tools for codification and diffusion (i.e., information codification and diffusion are culturally-dependent

and socially-embedded). Quand m&me, in order to solve an economic puzzle or an institutional mystery in

any given society, one should unearth the anatomy of codification and diffusion of information. Yet

Williamson's scheme of transaction costs ignored these insights about information codification and diffusion

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and had no regard for culture space or social contexts. Boisot and Child stated,

Bounded rationality and opportunism are responses to an information environment that has
been insufficiently specified by Williamson. He has concentrated on information
impactedness - degree of nondiffusion in the culture space - and has relegated problems
associated with codification under the catch-all term of atmosphere. What our brief outline
of Chinas experience with its enterprise reforms has tried to show is that the codification
variable has an important bearing on the governance options available either at the level of
the individual firm or at the broader institutional level (ibid. p. 525).

2.31 Boisot and Childs description of Chinas transition.

In 1988 Boisot and Child believed that understanding Chinas transition could be helped by their

typology of transaction-govemance structures, in a matrix of such combinations of codification and

diffusion that were disengaged from the unidimensional market-hierarchv continuum" but were related to

cultural space (ibid. 524). Later, in 1996, they referred to their typology of transactional environments

created by information codification and diffusion (1996, 603). They listed four dominant institutions that

could fashion transactional environments and define market arrangements: bureaucracies, markets, fiefs,

and clans, all of which needed to be researched,

The outcome of such research will help us to assess how far the production and distribution
of information impinges on the way that the production and distribution of other goods and
services is organized (1988, 526).

Corresponding to their typology, Boisot and Child generated a matrix distinguishing between the

diffusion/undiffusion and codification/uncodification of information in bureaucracies, markets, fiefs, and

clans (see Table 2.31a):

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Table 2.31a: Information matrix of dominant institutions
in cultural space (C-space), according to Boisot and Child

Information:
Undiffused Diffused

2. BUREAUCRACIES 3. MARKETS

Diffusion of information: Diffusion of information:


Codified centrally controlled; virtually unlimited;
Relationships: impersonal; Relationships: impersonal;
Goals: hierarchically imposed; Goals: freely chosen by agent;
Coordination: hierarchical; Coordination: self-regulation;
Information access size: medium; Information access size: very large;
Uncertainty: high Uncertainty: low;

1. FIEFS 4. CLANS

Diffusion of information: Diffusion of information:


Uncodified very restricted; limited;
Relationships: personal; Relationships: personal;
Goals: hierarchically imposed; Goals: by negotiation;
Coordination: hierarchical Coordination: by mutual adjustment;
Information access size: small; Information access size: medium;
Uncertainty: high; Uncertainty: high.

Source: Adapted from Boisot and Child 1996 Figure 2 (p. 603), which is a slight revision of Boisot and
Child 1988 Figure 1 (p. 509).

Using this information matrix, Boisot and Child illustrated Chinas bureaucratic and market failures

prior to and during its transition.

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Figure 2.31a: Boisot and Childs 1988 illustration of Chinas bureaucratic and
market failure with reference to cultural space

Information

Codified
(Impersonal)
The markets and
hierarchies continuum Markets

Bureaucracies

The ir The iron laws of


of fief oligarchy

Fiefs Clans

Uncodified
(Personal)
Undiffused Diffused
(Relational)

Source: Adapted from Boisot and Child 1988: Figure 3, p. 526.

Using a figure (see above Figure 2.31a), Boisot and Child illustrated Chinas bureaucratic and

market failures prior to its transition corresponding to the different types of environments of transacting

governance (or so-called economic orders), and explored the potential failures that could emerge during the

transition indicated by different moves back to certain indigenous environments in Chinas cultural space,

unlike those that Western mainstream economists would expect (for the details, reader might have to see

their article) [78]. As they described it, Chinas transition could be seen as a search for a form of governance

that would integrate bureaucratic and market transactions" (ibid. 513) [79],

Boisot and Child also contrasted their matrix with the unidimensional market and hierarchies

continuum proposed by Williamson in 1975 and mediated by Nee to describe the rebuilding Chinas

economic institutions. As Boisot and Child's matrix illustrated, forms of economic order or transacting

governance and their rebuilding process existed beyond the market and hierarchy continuum. The iron laws

of fiefs were characterized by transactions with relatively noncodified information that was asymmetrically

distributed within the relevant population of low diffusion, i.e., small numbers, hierarchically structured

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through face-to-face and personalized power relationships that often have to be charismatically legitimated

(ibid. 508) I80]. The iron laws of clans (resembling Japans giant industrial groups or Mancur Olsons 1965

logic of collective action"; ibid. 525) were characterized by transactions with relatively noncodified information

that was widely diffused within the relevant population, although this remained based on personal trust and

informal ties (see their further elaboration in 1996, 604). By using their typology, Boisot and Child attributed

Chinas market failures and bureaucratic failures to the deficiencies of the iron laws of fiefs" and the iron

laws of clans. By the same token, a path of the iron laws of fiefs" toward the iron laws of clans illustrated

Chinas unique path of modernization in a direction different from Western market economies, given Chinas

bureaucratic decentralization. It thus appeared according to Boisot and Child that only a bureaucracy

compliant with the rational-legal codification and diffusion, which came out short in current China, could carry

out such a transformation. As explained in 1996 (604-5),

Using the codification/diffusion framework as an analytical tool, Boisot and Child (1988)
argued that China would have been inhibited in decentralizing from bureaucracies to
markets, had it wanted to, because it had not actually built up a stable codified bureaucratic
order from which to decentralize. A preference for interpersonal accommodation - an
orientation to particular individuals and relationships rather than to impersonal rules -
coupled with the irrationalities of the post-1949 command economy, was always
undermining the countrys attempt to develop into bureaucracies and pulling China toward its
traditional mode of social organization. ..The process is self-reinforcing in that the absence of
a rational-legal institutional framework fails to engender confidence in a wider system of
bureaucratic or market transacting outside networks based on personal power, commitment,
and trust. Boisot and Child labeled this tendency the iron laws of fiefs....In China...the
bureaucracy that the communists inherited in 1949 was 'patrimonial' (Weber 1964), and
feudal in its operations. It was in the hands of an unspecialized class of literati that, although
dirigiste, interventionist, and particularistic in its orientation, was more concerned with
formality of bureaucratic codes than with their rational-legal content of effects. Its survival
owed much to the fact that the simple and cellular preindustrial society it had presided over
was comparatively undemanding of coordination and rational...Without the courrtervailance
of a legal-rational bureaucracy, however, Marxism-Leninism in China operated through the
fieflike traditional mode of social organization. This was reinforced by a Chinese cultural and
cognitive bias against abstraction. Abstraction is a prerequisite for the creation of robust
codifications and the construction of a rational-legal order. If codification seeks to economize
on data processing by assigning the data of experience to categories, abstraction seeks to
economize on the number of categories used in the act of codifying (Boisot 1995). It involves
a move away from treating each specific exchange concretely sui generis and toward the
use of general principles that apply predictably and systematically to every case.

In 1988 Boisot and Child cautioned that their diagrammed typology of Chinas cultural space with

four quadrants might be only descriptive rather than explanatory (ibid. 508) I82]. Perhaps they remained

unsure of their categories, since they were derived from Western rather than indigenous perceptions f 3].

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They were both aware that Chinas patterns of abstract thought throughout its history could have uniquely

affected its current decentralization to market (1996, 604-5).

In Boisot and Child, China's transition during its new search for a form of governance that would

integrate bureaucratic and market transactions (ibid. 513) could be seen as paralleling its passage from the

iron laws of fiefs to iron laws of oligarchy or clans in social organization and exchange. But such a

passage to the iron laws of oligarchy was quite vulnerable to market failures, just as the previous iron laws

of fiefs had been vulnerable to bureaucratic failures I84]. Boitsot and Child explained Chinas need for such a

transition in the following context,

...it [China's 1949 revolution] faced the problem that the charismatic leadership style - most
effective in the governance of a fief - that Mao had displayed during the Yenan Period in
the revolutionary base areas could no longer cope on its own with the transactional scale
and complexity of national government ...The result, predictably, was clan governance and
factionalism (ibid. 512; brackets mine).

According to Boisot and Child, Chinas bureaucratic failures prior to its transition could be seen as

the failures of its fief quadrant or mode I85]. Therefore, a logical prediction drawn from their figure (i.e., above

Figure 2.31a) could be that Chinas transition of transacting governance ought to be in a direction moving

toward an economic order based on well-codified and widely diffused information. As they concluded,

...the 'iron law [of dan] might work in reverse when a parochial structure is overwhelmed by
volumes of well-codified and readily diffusible data...(ibid. p. 526; brackets mine).

Boisot and Childs description of Chinese bureaucratic and market failures prior to and during its

transition has advantages over Williamsons and Nees unidimensional market-hierarchy continuum. Boisot

and Child could perceive the market-hierarchy relational continuum to be sodally embedded in Chinas

cultural space. China's bureaucratic failures ought to be seen as those of its fiefs, a particular form of its

bureaucracy in the pre-transitional era, but not those of any modem bureaucracy (ibid. 525). Although the

fiefs might follow their hierarchical rules, their hierarchical rules are not the same as the hierarchical rules of

modem bureaucracy in the Weberian sense. By the same token, clans might follow their hierarchical

coordination in market competition, which is not the same as the hierarchical coordination in markets. Clan

coordination is through negotiation or collective action, whereas market coordination is through self

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regulation. In 1996 Boisot and Child added that collective action in China was based on a mutual adjustment

resembling that workable for Japanese developed interfirm networks or industrial conglomerates (ibid. 624).

Albeit Boisot and Child did not further clarify this, it is implicit in their framework that without such a stage of

formal bureaucratization China could not move toward a market economy. In fact, Chinas own transition

toward the hierarchy of iron laws of clan might abort, since it is susceptible to reproducing those

bureaucratic and market failures that once happened to its former patriarchal planning system. In the end,

Boisot and Child made virtually the same prediction as did Nee, based on his formal analysis, using a

unidirectional market-hierarchy continuum. This is a dilemma that counters Boisot and Childs logic of Chinas

network capitalism."

Boisot and Childs 1996 work (600-628) expressed their 1988 thesis in more general terms, viz. from

a comparative institutions perspective (621), to use their phrase. They continued to attribute Chinas rapid

growth to Chinas own experience and its unique system of industrial governance and transaction. They

continued the debate with Williamson and Nee over the thesis of unidirectional markets and hierarchies

continuum I86], exploring in particular the mechanisms of institutions working in Chinas transition (621-2).

Boisot and Childs major differences with Williamson and Nee might be captured in two associated

propositions that drew from their summary of Biggart and Hamiltons 1992 theses:

Proposition 1: The markets and hierarchies perspective, when applied to the modernization
process, assumes that policy options are located along a single dimension with the state
(bureaucracies) at one extremity and autonomous firms (markets) at the other. This
perspective assumes, therefore, that decentralization involves a transition from
bureaucracies to markets. A C-space fculture-spacel analysis indicates that it is also
possible to decentralize at a lower level of codification than is implied by the markets and
hierarchies perspective. In that case, the move will be from fiefs to clans.

Proposition 2: China offers an instance of such decentralization and in so doing, it is moving


not toward a market order, as it claims, but toward a form of economic organization that can
be labeled network capitalism and that to a lame degree appears to be characteristic of East
Asian societies.

Taken together, these two propositions extend the institutional options available for the
modernization process beyond those offered in the markets and hierarchies framework.
They do so in a wav that challenges both the widely held assumption that capitalism is a
unitary market-oriented phenomenon (cf. Braudel 1979) and the popular belief that
institutional and economic development invariably lead to a convergence with a unitary
capitalist order (cf. 1996, 624; emphasis mine; I feel indebted to Boisot and Child; many
of their assumptions were very instrumental to my thinking and helped organizing the

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thesis of this study).

An immediate benefit from Boisot and Childs is the possibilties that Chinas transition provides an

alternative to the conventional view that market transition must come through a structural transformation in

the state bureaucracy. For the transition to occur there must be a shift of economic order or transacting

governance; and that might be fathomed through a shift in network institutions. Boisot and Childs 1996

position might be recapitulated as follows: 1. The market-hierarchy perspectives, which are epitomized in

Williamson's theorems on transaction costs, essentially assume a neo-classical account of economic

transition that would follow a unidirectional path from bureaucracies to markets, viz. a unitary market

transition toward capitalism; 2. The neo-classical position posits the market and the state in binary

relationships, whereas they actually fall on a continuum within a cultural space t87]; 3. China's transition

follows a path of decentralization at lower levels of codification with reference to its Culture-space, namely, a

path of information network from vertically-personal-relationship-based fiefs" to horizontally-community-

based clans; 4. Chinas decentralization moved toward network capitalism as its emerging economic order

and toward new forms of organization that resembled other East Asian counterparts; and 5. An institutional

perspective such as that of Boisot and Child, while critically challenging neo-classics in theory and practice,

extends the analysis of institutional options in transition beyond the narrow market-hierarchy dichotomy.

Further, such an institutional perspective could suggest future research agendas that focus on selected local

economies and their linkages to the wider national and international economy (ibid.) I88].

In 1988 Boisot and Child imputed most of Chinas bureaucratic and market failures to the

deficiencies of China's patrimonial style of governance that relied on fiefs or clans for information structuring

and sharing (fitting Webers particularism and substantive rationality) H - At that time Boisot and Child

blamed fiefs and dans for impeding Chinas market transition I90]. In 1996 they praised Chinas particularism

and applauded its network organizations and informal sectors as dynamic sources of Chinas transition.

The Chinese system of network capitalism works through the implicit and fluid dynamic of
relationships. On the one hand, this is a process that consumes much time and energy.
On the other hand, it is suited to handling complexity and uncertainty. Networks offer
greater capacities for generating and transmitting new information, and when they are
sustained bv trust-based relationships they offer a cushion against the possibility of
failure that is a concomitant of uncertainty (ibid. 625; emphasis mine).

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On the basis of their analysis, Boisot and Child described the contrasts in different expectations by

Western and Chinese companies wishing to achieve differing levels of success in their China market policies

(625):

Westerners may well believe that their best policy is to enact their Chinese business
environment via formal dealings with the state, whereas Chinese investors may well enact
their environment via the invisible weak network...overseas Chinese investors are more
likely to establish business relationships through friendship ties or other informal contacts
than are Western investors (625).

This is because,

The social rules of business in China are not those to which Westerners have become
accustomed or which conform to their stereotype of socialist" economy. What they find
when engaging with China is a system that in its transformation is giving rise to a distinctive
institutional form - network capitalism (626; emphasis mine).

Rational-legal bureaucratization based on formal codification could have remained a prerequisite to

market transition, as was the case in the late feudalist Europe (ibid. 601). Yet in terms of modernizing a

nations economic order, feasible alternatives do exist, as shown in the East Asian transformation as well as

in Chinas transition, that challenges Western conventions of transitional processes, outcomes, and even

causes [91], In this light, for example, the iron laws of oligarchy were no longer seen as a cause of Chinas

market failures but rather as a dynamic force for Chinas marketization.

Boisot and Child claimed that they were not prepared to challenge the universal validity of

conventional Western assumptions (ibid. 621) f92]. However, they were willing to criticize certain elements of

those assumptions. Their Figures 1 and 3 in 1996 (cf. pp. 602, 622; i.e., adapted in the following Figure 2.31 b

and 2.31 c) displayed such a networked alternative workable for Chinas transition path [93].

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Figure 2.31b: Boisot and Childs 1996 vision of institutional regimes in transition
relative to the information matrix in cultural space (C-space)

Information:

Codified
(Impersonal)

Markets (Western Capitalism)

Bureaucracies (FSU

Clans (Reforming China Moving Toward


Network Capitalism)
* Fiefs
Uncodified (Pre-Reform China)
(Personal)
Undiffused Diffused
(Relational)

Source: Adapted from Boisot and Child 1996: Figure 1 on Institutions in the C-space, p. 602; also in
comparison with Boisot and Child 1988: Figure 3 - Bureaucratic and market failure in the culture
space, p. 526. Label: * Symbol of a Regime; the parentheses mine.

Figure 2.31b based on Boisot and Child describes different types of dominant institutions

according to their different levels of information codification and diffusions (602). For the purpose of

comparison, see Table 2.31a and Figure 2.31a above (which are adapted from Boisot and Childs article

in 1988).

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Figure 2.31c: Boisot and Childs version of the Western capitalist transition
compared to the Chinese alternative transition relative to the
regime changes of the information matrix in cultural space (C-space)

Information:

Codified
(Impersonal)
Markets: Western Market Capitalism

Bureaucracies

Clans (Reforming China Toward


Network Capitalism)
Fiefe
Uncodified (Pre-Reform China)
(Personal)
Undiffused Diffused
(Relational)

Source: Adapted from Boisot and Child 1996: Figure 3, p. 622 [94]; the parentheses mine.

M odels:------------- Western path (Williamson & Nee) Chinese alternative (B&C)

Figure 2.31 b highlights Boisot and Childs comparison between Western capitalist transition and

Chinese alternative transition. Two points are noteworthy for our observation: 1. Varieties of transitional

economic paths emerge in addition to the bureaucracy-market path followed by the West. These paths are

delineated as a distinct ensemble of social relations and information carriers encapsulating their respective

institutional environments and contexts. 2. Alternative transitional paths can be conjectured: through a

Western path toward market economies (including the FSUs path toward market capitalism), a Chinese path

toward quasi-market economies (e.g., Boisot and Child account of so-called network capitalism), or possibly

some other paths toward some other forms of economic system.

According to Boisot and Child, the neo-classical account of Chinas transition clung to market-

hierarchy relations is basically consistent with Williamsons theorems on transaction costs and N ees

scheme. This neo-classical account could be envisaged in a path from fiefs (uncodified/undiffused

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70
information system) through bureaucracies (codified/undiffused information system) in its aborted far-

searching attempts in the previous command economy and even in Chinas history. In such a case, the

destination would be to markets (codified/diffused information system) (618, 622). Boisot and Child

actually explored such a possibility in their 1988 work, although even at that time they doubted if Chinas

transition under the given institutional circumstances could reach such a destination. At that time Western

scholars were looking for those attributes in China that they had expected for modernizing economic

order, like efficiency-seeking and professional specialization based on modem division of labor, through

formalization, codification, legalization, and bureaucratization. However, these attributes barely emerged

in China. Boisot and Child addressed,

China had not been able to sustain a satisfactory position in the bureaucracies region of
Figure 1 (economic regulation via a central planning bureaucracy), while the attempt to
have the state exercise direct central initiative and control through traditional fieflike
social formations proved disastrous (ibid. 618; Boisot and Childs Figure 1 refers to our
Figure 2.31 b above).

Boisot and Child in their more developed thesis in 1996 maintained that China's transition had so far

evolved internally through its own institutional mutations from a fief system (uncodified/undiffused) to a clan

system (uncodified/diffused) (ibid. 613), depending for economic transactions more on processing the

information flow through well-diffused personal networks, rather than through a well-codified bureaucracy

(623, 625). This is a path-dependent-featured devolution, parallel to East Asian patriarchal bureaucratization,

which would focus more on the strengths of diffusion for economic transactions than those of codification.

Given Chinas many obligatory networks (including overseas diasporic groups and the like) that had

developed as a result of Chinas unique history, culture-space, and demographic structure, China could

expect such obligatory networks I95] to provide alternative systems to support its economic development and

fast growth. Boisot and Child pointed out that a fundamental feature of China's institutions is their structure of

property rights and their social embeddedness providing safeguards against the market failures often seen in

the Western experiences, failures linked to formal contracts assured by bureaucratically-administrated

property rights. A full examination of these cells in Table 2.31a and Figure 2.31c (see above) could

substantially extend the scope of this study.

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In short, to Boisot and Child. Chinas emergent economic system and forms of institutions in

transition can be perceived as socially chosen and as linked to Chinas unique experience and social

contexts, that differ from those of China's Western counterparts. Boisot and Child thus likened Chinas

transition to a shift of hierarchical types of network-featured information organization. As for information

network, Boisot and Child were chiefly concerned with the depth and nature of its social embeddedness

that was unique and critical to Chinas transition (623) I96].

2.32 Boisot and Childs thesis of Chinas network capitalism

In their 1996 volume, Boisot and Child concentrated their attention on the failures of neo-classical

economics and modernization theory to account for Chinas rapid growth by signing conventions on property

rights through formal bureaucratic codification and by market competition in a growing integration with the

world economy:

These developments would appear prima facie to be moving Chinas economic system
toward market capitalism. China has distinctive political, institutional, and cultural
characteristics, however, and it is recognized that such factors can give rise to different
modes of economic organization (Hamilton and Biggart, 1988; Whitley 1994) (cf. Boisot and
Child 1996, 600) [97].

The conventions China was being asked to sign had been drawn basically from Western

experiences that did not apply to China. Boisot and Child noted that

Chinas rapid economic development is being accomplished through a system of industrial


governance and transaction that differs from Western experience (ibid. 600).

The assumed conjunction between market relations and capitalist (or at least non-state)
ownership, made by both Nee and Whitley and drawn from the Western model, does not
necessarily apply to China (ibid. 610).

Boisot and Child recognized that Chinas own unique experience included a dynamic mix of

government and non-state enterprises in facilitating business networks at the local level that could no longer

be seen as either socialist nor capitalist f98].

The combination in contemporary China of decentralization from central authorities with


the bottom-up dynamic provided by township and village enterprises leads to a
perspective on the role that government can play in facilitating business networks at the
local level that is quite different from Western experience...The mixed pattern is certainly

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72
not a socialist planned economy, nor is it a Western capitalist system. The so-called
township village enterprise is a new animal, a species in economic development that has
yet to be properly defined (Ibid. 619-20).

Boisot and Child noted that the emerging economic order in such a dynamic mix actually was

community based and personal-relationship-related ["]. Combined with their information matrix, Chinas

transition thus could accentuate its economic order in a shift from personal-tied information structure (less-

codified and -diffused hierarchy of fiefs) to relational-tied information structure (less-codified but more-

diffused hierarchy of clans), a shift of socially embedded types of network.

Bruun (1993) argued that the state and the family (or community) - fundamental
institutions in China - present a dichotomy that has historically been in mutual tension.
W e are suggesting, by contrast, that the significant feature of the emeraina Chinese
system lies in the wavs government and community or family work together within a
system of relatively uncodified relationships that derives legitimacy from embedded social
practice rather than from formalized ownership and property rights (B&C 1996, 620;
emphasis mine) [1U0].

This significant feature of the emerging Chinese system led Boisot and Child to pose such research

questions as: what type of economic order is emerging in China? How much does Chinas economic order

differ from Western economic orders? How can we explain the puzzles in Chinas conjunction between

market relations and non-state ownership? Where could decision makings be located within what appear to

be quite fluid and dynamic systems (625-6)? Boisot and Child inquire:

If, as Nee (1992) suggested, there is a newer system of marketized transactions in addition
to state-dominated nonmarket firms, does this merit special attention as the Chinese
economic system of the future (cf. Qian and Xu 1993)? (ibid. 600).

...the question we shall be addressing is whether it (Western market system, characterized


by impersonal economic relationships, large-numbers transacting, relatively decentralized
self-regulating economic units, a plurality of goals, and the other constituents of the ideal
type] can be applied to China and, if not, what kind of alternative characterization would be
appropriate for that country (ibid. 603).

W e argue that China is treading a path toward modernization that differs from Western
experience and that the essence of this can be analyzed in institutional terms. W e then
tentatively identify the distinctive features of Chinas emerging economic order, by reference
to Chinas business system and markets, capitalism and government with that system (ibid.
601).

To Boisot and Child, what makes a network matter to Chinas transition does not lie in its

presence in China. For even the W est recently witnessed a rapid growth of its various forms of the

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network competition (ibid. 612). As Boisot and Child state:

W e have argued that...the networks of the emergent Chinese capitalism are qualitatively
different from those within the Western market system, for the latter continue to be based
on legal contract and ownership rights rather than on long-term trust relationships (625)

To make further comparison between China and the West about economic governance, Boisot and

Child also suggested a check on how to apprehend the nature of transaction arrangements.

Many business transactions in China appear to be settled through negotiation with a


system of network relations based on interpersonal reciprocal obligations (guanxi), with
local government being a major player as resource provider, facilitator, and tax collector
(see Pye 1995). These transactional arrangements, weak in Western terms
(Granovetter 1985). appear to have considerable latent strengths (ibid. 612; emphasis
mine).

Quite contrary to Western market arrangements based on legal contracts, many of Chinas

transaction arrangements are based on interpersonal networks and reciprocal obligations in terms of guanxi

(i.e. personal relations). Yet these transactional arrangements through negotiations between enterprises and

local authorities "appear to have considerable latent strengths," since they can utilize the ambiguity in

property rights to institute flexibility and to reconstitute the channels of transaction beyond the formal-legal

reach to tap into China's markets and to meet Chinas changing environments [102].

As Boisot and Child reiterate, this would eventually involve a theoretical extension of the debates

over market-hierarchy relations rekindled by Williamson in 1975. According to them,

As it evolved, the markets and hierarchies formulation established a unidimensional


continuum, with market coordination at one end and hierarchical coordination at the
other. Clan or federal forms of governance (Ouchi 1980; Butler 1983) and relational
contracting (Williamson 1985) could then be located at notional points along this
continuum - not quite markets but not quire hierarchies either (ibid. 602).

From Boisot and Child's perspective, a unidimensional continuum between markets and

hierarchies, as had been suggested by Williamson and Nee, appeared inadequate [103j, since it ignored

those transaction arrangements beyond markets and hierarchies (or contextual data; ibid. 603), that

vary along with their culture-space," such as forms of fiefs and clans.

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Boisot (1986) questioned the ability of a unidimensional markets and hierarchies


continuum to capture adequately the transactional options available in different cultural
and institutional settings. Using a conceptual framework that he labeled the culture space
or C-space, which relates the diffusion of transactionally relevant knowledge within a
given population to how far it has been codified, he showed that the clan forms of
governance, together with a form of governance that he labeled fiefs," could not be
convincingly depicted as mere staging posts between markets and hierarchies. W e use
the C-space framework here to illustrate the special and challenging characteristics of
Chinas modernization (ibid. 601).

In Boisot and Child, the main weakness of Nees propositions is that they fail to recognize that

Chinas institutional environments and arrangements are quite different from those in Western market

economies (see above Figure 2.31c).

As Boisot and Child suggested in their 1988 work, to contrast business negotiations and economic

coordination, and transaction arrangements in China from those in the West, one has to look at two critical

dimensions - (1) the codification and (2) the diffusion of information in fashioning those market arrangements

(see Figure 2.32).

Figure 2.32: Boisot and Childs Information structure by codification vs. diffusion

Level of Hierarchy:
Codification
(Depersonalization)

Space for Modes of Network Organization

Level of Marketization: Diffusion


(Personalization)

Figure 2.32 can be seen as a more rarefied abstraction of the previous figures. It addresses the

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75
degree to which information accessed through codification or information accessed through diffusion is

central to identifying the key institutions in Chinas transition, including different property rights or forms of

ownership. The Space for Modes of Network Organization in the above figure corresponds to an information

matrix (see above Table 2.31a) that distinguishes between the diffusion/undiffusion and

codification/uncodification of information in bureaucracies, markets, fiefs, and clans.

For Boisot and Child, the unique transition of Chinas economic order could be traced to unique

features in Chinas information matrix, its so-called "quasi-market networks," or its distinctive institutional

forms (613),

Here, we identify the broad institutional nature of this distinctiveness within a framework of
information codification and diffusion...The limited extent of codification of information in
China and its communal property rights and organization of economic transactions suggest
that decentralization from the former state command system is giving rise to a distinctive
institutional form - network capitalism.

But what really gives rise to such a new economic order in China is historically derivative. As

Boisot and Child explained,

China thus demonstrates that a modernizing economic order is able to operate in the less
codified domain of the C-space...It is therefore not the presence of networking that is
distinctive about China's emerging economic order but, rather, the depth and nature of its
social embeddedness. Redding (1990, 95) has noted how living in a collectivist and group-
dominated society is a cultural tradition for the Chinese. The roots of networking as an
institutionalized practice are ancient and extensively developed in China (ibid. 623;
emphasis mine).

The Chinese path to modernization since 1949, by contrast, involved first an abortive
move up the codification scale (state planning), punctuated by wild oscillations toward
mass mobilization, and then, after a reversion into fiefs, a subsequent decentralization,
coupling with traditional systems in the lower reaches of the C-space. In the absence of
effective codification, and given traditional Chinese social organization, such
decentralization leads not to markets but to clans and permits the more local and
personalized institutional order, which, following other observers of Asian economic
institutions (Biggart and Hamilton 1992; Gerlach and Lincoln 1992; Berg 1994), we shall
label network capitalism (ibid. 621-2).

People have to understand the unique context of such an emergence in Chinas transition. This

could all come along with Chinas decentralization, which has its historical precedents and social

embeddedness, and which could be seen as a reaction to the failures of market and hierarchy under the

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76
former planning system and as an organizational response to the high demand for speeding industrial

diversification and economic hybridization in transition. According to Boisot and Child,

China has always had a significant amount of small-scale commercial and industrial
activity outside the centrally planned command economy, but since 1979 the industrial
system has become considerably more diversified...Today, there is a free market for
most consumer goods, while the market remains supplementary to planning only in the
production and supply of some industrial goods and materials, especially those
considered to be of strategic significance. Moreover, several different forms of industrial
property rights have now emerged alongside a diversification in the forms of enterprise
ownership and of relationships with the organs of government, including different types of
contracts for the management of state-owed enterprises (ibid. 608-9).

According to Boisot and Child, as China decentralized and found itself growing at an ever

accelerating pace driven mainly by the boom of its non-state sectors [104], what was happening was

overwhelmingly less and less controllable by the administrative bodies of Chinas central authority:

Although economic reform measures were enacted at an ever accelerating pace throughout
the 1980s and the early 1990s, decentralization measures have encountered problems on
the ground. The state has lacked both the appropriate economic and institutional concepts
and the 'low-context (Hall 1976) culture that would allow such measures to usher in a
workable market order. The situation has not appreciably changed in the 1990s. The
institutions that characterize a rational-legal system - an effective central bank,
macroeconomic levers, enforceable and consistent laws - remain absent, all official rhetoric
to the contrary notwithstanding. The freeing up of the financial system, for example, has led
to the emergence of a sizeable secondary credit sector in which lending takes place through
direct relationships between firms and other bodies at very high interest rates; this sector is
beyond the control of the monetary and regulatory authorities (CEA 1993). Chinas growth
has been barely controllable, with a continuing tendency to overheat, and the only tools
available to central policy makers for bring the economy under control remain the
microeconomic ones designed for a command economy in which firms come under direct
administrative authority (Economist 1995a) (ibid. 606).

Given the past failures of Chinas markets and hierarchies, in which Chinas economic order had

seemed so inept and its decentralization so problematic, how can one explain Chinas dramatic

turnaround and its sustainable fast growth for two decades [105]? Boisot and Child posed a question,

If. according to Western experience, modernization requires institutional changes moving


transactions first toward bureaucracies and then toward markets China cannot be said to
be modernizing effectively. Yet if China is not modernizing effectively, how does one
account for its spectacular performance on the criterion of growth - an average of 9% per
annum in the 1980s and in double figures since 1992?.. .This means the question can
now be reformulated: How can China be achieving such rapid rates of growth while
retaining an institutional order so heavily invested in the lower, uncodified regions of
Figure 1? (ibid. 606-7; Figure 1 here refers to Boisot and Child Figure 1, ibid. 602, from
which Figure 2.31b above is adapted; emphasis mine).

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In Boisot and Childs view, the state government to compensate for its loss of control due to

decentralization has no option but to engage actively in direct interpersonal encounters with economic

agents at local levels for sharing information, raising funds, and allocating resources.

To function at all they p.e., the firms] require direct interpersonal encounters between state
actors and myriad economic agents in highly particularistic circumstances. Under the
economic reform, governmental encounters with economic agents have shifted significantly
to the local level and the center has lost much control over the provinces and municipalities.
This is evidenced by the share of tax revenue accruing to the central government, which,
according to the World Bank, amounted to 34% of GDP at the beginning of the reform
process 15 years ago and shrank to 19% by 1994 (Economist 1994a) (ibid.).

It is important to note here that Boisot and Child found that the lax control by the state has

effectively placed Chinas institutions in highly particularistic circumstances. Later on, Cao, Qian, and

Weingast in 1999 elaborated this unique situation created by Chinas decentralization in the sense that it

had actually hardened local budget constraints specific to their respective contexts. This is very crucial,

because under such a new situation, the state and its administrative bodies might take it as functionally

imperative to deal with the problems of these personal relationships seriously, much more than to deal

with the problems of rational-legal bureaucracy, and to deal with information diffusion or sharing more

seriously than with information codification or structuring. And this makes Chinas market and business

systems quite distinct from their Western counterparts in conception and practice. Within the emergent

economic order. Chinas new economic sectors and enterprises, while beginning to work their own wav

for economic coordination, are basically embodied in a mix of administrative units and economic units,

and in a mix of community-based personal arrangements and market arrangements. This differs from

N ees and W hitleys associated definitions and perceptions of Chinas hybrid economy or Chinese

business system (ibid. 610).

Chinas emerging economic order is constituted by a combination of communal property


rights and transactions in which contingent risks are managed in these networks
informally on the basis of accepted social practice rather than by reliance on formal laws
of contract. The security of property rights, which, according to the Western tradition is
guaranteed by the rule of law in democratic societies, in China derives primarily from a
relatively uncodified process of legitimization within the community as a socioeconomic
network. The security of Chinese rights to employ economic assets in the fulfillment of
transactional obligations is supported by the intervention of officials at the various levels
of government to safeguard what is a politically and socially acceptable use of those

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78
rights. In terms of our analytical framework, China appears to show how a clan-based
system of transactions can function successfully based on a communal definition of
property rights, rather than these being defined externally and from above through a legal
system that identifies property rights based on individual ownership. China thus
demonstrates that a modernizing economic order is able to operate in the less codified
domain of the C-space (ibid. 622-3; emphasis mine).

That is, the kind of economic order emergent in Chinas transition is in a conjunction of

administration and markets. In Boisot and Childs phrase, it is the market-oriented, administratively

supported system of networked transacting; ibid. 614) with so-called entrepreneurial connections with

the bureaucracy (619). This differs from both the Western well-codified industrial networks of firms and

Whitleys centrifugal business systems of the Oriental small firms. In China, both codification and

diffusion of information heavily rely upon personal relationships [106].

This kind of system of local quasi-market networks in Nees phrase [107], facilitates transactional

arrangements, breeds long-term trust obligations, and provides institutionalized sources of working capital

and information access. It also economizes on transaction costs and compensates for risks due to

ambiguous property rights by offering flexibility and assuring opportunities through negotiations.

...the advantages [are] these long-established relationships could provide in an economic


environment in which uncertainties persisted about the honoring of trading agreements,
the assurance o f quality in goods exchanged, the provision of working capital, and so
forth. These transactions were founded on longstanding economic relationships between
key individuals within the organizations concerned. The assurances that underpinned the
transactions derived from mutual trust...[in] local quasi-market networks [that Nee
analyzed]...local government agencies play a facilitating role and benefit from the tax
revenues that derive from the stimulation that dynamic networks provide to local
economic growth. The development of both internal and external subcontracting,
particularly by large enterprises, serves to extend such networks. External subcontracting
encourages the growth of close personal relations between managers and technical staff
of the collaborating firms, particularly when technical quality specifications and delivery
schedules need to be tightly controlled (Child 1994, chap. 7) (ibid. 612-3; brackets mine).

Such networks dynamically prompt the vertical and horizontal integration of Chinas economy and

nurture Chinas economic growth at both micro- and macro economic levels.

It has also become quite common for Chinese enterprises to form alliances and mergers
to provide horizontal and vertical integration (Su 1994). These alliances contribute to the
development of quasi-market networks within China and appear to constitute a growing
trend (ibid. 613) f 08].

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Boisot and Child also noted that as Chinas economy became increasingly integrated, the ways it

integrated also become more sophisticated. Chinas sectoral economy in its changing hierarchical order

could provide such supportive evidence. They noted interesting differences between the growth of

Chinas state-owned enterprises and non-state-owned enterprises [109]. This move toward vertical

integration also paralleled Chinas proceeding in horizontal integration, through approaching formal and

informal alliances among industries, sectors, and enterprises for economic transacting.

...A shift from fieflike to clan-based transactions within Chinas economic order is
evidenced by several developments. The first is the growing share of economic activity
accounted for by non-state-owned enterprises. State-owned enterprises are more
beholden than other Chinese firms to specific governmental authorities in which custody
of their ownership is vested, such as ministries and economic commissions. The
structure of control over state-owned enterprises, and in some cases their input-output
transactional networks, tends to be narrower in scope and to retain more fieflike
characteristics. Control over non-state enterprises is less specific, and their patterns of
resource dependency lead them into a wider network of external organizations from
which they transact factor inputs and dispose of their outputs. Second, an increasing
number of enterprises are widening the scope of their transactions, and securing greater
economic independence from higher governmental bodies, through the formation of joint
ventures with foreign firms investing in China. These linkages with foreign firms extend
their networks beyond the scope of localized fiefs. Third, more Chinese enterprises are
forming alliances between themselves, chiefly to provide horizontal integration and to
enlarge the scope of their transactions within the Chinese economy as a whole (ibid.
623).

The activities in these economic sectors differ in many ways from neo-classical conventional

beliefs regarding unitary market transitions, as well as Komai et al.s visions of market competition, based on

neo-classical assumptions. Boisot and Child maintained that China's transition could be seen as moving

from fief typed networks to clan typed networks (613, 619) toward network capitalism (622).

In Boisot and Childs perspective, in China, property rights in each economic sector are not clear-

cut. They take plural forms that are socially embedded and community-based, and further articulated by

and mixed with many contingent institutional underpinnings [110].

The case of China prompts the realization that property rights" can be a complex mixture
that does not constitute a simply binary set of possibilities - state vs. private." In China,
a bundle of property rights is exercised by different bodies, and de facto property rights
tend to emerge from continuing processes of negotiation between central, regional
community, and private interests. Moreover, the rights relate to such diverse matters as
the appointment of senior enterprise managers, allocation of profits, investment funding,
and formation of interfirm relationships. These rights, in the context of different categories
of firms, are articulated through a variety of institutional structures, some of which are

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more strongly oriented toward the interests of the community than those of either the
individual or the state. In this respect, again, the contrast between Chinas economic
development and that of the West is consistent with the view that different institutional
frameworks are capable of generating economic development in different societies. While
the Chinese have explained the post-1978 economic reforms as a move from a bureaucratic
to a market-led system of industrial coordination, they have been at pains not to present this
as a move toward capitalism and private property rights...Markets and hierarchies, in this
perspective, are just tools - mechanisms for coordinating transactions - that with suitable
adjustments can each be placed equally effectively at the service of a socialist or a capitalist
order...their disassociation of marketization from private ownership reflects a distinctive
feature of Chinas economic development that appears to be socially embedded...The lively
current discussion on the possibility of introducing stockholding systems to state enterprises
points to a further impending redefinition of their ownership (615-6) (emphasis mine).

Chinas case might serve as a competing alternative to a Western model of economic

development. However, at this point, Boisot and Child would rather reserve judgment on whether or not

Chinas current structure of property rights could be permanent or might need a redefinition [111]. As they

cautioned,

The nature of such redefinition is uncertain, since it will depend on the determination of
which groups are entitled to own stock and the percentage of enterprise assets that are
allocated to stockholders. It is therefore quite difficult at this moment to comment on the
prospects that the state sector will be privatized and whether, in this respect, there will be
a move toward a capitalism of the Western variety. If there is. it is quite likely that the
institutional basis on which ownership rights are defined will not accord to the highly
formal and legalized Western pattern (ibid. 616; emphasis mine).

Examples of currently unique Chinese establishments of ownership rights are Chinas township-

village enterprises. According to Boisot and Child:

Whereas the reform of state enterprises has been from the top down, township-village
enterprises (TVEs) have emerged and proliferated from the bottom up. The consequence
is that their ownership status is very ill-defined (ibid. 616; emphasis mine).

Boisot and Child realized that Chinas TVEs could demonstrate their ability to drive local

economies not through their ownership status but through their operations.

Overall, it seems appropriate to break away from the legally based Western notion of
property rights that emanates from ownership and, instead, adopt a concept more
appropriate to China that allows for the possibility that (1) such rights may be granted
upon administrative sufferance and (2) that their terms can be subject to a continuing
process of renegotiation. In that case, the significant research question is not so much
who owns Chinese business assets as who controls and regulates them and through
what social process, a question that Berle and Means (1932) asked of the large American
corporation six decades ago (ibid. 617).

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The legitimacy of an enterprise in terms of its ownership is actually granted through the

enterprises operations as an administrative unit, even while the state sector per se is transforming its

formal structure through privatization (i.e., its ownership, administration, management, and their systems

of regulation and codification). In the latter case, the governments of the various levels are actively

engaging in economic operations and behave like business partners. Close alliances among enterprises,

communities, and governments, while accentuating the dynamic role of the government in facilitating

business networks at the local level [112], could make all parties more entrepreneurial in transition.

According to Boisot and Child, entrepreneurial connections with the bureaucracy create clientelist networks

(619). This mix of economic and administrative powers has developed various forms of hybrid firms"

(ibid. 617) that could not be found anywhere in the West.

...hybrid firms have provided an extremely important dynamic for economic growth and
development at the micro level. They also contribute importantly to the formation of
business networks that, among other things, stimulate innovation through information
exchange and innovation. They are often formed and operate on a basis of personal trust
rather than formal contract (ibid.).

Boisot and Child saw in Chinas emergent structure of property rights something they labeled

quasi-capitalism.

There is a juxtaposition in China of (1) an emergent form of what at best can be termed
quasi-capitalism, incorporating important aspects of governmental patronage, and (2)
marketization (ibid.).

This will, according to conventional Western thinking, inevitably generate certain


fundamental tensions, and it remains to be seen how significant these are. One such
tension stems from the temptation of government officials to introduce non-economically
rational criteria into resource allocation by firms (cf. Child and Lu, 1996). Another derives
from the increasingly local focus of industrial governance, which may in several ways
inhibit the flow of investment funds to their nationally most beneficial uses, such as
through pressures to retain surplus funds within the locality or the discouragement of
outside investors because of the risks they perceive to stem from local interpretations of
the law and the distortions introduced by local corruption. As Faure (1994: 87) stated,
The present danger in the development of a market in China lies in the very real
possibility that with the devolution of state power, local authorities may take away what
the state world concede. It is as vet unclear if the state can effectively curb the
emergence o f patronage networks built upon the personal influence of members of the
officialdom (ibid. 617; emphasis mine).

In summary, Boisot & Childs 1996 version of network capitalism developed Biggart and Hamiltons

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theses of East Asian economies in 1988 and 1992 [113]. Their description of Chinas emergent structure of

property rights juxtaposed with a governmental patronage network and marketization cast doubt on whether

privatization could plav a part in Chinas transition. What has been happening in China challenges neo

classic theses like the "autonomy of economic actors," "formality of modem bureaucracy," as well as the triad

corollary of "decentralization, privatization, and marketization" [114]. What has been happening in China also

counters some neo-Marxist views that capitalism is a unitary market-oriented phenomenon, and that modem

economic development invariably leads to a convergence with a unitary capitalist order (F. Braudel 1979,

1985; also cf. B&C 1996, 624). With reference to Chinas cultural-space, Boisot and Child conclude that

Chinas emergent economic order is actually in transition to quasi-capitalism," reflecting an East Asian type

of transacting-govemance with a propensity for information diffusion rather than information codification. Its

transition presents a passage of network capitalism from the iron laws of fiefs to the iron laws of clans,"

which is socially embedded, personally-related and community-based.

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2.4 Qian and Xu: Chinas M-form hierarchy in transition

As we have just seen, Boisot and Child (1996) saw Chinas emerging economic order rising from

its decentralization reforms that certain particular circumstances encouraged both local governments and

local enterprises to pursue entrepreneurship. In some ways Boisot and Child drew on Qian Yingyi and Xu

Chenggang's earlier 1993 thesis that Chinas M-form hierarchy played a key role in Chinas economic

transition, illustrating how a countrys economy could be shaped in each countrys own situation (1993b,

158). Qian and Xus two joint treatises were published in 1993 (1993a. 'T h e M-Form Hierarchy and

China's Economic Reform," European Economic Review. 37, pp. 541-548; and 1993b. "Why China's

Economic Reforms Differ, the M-form Hierarchy and Entry/Expansion of the Non-State Sector."

Economics o f Transition 1: 135-170). For purposes of discussion these two essays will be treated as

complementary. According to Qian and Xu, prior to Chinas reforms China was being administered by an

M-form hierarchy (1993a, 543; 1993b, 137-8; with M-form hierarchy referring to a (single-layer) multi

divisional form of organization by brand name or geography). The term M-form hierarchy had been

used earlier by A.D. Chandler, Jr. (1966, 1977, and 1985), as well as by Chandler et al. (1980). An M-

form" hierarchy differed from a U-form hierarchy (a unitary form of organization along functional lines)

that characterized the former Eastern Europe and the former USSR. In Qian and Xu, the fact that China

had an M-form hierarchy enabled China to make its transition by going through economic

denationalization and deconcentration instead of privatization. In the late 1990s, when the privatization of

Chinas SOEs was looming large [115J, Qian revised his position. In a 1999 joint article with Cao and

Weigast, Qian stated that the federalism, Chinese style, has induced privatization, Chinese style [Cao,

Yuangzheng, Yingyi Qian, and Barry R. Weingast. 1999. From Federalism, Chinese Style to

Privatization, Chinese Style." Economics o f Transition, Vol. 7, (1) 1999, p. 103]. According to this

changed perception, China's decentralization had drawn its political logic from federalism, Chinese style,

which was key for explaining Chinas transition [116]. Thus Chinas privatization could be seen as local-

govemment-driven. The reforms of decentralization, featured by denationalization and deconcentration,

could eventually be integrated with Chinas privatization in its own way [117].

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2.41 Qian and Xus comparative study of the organizational structures in different transitions

In 1993 Qian and Xu had declared,

W e have provided a comparative analysis of transition from institutional perspectives,


and have addressed the issues of how initial institutional environments differ between
China and Eastern Europe and the former Soviet Union, how reform and transition
strategies in China depend on institutional conditions: and how the institutional changes
of decentralization affect Chinas transition path and outcomes (1993b, 156; emphasis
mine).

In this context Qian and Xu had distinguished between Chinas M-form hierarchy and the U-

form hierarchy of the former Eastern Europe and the former Soviet Union (hereafter FEE and FSU).

Accordingly, Chinas M-form hierarchy was proposed as describing the initial conditions of institutions

prior to Chinas transition. This could be traced back much earlier to Maos era of the Great Forward

Leap in the late 1950s (ibid. 424; also cf. Cao, Qian, and Weingast 1999, p. 125) [118].

Qian and Xus 1993 inquiry entered into a debate in mainstream scholarship over whether Chinas

fast growth was attributable to its much lower initial development stage or to its gradual approach to its

economic transition (Qian and Xu 1993a, pp. 541-2) [119]. Qian and Xu pointed out that despite widespread

misimpressions, China did not necessarily begin from a much lower initial development stage than did the

former Eastern Europe.

Chinas level of industrialization was perhaps higher than most people would think... In terms
of GNP, Chinas industry accounted for about half in 1978, as compared to 60% to 65% in
Eastern Europe (1993b, 136).

According to Qian and Xu, Chinas reforms had been

more successful in the industrialized regions with a weak central government control than in
the less developed regions (1993a, 542).

Reforms have been less successful in both less industrialized regions (like the Northwest
provinces) and the more industrialized regions with strong central government control (like
Shanghai and provinces of Liaoning and Jilin); the latter share similar problems to those of
the earlier Hungary reform. This fact suggests that one cannot explain the success of the
reforms by low level of development alone (1993b. 136) [120].

So Qian and Xu turned to the other possible explanation for China's fast growth, i.e., its gradual

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approach to its economic transition. They asked why and how the gradualism could be successful in China

but not in Eastern Europe. From the early 1960s to the late 1980s Easter Europe had intermittently

experimented gradual reforms. As Qian and Xu illuminated, when the gradual reforms failed, Eastern Europe

turned to radical transitions [121]. They stated:

The argument for gradualism also raises more questions than answers. First, the agricultural
reform in China proceeded very fast in the early 1980s. The abolition of the commune
system and the nationwide establishing of the household responsibility system (an
ownership reform) was implemented almost at one stroke, and can thus be viewed as a big
bang. More importantly, Eastern Europes radical transition should not be examined in
isolation: it came after deep troubles of failures of many years of gradual reform. In fact, the
Hungarian reform started in 1968 with some initial success, but then ran into difficulties in
the 1980s. Ironically, in several respects China followed Eastern Europe's gradual reform
measures. If Chinas gradualism is a success, why has it worked in China but not in Eastern
Europe? On the other hand, why was Chinas success not a temporary one, and will China
soon encounter problems similar to Hungarys (1993b, 137)?

Pursuing the possible role of gradualism in China's transition, Qian and Xu launched their inquiry:

W e first make an observation and provide extended evidence...We then theorize an


institutional reason which is responsible for this phenomenal expansion and for the
concurrent emergence of the market (ibid.).

Like Nee, and Boisot and Child, Qian and Xu started gathering their evidence from Chinas fastest

growing sector - the non-state sector. They then recognized that the rapid growth of Chinas non-state

sector might explain why the state sector had shrunk so dramatically and how the economy might be

denationalized even without full privatization [122].

The Eastern European transitions have shown that the massive and fast privatization of
the state sector is rather costly. Given the initial condition of the M-form organization in
China, the evolutionary approach of developing the non-state sector is perhaps an easier
and less costly way at the initial stage of transition. Eventually, with the continuation of
this process, the state sector will be forced to share a minor role in the national economy.
Moreover, the rapid expansion of the non-state sector has important implications for
denationalization of state enterprises for further reforms in China: successful non-state
enterprises will eventually take overstate enterprises (1993a, p. 548; emphasis mine).

During the period from 1981 to 1990, the share of the non-state industry in the national
total has expanded from 22% in 1978 to 47% in 1991. If this trend should continue,
Chinas state sector would shrink to about only one quarter of the total by the year 2000,
even without massive privatization (ibid. p. 543).

As Qian and Xu noted, the continuing growth of Chinas non-state sector throughout the entire

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economy provided such an alternative argument that the non-state sector, (not necessary the private

sector alone), could be the main earner of economic efficiency and improvement:

Although true private industry in China did not appear until the early 1980s. the collectives
had growth from 11% out of the national total in 1969 to 22% in 1978. or about one per cent
increase in output share every year. However, the dramatic shift of weight towards the non
state sector has been apparent since 1979: The non-state sector in industry has on average
experienced an increase in industrial share of two percentage points every year for 13 years.
Accompanied by the high growth rate, the non-state sector is also more efficient than the
state sector. The annual growth rate of total factor productivity of the non-state enterprises
was much higher than that of the state enterprises (ibid. 140-1; emphasis mine).

The unexpected, and perhaps unintentional, growth of the non-state sector is critical for the
success of China's economic reforms...Chinas non-state sector is engaged in all kinds of
activities: construction, transportation, commerce, service, and in particular, industry. This is
perhaps a crucial difference between Chinas non-state sector and that of Eastern Europe
before 1989.. .Accompanied with the high growth rate, the non-state sector is also more
efficient that the state sector. For example, the annual growth rate of the total factor
productivity of the TVEs was about ten times higher than that of the state enterprises
(1993a, pp. 542-3; emphasis mine).

Eastern European transitions were similarly initiated by the boom of the non-state sectors in their

economies. But as Qian and Xu noted, the sustaining growth of Chinas non-state economy has been

uniquely rooted in tremendously boosted local initiatives rather than in the initiatives coming from above - the

government reform programs, witnessed in Eastern Europe.

One important characteristic about the entry and expansion of the non-state sector in
China should be emphasized: the fast and sustained entry and expansion occurred
largely from local initiatives, not from an intentional design of a reform program by the
central government, and it took an evolutionary rather than revolutionary path 1993a,
543) [121

Both China and Eastern Europe had launched their respective decentralization program relatively

early. Hence it remained unclear why the outcomes of their decentralization programs differed so much. In

their efforts to understand why, Qian and Xu looked into the different kinds of hierarchical structures that

existed in China and Eastern Europe prior to reforms [124]. According to Qian and Xu, such a search might

provide an institutional explanation for Chinas fast growth in an incremental fashion using various unigue

trial-error experiments.

The organization structures of both Eastern Europe and the Former Soviet Union were of a
unitary form based on the functional or specialization principles (the U-form economy),
and in contrast, the Chinese hierarchy has been of a multi-layer-multi-regional form mainly

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based on a territorial principle since 1958 (the deep M-form economy, or in short, the M-
form" economy). The M-form structure has been further decentralized along regional lines
during reform with both increased authority and incentives for regional governments, which
provided flexibility and opportunities for carrying out regional experiments, for the rise of non
state enterprises, and for the emergence of markets. Our institutional approach is able not
only to incorporate and link together aspects of the arguments concerning the level of
development and gradualism, but also to explain richer phenomena such as the successful
use of experiments in China but not elsewhere.. .This explains how the rise of the non-state
sector occurred by gradually weakening the existing hierarchical control without destroying
the existing structure at one stroke (1993b. 137: emphasis mine) fi2tT

In contrast to the enterprises under Chinas M-form economy, the Eastern European counterparts

under U-form economies were strictly controlled by the ministries of the central governments, and even

regional governments were subordinates of the center and only implementing the plans from
above without much autonomy (1993a, 544) [126].

As a result, the Eastern European and USSR enterprises were mostly large-sized and highly

specialized (see Table 2.42 below). Accordingly, as Qian and Xu pointed out.

Comprehensive and rigorous planning and administrative coordination between ministries


and between enterprises were crucial for the normal operation of the U-form economy
(1993a, 544).

Why the FSU and FEE chose such an U-form hierarchical design might have a couple of historical

explanations. One was the ideological obsession with economies of scale and gigantic factors that can be

traced back to the early establishment of the Soviet Union (ibid.: T h e U-form organization takes full

advantage of economies of scale and specialization). For this Qian and Xu added their endnote (24) that

Lenin made this famous remark in his book The State and Revolution (1917): 'The whole
of [socialist] society will become a single office and a single factory. This ideology can be
attributed to Marx (ibid. 160).

Another explanation could be that the 1920s notion of modernizing the Soviet economy was strongly

affected by the then-extant knowledge of organizing industrialization prevailing in the West.

...when the Soviet Union began to establish a centralized economy in the 1920s, the U-form
was the only way of organizing industrial activities within large corporations in the West, as
the multi-divisional firms in capitalist economies had not yet emerged. The claims of Lenin
and Kautsky about establishing a socialist economy as a gigantic factory also reflected the
prevailing knowledge about economic organization at that time (1993b, 143).

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Still another explanation could be the political objective of the Soviet Union on account of its

hegemony throughout its own territory and over Eastern Europe.

...there were political reasons for the U-form organization, particularly under Stalin, to
achieve better control by Moscow over the Soviet Republics and the Eastern European
countries. Because each region of Eastern Europe and the Soviet Republic was made a
branch of the grand hierarchy, all regions became strongly interdependent, and ultimately,
were dependent on Moscow (ibid.).

But once the economies of the Soviet Union and Eastern Europe became modernized and more

complex, inflexibility, ineptness, occlusion of U-form hierarchies and the huge expense of any change and

reform became increasingly apparent.

In order to change the organization structure, Nikita Khrushchev in 1957 abolished the
ministries altogether and introduced 105 Regional Economic Councils (Sovnarkhozy), to
which all the state enterprises were subordinated. However, this reform did not go very far
and soon failed. Given the already very concentrated industrial structure, a change from a
unitary form to a multi-regional form required both political changes and economic changes.
The power of ministries would be weakened, large enterprises would be broken up or new
duplicating enterprises would be established, and all of these were very costly. In 1965,
blaming the growing localism of the Sovnarkhozy and the difficulties of coordinating a
regionally operated planning apparatus, the regional coordination system was replaced by
the former ministerial system (Gregory and Stuart 1981) (ibid.).

In contrast, Chinas economy was organized under a M-form hierarchy from the start. This provided

Chinas economy with local initiatives and market competition.

This is critically important: it is precisely because of the autonomy and incentives


provided to the bottom levels of the regional governments in China that the non-state
sector was able to grow so fast (1993b, 138; emphasis mine).

From their inception, those non-state enterprises (most o f them are not private though) have
been market-oriented. Furthermore, competition between regions for getting rich fast puts
pressure on the local governments to concentrate on growth and their limited access to bank
credits maintains discipline on their behavior (Ibid. 137; emphasis mine) [127].

Why did China choose decentralization reforms under its M-form hierarchy? First, China chose to

maintain its existing regime during its transition, unlike the FEE and the FSU (1993b, 137). From the

beginning the existing regime remained in power, the central government played an important role, although

not very critical (ibid. 149) (though the nature of the regime has arguably changed along the way). Second,

many enterprises had existed in China's economy outside the scope of planning and control prior to reform

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(ibid. 155). Throughout the decades these enterprises had constantly bargained for local discretion or

hierarchical devolution and had eventually become widespread. Their spread was particularly precipitated by

the development of horizontal coordination within the state sector between regions and between enterprises

that started in the Cultural Revolution, when the state sector became crippled [128]. Third, instances of the

chosen M-fonm hierarchy and horizontal coordination had been particularly affected historically by some of

Maos legacies. Fourth, many local initiatives that boosted Chinas reforms actually fit in well with China's

heterogeneous regional reality, reflecting patterns of uneven regional development. Many of the institutional

choices were geographically determined.

Qian and Xu described the organizing of Chinas economy along regional lines and the particular

reasons and contexts as follows,

There are several reasons why Chinas economic organization evolved into the M-form.
First, historically, before the Chinese Communist Party fully took power of China in 1949.
both the economy and the military forces in regions under Communist control were
organized in a M-form. The organizational heritage and skills accumulated in history have a
deep influence on the evolution of the organizational structure of the Chinese economy.
Second, technologically, poor communication and transportation facilities in a large country
make the M-form organization an easier choice for the Chinese. Third, politically, nationalism
was less a problem in China than in the Soviet Union and Mao had many other means (for
example, political movements) to hold the country together. Fourth, militarily, as Mao was
worried about the Soviet and American air-raid invasion and the Third World War, industries
were dispersed into inland areas and placed under the supervision of the regional
governments. Finally, culturally, there is vast classical literature in China on the art of
managing multi-regional organization because for more than two thousand years the
Chinese empires were basically organized along regional lines. Chinas M-form hierarchical
structure has evolved since 1958. Because of ideological and political reasons, Chinas first
five year plan (1953-1957) was formulated with the help of the Soviet experts, which was a
process of copying the Soviet Model - the U-form organization - into the Chinese economy.
Toward the end of the first five year plan, Mao was increasingly dissatisfied with the over
centralization and bureaucratization in the Soviet model. In his famous 1956 speech on the
ten major relationship, Mao discussed the relationship between the central and the local
governments and advocated the ideas of mobilizing two initiatives of both central and local
governments" (diaodong zhongyang he defang liangge jijixing) and walking on two feet
(liangtiaotui zoulu), the latter referring to development of both central and local industries
[129]. These ideas later became official government policies and were subsequently
implemented. Under Maos initiative. China started to deviate from the Soviet model and
move toward the direction known as administrative decentralization" within the hierarchy.
Two major waves of administrative decentralization occurred in 1958 (the Great Leap
Forward) and in 1970 (the Cultural Revolution): the central governments bureaucracy was
trimmed; supervision authority of many state-owned enterprises was delegated from
ministries to provinces and cities or even counties; and local governments initiatives for
developing their regions were encouraged. The legacies of Mao had a great impact on the
organizational structure of the Chinese economy. As far as the initial institutional conditions
for economic reform are concerned. Chinas multi-laver-multi-reoional hierarchical structure

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90
prior to 1979 was already substantially different from that of the unitary hierarchical form
inherited in Eastern Europe and the Soviet Union before their economic reforms (ibid. 145;
emphasis mine).

The fact that Chinas economy organized in a M-form hierarchy was not accidental. It emerged from

geographic reality and China's bureaucratic history.

In Chinas official language, regions at each level are called blocks (kuaikuai), as opposed
to branches (tiaotiao), and bureaucratic supervision takes place along the lines of function
and specialization. Instead of mainly following functional or specialization principles like
those in Eastern Europe and the Soviet Union, the Chinese economy is organized into a
multi-laver-multi-reaional form mainly according to territorial principle, in which each region
at each layer can be regarded as an operating unit. Each unit is further divided along
geographic lines and at the same time the unit controls its own enterprises along functional
and specialization lines. Regions are relatively self-contained; that is, they are self-sufficient
in terms of functions and supplies in production. Directly under the control of the central
government are 30 province-level regions (blocks) and a few dozen functional and industrial
ministries (branches). Before the economic reform which began in 1979, industries in China
were much less concentrated than those in Eastern Europe and the former Soviet Union and
there was a large number of state-owned industrial enterprises not controlled by the central
government. This is true for light industries as well as for heavy industries. In 1978, the
share of industrial output of state-owned enterprises controlled by the central government
was less than one half of the national total (Wong 1987). In the automobile industry, almost
all enterprises in Eastern Europe and the Soviet Union were directly controlled by the central
government and the number of the enterprises was rather small. In China, there were 58
enterprises making automobiles before the reform, and most of them were controlled by the
local governments (Wang and Chen, 1991). Consistent with this, the number of products
directly under the central plan in China was much smaller, only 791 in 1979 (Zhu 1985), as
compared to more than twelve million in the former Soviet Union in the late 1970s (Nove
1980). Wrth a much reduced work-load. the desired number of ministries in the center is
much smaller than in the Soviet Union (less than 30 vs. more than 6 0 )...The commune
system in the rural area between 1958 and 1984 provides a good example showing some of
the features of the bottom level of the M-form hierarchy. A commune (now township)
government was a bottom-level government in China (only the level of village is below it).
Far from having specialization and division of labor, a commune encompassed all kinds of
activities of industry, agriculture, commerce, education, entertainment and even military
(peoples militia"). The counterpart of the commune in urban areas is the neighborhood
committee, which similarly has many of its own collective enterprises (ibid. 144-5; emphasis
mine).

Chinas decentralization reforms since transition extended its economy along regional lines and

made its M-form hierarchy even deeper [130]. The decentralization policies prompted a number of institutional

changes at the levels of administrative divisions (branches) along the regional lines (blocks):

First, a fiscal revenue sharing system between any two adjacent levels of governments was
implemented starting from 1980. Although schemes vary both across regions and in time,
the basic idea is that a lower level regional government enters into a contract with the upper
level regional government on the total amount (or share) of taxes/profits revenue (negative
means subsidies) to be remitted for the next several years, and the lower level government

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91
1^1
keeps the rest [ ]...Second, the so-called extra-budgetary revenues (i.e., the second
budget) of the local governments and ministries were expanded. Eighty per cent of these
funds belongs to state-owned enterprises as retained profits over which the local
governments and ministries have substantial control. Before the reform, the extra-budgetary
revenue was relatively small, 9% of G NP in 1978 compared to the budgetary revenue of
35% of GNP. In 1991, the extra-budgetary revenue was up to 15% of GNP while the
budgetary revenue was down to only 18% of GNP (Sicular, 1992). Third, the banking system
in China was also decentralized with the separation of the central bank and the specialized
banks in 1983. Although banks were still owned by the state, each regional branch of the
specialized banks was required to link their total credit extension to deposits collected within
the region (cundai guagou). In case deposits fall short in a specialized bank, it is the regional
branch of the central bank (not the general office of that specialized bank) which is
responsible for reallocating funds within the region or asking for refinancing loans from the
central bank. This regional-based banking institution was also deep, as the central bank in
China has branches even at the county level. Although the banking system was somewhat
re-centralized in terms of personal appointments starting in the fourth quarter of 1988, the
influence of the regional government (through regional branches of the central bank and
specialized banks) on credit remained rather strong. Fourth, more autonomy was granted
and more responsibilities were assigned to the regional governments. These include
reduced planning scope of the central government, increased authority of local governments
for determining prices, for setting up new firms, for making investment with self-raised
funds, that is, funds drawn from the extra-budget or borrowed from banks. At the same
time, burdens of fiscal expenditure were also decentralized, local government assumed
greater responsibility for providing education, health, housing, local infrastructure, etc.
(ibid.146-7; emphasis mine).

As a result of these changes, local governments in China became residual claimants and had

more incentives to maximize local revenues.

Because the local governments budgets are highly dependent on local enterprises, they
have incentives to set up more enterprises using their newly-gained authority. More firms
mean more revenue, more revenue means more resources for regional development.
With such a decentralization, local governments do not receive a great deal of financial
support from above and consequently, their responsibilities to above are also small (ibid.
147).

Tables 2.41a and 2.41b illustrate how fiscal shares of budget revenue and expenditures

between the central government and local/ regional governments changed after Chinas

decentralization reforms.

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Table 2.41a: Changing fiscal sharing in China between central and local
governments: public revenue and expenditure (1)

(Unit: 100,000,000 yuan)

Year Government Revenue Government Expenditures


Total Central Local Total Central Local

1981-90 Rate (% ) 11.9 17.6 8.5 12.1 7.6 15.4

1980 1160 285 876 1229 669 562


1985 2005 770 1235 2004 795 1209

1986-90 Rate (% ) 12.0 15.5 9.2 13.0 9.6 14.9

1990 2937 992 1945 3084 1005 2079

1991-95 Rate (%) 16.3 26.8 9.0 17.2 14.7 18.4

1994 5218 2907 2312 5793 1754 4038


1995 6242 3257 2986 6824 1995 4828

Source: above categorical statistics converted and calculated from China Statistical Yearbook, 1996: p.
22-3.

Note: Rate refers to the change as % of GDP in the given period.

As Table 2.41a demonstrates, central government revenues steadily increased between 1981

and 1995, exceeding local government revenues in 1995. In terms of government expenditures, both

central and local government expenditures increased between 1981 and 1995. However, during this

same period, local government expenditures increased more rapidly and to a level more than twice as

high as central government expenditures.

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Table 2.41b: Changing fiscal sharing in China between central and local
governments: public revenue and expenditure (2)

(% per annum)

Year Government Government


Revenue Expenditure

Central Revenue Local vs. Central Expendi Local vs.


as G D P (%) Central Ratio ture as G D P (%) Central Ratio

1980 25.7 307.8 27.2 84.3


1985 22.4 160.5 22.4 152.0
1990 15.8 196.0 16.6 207.0
1995 10.7 91.7 11.7 242.0

Source: above categorical statistics converted and calculated from China Statistical Yearbook, 1996: p.
34-5.

As Table 2.41b demonstrates, between 1980 and 1995 Chinas central government revenues as

well as expenditures declined significantly as a percentage of GDP. During that same period the ratio of

local government expenditures to central government expenditures more than doubled. 1985 was a

critical year. M any key reforms were instituted in 1984, and many new laws were enacted [132].

Unlike Boisot and Child, who explained Chinas networked transacting governance as a result of its

decentralization, Qian and Xu explained Chinas decentralization largely as a result of its unique M-form

hierarchy prior to the reform [133].

Give this structure of the hierarchy. China also followed a much more decentralized method
than their Soviet counterpart in the process of making a plan: each region first formulates a
plan, then the higher government makes a balance, all the way up to the central government
(1993a, 544; emphasis mine).

And Qian and Xu certainly provided evidence that Boisot and Child could later develop. For example,

according to Qian and Xu, decentralization created substantial autonomy for the local governments so that,

while under strictly hard budget constraints and facing considerable pressure of market competition, these

local governments had to tolerate the fast-growing private enterprises and had to engage in their own

entrepreneurial efforts for survival. This internalized approach allowed China to generate rapid growth

through its local initiatives without totally destroying the existing structure. In this way China was able to take

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94
an incremental approach to its transition. As Qian and Xu emphasized,

Having recognized the costs associated with decentralization along regional lines, our
analysis focuses on a neglected but important aspect of benefits of a multi-layer multi-
regional form of organization, that is, the opportunity and possibility that the M-fomri
organization provided to facilitate sustained entry and expansion of the non-state-sector.
This is mainly because, under the M-form organization in China, governments at the bottom
levels of the hierarchy have little bargaining power vis-a-vis their superiors but have
substantial autonomy in developing their own regions by establishing market-oriented
enterprises outside the state sector. Furthermore, competition between regions for getting
rich fast puts pressure on the local governments to tolerate ad even to encourage private
enterprises as well. The very limited bargaining power and substantial autonomy together
weaken bureaucratic controls and strengthen market activities inside this M-form hierarchy.
What makes Chinas case particularly interesting is the fact that the rise in the non-state
sector (including the private sector) occurred by gradually weakening the existing
hierarchical control without totally destroying the existing structure like the one experienced
by Eastern Europe and the USSR (1993a, pp. 542-3; emphasis mine).

2.42 Qian and Xus account of Chinas M-form hierarchy

To Qian and Xu, one of the main strengths of Chinas M-form hierarchy lay in the semi-autonomous

power that local governments could gain. But the financial semi-independence of these local governments

also meant that they had to rely on the market performance of local enterprises with which they were

associated rather than relying on the performance of those from above,

This is particularly true for the bottom level governments (i.e., township and village
governments in the rural area, and district and neighborhood governments in the urban
area). At the bottom levels of the hierarchy, community governments are in a very low
bargaining position vis-a-vis the government hierarchy and the banks (1993a, 544).

...the role of local governments before the economic reform was still limited compared to
that after the economic reform. Before 1979, as the fiscal system remained very centralized,
the local government had little financial resources for regional development. Autonomy of
the local governments was also limited given the constraint of the central planning and the
use of markets not being officially sanctioned. Furthermore, the Chinese economy was a
closed one without informational and technological exchanges with the rest of the world. The
subsequent reforms since 1979 opened up the Chinese economy to the outside world. The
scope of planning was gradually reduced and the use of the market was encouraged. More
importantly, several reform policies were carried out that have meant authority, information
and incentives being decentralized to the regional governments. It is only after these
complementary reform policies that initiatives of the regional governments were mobilized
and the market emerged beyond the boundary of each region (1993b, 145-6).

Thus the real mechanism was hard budgets constraints. Both local governments and local

enterprises had to face fierce market competition. The new situation demanded that they both seek

entrepreneurship.

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95

...the budget constraints for non-state enterprises are much harder than the state-owned
enterprises. With hard (or harder) budget constraints, community governments are more
conscious about risks and profitability and, in the final analysis, the efficiency of their
enterprises. The number of township and village enterprises that went bankrupt during the
1989-91 retrenchment could be used as evidence for the harder budget constraints in the
non-state sector. In 1989, about three million township and village enterprises went
bankrupt, or were taken over by other township and village enterprises nationwide, while in
the same year almost all loss-making state-owned enterprises were bailed out by the
state...the loss-making state enterprises accounted for 31% of all the state enterprises in
1990 (1993b, 152).

Certainly it would make sense for the local non-state enterprises to pursue efficiency, as they faced

market competition and hard budget constraints. And local governments would have something to gain by

supporting those local non-state enterprises capable of creating revenues and profits.

Compared to their counterparts in the U-form economy, regional governments in China pay
less attention to bargaining with the higher authorities because they have less to gain from
bargaining within the hierarchy. The local government has to raise revenue on its own
without much help from above, and so it has strong incentives to set up and to support local
enterprises for revenue generating and employment purposes. Some scholars even view a
township or village as a corporation", and the government of township as the board of
directors and the management team of the corporation (Oil 1992) (1993b, 152).

Harder budget constraints in market competition that brought uncertainties to the local agencies

could force them to change their behavior and terminate those troubled enterprises with bad performances

[134]. In this way, as Qian and Xu indicated, both the weak bargaining power and the semi-autonomous

position could provide local governments and the non-state sector with some form of the incentives for

market-oriented institutional changes and ultimately promote market competition between different regions

n.
In a M-form organization, coordination at the centre is not so critical, thus providing semi-
autonomv together with higher-powered incentives to local governments may be
optimal...After further decentralization in the region, local governments have more
incentive to build up their regional empires and officials have less interest in promotion to
a higher rank. Because the regions are self-contained with delegated authority and
because different regions engage in a similar composition of activities, aggregate
indicators like growth in revenue or output reflect the true performance of the regional
government rather than random noise. Therefore, tournament or yardstick competition
between regions is a powerful tool for providing incentives bv filtering out common or
systematic uncertainties (Holmstrom 1982). In China regional governments often take
great pride in being ranked in first place in a competition among neighboring
regions... This type of incentive would be less effective and more costly to provide to
ministries in the U-form hierarchies because idiosyncratic uncertainty is more significant
(1993b. 150; emphasis mine).

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96

According to Qian and Xu, efficiency can be institutionally initiated.

Although privatization, understood as a process of simply transferring ownership from the


state to citizens, might be achieved relatively quickly, privatization as a mechanism to
achieve efficient organizational structure and competitiveness is bound to be a Iona
historical process. Typically, the privatization process per se does not automatically
change the industrial structure of the economy (Czech Republic is an example). If the U-
fonm structure is not changed, the fundamental problems related to the high degree of
concentration may still remain after privatization (1993b, 157; emphasis mine).

The development of the non-state sector has benefited from agriculture reforms in at least
three aspects: 0) capital accumulation; (ii) release of labor force; and (iii) creation of
demands (ibid)- However, surplus labor, financial savings and potential of markets by
themselves cannot be transformed into growth automatically. Institutions are required to
facilitate trade, and entrepreneurs are needed to organize production and distribution. It is
the M-form organization that provides the flexibility within the system for efficient utilization of
those favorable conditions (ibid. 155-6; emphasis mine).

As Qian and Xu here underscore, different hierarchies with their U-form or M-form essential

features could generate different sets of combinations of costs and benefits for their respective

economies.

The costs and benefits of a U-fomn and M-form organization affect the static efficiencies,
stabilities, and evolutionary processes of the system (1993a, 545).

In the U-form organization, industries are highly concentrated, the regions are highly
specialized, and the operating units of ministries and enterprises alike are strongly
interdependent. Hence a rigorous coordination at the centre is crucial for maintaining the
normal operation of the economy, and a decentralized coordination at the regional level may
not be efficient (1993b, 149).

The costs and the benefits of different forms of organization are determined by the essential
features of the organizational structures...Compared to the U-form hierarchy, the M-form is
less efficient in utilizing scale economies. The automobile industry in China provides an
extreme example: there are more than a hundred small-scale state-owned auto makers in
China, each producing on average about ten thousand automobiles annually. It is typical that
regional governments in China control both heavy and light industries, and therefore regions
are less specialized in products and industries are less concentrated. This leads to criticism
of Chinas local industrialization for inefficient scale and wasteful duplications, and for
associated regional protectionism and segmented markets, in particular in the presence of
distorted prices and taxes (Wong. 1992). On the beneficial side, duplication may reduce
vulnerability and increase reliability of supplies under uncertainty. It mav also induce
competition and facilitate technology diffusion into inland areas. Furthermore, less
specialization mav also be more beneficial, less specialization mav reduce coordination
costs (Becker and Murphv 1992). and less specialization mav also make workers more
efficient in learning and in operation, as shown by the Japanese experience (Aoki 1986).
(ibid. 147-8; emphasis mine) [1i>e].

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97
In Qian and Xu's view, what distinguishes Chinas M-form hierarchy from Eastern European U-form

hierarchy has more to do with the different internal structures of the regional governments than with the kinds

of relationships at the top level between the central government and the provincial government. In Chinas

case, what makes its M-form hierarchy unique is its distinct internal structure of regional governments in a

deep M-form hierarchy.

...the internal structure of a province in China is different from that of an Eastern European
country, even though the size may be similar. For example, Hungary with a U-form hierarchy
has a different organizational structure from Guangdong province of China. As a province,
Guangdong is a part of the large hierarchy of China. But Guangdong itself is also organized
in an M-form, with multiple regions consisting of prefectures, counties, townships and
villages, and all of them are self-contained economic units (1993b, 145).

The M-form hierarchy has lower requirements in communication and information processing
in which to coordinate its operation due to its decentralized nature. For example, in the
former USSR, the central government had to coordinate the production and distribution of
millions of products. But in China, the central government dealt with only a few hundred
products. The rest was taken care of by the local governments independently (1993a, 545).

In such a deep" M-form economy, at the lowest level Chinas industrial structure consisted of many

small- and mid-sized non-state-owned enterprises including private firms , localized at the levels of villages,

townships, and counties; and most of its state-owned enterprises were concentrated on the levels of

provincial and city governments. Qian and Xu provided the following 1985 data (Table 2.42a),

Table 2.42a: China: distribution of state-owned industrial enterprises


by administrative levels (1985)

Central Provincial and County


government city governments government

Number of state-owned 3,825 31,254 35,263


industrial enterprises

Share in total 19.57 44.57 8.98%


industrial output %

Source: cf. Qian and Xu 1993b, p. 170, Table 4.1.

According to them, by 1985 Chinas decentralization reforms had begun to affect Chinas industrial

structure,

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98
First, more state-owned enterprises were delegated to local governments. In 1985, the state-
owned industrial enterprises controlled by the central government accounted for only 20% of
the total industrial output from enterprises at or above township level, while the provincial
and city government controlled 45% and county government 9%...Second, the Chinese
industry has become even less concentrated. For instance, there are more than 100 color
television assembly lines, and every province has at least one. The number of enterprises
making automobiles increased from 58 before the reform to 116 in 1987 (Wang and Chen,
1991). Third, the average size of state enterprises in China is much smaller than that in
Eastern Europe and the Soviet Union, and is quite close to that in the West. For example, in
1988, employment per enterprise in manufacturing was 806 in the Soviet Union and 460 in
Hungary, as compared to 145 in China and 96 in Italy. In clothing, the corresponding figures
were 6,600 in Czechoslovakia, 307 in Hungary, 80 in China, and 71 in Italy...In spite of
twenty years of reform, the average size of Hungarian enterprises remained substantially
larger than that in the West (ibid. 147).

To illustrate their last point about the relative sizes of industrial enterprises, Qian and Xu compared

China and Eastern Europe, the former Soviet Union and the West in 1988 as follows (see Table 2.42b),

Table 2.42b: Com parison o f the size o f enterprises in C hina, Eastern Europe,
the FSU and the W est (Italy and the United K ingdom ) in 1988

Unit=number of employees per unit of enterprise

Manufacturing Food Products Clothing

1988:

Czechoslovakia 2930 1609 6600

The Soviet Union 806 290 402

Hungary 460 925 307

Yugoslavia 311 243 402

Italy 96 71 71

United Kingdom 35 67 25

China

1988 145 75 80

1995* 118 234 87

* I added the 1995 statistics; the sizes of Chinas enterprises in the year were calculated by the ratio of
numbers of employees vs. total number of enterprises).

Source: Industrial Statistics Yearbook, Volume 1, United Nations, Geneva; cit. Qian and Xu 1993: 170; for
Chinas data in 1995, cf. Statistical Yearbook o f China, 1996: pp. 402, 414.

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In 1988, the average sizes of Chinas enterprises in Manufacturing, Food Products, and

Clothing were much smaller than those in the FSU and the FEE; and the size of Chinas Manufacturing

enterprises shrank between 1988 and 1995. Chinas non-state sector had many more mid- and small

sized enterprises than Chinas state sector.

Later, in 1999, Cao, Qian, and Weingast further clarified the point that enterprise size also has a

significant impact on the momentum, pace, and method of privatization in the state sector.

In China, there are two separate worlds in the state sector one of small and medium SOEs
[state-owned enterprises] under the supervision of local governments, and another of large
SOEs under the supervision of the central governments. In contrast to Eastern Europe ana
the former Soviet Union, the distribution of SOEs by size in China is skewed toward the
small enterprises; further they are spread throughout the country rather than having a
geographical concentration...Therefore, privatization of small SOEs is equally, if not more,
significant in China than the reform of large ones. In a 1995 survey, the State Assets
Management Administration reported that the state sector had about 300,000 SOEs. The
top 1,000 SOEs accounted for 40% of total assets, 51%of net assets, and 66% of profits in
the state sector (Peoples Daily, August 1 4 ,1 9 9 5 )...In 1993, although large industrial SOEs
accounted for about two-thirds both in profits and taxes and in net value of fixed assets,
small and medium industrial SOEs together accounted for 95% in number, 57% in
employment, and 43% in output of the state industrial sector...some of them [very larger
enterprises] are in natural monopoly industries such as telecommunications and railroad
transportation; and some are in government monopoly industries such as airlines, banks,
electricity, oils and petrochemicals (107-8; brackets mine).

The process of SOE privatization at the county level (one level above township and one
level below city) began with pioneering counties such as Yibin of Sichuan, Shunde of
Guangdong and Zhucheng of Shandong as early as 1 9 9 2 ...It became widespread after
1994 [137]. Surveys suggest that by the end of 1996 up to 70% of small SO Es had been
privatized in pioneering provinces; most counties had moved from an experimentation
stage to a promotional stage; and many provinces have completed zhuanzhi, or change
of ownership, in more than 50% of their small and medium SOEs at the county level.
Some economists in China predict that most small SOEs at county level will be gone
soon, although some of them may remain SOEs in name (ibid. 109).

Cao, Qian, and Weingast documented the size of state-enterprises as follows (see Table 2.42c),

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100
Table 2.42c: State-owned enterprises in China by size, 1993

Number Output Employment Net Value Profits and


(%) (%) (%) of fixed tax es (%)
assets (%)

Large 4.7 56.7 43.2 62.0 66.7

Medium 12.9 23.6 25.6 18.6 19.4

Small 82.3 19.7 31.1 19.5 13.9

Source: China Statistical Yearbook, 1994, pp. 388-91, except employment figures, which are from the State
Statistical Bureau; cit. from Cao et al. 1999, Table 1, p. 108.

Small-sized and mid-sized SOEs having higher debt-equity ratios are more vulnerable to market

failures, some of which have driven them toward privatization. Large-sized SOEs, having lower debt-equity

ratios, have suffered less from hard budget constraints and thereby have lacked the momentum for

privatization (ibid. 109).

Qian and Xu went on further to specify and compare the differed functional properties of the U-form

hierarchy and M-form hierarchy,

In a U-form hierarchy, incentives of subordinates are designed for implementing the


commands from the above. Agents are subject to frequent and arbitrary control of their
superiors, and thus they try to avoid any change or risks. In M-form organization, local
governments are given semi-autonomies. Compared with the U-form hierarchy, it is less
effective in implementing orders from the above in a well coordinated wav, but it is better in
mobilizing initiatives from bottom level units. This is because the local governments are not
subject to arbitrary control from the above for tasks within their autonomies. This feature of
the M-form organization induces strong incentives for local governments to conduct
experiments (1993a, 545; emphasis mine).

In the M-form economy of China, coordination is distributed at all levels of the hierarchy:
regional governments have substantial responsibility for coordination in addition to the
important (though not critical) coordinating role of the central government. There are two
reasons which favor a more decentralized coordination vis-i-vis a more centralized one:
First, to the extent that information is initially dispersed, local governments have better
information than the central government amply because they are closer to the sites. Hence
the local information is better used by local governments than by the central government for
regional development. Second, decentralized coordination has lower requirements for
capability in communication and information processing. The burden of communication and
information processing is reduced since fewer messages need to be transmitted and fewer
tasks need to be coordinated. Therefore, the M-form hierarchy has advantages when there
is a high degree of complexity in an economy and the communication and information
processing technologies are backward. However, decentralized coordination may also result
in inefficiency when a market is incomplete (Weitzman 1974, Bolton and Farrell 1990, and

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101
Milgrom and Roberts 1992). In the case of China, interdependence between economic
activities in different regions is not strong, and a more decentralized coordination is likely to
be preferred to a more centralized one as in the U-form. other things being equal (1993b,
149; emphasis mine).

According to Qian and Xu, the regional interdependence and inter-industrial interdependence under

the M-form hierarchy in China have been much weaker than their counterparts under a U-form hierarchy in

the FEE and the FSU. These have facilitated Chinas reforms across regions and industries through constant

yet much less costly error-trial experiments and through incremental institutional mutants. As a result, Chinas

transition had taken on an evolutionary path toward marketization without sudden, structural, and costly

changes,

It is acknowledged that one major feature in the Chinese reform is its success in using
experimental approaches [McMillan and Naugthton (1992) and Singh (1991)]...The question
arises: why is China special by using experimental approaches? In the U-form organization,
all industries are highly specialized and so are the regions. Thus, operating units are heavily
interdependent and rigorous vertical administrative coordination is crucial for maintaining the
normal operation of the economy. In such a case, allowing one or a few regions to do
experiments may be very costly or perhaps not feasible. These features of the U-form
hierarchy make the scope of regional experiments limited, which may reduce the chance of
being a success. Even when an experiment was a success, a large-scale promotion of one
experiment required high coordination cost economy-wide. In the M-form organization,
however, the regional interdependence is relatively weak. In this case, the regional
experimental strategy of reform in an M-form organization is less costly and more feasible:
even a failure in the experiment will not considerably disturb the whole economy. With more
experiments, therefore, under the M-form structure, people in different regions have more
chances to develop a large variety of 'mutants, and to compare and to select among
various alternatives. In this sense, the M-form organization is more flexible in the institutional
evolutionary process. In contrast, the extremely strong regional dependence in the U-form
organization makes the institution more rigid and difficult to change (1993a, 545-6) [138].

In Eastern Europe and the Soviet Union, some experiments had been introduced in their
reforms before 1989. However, the experiments were often unsuccessful; even when
they were successful in the local area, they were rarely promoted nationwide. Economists
tend to believe that regional experiment is not the right approach to reform a planned
economy. However, one major feature of the Chinese reform is its success in using local
experiments and in adopting the bottom-up" approach (Chen, Jefferson and Singh,
1992; McMillan and Naughton 1992). The a question arises: why is China so special in
using experimental approaches? In a U-form organization with a high degree of
interdependence between operating units, allowing one or a few regions to do
experiments may be very costly or perhaps not feasible. This is because experiments
generate shocks and may disturb normal operations of the economy regardless of the
success or failure of the experiments evaluated at local level. This makes the scope of
regional experiments more limited and chances of success smaller. Even when an
experiment was a success in a particular industry or region, its relevance to other
industries and other regions is less significant because of heterogeneity across operating
units. Given these features of the U-form hierarchy, economic reforms will more likely be
earned out in a top-down" fashion, in which decisions for changes have to be more
centralized to minimize transition costs. In the M-form organization, however, the regional

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102
interdependence is relatively weak, so even a failure in the experiment will not
significantly disturb the whole economy. In this case, the regional experimental strategy
of reform in an M-form organization is less costly and more feasible. Under the M-form
structure, large scale regional experiments can be carried out, many regions have a
chance to develop a large variety of mutants. and the central government mav be able
to compare and select among various alternatives. Furthermore, because adjacent
regions are similar in terms of economic structure, a successful experiment in one region
can be promoted relatively easily in other regions. Hence, under the M-form organization,
reforms may proceed more efficiently with the bottom-up approach, which provides a
less costly way of learning to establish and to use market institutions in a unprecedented
environment. This makes the M-form organization more flexible in the institutional
evolutionary process (1993b, 151; emphasis mine).

Here Qian and Xu argued that the weak interdependence of Chinas M-form hierarchy was rather

conducive to feasible reform experiments and to more efficient bottom-up institutional learning. The

main reason was that Chinas existing weak organizational interdependence could help China endure those

exogenous shocks and avoid those structural syndromes that Eastern Europe had suffered under the

structural transformations in their U-form economies [139]. This illustrates the Chinese saying that while the

sky darkens in the western side, it can still brighten in the eastern side.

In the M-form economy, a region-specific shock mav not affect the economy as a whole
because industries are spread out in many regions. The sustainability of the Chinese
economy during the Cultural Revolution illustrates this point. During that period, some
regional economies in China collapsed (due to factional conflicts) but the national economy
did not: national income dropped in only two years (-7.2% in 1967 and -6.5% in 1968), and
recovered quickly afterwards. On the other hand, since different regions have similar
industrial compositions, an industry-specific shock may affect all regions, but in a similar
way. This may reduce the aggregate adverse effect for several reasons: each region is
better capable of dealing with the shock locally since the magnitude of the shock is smaller;
regions may adjust better to the new environment by learning from each other since all
regions face similar shocks; and the incentive may become less of a problem because the
shock is transformed into a systematic one in the M-form organization rather than an
idiosyncratic one as in the U-form organization (1993b, 149-150; emphasis mine) [140j.

Chinas M-form hierarchy with its path dependent nature enabled China to follow a strategy for

denationalization" instead of privatization" (1993b, 156). This strategy was followed because Chinas

transition has been strongly backed by its local discretion and its advantageous structure of cost diffusion.

With the crowding-out effects of takeover, mergers and transformation of ownership, the
economy will eventually rely more on the non-state sector. This is perhaps an alternative
way to privatization and a less painful path of transition for China. To the extent that the
majority of the non-state sector has community or local government ownership rather
than private ownership at the present time, China can be better described as
'decentralized market socialism according to its ownership structure (Qian and Xu 1993)
(ibid.) n .

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According to Qian and Xu,

The recent Eastern European experiences have shown that massive and fast
privatization of the state sector is rather costly. Given the initial condition of the M-form
organization, it may be easier and less costly for China to follow the evolutionary
approach of developing the non-state sector rather than the revolutionary approach of
massive and fast privatization. Eventually, the state sector will be forced to share a minor
role in the national economy. This has important implications for the possibility of
denationalization, instead of privatization of state-owned enterprises in China in the future
(ibid.).

Our analyses have demonstrated that the success of Chinas particular gradual reform
strategies depends on its initial institutional conditions...that is, the transition is a path
dependent evolutionary process... One of the important implications of our analyses is
that the difference in the initial institutional conditions concerning the organizational
structure of the planning hierarchy should be taken into account when making policy
suggestions for other countries based on China's reform experience. The central idea
underlying our theory is that, in addition to ownership, the organizational structure of the
economy matters (ibid. 157: emphasis mine) f1^ l.

In the underlined portion of the second paragraph above, Qian and Xu make a statement that

provides a theoretical premise for this dissertation [143]: The paths and outcomes of transitions, and the

desirability of those outcomes vary according to the initial institutional conditions and environments. This

theoretical premise differs from conventional claims calling in all instances for unidimensional market

transitions through radical privatization, regardless of how costly tat might be. As Qian and Xu concluded,

W e have discovered several important linkages between the reform process and the
organizational structure of centralized economies, which have policy implications, though
tentative, for other economies in transition. First, decentralization and deconcentration of
the state sector are desirable in their own right, and for facilitating entry and growth of
private business (Aghion, Burgess, and Xu 1993). There are several reasons: (i)
Although privatization, understood as a process of simply transferring ownership from the
state to citizens, might be achieved relatively ouicklv. privatization as a mechanism to
achieve efficient organizational structure and competitiveness is bound to be a long
historical process...(ii) If for some reason privatization will be delayed, then there is a
need for explicit policies to maintain and restructure the existing state-owned enterprises.
The policies of decentralization and deconcentration of state enterprises are beneficial in
generating competition and improving performance (perhaps with the exception of the
natural monopoly industries) and (iii) decentralization and deconcentration of the state
sector will facilitate and speed up entry and growth of new private businesses, which is a
vital part of privatization both in the long run and in the short run. The growth of the
private sector in Eastern Europe and the former Soviet Union has so far remained limited
to trade, services and construction, while other sectors such as manufacturing industries
have not yet been much affected. The monopoly and monopsony power of the
concentrate state enterprises or newly-privatized firms are one of the major barriers to
entry and growth. Decentralization and deconcentration will reduce these barriers. In
addition, decentralization of financial institutions also helps private firms to access credit,

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104
which is again critical for the fast growth of the private sector...Third, given the
unprecedented and complicated nature of the transition from centralized to market
economies, an experimental approach mav be a less costly wav of learning to establish
and to use market institutions in transition. Economic theory does not provide sufficient
guidance for the transition. Other countries experience mav be relevant, but must be
adapted to each country's own situation. By the decentralized nature of market economy
and by the very nature of the transition, a lame amount of bottom-initiated institutional
experimentation is needed to acquire knowledge in transition. Although the U-form
structure is not suitable for large scale experiments as we analyzed in this paper, it is still
possible to establish some special areas for the purpose of experimentation. To avoid
interfering with the normal operation of the economy, these regions should be located
outside the old industrial bases and far away from the central control, as was done in
China. Alternatively, after decentralization and deconcentration of the state sector, the
economy will be more suitable for local experiments (1993b, 157-8; emphasis mine).

Despite the rationale for such an experimental transitional path through denationalization, the state

still needs to make a credible" commitment to warrant the implementation for such a path (ibid. 120) [144]. To

Qian and Xu, such a commitment could be a key to solving the fundamental political dilemma of an

economic system."

In any economy, incentives cannot be really created unless the government is able to make
a credible commitment not to expropriate promised incomes and not to subsidize loss-
makers. Absence of such a commitment was a legacy of centralized economies that led to
the ratchet effect (excess profits were constantly siphoned away, Berliner 1957) and the
soft budget constraint" (loss-makers were continually bailed out, Komai 1980)...In contrast,
credible commitment may be achieved under decentralization. Dewatripont and Maskin
(1991) argue that dispersed banks and decentralized information structures can harden the
budget constraint....During Chinas decentralization, many upper levels of government
departments and bureaux were removed or merged, and the number of bureaucrats was cut
down. According to Migrom and Roberts (1990), this reduces information channels between
the superior and the subordinates, which in turn reduces influence costs. Thus a better
commitment may be achieved as less information reaches the top (1993b, 150). The central
government in the former Soviet Union retained strong discretionary power during its
reforms. In contrast, Chinas reform policy of decentralization of authority to local
governments makes it difficult for the central government to use its discretion [145]. In his
study of the history of economic development Weingast (1993) emphasizes the role of
decentralized political institutions in achieving credible commitment to thriving markets by
the state. The crucial aspect of what he called market-preserving federalism" is that the
central governments authority to make economic policy must be limited and this authority
must be placed in the hands of the local governments. This is viewed as the key to solving
the fundamental political dilemma of an economic system": a government strong enough to
protect property rights is also strong enough to confiscate the wealth of its citizens. One of
the key differences between Chinas and Russias reforms, as seen by Weingast. is that
China proceeded in this direction but Russia did not (1993b, 151; emphasis mine).

Qian and Xus view of political commitment was later developed by Cao, Qian, and Weingast in

1999 into their arguments for federalism, Chinese style.

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2.43 Chinas M-Form hierarchy and its hybrid economy in transition

Qian and Xu also explored how well China's M-form hierarchy could function in a hybrid transitional

economy. Considering the fact that China maintained its existing central regime throughout its transition, one

could reasonably expect that the state governments roles were crucial in carrying out the transition. But the

role of the central government came into play with a mix of regulatory control and acquiescence allowing

greater local discretion and flexibility for ongoing local experiments beyond the central plan. Later in 1999,

Cao et al. likened such a role to one of federalism, Chinese style, resembling a laboratory of the local

governments" (124) for bolstering and protecting various local initiatives and local activism. According to

Qian and Xu,

The fast growth of the non-state sector is not in the plan of the government, but rather
almost a spontaneous process under a relaxed political and economic environment. The
central government acknowledged openly that the fast growth of the non-state sector was an
unexpected surprise. Chinas case demonstrates that with commitment to economic
development and commitment to decentralization, whether this be conscious or not, reforms
can go very far even with the limited roles of the central government, given the M-form
structure and incentives to lower-level government in expanding non-state enterprises.
Compared to the central governments role in Eastern Europe and the former Soviet Union.
Chinas central government is relatively passive in guiding the reforms. It has not provided
any coherent plan for the reform. It gives a green light for local experimentation, and it
approves and promotes successful reform measures discovered in the course of regional
experiments. At the same time, it also imposes limits on reforms or institutional changes; for
instance, it continues to restrict the activities of state-owned enterprises and it is against
mass privatization. The observed gradualism in China is, to a large extent, a reflection of
these binding limits... More provincial governments are authorized to experiment with
different reform measures in their provinces within the limits set by the central government.
This helps to explain why there are lame variations in the reforms from province to province.
In many cases, a higher level of regional government protected their lower level
governments and the non-state enterprises at a time when the political atmosphere at the
center turned against them (1993b, 154; emphasis mine).

Qian and Xu argue that the fast growth of Chinas non-state sector (consisting mainly of those urban

COEs and rural TVEs by 1991) was attributable to the local initiatives boosted by Chinas M-Form hierarchy

that allowed for extensive market activities at the discretion of local authorities at the bottom of the hierarchy.

The most relevant aspects of the M-form organization are those associated with the two
bottom levels of government, that is, township and village governments in the rural area, and
district and neighborhood governments in the urban area (1993b, 152).

...by 1991, collectives and joint ventures were the dominant majority of the non-state sector,
and private-owned enterprises played a minor role in the national scale. The collectives and
joint ventures have a larger scale of operation, employ better technology, and absorb more

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106
human capital. This is because in China, there is still a lack of legal protection of private
property rights, let alone commitment to private ownership. Private firms often face
discrimination in obtaining credit, labor and material supplies (Nee 1992). Local government
ownership like a township or a village enterprise can be viewed as an institutional response
to such an environment, in which they have comparative advantages over both private and
state ownership. They are politically correct. protected by at least some level of
government, and they also enjoy the flexibility of business operation that the state-owned
enterprises are lacking (1993b, 141; emphasis mine) [146].

Qian and Xu described Chinas official classification of its hybrid economy into state-sectors vs. non

state sectors, according to the levels of their geo-based administrations (ibid. 140). Such a geo-based

classification differs from Nees binary classification of Chinas ownership structure into marketized sectors

vs. non-marketized ones (see above Table 2.21 d). According to Qian and Xu, the state-sector enterprises

could be further classified as follows,

In practice, every state-owned enterprise is affiliated to one of the following four levels of
government: (1) central; (2) provincial (with a population size of dozens of millions); (3)
prefecture (with a population size of several millions); and (4) county (with a population size
of several hundreds of thousands)...Typically the responsible government delegates the
supervision of its" state-owned enterprises to the industrial ministries/bureaux. Therefore,
even for the state owned enterprises, they are not homogeneous in terms of control (1993b,
138) [147].

Qian and Xu noted that the state enterprises under Chinas M-form hierarchy were not

homogeneous in terms of control" according to their local levels of administration. This observation provided

support for Cao, Qian, and Weingasts 1999 observation that the privatization of the state enterprises varied

in many ways according to their sizes.

According to Qian and Xu, Chinas non-state sectors included those urban and rural collectives (or

the community sectors according to their alternative classification; Table 2.43a below; cf. Qian and Xu

1993b, 140), and private sectors [148].

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Table 2.43a: Qian and Xu - Classification of Chinas non-state sectors
by industries and administrative levels

Official
Classification Collectives Individual Others

Urban District Neighborhood Urban Urban Private,


Enterprises Enterprises Cooperatives Individual
.Foreign
& other
Rural Township Village Rural Rural Joint
Enterprises Enterprises Cooperatives Individual Ventures

Alternative
Classification Community Private
By Q&X

Source: adapted from Qian and Xu 1993, p. 139.

Note:

1. Following the new version of the China Statistical Yearbook 1996, "Urban" herein is defined as
"structure of gross industrial output value of at and above township level;" and "Rural" is defined
as "structure of gross industrial output value of at and below village level."
2. "Private" sector is defined to include self-employed, private domestic firms, joint ventures, and
foreign-owned firms.

Rural collectives included township and village enterprises (TVEs) affiliated to the respective

governments of townships and villages and other collectives in rural China.

The predecessors of township and village enterprises (TVEs) were commune and brigade
enterprises (CBEs) emerging during the Great Leap Forward in 1958. The ownership form of
township and village enterprise is truly a Chinese invention that has not been found
elsewhere (ibid.).

Chinas private enterprises are much more heterogeneous and idiosyncratic than enterprises in

Chinas other sectors. They include household/individual enterprises (no more than 7 people in each) and

seven other types of enterprises with more than 7 people in each, including foreign enterprises and joint

ventures with foreigners, and other types of joint ventures (e.g., those between state and private enterprises),

and joint stock companies. These enterprises are more reliant on market-oriented mechanism for regulation

and efficiency. The seven other types of ownership did not emerge until the eariy 1980s" (ibid.). Qian and Xu

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added, some TVEs and urban district and neighborhood enterprises are de facto private enterprises with

vaguely defined ownership under the name of collectives (Qian and Xu 1993b, 140). Rural enterprises in the

non-state sector and both rural and urban enterprises in the private sector experienced unprecedented

growth in China during this period.

Within the non-state sector, the largest and the most dynamic part is the segment of rural
enterprises, also known as Township, Village and Private Enterprises (TVPs). Between
1978 and 1991, the number of rural enterprises increased from 1.5 million to 19.1 million and
employment increased from 28.3 million to 96.1 million. Between 1981 and 1990, the total
output by rural enterprises grew at an annual rate of 29% , in which the industrial output grew
at 28% , much higher than the national average of 13%. Exports by township and village
enterprises (excluding private enterprises) increased at an average annual rate of 65.6%
from 1986 to 1990... With the rapid growth of rural enterprises, their status in the national
economy has changed from a subsidiary sector of agriculture to an important engine of
growth...By all measures, the Chinese rural enterprises had already expanded to more than
half of the non-state sector and to about one quarter to one-third of the national total bv
1991 .The rapid growth of the rural enterprises has changed the industrial structure of the
Chinese rural areas as well. In 1980, the share of agriculture in gross output value in rural
areas was 69% and the share of non-agriculture was 31%, of which industry accounted for
only 20%. Ten years later, in 1990, the share of agriculture output had dropped to 46% and
the share of non-agriculture output increased to 54%, of which industry accounted for 40%
(Qian and Xu 1993b, 141; emphasis mine).

Employment by the rural private sector was about 24% and total output about 14% of the
rural total in 1984, the corresponding numbers increased to 49% and 33%, respectively, in
1988...An important part of the private sector in China is individual business. China
restored individually or household-operated business in 1978 and since then, this segment
of the private sector has registered rapid growth in both urban and rural areas, largely in
industrial and commercial enterprises. Between 1981 and 1988, the number of individual-run
enterprises increased seven-fold, from 1.8 million to 14.5 million, and employment increased
nine-fold, from 2.3 million to 23.0 million (ibid.).

As Cao et al. 1999 further documented, rural enterprises (including both TVEs and private

enterprises) have already become a major force of domestic industrial production since 1992 (see Table

2.43b).

Both foreign firms and domestic non-state firms have become the major sources of the
competition. The former are the result of the rapid increase of foreign direct investment
(FDI) to China, and the latter are mostly from rural enterprises which include both
Township-Villaqe Enterprises (TVEs) and private enterprises. Bv the mid-1990s, foreion
firms together with rural enterprises already accounted for more than half of Chinas
industrial output. As a result, competition pressure on SOEs from non-state firms reached a
new le v e L .Beoinninq in 1992. rural enterprises (including both TVEs and private
enterprises) also expanded, becoming a major domestic competitive force. In 1993, rural
enterprises accounted for 45% of coal production, 37% of cement, 59% of paper, 61% of
electric fans, 70% of canned food, and 42% of silk products (China Industrial Development
Report 1996) (ibid. 118-9).

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Table 2.43b: Chinas rural industrial employment and rural share


of national industrial output, 1986-1996

1986 1990 1991 1992 1993 1994 1995 1996

Rural non-farm employment (million) 79.4 92.6 96.1 106.3 123.5 120.2 128.6 135.1

Rural Industrial employment (million) 47.6 55.7 58.1 63.4 72.6 69.6 75.6 78.0

Share of rural industrial output to 0.22 0.25 0.31 0.37 0.45 0.46 0.46 0.47
national industrial output

Source: China Statistical Yearbook, 1997; adapted from Cao et al. 1999, p. 119.

In Qian and Xu, accompanying Chinas hybrid economy is an emerging institutional environment

(helped by China's M-form hierarchy) of competitive horizontal relationships between regions, industries,

local enterprises, and economic sectors. This industrial environment is conducive to market activities. It is an

environment that could not be found in economies under a U-form hierarchy. In many ways this environment

is directly responsible for the rapid market expansion and the booming non-state sector in Chinas transition.

Another important feature, which distinguishes the M-form hierarchy from the U-form
hierarchy, is the horizontal, and potentially competitive, relationship between regions and
between regional governments. The horizontal relationships between regions create a
condition for market-oriented transactions and trade among enterprises outside the scope
of the state planning. It soon generates a competitive market environment. This is how
the market mechanism in China emerged at such a fast pace within the existing
hierarchical system. In contrast, in the U-form hierarchy, transactions between two
enterprises advance mainly through their common superior. The rationale of this rule can
be justified by the specialization of the enterprise. With a high degree of specialization,
rigorous administrative coordination is important for the normal operation of the economy.
Thus the development of the horizontal relationship inside a U-form hierarchy may
severely damage the normal operation of the hierarchy. Without the horizontal
relationship developed, the market mechanism is hard to emerge and evolve (1993a, p.
547; emphasis mine).

In fast-growing areas like Guangdong and Jiangsu, many non-state enterprises hire more
than half of their labor from inland provinces like Sichuan and Hunan. Capital poured into
these areas as well, as shown by the substantial increase in bank deposits in the last few
years [149] (1993b, 153).

In capitalist history, an evolution of horizontal independence has been a prerequisite for rising market

competition and the emergence of market economies. But China with its M-form hierarchy could bring about

such an evolution within its existing structure of institutions during its transition. Chinas M-form hierarchy

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110
offered a great tolerance of horizontal autonomy that provided incentives for the regions, industries,

enterprises, and individual cadres to pursue entrepreneurship and engage in endogenously-incubated market

competition.

In Chinas reforms, entrepreneurship is developed inside the M-form hierarchy. With the
weak bargaining position in the hierarchy, low-rank officials temptation for promotion in the
hierarchy have been reduced. An alternative for their career is doing business. Some
officials quit their jobs to do business, more officials do business on their jobs. Instead of
implementing commands from above, their major job is to use their autonomous power in
earning profits. Entrepreneurship is developed among many local government officials or
Party cadres. There are many valuable human capitals accumulated in the M-fomri hierarchy
which are better utilized when government officials are transformed into entrepreneurs (ibid.
547; emphasis mine).

The success of the agricultural reform itself is helped by the M-form structure. The
household responsibility system was based on experiments initiated by regional
governments (villages, township, county and province) before it was promoted nationwide by
the central government. Strong motivation and initiatives by local governments, tolerance on
the part of the central government, and rapid promotion of this system, are all made possible
by the M-form organization structure (ibid. 156; emphasis mine).

Qian and Xu also pinpointed in the final section of their work (1993b) that Chinas M-form hierarchy

had its overall impacts on other transitional reforming measures and achievements, such as China's open-

door policy, its dual-price system, its success of agriculture reforms, etc. (ibid. 154-6) [150j.

In summary, Qian and Xu's model signals the emergence of a revisionist institutional insight

through a historical comparison of transitions. According to them, Chinas economic hybridization actually

dovetails with a new spectrum of hierarchical alliances, more favorable to coordination and cooperation in

an emerging decentralized and integrated system - federalism," Chinese style. In Qian and Xu' view,

Chinas M-form economy provided a path toward "decentralized market socialism" (1993b, 157). In

retrospect, Nee (1989) also acknowledged that transitions were launched by the planning regimes. But unlike

Qian and Xu, Nee also rejected the idea of transitions with multiple approaches and paths, because he

treated all bureaucracies from the former socialist economies as intact fait accompli with no regard to their

variations and their historical and cultural contexts (17). N ees classification of China's hybrid economy

reflected his thesis of market transition by distinguishing between marketized sectors and non-marketized

ones. In contrast, Qian and Xu were inclined to define sectors according to their regional divisions and

administrative levels (i.e., blocks and branches).

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111

In rejecting Nees approach to rebuilding economic institutions based on a unidimensional market-

hierarchy continuum," Boisot and Child made endogenous comparisons of hierarchical changes of

transacting governance, networked-switch-featured, in reference to Chinas cultural space. Qian and Xu

compared Chinas transition and Eastern Europes transition in terms of their respective organizational

structures. Qian and Xu attributed Chinas momentum to its decentralization reforms under an M-form

hierarchy that greatly boosted the local initiatives and generated a boom of the non-state sector. Qian and Xu

traced Chinas and Eastern Europes different hierarchical forms to the initial conditions of institutions. By

contrast, Boisot and Child attributed the unique forms of Chinas bureaucracy before and after the transition

to the lower regions of China's information matrix. Boisot and Child rephrased Qian and Xus M-form

hierarchy in terms of networked organizations in Chinas cultural space. Both Boisot and Child and Qian

and Xu believe it is important to note the institutional particularities in Chinas contexts, particularly those

existing in China priorto its transition.

Qian and Xu especially credited the utility of Chinas M-form hierarchy in facilitating Chinas gradual

institutional reforms. A successful reform could spread quickly throughout one region, several regions, and

even the entire nation by way of geographically-based duplications in the M-form economy. In the meanwhile,

an unsuccessful reform experiment could swiftly be terminated and disappear, since nobody would want to

adopt the reform, and since the regions and locals had been endowed with their own discretionary authority

to decide what was the best for them in their own circumstances (referred to as vertical non-uniformity" by

Cao, Qian, and Weingast 1999). It thus suggests that through such a decentralization China finds its own

way against bureaucratic inertias and economic inefficiency in general. Later on in 1999, Cao, Qian, and

Weingast named this sort of regionally-based decentralization (favoring local incentives and competition yet

without forfeiting central control) federalism, Chinese style.

While attributing Chinas recent institutional changes to Chinas decentralized reform policies within

an M-form hierarchy, Qian and Xu did not compare Chinas current M-form hierarchy with earlier or later

hierarchies. Thus Qian and Xu essentially accepted the M-form hierarchy as static. They also deliberately

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112
avoided serious talk about the state sector and the reforms of the state institutions and their impacts on

changing the structure of the existing hierarchies (cf. Qian and Xu 1993b, endnote 7, p. 158) [151]. Boisot

and Child differed from Qian and Xu in that they attributed Chinas transition to be a switch from a fie f type

hierarchy to a clan type hierarchy. Another difference between Boisot and Child and Qian and Xu comes

from the fact that while Qian and Xu's examination of a M-form hierarchy looked at the roles of formal

organizations of the state and local governments, Boisot and Childs examination of networked hierarchy

looked at Chinas actual economic governance as well as at informal organizations working in Chinas non

state sectors. Despite the strengths of these two models, neither one seems able to explain how Chinas

institutions and organizations could be endogenously changed through internal reforms and mutations to

spearhead Chinas transition, or to recognize that the internal reforms and mutations were outcomes of social

actions in the transition rather than that were unintentionally chosen. Thus neither model could explain why

China turned to privatize the state sector of the economy as part of its economic transition. The next chapter

will try to address these and similar questions with alternative, more encompassing explanations.

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2.5 A brief comment on institutional models of Chinas transition

This chapter has first of all examined some existing models of post-socialist transitional

economies, most of which concluded that privatization was a major, universal component of all

transitions. Yet that would meet some empirical counters. For example, we found the inconsistencies

between the different transitional economies and their performances. In Chinas case, the impacts of

privatization on its growth seemed paltry in the 1980s, relative to the impacts of collective-owned

enterprises (COEs), consisting of most of the non-state sectors. Only after the 1990s did the association

of privatization with Chinas growth becomes manifest (cf. Cao, Qian, and Weingast 1999). This fact

suggests that China's transition and its success cannot be explained by privatization alone (ibid.).

At this point, I think it may be useful to quote C. Lanes 1995 account of institutionalism.

According to Lane,

... institutionalism accords overriding importance to national distinctiveness in industrial


organization, attributing this to the influence of historically grown, enduring institutional
frameworks which create the lenses through which organizational actors come to view
the world (DiMaggio and Powell 1 991:13). In the process, institutions both constrain and
enable actors, and, in the words of Jepperson (19 91 :1 46 ). *are vehicles for activity within
constraint. The concern of institutionalists to understand how social choices are shaped,
mediated and channeled by institutional arrangements has long informed scholars in all
the social sciences, and a variety of different institutionalist approaches are on offer (p.
10; emphasis mine).

If I paraphrase Lanes statement correctly, he says: 1. Institutions have their own history and are

affected by their history. 2. As institutions are persistent, constrained, and dynamic, they may function as

both conditions and drivers. 3. Dynamics of institutions affect and are affected by the social actors,

including institutional and organizational actors in the sense that institutions and organizations are

human-made, and they are carriers of human history. 4. Institutional sociologists must discover what

motivates these social actors to make their choices and frame their actions, what ulterior motives may lie

behind their choices and actions, and how those different institutional environments and arrangements

can mediate and shape the actors choices and actions.

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Much of the institutional scholarship on Chinas transition has been critical of the neo-classics; and

many of the institutional theses have evolved from critiques of the neo-classics. The institutional scholarship

on China has focused on market, hierarchy, or network institutions, whichever appeared to be galvanizing the

transition most dynamically. Nee looked for ways of rebuilding economic institutions. Eoisot and Childs

looked for networks and their effects on economic order. Qian and Xu probed into different organizational

structures that affected transitions away from the former planned economies. In my own terminology, Nee

uses a market-approach, Boisot and Child use a network-approach, and Qian and Xu use a hierarchy-

approach. Empirically, they all focused their attention on the fastest growth of the non-state sector. According

to Nee, the fatest growth was driven by market mechanisms. According to Boisot and Child, the fastest

growth was driven by changes in Chinas bureaucratic structure, Chinas information matrix, and Chinas

culture-space, since information imbalance played a critical role in Chinas economic transition. In Qian and

Xu, Chinas transition was driven by the non-state sector of the economy, which was local-govemment-

driven; thus local initiatives, facilitated by Chinas decentralization under its M-form economy, were the driving

forces of Chinas economic transition.

But all these efforts could be seen to draw on J. Komeis 1956 assertion about soft-budget

constraints prevailing in most planning economies, placing structural limitations on those systems. From there

it could be argued that any significant transition away from a planned economy would ultimately require a

regulatory switch from the mode of the hyperactive bureaucratic control by the state hierarchy to the mode of

market-approached management guided by free-economic mechanisms for efficient allocation of resources.

In other words, a concern for efficiency would eventually generate the transition (cf. Lin et al. 1996: 75-83)

[152]. But coming in the late 1980s, Komais view of transitions along a unidimensional market-hierarchy

continuum" became problematic and unconvincing when faced with transitional realities. Some scholars may

still insist that market-oriented arrangements are the most fundamental prerequisite for transition. Others are

inclined to think of alternatives that blend both efficiency and legitimacy, or that deal with the boundary

between efficiency and legitimacy, etc. For example, all three aforementioned models treated efficiency as

institutionally built. Boisot and Childs model and Qian and Xus model went even further. In Qian and Xu's

model, institutional dynamics were treated more as arrangements than environments. All three of these

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alternatives further raised questions about the boundaries between markets, hierarchies, and networks and

their interactions, all of which can affect transitions.

These three different models epitomize the alternative choices between market, hierarchy, and

network approaches to the transition away from a planned economy. Nee's model centers on a market-

oriented transition. Boisot and Childs model centers on networked-based economic reforms; and Qian and

Xus model centers on the local-govemment-driven institutional changes under Chinas M-form hierarchy.

In contrast to Boisot and Childs model (which likens networks to their information matrix in

Chinas cultural space in a more flat and flexible structure between two poles - market and hierarchy),

and in contrast to Nee's thesis (around market-hierarchy binary relations and transition mainly driven by

market-induced competition and concern of enhancing efficiency), Qian and Xu further identify efficiency

as institutionally-constructed; its improvement and economic streamlining are made through local

entrepreneurship driven by decentralization reforms under the regionally-specific M-form economy. As

Aoki stated in 1995,

Qian and Xu analyzes how differences in coordination mode between planning regimes
in the U SSR and China may affect the speed, effectiveness, and mode of transition to a
market economy. In the USSR, planning was coordinated through centralized ministerial
hierarchies organized on a functional (industrial) basis, whereas in China coordination
opted to be decentralized on a geographical basis in a locally integrated manner [note:
yet it differs from Hungarian decentralization on the basis of operation units but still under
control of functional departments of specialization, which can thus be regarded as an
incomplete decentralization]. Regional decentralization in Communist China was
deliberately pursued as Mao's strategy to thwart possible disaster that might be inflicted
by external attack. This communist legacy seems to m ake the gradualist transition in
China viable as well as to foster the development o f a more decentralized market
economy (cf. 1 9 9 5 ,1 7 ; bracketed note and emphasis mine).

Another way of comparing these three institutional models is to look at how they have dealt with

developments in China in the 1990s. In the 1990s, Chinas transition was determined more by reforms in

the state sector than in the non-state sector. As Boisot and Child claimed,

One of the most difficult problems facing the current reform of state enterprises away
from the contract responsibility system toward a modem corporate system lies in
determining who has the right to select their boards of directors (1 9 9 6 ,6 2 0 ).

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For a long time property rights were assumed to be a critical variable at the heart of China's

transition. But Boisot and Childs thesis paradoxically suggested that China's marketization upon the

basis of common lands and communal property rights could present a new route different from

privatization. Qian and Xu earlier held a similar view of privatization. But according to them, Chinas

decentralization could be only a transitive step to avoid the heavy costs of radical privatization, given that

privatization was still viewed in the end as vital to an eventual transition. In 1993, Q&X favored such an

organizational perspective that necessitated a separation of economic administration from ownership and

took the economic administration more seriously than ownership. According to Qian and Xu, it is hard to

envisage Chinas current reform on a trajectory differing from the objectives of the existing regime and

giving up its institutional commitment to some kind of socialist end (note: Qians tone later on softened in

his joint article with Cao et al., describing central governments relaxation of the ideological constraints

(ibid. 1999, 120). China's transition has been directed on a path towards decentralized market socialism,

precipitated by Chinas unique hierarchical structure and political legacy. Seen in this light, it can be

argued that hierarchical devolution, institutional coordination and the fitness of its organizational form to

its transitional needs have worked very well and have proven to be more critical than ownership structure

in achieving transitional success (cf. Aoki 1995, p. 17).

For Boisot and Child, the difficulties in Chinas economic governance have added to the

difficulties in determining ownership in China's hybrid economy [153]. Boisot and Child featured Chinas

economic order networked with Chinas cultural space. Yet their managerial perspective made it hard for

them to dismiss N ees view that treated the dynamics of private sectors independently as the primary

solution to the dilemma of economic governance in Chinas transition. To Qian and Xu, Chinas hybrid

economy has derived its unique characters from Chinas initial institutional condition the M-form

hierarchy. For Qian and Xu Chinas primacy lies more in its collective ensemble -- the rural TVEs and the

urban COEs comprising most of the non-state sector. Further administrative relaxation to promote local

initiative, flexibility, and discretion could be crucial to initiate and boost Chinas transition.

While Boisot and Child's arguments remain indeterminate between management and property

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rights, Qian and Xus perspectives seem more certain of the role of hierarchy in building managerial

ability to tackle the dilemmas of ownership in transitions [154J. Yet the recent uptrend in Chinas economy

appears to counter both Boisot and Childs arguments and Qian and Xus earlier perspectives. Chinas

reforms now tend to anchor on overall privatization inclusive of the state sector, as the private sector

demonstrates its unprecedented momentum for the transitional upgrade with the countrys incoming

access to the World Trade Organization [155]. Qian and Xu never intended to explore any further

implications behind Chinas unique decentralization, in spite of their acknowledgment of the state role in

hierarchical reforms and in promoting non-state sectors. For example, Qian and Xu did not pay further

attention to the reforming SOEs, which one can now see brought more dynamics to the transition.

It was not until 1999, did Cao, Qian, and Weingast in their treatise acknowledge that the main tool

for the current project of SOE restructuring was privatization (cf. Cao, Qian, Weigast 1999, 104-5). In

Cao, Qian, Weigasts version (ibid, 103), the decentralization, highlighted by economic denationalization

and deconcentration, eventually boosted local entrepreneurship and propelled local governments to seek

privatization of the state sector through two major processes, i.e.. reforms for hardening budget

constraints and increased competition from the non-state sector, rather than the programs of privatization

from above. Other mentioned factors affecting the incentives of local governments for privatization

included the role of the central government and of SOE managers (ibid. 120) [156], as well as the costs

and benefits of the alternatives, etc. (ibid. pp. 121, 123) [157]. Hence it was the local governments with

their incentives that drove Chinas privatization in a fashion of gradualism. As Cao and Qian et al. stated,

Our argument about privatization combines with the evidence from previous reform
initiatives to suggest a general and consistent pattern of what might be called economic
reform, Chinese style. The Chinese style of reform relies on the 'laboratory of the local
governments to pursue reform (ibid. 123). In many of Chinas major reform efforts,
reform began on an experimental basis in a few local areas. The successes were then
learned and imitated on a moderate scale by a few provinces. If these beta experiments
succeeded, they were recommended and promoted by the central government as a
national policy. This sequential set of experiments creates a series of templates for
reform, adopted first at the local level, then at the national level. In doing so, local
governments adapt one of the templates to their local conditions, sometimes creating
new ones. This explains in part why we observe a great number of varieties of reform
across different regions in China...At any given point in time, this pattern of reform is
characterized by a horizontal non-uniformitv" of reform with some areas doing
experiments and other areas waiting - or resisting - as described above. Furthermore,
over time the reforms expand in scope to include new issues, often being initiated at

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118
different levels of government: Agriculture reform began at the household level: TVEs at
the village and township level: privatization of SOEs at the county level: lay-offs of state
workers at the city level: and marketization at the provincial level. This vertical non-
uniformity" has progressed steadily and has continuously generated substantial pav-offs
over the past two decades. Together, these reforms have led Chinas transition into a
new stage (ibid. 123-4; emphasis mine).

According to Cao. Qian, and Weingast. Chinas M-form decentralization embodies its new

political logic federalism. Chinese style, which warrants Chinas privatization, while favoring risk

aversion, i.e.. to reduce the ex ante resistance to privatization" and to increase the durability of reform

ex p o s f (pp. 111-2) [158]. This has provided political incentives for local governments to promote

economic gain and enhance efficiency through a variety of experiments suitable to their contexts and

circumstances in Chinas M-form economy [159]. The privatization, Chinese style, is characterized by three

features: (i) financing privatization, (ii) corporate governance and 'stock co-operatives, and (iii)

privatization with new investments. In their 1999 analysis of Chinas economic development, Cao, Qian,

and Weingast identified a wide variety of forms of privatization and associated cases (ibid. 110-112).

Under Chinas federalism, local governments have undertaken far-reaching reforms in Chinas taxation

system and financial markets and had lifted the countrys transition to a new stage. As Cao, Qian, and

Weingast stated,

Local governments can be an inducement for efficiency-enhancing privatization and


restructuring when they are under hard budget constraints and facing market competition.
Therefore, privatization, Chinese style, can be better understood in the framework of
federalism, Chinese style (ibid. 123).

In 1995, China began a quiet reform in privatizing and restructuring its SO Es under the
slogan grasping the large and letting go the small" (zhuada fangxiao). This reform has
proceeded in three areas: (i) privatization of small SOEs at the county level; (ii) mass lay
offs of SOE workers at the city level; and (iii) mergers (jianbing),
groupings/conglomerations (jituanhua), corporatizations (gongsihua), and initial public
offerings (IPO ) (shangshi) of some large SOEs which often involve the central
Qovemment. SO E reform has made significant progress in the first two areas. By the end
of 1996, up to 70% of small SO Es had been privatized in pioneering provinces and about
half were privatized in many other provinces. Furthermore, about ten million workers from
SO Es and urban collectives were laid off in 1996 and an additional 11.51 million workers
were laid off in 1997. In these two areas, local governments have been the driving force
underlying reform. Moreover, these reforms have thus far proceeded relatively smoothly
and with fewer social problems than expected. The third area of reform has not yet made
any significant progress, and we will leave it out in this paper [160J (104-5).

Chinas particular federal framework provides two major sources of political incentives for
local governments to undertake the reform. First, recent reforms in tax, fiscal, monetary.
and banking policy have hardened the budget constraints of local governments. The hard

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119
budget constraint means that local governments - and the SOEs under their supervision
- must survive using their own financial resources. In China it is the hard budget
constraint that prompts local governments to privatize. This reform path stands in
contrast to SO E privatization in Eastern Europe and the former Soviet Union where
reformers attempted to use privatization to harden the budoet constraints of enterprises.
Second, increased competition within the state sector and, more importantly, from the
non-state sector raises competitive pressures on SO Es. Because of the fifteen years of
successful reform, the non-state sector in China has already become a major force in the
economy, for example, foreign firms and rural enterprises alone have accounted for more
than one-half of the national industrial output...we argue that harder budget constraints.
together with increased competition, have changed the costs and benefits to local
governments for keeping S O E s... Under hard budget constraints, increasingly poor SO E
performance implies that these enterprises have become increasingly heavy fiscal
burdens for the local government budget. Financing these losses crowds out other
expenditures, thus providing local governments with an incentive to privatize and
restructure SOEs. The recent Fifteenth Congress of the Chinese Communist Party in
September 1997 adopted a national policy to replace state ownership as the dominant
ownership form of firms in the economy and to support privatization. This policy should
be viewed as an endorsement, rationalization, and promotion of what is already going on
in many local areas...With respect to privatization and restructuring of SOEs. local
governments have pushed the central government. This pattern of reform in privatization
parallels many earlier reforms such as the introduction of the agricultural household
responsibility system in the late 1970s. Both the recent privatization and the 1970s
agrarian reform featured a guiet revolution from below. Both were later promoted by the
central government. This was not an accident. The initiatives of local governments and
the tolerance of. and later promotion by. the central government are precisely the
predictable consequences of federalism (ibid. 106-7; emphasis mine).

In 1993, the year their work was published, Qian and Xu could not have drawn such a conclusion

regarding the privatization of the state sector.

This chapter offers an overview of the institutional discourse on transitions and three institutional

models linked to the study of Chinas transition. Each model contains strengths and weaknesses. In

Chapter 3, we shall provide our critique of the weaknesses of these three models. The evaluation will

serve as a transition to Chapter 4 clarifying some assumptions and methodological issues from a

historically institutional perspective, which I shall call a New Institutional Historical Comparison (thereafter

N IH C ). Chapter 5 will analyze some of the intricate contexts and contingencies in Chinas past

experience, the heterogeneous conditions in its present transition, and the dynamic roles of its social and

institutional actors.

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12.0
Endnotes of Chapter 2:

1. Readers may also refer to a contrast between Althusser's structuralist version and Gramsci's revisionist
notion of "historical bloc" with the base/superstructures dialectic (cf. Althusser. 1966. Reading Capital;
Antonio Gramsci. 1927, Prison Notebook 8, note 182; also, Christine Buci-Glucksmann. 1980. Gramsci and
the State. Trans, by David Fembach. London: Lawrence and Wishart. pp. 278-9). The discussion of these
theses may be beyond the current subjects.

2. cf. Friedrih, Carl J. and Zbigniew K. Brzenzinski 1956, Adam Ulam 1963, Schapiro, Leonard 1967,1972;
and David Lane 1976 and Stephen F. Cohen 1980 critiques of the theory of totalitarianism. Here it is
necessary to keep in mind the context of early scholarship on state socialism and transitional economies.

As regards the critics of totalitarianism, for instance, C. Friedrih et al 1956 claim (p. viii) that At present the
Soviet Union still exhibits all the criteria of totalitarian dictatorship, even though the extent of terror may in
some respects have dropped to the level prevalent in national Fascist regimes, which could always count
on a considerable amount of political consensus. The psychic terror exercised by holistic groups can be
more terrifying than the threat of death and torture." Ibid. p. xiii: ...T he manuscript [of this volume] was
completed in Dec. 1955. In view of the events in the Soviet Union surrounding the Twentieth Party
Congress, held in Feb. 1956...the hard core of the analysis has not been changed; developments up to
now do not appear to call for any such revision; as yet no fundamental change seems to have occurred in
the Soviet system. The party continues to play its crucially important and predominant role and, indeed,
the significance of the party as the mainspring of the system has increased. Ibid. pp. 4-5: Totalitarian
dictatorship may, in a preliminary characterization, be called an autocracy based upon modem technology
and mass legitimation...Totalitarian dictatorships of our time are characterized by a vast amount of
'legislation, necessitated by the requirements of a technically industrialized economy and of the masses of
dependent operators involved in such a society. Ibid. p. 17: ...the innovation of the totalitarian regimes, is
the organization and methods developed and employed with the aid of modem technical devices in an effort
to resuscitate such total control in the service of an ideologically motivated movement, dedicated to the total
destruction and reconstruction of a mass society. It seems therefore highly desirable to use the term 'totalism'
to distinguish the much more general phenomenon just sketched...Totalitarian dictatorship then emerges as
a system of rule for realizing totalist intentions under modem political and technical conditions, as a novel
type of autocracy. P. 21: The basic features or traits...to be common to totalitarian dictatorships are six in
number. The 'syndrome, or pattern of interrelated traits, of the totalitarian dictatorship consists of an
ideology, a single party typically led by one man, a terroristic police, a communications monopoly, a weapons
monopoly, and a centrally directed economy." P. 47: In the mature totalitarian society, the role of the party is
a distinctive one, which bears little resemblance to the role of parties in democratic societies. P.51: T h e
party bureaucracy is undoubtedly the hard core of the Soviet system. P. 85: ...the ideology shapes the
behavior of the totalitarian leaders as well as of the mass following. Pp. 88-9: ...a totalitarian ideology would
be one that is concerned with total destruction and total reconstruction, involving typically an ideological
acceptance of violence as the only practicable means for such total destruction...This total change and
reconstruction in its very nature constitutes a 'utopia. Pp. 375-6: What then is going to be the course of
totalitarian development?...it seems most likely that the totalitarian dictatorships will oscillate between an
extreme of totalitarian violence and an opposite extreme of an actual breakdown...[with respect to the future
transformation,] a number of other factors, some of them countervailing in impact, are at work, such as the
personality of the dictator, the success of the regime in mastering its foreign and domestic problems, and
major technological breakthroughs. In this connection, it is argued that the technological needs of an
advancing industrial civilization will play a decisive role. There is the possibility here of an inherent conflict
between industrialization and totalitarian dictatorship, through the rise of a class of managers and
technicians. These, when allied with the military, might wish to abandon the ideology and the party and thus
bring the totalitarian dictatorship to an end. This development is conceivable, but not very likely...[Because]
as part of this general pattern, autocratic organizations have tended to turn to violent aggression as a way of
solving their difficulties. ..ideology plays a greater role in this respect."

For many early Western Marxists (e.g., LukScs, Gramsci, etc.), Marxs inauguration of his challenge against

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capitalism began with his 1844 "Economic Manuscript" that assumed a humanitarian synthesis between
nature and mankind as communism. Namely, while human beings creating society are on their historical
mission to revert it to its essence as "human nature", or "second nature", the nature per se as raw nature will
eventually have been transformed by the society with its social appearance or as humanized environment not
antagonist to human beings. As Marx had spent his entire life working on "Capital", he insisted on his
communist ideal not a utopian truism and tautological hypothesis but starting with its scientific base inherent
in the logic of capitalist economy. These provocative arguments at his age revealed the inhuman nature of
early industrial capitalism and inspired thousands of socialist reformers to realize his utopia at the time. With
the endeavors of the pioneer socialists, Lenin first heralded the arrival of such a nascent social system in the
wake of the "October Revolution", which had effectively transformed the communist ideology into his Soviet
practice. The world subsequently divided into two antipodal camps. One, based on a natural economy in
continuity with the previous civilizations, continued to abide by the market-oriented inexorable laws. Another,
as a social artifact distinct from other erstwhile social forms, was reconstructed through certain social
transformations by working class, peasants, and other social groups, attempting to change the nature of
commercial society upon the basis of natural selection, so that the whole of mankind could move forward to
an imaginary rational society with "human nature" in the future. Stalin's era began to perform such a utopian
ideal, yet through so-called Soviet "industrialization", i.e., a large-scaled and systemic state intervention with
the economy, imbued with orthodox dogmatism. Such an "industrialization," started with an illusion about the
Russian reality or/and false consciousness of collectivization, led to economic inefficiency, prolonged
stagnation, as well as organizational inertia and political crisis that soon provided immediate targets for anti
communist Western scholars in the era of cold war, including the neo-classic mainstream, who had regularly
criticized the Soviets party politics and totalitarianist regime. In such a context Soviet "industrialization" was
typically portrayed as an extreme case, apt to generate systemic distortion of the relationships between
commodity and markets, with unlimited exploitation and excessive control over the natural resources, ruthless
internal eradication of political dissidents, militarization of economic organizations, etc.

3. For a more detailed elaboration, see Stark and Nee 1989, pp. 3-7: Initially developed to analyze the
overthrow of the old order (be it through revolution or in the aftermath of war) and the rapid consolidation
thereafter of new regimes, the theory of totalitarianism gave explanatory primacy to global ideologies,
Leninist parties, and individual leaders. In its classic expression, the totalitarian model portrayed the Leninist
party as bent on establishing total control over Soviet society through mass terror and party-dominated
hierarchies, destroying the boundaries between state and society and eliminating any autonomous social
institutions and processes. Less thoroughly entrenched in the study of Chinese communism, the theory of
totalitarianism had enormous influence in the field of Soviet and East European studies, molding the
orthodoxy in Western scholarship between the late 1940s and early 1960s...Within the totalitarianism
framework, critics charged, the analysis of change in socialist societies was limited to the transition, however
dramatic, from the old order to the new...the analysis of diversity across socialist societies was limited to
national differences in party leaders interpretations of Marxist-Leninist doctrine. Similarly, the analysis of
differences across social systems was confined to the contrast between communism's night and
democracys day, and hence the study of state socialism was unable to benefit from insights produced by
theoretically guided transystemic comparison. The search for an alternative framework began by accepting
as given totalitarianisms account of the Leninist project as directed toward total control by the party-state
over society but then went on to elaborate the unintended consequences of such a project. The typical steps
in such an analysis can be schematized as follows. Having consolidated its position after a revolution, a
ruling Communist party, to remain in power in contemporary historical conditions, must be devoted to
economic growth. Such growth requires industrialization and the introduction of modem technologies, which
in turn require a set of modem values and institutions at odds with the revolutionary enthusiasm, efforts at
top-down mobilization, and attempts at totalizing control that initiated the chain of
consequences...dissatisfaction arising from the limited utility of the totalitarian model in explaining change
and diversity in communist societies stimulated interest in applying new conceptual developments in the
behavioral sciences to the study of communism. Modernization theory, coupled with interest group
pluralism, posited an optimistic framework of evolutionary change that, over the long run, would result in the
inevitable death of the utopian goals espoused by revolutionary Marxism. Processes generic to
modernization would work out their inexorable logic and remake state socialism after the image of the

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advanced industrial societies. The analytic tools for the comparative study of modem communism need not
be taken from the analysis of Hitlers Germany but could be applied directly from the analysis of other
Western democracies because, in fact, the two systems were becoming alike. Whereas totalitarian theory
had viewed capitalism and communism as polar opposites on divergent trajectories, modernization theory
saw existing socialism on an evolutionary course convergent with that of all modem industrialism.

Note: references for interest group pluralism may include G. Skiling 1971: "Interest Groups and
Communist Politics.

4. Ibid. p. 52: ...such a shift is likely to reduce the political power of the agencies of coercion; moreover, it
will tend to reinforce the role 'economic man' and correspondingly to reduce the importance of
Communist ideology in the life of the working masses...once the structural obstacles to economic
development have been removed, economic growth may be expected to proceed most rapidly if further
violent upheavals are avoided and all productive classes can go about their daily business with a sense of
both personal and social security,"

5. Ibid. Lowenthal continued that It seems to reflect the basic dilemma of these new authoritarian
dictatorships, which, in contrast to the totalitarian dictatorships they have succeeded, have found it
necessary to tolerate certain limited elements of pluralism but are still seeking to keep them under tutelary
control.

6. cf. Komai 1989, p. 32: The influence of the Hungarian experience, however, does not stop at the
borders of this small Eastern European country...The leaders of the Chinese economy are studying the
Hungarian situation carefully in an effort to learn from its successes and failures...In the Soviet Union and
in a few smaller Eastern European countries, where a genuine reform has not yet begun, the advocates
of more far-reaching changes refer to Hungary frequently...the Hungarian reform has some global
relevance." But Komai also admitted the limits of Hungarian reforming experiences (ibid. p. 94): The
questions raised above cannot be answered by speculation, only by historical experience. Up to now,
Hungary does not provide a conclusive answer. W e must wait and see what may be revealed by
Hungarian or Yugoslav or Chinese experience or by the history of any other socialist country that may
take the route of reform Also cf. Nina P. Halpem 1985.

Also cf. Nee and Stark 1989, p. 2: ...Largely in response to the perceived dam ages of the Cultural
Revolution and mainly in agriculture, Chinese reforms were initially introduced in highly piecemeal fashion
in 1978. But in 1984, after the establishment of a special reform commission influenced by the Hungarian
experiences, far-reaching reforms were more systematically implemented. Thus in the current situation
some segments of the Chinese leadership are looking to Eastern Europe (and to Hungary in particular)
not for material as object lessons in morality plays, but for the economic lessons that can be learned
about reforming a centrally planned economy. As a result, some of the same economists from Eastern
Europe who were writing pioneering dissertations in the 1950s on new approaches to socialist economics
are now being invited to China to engage in discussions with their counterparts about the prospects and
problems of market reforms in socialist economies...In world-historical terms, when decentralization and
privatization give 10 million Hungarians more economic autonomy, the efforts are path-breaking; but
when reprivatization gives more than 800 million Chinese peasants the right to manage their own
production, the consequences are epochal.

7. cf. J. Komai 1986a, p. 3: ...Hungary is in the forefront of experimentation with new economic methods,
institutions and mechanisms. Hungary as a laboratory of the history of socialism deserves attention from
the outside world, which can perceive as much as filters through the laboratory walls or as much as can
be appreciated on a superficial visit.

Also cf. M . Mesner 1996, p. 292: The reformers took Hungarys three-tiered price system as their model
- on the assumption that Hungary w as the most advanced model of 'm arket socialism, blissfully ignorant
at the time of Hungarys rapidly deteriorating economy."

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8. cf. Nee and Stark 1989, pp. 9-10 (emphasis mine): Based on field research in a number of Hungarian
enterprises...[Komais] study has been described as the first examination of the socialist economy which
'did not explain what the mechanism of the economy under central plan directives ought to be, but how it
did operate in reality, and why it did not ensure the expected development and efficiency of the socialist
economv...The significance of Komais theoretical breakthrough is that he showed how the same
mechanism that produced rapid economic growth in planned economies give rise, in the long run, to an
economy of chronic shortage, hindering further economic growth. In Komais view, the problem of
shortage is the central, unavoidable feature of planned economies. It is rooted in the budgetary
constraints facing the socialist firm, which are 'soft' because the firms survival and growth are not
dependent upon its present or future financial situation..."

9. cf. Nee and Stark 1989, p. 16: Hierarchies and markets. Just as the evolution of hierarchical
organizational forms has been explained as a means to economize on transaction costs under conditions
of market failure in capitalist economies, so the shift from hierarchies to markets should be understood as
a response to organizational failures in socialist economies. Komais soft budget constraint, for example,
can be viewed as an organizational failure generic to centrally planed economies. Organizational failures
in state socialism are rooted in the relationship between the firm and the state, that is, in the allocative
processes of central planning. Public ownership, Komai argues, fosters paternalism on the part of central
planners."

10. According to Cao, Qian, and Weingast (1999, 116): The soft budget constraint is widely seen as one
of the biggest problems for both governments and enterprises in all transition economies. Put simply,
enterprises of governments which are endless bailed out have no incentive to make financial prudent
decision, let alone efficient ones.

11. See Nee and Starks description of the reform history in the former socialist economies, cf. Nee and
Stark 1989, pp. 25-6: The history of market reform in socialist economies has been marked by
decentralization and centralization, expanding markets and restoration of hierarchies, and alternating
periods of reform and counterreform. From the 1960s to the present [up to 1989], reforms in Eastern
Europe have taken a zigzag course of initiatives and retrenchment. Stimulated by the post-Stalinist
climate of greater flexibility and openness to change as well as by anxiety over the loss of dynamism
under central planning (reflected in the downturn in the rate of growth of the Czechoslovak economy in
1963), a wave of reform fever swept through Eastern Europe in the mid-1960s, a wave of reform fever
sweprt through Eastern Europe in the mid-1960s infecting even the most deeply conservative regimes
such as the German Democratic Republic (G D R ) and the Soviet Union. With the exception of Hungary
and Yugoslavia, these reforms proved to be short-lived, and by the 1960s, retreat from reform policies
was in full progress, as central planning bureaucracies reasserted their dominant control over the
economy. Such was the fate of reforms in the G D R , Czechoslovakia, and Bulgaria. Reforms in Poland,
halfhearted at best, were derailed after the 1970 workers rebellion resulted in the overthrow of Gomulka,
though attempts were resumed in 1972-73. By 1975 reform measures were tabled under the pressure of
Polands rapid deteriorating economic conditions. Only Hungary and Yugoslavia retained the basic
features of the reform programs, though the efforts in these countries also fell shorts of reformers
expectations."

12. As Komai explained (ibid. 268; emphasis mine), A classical state-owned firm is in a different
situation. To obtain the approval of its superior organizations and obey their instructions it should produce
without interruption; the problems of obtaining supplies associated with shortage impede this. So the firm
tries to stockpile inputs. In fact, only the supply constraint is effective; if a firm manages to gain access to
the inputs, it can certainly finance the purchase of them, since its soft budget constraint presents no
obstacle. It is not really a response to prices, particularly not on the input side. So the firms demand of
the inputs for current production is not strictly constrained: instead, it is inclined to run a wav. It is hardly
worth asking how much the firm's voluntary constraint on demand would be, since even a smaller quantity
than that would encounter the supply constraint (or the administrative constraint imposed by the authority

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124

rationing the inputs...).- The phenomenon of 'runaway demand appears far more acutely in the
allocation of investment goods, which is the subject of the next section." Komai then added his Footnote
(8) beneath this page: I used the expression 'almost infinite demand for cases like this in my earlier
works. This caused misunderstandings. I hope the expression used above ('inclined to run away) will be
clearer. Also, ibid. 270: [In a capitalist firm,] The conclusion is obvious: demand for investment
resources is constrained. Though it may rise steeply from time to time, there is no continuing runaway.
The situation is sharply different in the case of a classical socialist firm. The self-restraint just described
fails to apply for numerous reasons...Since the budget constraint is soft, decision makers are not afraid
investment may lead to financial failure. Any such fear is even less justified because responsibility is
shared with the superior organizations, which have endorsed the investment project and may even have
forced the firm to implement it. Whatever kind of financial rescue is chosen for an unsuccessful
investment, the bill is ultimately picked up by the state, that is, by everybody - and nobody. There is no
one like the owners of a private firm to be hit in the pocket when a loss is incurred. No one feels a true
inner interest in ensuring caution in the handling of the money, which is the states money - and that is
the root cause behind the lack of voluntary restraint to counter the appetite for investment. Sales
prospects are no problem: whatever is produced, demand will adapt to supply...Again the conclusion is
obvious. There is a constant runaway demand for investment resources from the state-owned sector
under classical socialism...Demand for investment credit exceeds supply. The vertical application and
horizontal demand for plant, construction, and installation is more than the allocating authority has at its
disposal and more than the producers of them have physically available.

13. Ibid. p. 8: W e shall center attention on the producer firm, dealing exclusively with the short-term
behavior of the firm. It is presumed that the firm strives for increasing production, and we shall not
question its motivation, i.e. whether its impetus comes from the command of superior authorities, from its
own voluntary decision (with a view to increased profit), or from bonuses promised to the managers, or
from the urgings of customers, etc. The question is the following: what are the constraints limiting efforts
at increasing production?...Constraints are divided into three large groups: 1. Resource constraints: The
use of real inputs by production activities cannot exceed the volume of available resources. These are
constraints of a physical or technical nature...2. Demand constraints: sale of the product cannot exceed
the buyers demand at given prices. 3. Budget constraints: Financial expenses of the firm cannot exceed
the amount of its initial money stock and of its proceeds from sales...Which of the three constraints is
effective is a defining characteristic of the social system...In the solution of a programming problem,
equality holds for some of the constraints which are given originally in the form of inequalities...The
constraints for which equality holds are effective because they actually delimit the choice. Production
would have been greater had the effective limits not been reached. However inequality holds for other
constraints ( they are not exhausted) in the solution of the programming problem, these are not effective
from the point of view of a momentary solution. It is as if they are not there: they are redundant, exerting
no influence on the choice. It is always the comparatively narrower constraints that are effective, for these
conflict with the endeavor to raise production. Relatively looser constraints are not effective.'

Komai then further distinguished the effective profit making from the effective budget constraints. Ibid. pp.
13-15: ...A budget constraint is hard if it is asserted with iron discipline: the firm can spend only as much
money as it has...The budget constraint is soft, if the above-mentioned principles do not get asserted
consistently. The hardness or softness of the constraint can be started indirectly and through the
observation of two phenomena. First, survival. The budget constraint is hard if grave financial difficulties
drive the firm to bankruptcy...The budget constraint is soft if the state helps the firm out of trouble, There
are various means to do so: subsidies; individual exemption from the payment of taxes or other charges
(their full or partial remission or postponement); allowance on the centrally fixed price of an input; open
increase of the centrally fixed selling price or toleration of a hidden price increase; credit granted on soft
conditions; prolongation of the due credit repayment, etc. The state is a universal insurance company
which compensates the damaged sooner or later for every loss. The paternalistic state guarantees
automatically the survival of the firm. The second phenomenon...with regard to hardness or softness of
the budget constraint is the growth of the firm. The budget constraint is hard if the growth of the firm
depends on its own financial position, i.e., on the one hand, on how much it has been able to save and

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accumulate from its earlier profit, and on the other hand, or whether - under hard 'conservative
conditions - it is ready to take out credit and is able to get credit for investment purposes. This depends
on the prospects of its financial situation and the expected profitability of the investment. If the investment
proves to be a financial failure, it may lead to bankruptcy of the firm. The budget constraint is soft, if the
growth of the firm is not tied to its present and future financial situation. In this case there is no failure: the
firm survives even when investment entails grave losses. W hat I call here the hardness of the budget
constraint is not identical with what is called 'profit incentive of the firm* in disputes about economic
management reforms in socialist countries. Profit incentive - e.g.. profit sharing of managers and workers
- is compatible with a soft budget constraint. In such cases managers of the firm ask superior authorities
for financial support exactly in order that workers (and maybe also the managers) can get their usual
profit share even in the case of losses. Hard budget constraints are effective in the sense we have
explained. They constrain action and the freedom of choice. 'W e can spend only as much money as we
have. 'If we invest badly, we shall die of it. Soft budget constraints are not effective. The financial
situation of the firm does not constrain action. Money has only a passive role. Let it cost what it m ay.
'The main thing is to acouire material and capacity, and money for it will be found in some wav. 'O nce we
have a contractor, we shall not stop the investment just because we have no money. 'If there is a loss,
the state budget will take it over. The preceding stereotypes of common thought in business circles
suggest that the hardness or softness of the budget constraint reflects an attitude. It must not be mistaken
for the book-keeping category of the balance sheet of the firm. The latter is an ex post identity. It is a
relationship which holds all the time: the difference of the terminal and the initial money stock is identical
with the difference of incomes and of expenses. As opposed to this, the budget constraint - if hard and
thereby effective - is an ex ante behavioral regularity, which exerts an influence on the firms decision.
Exactly because it is an ex ante constraint, it is related to the firm managers expectations...beyond a
certain limit, the manager can expect almost with a 100% certainty that the survival of his firm is
guaranteed: it can stand every loss and investment financial failure. If the overwhelming majority of firm
managers have this expectation for the future, it can be said that the budget constraint is soft. In the
'classic' form o f socialist economy the budget constraint is soft. "

14. Komai labels the planned economy of state socialist redistributive mode as "resource-constrained" at the
macro level as opposed to "demand-constrained" in the market economy (cf. 1986a, pp. 9-10). He predicted
with caution that even when a socialist firm is operating in a more decentralized and market like environment,
Hungarian reform under state ownership may continue to reproduce the problems of soft budget constraints.
Komai's rigorous work is thus perceived as a supplement to Polanyi's observation of the "invisible hand" in
market economy in that a socialist economy has its own self-reproducing institutional mechanisms. The crux
to its soft-budget constraints is through state redistribution (cf. Nee and Stark's discussion in their introduction
to the 1989 volume).

15. cf. Nee and Stark 1989, p. 20: ...Alec Noves view that there can be only two alternative forms of
economic coordination in socialist societies, market and bureaucratic...

16. To compare with others of the similar interests, see Lippi 1979 Value and Naturalism in Marx.

17. According to Rubin criticism (1923, published in Moscow; dt. from Nove 1983, 29), values and prices of
production are "not as theories of two types of economies, but the theory of the same economy at two levels
of abstraction."

18. To compare Noves arguments with Komais, see Komais discussion about Galbraithian socialism.
cf. Komai 1989, p. 89 (brackets mine): I call the first school Galbraithian socialism. A dispute...goes on
between them [Galbraithians] and the school of radical re formers...The Galbraithians contend that
radicals advocate an anachronistic system. The radicals, they say, want to introduce a mechanism into a
socialist economy that would recall early nineteenth-century Manchester capitalism: a market free from
any government intervention and the predominance of small economic units. They are socialistic
Friedmanites - so the rebuke goes - although the true nature of contemporary capitalism is quite
different...Contemporary capitalism is a dual economy. The first sector is a small group of huge and very

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powerful corporations, many of them in monopolistic or oligopolistic positions, intertwined with and
sheltered by the government. It operates in an environment created by a large and powerful bureaucracy
that intervenes in the economy continuously through Keynesian demand management, price and wage
regulation, protectionist measures, and so on. The second sector is composed of small producers, small
merchants and the households, whose activities are coordinated by the market. Although both sectors do
exist, the first is the really powerful and dominant one and the second is ancillary and subservient. If that
is true in the case of modem capitalism - so the argument of the Galbraithian school goes - there is no
reason to require more decentralization in socialism. On the contrary: a socialist system has the
possibility and the obligation to apply central planning and coordination more consistently and to establish
more thorough links between the central and the large enterprises. The crucial role of central planning
must not be disguised bashfully, but should be openly and proudly declared, and, of course, much better
organized than before... Galbraithian school is accused in some writings of desiring the restoration of the
prereform command econom y...W hat they do suggest is the legitimation of the status quo. They justify
the dualities of the present system: the coexistence of public and private sectors, bureaucracy and
market, large and small firms, provided that the first component in all these pairs has the undisputed
upper hand...They would legitimate the actual state of affairs, suggesting minor changes for
improvement, but reject any further radical change that would go much beyond the present
situation...The trouble is that the similarity is exaggerated. True, modem capitalism is a system very
different from a perfectly competitive atomistic Walrasian world...Without seeking completeness. I will
underline only a few attributes relevant in the present context." My note here is that Komais
completeness expects a complete structural transformation in these economies.

19. cf. C. Bettelheim 1970 in Paris who underscores that "a product is often the work of all of society and not
only of that laborer or group of laborers who have made it...Their work involves very large amounts of the
work of others, to provide tools, materials and means, which are combined within a highly complex
organization...Most are made by workers who also produce simultaneously a great variety of products, so
that their contribution to each product cannot be precisely determined..." (op. tit. ibid. 30).

To illuminate Nove's arguments, I can think of no better example than todays equity markets, which have
utility in making money beyond the reach of industrial production. Here we can cite Martin W olfs latest
articles introducing the associated puzzles and the new search for solutions as supplements for Noves
early contentions, cf. The price of stocks is still high - No matter what new economy theories suggest,
equities have deviated massively from their underlying value" in Financial Times, p. 15, W ed. Oct. 17,
2001: ...Historical experience is that it is adjustments in prices, not earnings, that bring the market back
towards long-run equilibrium. Here the measurement used is by the valuation ratio, or Tobins Q - the
ratio of the stock markets valuation of corporate net assets to their replacement cost. Ibid: ...Two years
ago, Q was higher even than in 1929. On September 21, argues London-based Smithers & Co, the
market still needed to fall by another 30% to reach its historic average (without overshooting on the
downside). At its peak, the market needed to fall by two-thirds. Similarly, the long-run average p/e ratio is
14, consistent with a real return of 7 %. Today the DataStream measure of the total market p/e is 23,
down from a peak of 33 in April 2000. Unless current earnings are far below long-run averages, the
market is again overvalued on historical m easures... In the full flush of enthusiasm for the 'new economy,
other arguments were m ade for the belief that an apparently grossly overvalued market was cheap.
Among the most important were the propositions - to which, alas, Alan Greenspan gave indirect support
- that exceptional productivity growth or improved returns on capital justified equally exceptional market
valuations. Neither experience nor economic theory supports the proposition that a higher rate of growth
of productivity means a durably higher return on capital. Productivity gains are usually bid away for the
benefit of consumers, workers, and owners of land. Again, at the level of the economy as a whole, the
higher the return on capital, the higher must also be its costs. This is not just a tautology. If growth is
expected to be higher, people feel richer and will want to spend more, including now. As the propensity to
save out of current income falls (and the desire to invest rises), real interest rates - and so the cost of
capital - will also have to rise. The conclusion that the market has been - and still is - hugely expensive
is also distressing for economists. It destroys not just almost any version of the efficient market
hypothesis but also the deeper principle that markets will eliminate any extraordinary opportunity to make

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money. If one accepts that the U S stock market has been three times overvalued, one has to ask why
that opportunity was not seized at once by a tidal wave of short-sellers. As it happens, one distinguished
economist, Robert Hall of Stanford University, has set out to resolve the puzzle. In the process, he has
done the world a great service by showing what needs to be assumed if the reputation of markets is to be
rescued. He has in effect tried to do for markets what 19lh-century physicists tried to do for the Newtonian
view of the universe...He has invented something called e-capital. E-capital is a body of technical and
organization know-how, captured neither in the remuneration of employees nor in physical capital. To
justify the stock market valuations of the 1990s, Prof Hall has had to imagine a huge quantity of this stuff.
Between 1990 and 1999, the stock of e-capital is said to have risen from almost nothing to equal the total
value of all tangible corporate assets. This accumulation of capital was unrecorded. Consequently,
estimates of corporate profits, savings, investment and gross domestic product have, on Prof Halls view,
been fa rto o low. To give orders o f magnitude, in 1999 gross e-capital investment world have been 13 %
of G D P. Prof Hall has also had to assume that neither companies nor government statisticians noticed
this but markets did. And then, most miraculous thing of all, in 2000 and 2001, trillions of dollars of the
stuff vanished...

20. In this matter, we might also add Boisot and Childs 1988 arguments as supportive evidence (518):
"Allocating profit-center responsibilities to workshops is now quite common in Chinese industrial firms and
requires comment. First,, the practice is consistent with the Marxist tenet that since only labor creates
value, workers rather than managers are the source of profit. For this reason, bonus payments to
managers are often below what is received by 'high-performing workers, and in general bonus levels are
not found to vary according to level of responsibility (Child 1988). Second, this labor theory of value merges
with a concern for industrial democracy that aims to make workers 'masters of their enterprise in a
meaningful way.

21. Here I would like to reiterate Nee and Stark's incisive perspective of rising new institutionalism in the
study of state socialism: Over the past decade, 'new institutionalist paradigms have been developed in
every one of the social science disciplines, brought about in political science because internal developments
in public choice theory undermined rational choice models lacking institutional constraints; in economics
because market failures could not be explained with the standard analytic tools; and in sociology because
efficiency models failed to explain economic behavior and patterns of organizational survival in the
institutionalized sectors of the economy. These diverse 'new institutionalisms share a critique of the
limitations of neoclassical economics, an emphasis on the interpenetration of economic organizations and
social institutions, and a commitment to represent complex relationships in formalized modes. These same
traits, rather than an allegiance to any one of the particular neoinstitutionalisms, characterize the recent
institutional analysis in the study of state socialism (Stark and Nee 1989:11-12).

22. See the relevant arguments by Lindblom, Charles 1977 Politics and Markets: The World's Political-
Economic Systems.

23. For instance, both Nee and Stark were dissatisfied with Kremlinologist analyses of inner circles and
party politics that left the cognition of the state-society configuration under the state socialism in a black box.
While concurring with Komais contributions to reveal "soft budget" problems in the economic institutions of
state socialism that may invite inefficient allocation of resources, both N ee and Stark agreed that market
inefficiencies had root causes in institutional constraints set by the state governments. They further raised
the questions of the institutional nature and characteristics of building modem bureaucracies under state
socialism. In their viewpoints, market mechanisms and economic efficiency would not automatically and
spontaneously emerge. Their emergence required rebuilding economic institutions.

Nee contended that it is the growth of competitive markets [in state socialist economies] that generates
organizational dynamics may result in greater reliance on legal-rational procedures and indirect
macroeconomic regulation to economize on transaction costs (ibid. 21). Thereby it may push the
transformation of central planning systems under state socialism. For elaboration, he extends Weber's
analysis of the relationship between competitive markets and bureaucratic rationalization into developing an

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institutional theory of changing state-society boundaries in China, showing that the process to establish the
institutional framework of a mixed economy generates pressures on state socialism for bureaucratic
rationalization. With this logic, he and Whyte consider the expansion of markets in the post-Mao reforms as
accompanied by the reduction of substantive bureaucratic control over social and economic processes and
by the emergence of legal-rational modes of organizational functioning." He emphasizes that as the state
withdraws from direct control over the economy, and as markets expand in scope and generate new
entrepreneurial activity in the private sector, the state must adopt a regulatory role in specifying and enforcing
rules and procedures which define the limits of state power (20-1) and within which economic actors are able
to operate. His study of state policy toward rural entrepreneurs provides a vivid attestation that the reforms
that increase bureaucratic procedures in the internal administration of the state can reduce bureaucratic
intrusion in the everyday life of a society.

24. cf. Nee and Stark 1989, pp. 26-7: A central contradiction of reform efforts in socialist economies
derives from the reform leaderships failure to cut back sharply or dismantle entirely the bureaucracy that
managed the command economy. This is largely because inherent in any reform effort is the fear that the
reform may fail to realize desired results...To minimize the risk of failure, reformers tend to move
gradually in carrying out organizational reforms that are aimed at sharply reducing the size of the
economic bureaucracy.

25. Otherwise, one might try to explain the bureaucratic collapse in the FSU and the FEE because of the
absence of sufficient modem experts, highly trained technocrats, and professional personnel. O r one
might try to explain the collapse because of the absence of benchmarking infrastructure that could
function as supporting system, and because of the lack of institutional leadership in transition. Those
state managers who were mostly ex-state officials, and the reformers, who are preoccupied with dramatic
actions, rushed to demolish entire bureaucratic machines without having considered the bureaucratic
infrastructure needed for delivering the transition. But with insufficient human resources, they could only
bear extensive risks in instituting the new systems. This made it more difficult for new regimes to recruit
fresh bllod from universities and advanced training programs to replace the old bureaucrats of the vested
interests. Furthermore, with such a scarcity of human resource, it is most unlikely to launch and boost
those indispensable R&D programs. Therefore, whatever the explanation for the bureaucratic collapse in
the FSU and the FEE during the transitional period, thesis on reduction in bureaucratic size - in itself -
could not provide the key to make transition from the state socialism.

26. See Boisot and Childs introduction to the debate over privatization in the W est (1996, 614): There is
a major debate in western economics about the relevance of property rights to economic performance.
Economic reform in the different socialist countries since the 1970s has intensified this debate, on which
the Chinese case should offer an important comment. Arguably the seminal text of the modem debate is
that of North and Thomas (1973: 157), who maintained that the key factor explaining the 'rise of the
Western world was the evolution of 'a set of property rights that provided the incentives necessary for
sustained growth; they attributed economic failure, including that of 'much of Latin America, Asia and
Africa in our times, to 'inefficient property rights. A large literature has emerged, arguing on both
theoretical and practical grounds that, with certain exceptions, state ownership of industrial assets is
incompatible with efficient operation. This argument has shaped the policy advice received by developing
countries, often as a condition of further aid from the Bretton Woods organizations (Cook and Kirkpatrick,
1988). Most recently, it has informed the advice given to the reforming communist countries: 'The
hallmark of market capitalism is that private capital has wide autonomy to enter or leave industries by
creating or closing enterprises and it has substantial control over the management of the enterprises it
owns (EBRD 1 99 3:11 3). Chinas rapid growth, and that of a wide spectrum of East Asian countries, calls
these broad judgments into question...

27. Even the US continues to have lots of problems in its private sector, such as its recent private-sector
financial deficit, cf. Americas slowdown has done little to remove the countrys serious economic
imbalances in The Economist, July 14th, 2001: ...If the private sectors balance reverts to its historical
average within three years, Messrs Godley and Izurieta reckon that this would cause a recession this

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129

year, with annual GDP growth in the five years to 2006 of only 1.1% . Even if the private-sector deficit fell
by only half, to 3% of GDP, [American] annual growth would average only 2% over the next five years. To
keep the three sectors in overall balance, higher net private saving must be matched by either a fall in
Americas current-account deficit or a swing in the budget from surplus to deficit.

28. "Whereas for several decades debate centered on finding a harmonious mix of plan and market in the
state sector, today in China and Hungary one is more likely to find economists arguing about the most
advantageous mix of public and private property forms across sectors of the economy" (ibid, 21). Also cf. Cao
et al. 1999, p. 542: Distinguished from Eastern Europe and the USSR, sustained entry and expansion of the
non-state sector in China during the reforms were forceful and fast enough to reach a critical mass by the end
of the 1980s. The non-state sector has in fact become the most important engine of growth in China. The
unexpected, and perhaps unintentional, growth of the non-state sector is critical for the success of Chinas
economic reforms.

29. China's non SOE share of gross industrial output by ownership during 1975-85 had almost doubled (from
19% to 35%). In contrast, its Hungarian counterpart in the same period was much slower with around 20%
changes (from 27% to 35%), as shown in Hungarian SO E share of national income. Note here: we use gross
industrial output share in China and national income share in Hungary, by assuming that the growth pattern
of the industrial structure is very close to that of the GDP or net income in both countries. Hence the
comparison here is only approximate.

30. A high note here is Chinas non-state sector with incremental growth since transition in sharp contrast
with its Hungarys counterpart suddenly looming large since 1991. The growth of Hungarys non-state
sector had essentially stagnated throughout the 1980s.

31. Ibid. See the original table as follows,

Hungary: Share of social sectors


in employment and national income
(Percentage distribution), 1966-84 (Selected Years)

Distribution of active Income-eamers contribution


income earners to national income

1966 1975 1980 1984 1975 1980 1984

1. State sector 65.0 70.9 71.1 6 9.9 73.3 69.8 65.2

2. Nonstate sector

a. Cooperatives 30.7 24.9 25.5 25.9 17.8 19.8 20.6

b. Household
farming . . . . 4 .0 3.2 2.8

c. Auxiliary
production
of employees - - - - 3.0 3.7 5.9

c. Formal
private
sector. 4.3 4.2 3.4 4 .2 1.9 3.5 5.5

32. Note: it is noteworthy that the agricultural sector in both economies has been more dynamic than the

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industrial sector, with more non-state share on it. If Hungarian data were available so that we could draw a
line of the non-state-share in industrial output only, then the line would be flatter than the current national
income line including the agricultural share. In other word, our lines drawn here represent a relatively
conservative observation. China's line (of the only industrial output) would likely appear more dynamic than
Hungarian one.

33. As Qian and Xu 1993 pinpointed (1993b, 137), unlike the case of Eastern Europe and the Soviet
Union, sustained entry and expansion of the non-state sector in China during the reforms were forceful
and fast enough to become an important engine of growth by the end of the 1980s.

34. In China, prior to 1958 rural areas were occupied mostly by small agricultural landholders. After 1958,
private land ownership had been replaced by collective brigades and state-owned communes in rural
areas, and they were subsequently transformed into SOEs and C O Es in urban industries and businesses.
Since the early 1970s, small holder of lands in rural areas were reassigned to the peasants in an effort to
solve the problems of incentive and unemployment. In urban areas, after the cultural revolution, the
central government aggressively adopted many new measures to expand those non-state owned
enterprises and to encourage the spread of those private businesses and enterprises.

35. Nee and Stark 1989, 22: "Once peasants have met the assigned quota production for sale to the state,
they are free to produce for the market place."

36. cf. Nee 1989,17: "The command economy turns to a hybrid economy, which Komai argues operates in a
condition of 'dual dependence in which the economy is coordinated by both vertical bureaucratic and
horizontal market relationships"

37. Ibid.: The transitions from state socialism in China, Russia and Eastern Europe provide natural
experiments involving change in the stratification order on a scale reminiscent of that experienced in the West
during the rise of capitalism. Comparative stratification research builds on modernization theory in assuming
that industrial development, whether socialist or capitalist, leads to convergence (Upset and Zetterberg 1959;
Treiman 1970; Grusky and Hauser 1984; Hauser and Gmsky 1984). Institutional theories, however, are
skeptical about theories of convergence driven by industrialism. If convergence pointed the way to state
socialisms future, the sweeping measures to institute a market economy in industrially developed Eastern
Europe and Russia would not have been necessary. Rather than focusing on the effects of industrial growth,
institutionalists insist that research on state socialism needs also to take into account underlying differences
in institutional forms. Such a focus on alternative institutional forms that provide a deep structure for
economic action underlies my argument that he shift from redistribution to markets gives rise to different
mechanisms of stratification."

38. That is, the failure of state socialism ought to be attributable to the lack of those market institutional
mechanisms functional only in the existing market economies. Such reforms of institutions in terms of
redrawing boundaries could also refer to redefining the conceptions of interests, or reversing the logic of
political economy behind the transition, changing from general interests to particular interests to from
particular interests to general interests."

39. Ib id .: Komais view of the tenacity of the bureaucratic mode of organization echoes W ebers 'iron cage
metaphor in which humanity becomes imprisoned by bureaucratic rationalization. Komai asks :'What caused
this tenacity? What is the explanation for the fact that the growth of bureaucracy is an almost irreversible
process?... In a shortage economy, when markets cannot accomplish the mutual adjustment of supply and
demand, bureaucratic coordination, argues Komai, becomes indispensable."

40. Whereas totalitarian theory targets party politics and ideologies in full charge of the oligarchic rule of the
state socialism, modernization theory accents the primacy of technology and modem values to explain
socialist industrialization and modernity.

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41. Ibid. 3: This set of essays is brought together, however, not simply to reach across the boundaries of
disciplines and area studies or to publish a compendium of related findings, but because the research
and analysis in these papers exemplify an emerging new perspective in the study of state socialism. This
new perspective, whose broad contours will be outlined in this introduction, is developing as an
alternative to the two major traditions - the theory of totalitarianism and modernization theory - that have
dominated the specialized study of socialist societies in the postwar period."

42. cf. Nee 1989,17: "The command economy turns to a hybrid economy, which Komai argues operates in a
condition of 'dual dependence in which the economy is coordinated by both vertical bureaucratic and
horizontal market relationships. The essence of dual dependence, however, is the continued dominance of
hierarchical forms of coordination over the socialist firm and the debilitation of the market mechanism by
persistent and pervasive bureaucratic microinterventions. This is the dilemma of partial reform that despite
giving a greater role to the market, all of the critical decisions - entry, exit, investments, prices and wages,
output, credit - still depend more on processes internal to the planning governance structure than on the
market. As a result, the problems of the soft budget constraint, shortage economy, and investment fever of
the pre-reform socialist firm persist in the post reform economy. Thus this reforming socialist economy
reveals the relative weakness of the market mechanism when confronted with an intact bureaucracy
accustomed to controlling economic action. Whether the actual mechanism of bureaucratic control is direct or
indirect, the effect on the firm is to weaken its responses to the market and perpetuate the conditions of
inefficiency associated with central planning" (emphasis mine).

43. cf. Nee 1992, 19: "Expanding markets, new economic institutions, and a changing structure of property
rights are incrementally transforming the institutional environment, resulting in changes in the comparative
cost of governance."

44. cf. Nee 1992, p. 3: Critical to the neoclassical contract regime in market societies is the maintenance
of legal autonomy based on clearly specified property rights. This provides the basis for litigation when
losses incurred exceed the level specified by excuse doctrine of the neoclassical contract. By contrast,
hybrids in reforming state socialist societies lack a well-specified structure of property rights and,
therefore, effective autonomy (e.g., Stark 1989). For this reason, the socialist hybrids must rely more on
personal ties than on legal contracts to provide assurances that the terms of a transaction will be met by
both parties (Carroll, Goodstein and Gyenes 1988). The need for intense investment in personal
connections (guanxi), stemming from having to cope with widespread uncertainties in the institutional
environment, provides the impetus behind the rise of local corporatism in China.

45. According to Nee, along with market expansion, the new alignment of interests becomes ingrained
into the emerging new structure of institutions, predominated by local corporatism among local
governments, marketized firms, and private enterprises with double-edged nature which could provide
protection for the entrepreneurs against central control, and which could also become an eroding force
against the transition.

46. cf. Nee 1992, pp. 3-4: Local government involvement in rural industry has been interpreted as a
distortion of partial reform that undermines the efficiency goals of economic reform (Wong 1986, 1987,
1990). The claim is that the causes of inefficiency were unwittingly transferred from central ministries
down to local governments, where they were compounded by the antimarket, protectionist conservatism
of local officials and the Maoist legacy of closed local economies. Although I do not disagree with salient
aspects of Wongs analysis. I propose an alternative new-institutional analysis in which the relationship
between local government and industry is viewed in corooratist terms, as an institutional arrangement that
represents a solution to the problem of weak market structures and incomplete market transition. Local
governments assist collective enterprises, which receive little from the state, to secure reliable access to
factor resources they need, especially those in short supply. They also oversee local labor markets and
appoint managers to collective enterprises not leased to private operators, serve as intermediaries in
critical negotiations with banks for access to credit, fix local prices on select numbers of commodities, and
approve and coordinate investment of extrabudgetary funds under their control for projects proposed by

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collective enterprises. Although such microinterventions by local government exert a softening effect on
the firm's budget constraint, local corporatism can enhance the firms competitiveness in domestic and
world markets by offering subsidies, facilitating horizontal and vertical economic integration, providing
access to credit capital, and investing in infrastructure such as schools, roads, public transportation, and
other services. In short, local governments may provide the backing and resources needed by
entrepreneurs to compete effectively in an economy characterized by partial reform, in which the still-
dominant redustributive institutions interact with market forces in a manner that subordinates market
institutions (emphasis mine).

47. As Nee criticized here, the prevailing scholarship would still be preoccupied with economic
conventions for such as those recurring themes of legitimizing privatization and rebuilding market
relations, etc., to account for the successes in China as well as in East Asia.

48. cf. Cao et al. 1999, p.124.

49. cf. Qian and Xu 1993, p.543: The non-state sector in China includes all enterprises not in the state-
sector. In Chinas official statistics, there are three categories of non-state ownership: collective
ownership, 'individual ownership, and 'other types of ownership (mainly private ownership and joint
ventures). The vast growing rural enterprises, which include Township and Village Enterprises (TVEs) are
all in the non-state sector.

50. Also see Boisot and Child 1996, pp. 609-10: W e therefore need to use a framework for analysis
within which the spread of markets and changing structure of property rights in China can be taken into
account. One available framework is that developed by Whitley (1991, 1992, 1994) for comparing
business systems. He argued that business system vary internationally in terms of three main sets of
characteristics: (1) the nature of firms as economic actors, especially their autonomy; (2) the way relations
between firms are structured to form markets, and (3) the logic that governs managerial systems of
coordination and control within the firms. He applied his analysis of these three constituents to 'market
economies in which 'control over economic resources is decentralized to private owners (1994: 155).
While reference to the three constituents can potentially identify differences between Chinese economic
sectors, the way he posited a necessary conjunction of market transactions and capitalist ownership
appears to be less appropriate...The application of Whitelys (1994) criterion characteristics helps to
make these distinctions more specific and in so doing demonstrates the plurality of Chinas present
economic order...."

51. According to Boisot and Child 1996, N ees classification ought to be revised appropriately to fit
Chinas reality (610); that is, These distinctions point to the presence of three main sectors within Chinas
economic order (1) a non-marketized state-owned sector, (2) a marketized non-private sector, and (3) a
(marketized) private sector." The following discussion is therefore based on their revised classification
instead of N ees original classification.

Ibid. 622: Three main sectors have been distinguished within Chinas emerging economic order. These
are the non-marketized state-owned sector, the marketized non-private sector, and the marketized private
sector. They vary in the extent to which their constituent enterprises engage in market transactions and
enjoy autonomy from the state in the exercise of property rights. They share, however, a high level of
engagement in transactional networks based on relational contracting and interfiim alliances that involve
governmental agencies in approving, supporting, and sometimes initiating roles.

52. According to Boisot and Child (ibid.): Nee (1992) has identified three categories of Chinese
enterprise according to the predominant mode through which their transactions are coordinated and the
rights over industrial property they embody. He called the three types the 'non-marketized firm, the
'marketized firm, and the 'private firm. Table 1 builds on N ees classification but also adds certain
refinements."

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53. ibid, 611: 'Their performance [in this sector] is judged more in the light of plan fulfillment than of hard
budget criteria. One-third of state enterprises are overtly loss-making, while another third have so-called
hidden (unpaid) debts; these firms rely on subsidies to keep them afloat."

54. Boisot and Child explained in 1996 how this ambiguity in property rights makes Chinas current
market transition so difficult (620): One of the most difficult problems facing the current reforms of state
enterprises away from the contract responsibility system toward a modem corporate system lies in
determining who has the right to select their boards o f directors. If this is the state as owner, then it is
hard to see how any reform will be affected. If this is not the state, then who else has the right, since there
are no other owners? Collective and private firms avoid this dilemma insofar as tangible social units
constitute their de facto ownership, whereas the ownership of a state-owned enterprise is intangible.

55. ibid: 'This undermines the decentralization of responsibility to enterprises as economic actors since it is
not clear under a non-market system who should bear the responsibility for losses, and under soft budget
constraints it is effectively government that does so."

56. cf. Private sector in China catching up state rivals - 'Socialist market economy scarcely less capitalist
than some in the West by James Kynge in Financial Times, p. 1, Thurs. May 1 1 ,2 0 0 0 (the underlined added
by myself): ...The IFC [i.e., the International Finance Corp, the private sector arm of the World Bank] figures
split Chinese corporations into six categories. They included state, agricultural and collective in the state or
semi-state sector. Shareholding, foreign and domestic private companies were included in the 'pure private
sector. The most statistically elusive of these categories is 'collective. a classification that denotes a mix of
private and state stakeholders. The IFC decided that nearly half of the companies that call themselves
collective should in fact be called private. These firms adopt the name collective to preserve a sense of
closeness to communist authority which can be useful in business. Discrimination against private businesses
is still commonplace. The 'big four1 state banks are generally more reluctant to lend to private companies
than to their traditional state-owned clients."

57. In fact, as Boisot and Child 1996 analyzed, for non-marketized state enterprises, marketized state
enterprises, and collective-owned enterprises, they all share the dual nature of market autonomy and
state-dependency in todays China. The difference is in the degree of their autonomy and the
dependence. This is contrary to Nees observations in these three sectors. Ibid. 610: The marketized
firm, according to Nee, falls outside the bounds of central planning, though it may rely to some extent on
local government to secure access to resources allocated through the plan. He regards the collectively
owned enterprise as the stereotypical marketized firm, and the economic contribution of collective
enterprises has grown considerably under the reform. It is necessary, however, to make some distinctions
that Nee has overlooked, within both the state-owned and collective categories. First, many state
enterprises now engage fully in market transactions and report to local government authorities (see Child
1994, for examples). They are therefore distinguished in Table 1 as 'm arketized state enterprises.
Second, collectively owned enterprise is a very broad category. It includes quite large urban
manufacturing enterprises that may in reality have a rather similar relationship with local government to
that of a marketized-state enterprise and are to that extent state-dependent. Thus the assumed
conjunction between market relations and capitalist (or at least non-state) ownership, made by both Nee
and Whitley and drawn from the Western model, does not necessarily apply to C hin a... In other word,
each section would represent its own form of duality or plurality with the blurring boundary among
different sectors, rather than a clear cut sector in a neo-classical sense of property rights, assumed by
Nee and Whitley, that would be appropriate to analyze Western market economies but not Chinese ones.
Moreover, the markets for those small CEOs located in townships and villages or TVE s might also be
distinct, and not efficient neoclassical markets often seen in the West; rather, they remain for the most
part small, local and hierarchically ordered. They retain formal links with local authorities and may enjoy
some preferences over access to resources such as working capital (ibid.).

58. Ibid. 611:"...this sector bears some resemblance to Whiteys state-dependent type of business system.
Firms in this sector do not enjoy the same degree of formal autonomy as do private firms, although their

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effective freedom of economic action is usually greater because of the support they enjoy from local
institutional intermediaries such as banks.

59. The state interference underscores the state dependence of these Chinese enterprises, or so-called
external dependency" problems by Boisot and Child in 1988. Pp. 518-9: Nothing exemplifies the
organizational interdependence of supervising bureaucracy and industrial enterprise as well as the so-
called 'mother-in-law problem...External dependency has been a common feature of all the enterprises
we have studied, with senior organizational members reporting, matrix-fashion, both to the enterprise
director and to their external supervisors in the municipal bureaucracy. Indeed, the line that separates a
state-owned enterprise from the bureaucracy is perceived to be more hypothetical than real by those
required to span it. As one of our interviewees put it, 'The manager of a state-owned enterprise is
considered to be a government official; the manager of a collective enterprise is not. Ibid. 520-1,
concerning an ambiguous external environment that this marketized non-private sector with duality would
encounter: Recently, however, three-year employment contracts have been introduced for new recruits,
and managers have been given more discretion in the setting of worker bonuses. Thus today more
freedom has been given to enterprise managers in the selection of new workers, even if the labor and
personnel bureaus still define the pool from which the selection is m ad e...T he question is whether this
increment of flexibility at the enterprise level points toward the market orientation that the Chinese
leadership is seeking to promote. The signals are mixed. For one thing, it is not easy to factor out
managerial 'passivity inculcated by years of compliance, a lack of training, and a providential view of the
state, from genuine bureaucratic constraints...Managers of state-owned enterprises, considered by many
in the PRC to be the key 'field workers of the reforms, thus face an ambiguous external environment that
can be read two ways. It can be seen as a competitive threat emanating from the market quadrant of the
culture space: In many product markets managers face deceasing guaranteed quotas, the need to secure
their own inputs, and the need to face up to 'interlopers, small undercapitalized new entrants from the
rural sector or outlying provinces that are beginning to nibble away at their market share; the closer one
gets to consumer goods in the PRC, the more this situation obtains. Alternatively, the environment can be
seen as a protective cocoon beckoning from the fief quadrant of the culture space: In spite of the
economic reforms, the state-owned enterprise remains a highly privileged player in a protected sector.
The preservation of privilege and protection requires that a quasi-feudal relationship with local
bureaucracy be maintained, and the price exacted from the firm for the guanxi (privileged relationship) will
be compliance and contribution.

60. Nee 1992 emphasized that The relationship herein remains feudal, with the protection ensured by
the local bureaucracy, in return for loyalty from the private and collective enterprises under its jurisdiction.
The phenomenal growth of official corruption in recent years bears eloquent testimony to this problem.
The implementation of company and contractual law enacted by the central government is very much at
the discretion of local authorities and often comes down to a matter of individual application.

Nee in 1992 referred COEs to those led by care-entrepreneurs, who, as he compared to those factory
directors in nonmarketized firms (i.e., SOEs; ibid. p. 14), have positive incentives for risk taking and
innovation, though they are more risk-averse than private entrepreneurs, who stand to profit mightily from
successful ventures (and lose greatly from failure). For cadre-entrepreneurs, success in the market place
does not lead to enormous personal wealth, except through illicit means. Like corporate executives in
capitalist corporations, cadre-entrepreneurs strive to advance their careers, to gain higher bonuses, and
to expand their organizational power and influence. Faced with intense market competition and operating
under hardened budget constraints, cadre-entrepreneurs know they cannot avoid taking risks and
innovating without jeopardizing their firms prospects for survival and growth. Cadre-entrepreneurs realize
that the capacity of local governments to underwrite unprofitable and inefficient firms is limited, unlike that
of the central state, a consideration the rash of bankruptcies of collective enterprises during the economic
retrenchment (1988-90) reinforced.

61. See Nees summary of the strengths and weaknesses of Chinas hybrid economy, cf. Nee 1992, p. 6:
The close interorganizational relationship between collective enterprises and local government not only

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is based on the structure of property rights but is reinforced by bilateral dependency. First, in a shortage
economy, collective enterprises, which are at the bottom of the hierarchy of industrial firms, must rely on
connections provided by local government to secure needed resources and credit. Similarly, local
governments became increasingly dependent on revenues from collective enterprises. Second, local
corporatism economizes on transaction costs when the institutional arrangements underpinning markets
are weak. In the absence of contractual law hardened by routine compliance and enforcement, marketizd
enterprises need political allies to go to bat for them in negotiating and enforcing contracts, especially with
dominant state agencies and enterprises. Because a state-owned enterprise or foreign firm might show
little compunction for strong-arm tactics and guile in direct dealings with smaller collective and private
firms, it may be to the advantage of collective enterprise managers to use joint negotiations involving local
authorities to enhance their negotiating position. State enterprises can be very slow in paying smaller
collective firms for subcontracted parts; such debts pose severe problems for local industries in meeting
current salaries and expenses. Another common complaint is the abrupt abrogation of contracts without
compensation for possible losses suffered by subcontractors. Obtaining business contracts with local
government backing may reduce transaction costs for state enterprises and foreign firms as well, by
providing official assurance that the terms set by the contract will be fulfilled in a timely manner. In
addition, a foreign or domestic firm subcontracting the production and assembly of a trademark
commodity will want assurances that the collective firm will not resort to opportunism by selling excess
brand-name products independent of the main firm.

62. See Boisot and Child's 1996 analysis of Chinas TVEs (616): Weitzman and Xu (1993) argued that
TVEs do not have any owners, in the spirit of Western property rights theory. Nominally, TVEs are
collectively owned enterprises, with community members being the owners. These collective owners do
not, however, have shares in a formal sense and are permitted to participate in the T V E on the basis of
their residency, a right that is mandated by the community government. The community government is the
de facto executive owner of the TVEs and is reported normally, to control them. The T V E is therefore not
a private capitalist firm in disguise, and there are legal restrictions to prevent it from converting into one.
So, while TVEs are highly successful non-state enterprises, with a growth rate of total factor productivity
about ten times that of state enterprises and accounting for about 38% of Chinas industrial output by
1991, they do not represent a shift toward capitalism in the western sense. TVEs and other Chinese
enterprises today may behave like Western capitalist firms, and indulge in an increasingly entrepreneurial
pursuit of market opportunities, but this does not necessarily mean that their constitution is of the Western
capitalistic variety.

63. See Nees 1992 revealing observation of the reciprocity of COEs with the state and market, cf. Nee
1992, p. 7: Despite the protectionist tendencies of local governments, the behavior of larger collective
enterprises is oriented toward extralocal trade. Because collective enterprises fall outside the central plan,
which encompasses state-owned enterprises, their growth became increasingly dependent on markets.
Although collective enterprises rely on local government to gain access to resources allocated through
the plan, such resources are limited. For this reason, they must turn to specialized markets to purchase
many factor resources. This often involves importing outside (domestic and foreign) investments and
technologies to sustain economic growth. Similarly, products produced by collective enterprises, aimed
not for local consumption but for extralocal sales, are more readily sold in regional markets than absorbed
by state redistributive agencies. An additional market incentive stems from state agencies fixing purchase
prices at lower than market price for most commodities. Enterprises that could purchase factor resources
at subsidized state prices and sell part of their products at higher market prices developed a keen interest
in arbitrage. Collective enterprises quickly oriented their production to the marketplace and contributed to
the rapid expansion of markets in China.

64. Boisot and Child further explicitly opine that the localized nature of state-dependency for the firms in
this sector is rather conducive to The development of their personal interoganizational connections.
1996, 611. Also, ibid, 612: "local government being a major player as resource provider, facilitator, and tax
collector." Because of this, the local governments want to reward them with indispensable networks and
assistance in gaining access to capital, raw materials, labor, and information. Also cf. Boisot and Child

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1988, p. 520: Indeed, it could be argued that the greatest stimulus for change in state-owned enterprises
today comes only indirectly from the enterprise reforms, in the shape of intensified competition from rural
collectives and individual enterprises. These have been growing at more than twice the pace of the state-
owned enterprises and, being far less controllable by state bureaucracy, have shown a mobility and a
vitality that holds promise for the future. If the volume of transactions in the market quadrant of the culture
space is on the increase in the PRC today, it may not be because existing state-owned enterprises are
changing their transactional style but because small, new, mobile firms are placing their uncommitted
transactions there.

65. Ibid. 6 11 :"... local agencies of the state fill many of the roles that in other business systems are played by
private intermediary institutions. The isolation of firms in this sector from supporting institutions...is therefore
relatively low.

66. Ibid. 614: The localized nature of state dependency for firms in this sector supports the development of
their personal interorganizational connections, which are of greater importance than appears to be the norm
for this type of business system, as described by Whitley."

67. cf. Boisot and Child 1996, 611: 'The characteristics of the Chinese marketized private sector have
several similarities to those Whitleys 'centrifugal' business system, which he illustrates by the example of the
non-mainland Chinese family business."

68. Nee in 1992 gave an analysis of the behaviors of those private entrepreneurs (PE) when he said that
they not only have stronger proclivities for risk taking and innovation, but their profit-maximizing
orientation and hard-budget constraints encourage more exacting cost-benefit calculations in their
investment decisions. Because profits accrue directly to them, entrepreneurial incentives are far greater
than those for cadre-entrepreneurs. They are growth-oriented, to be sure, but less so than either the
cadre-entrepreneur or even the factory director, who operate under softer budget constraints. Private
entrepreneurs face greater uncertainties due to the continuing instability of fundamental rules of the game
involving the market economy (Nee and Young 1990). They therefore are reluctant to make long-term
investments in the growth of their enterprise because, in the absence of adequate legal protection of
private property rights and possible hostility directed against them in a future political campaign, they
worry about possible appropriation of their assets. Instead, they invest to gain rapid returns on their
capital, emphasize liquidity, and spend their profits on conspicuous consumption such as new housing
and imported luxury commodities rather than investing in fixed capital. In this sense, their behavior
resembles more that of middlemen minorities (Bonacich, 1973) than that of modem capitalists
(Schumpeter 1942)" (ibid. p. 14). In my opinion, such an analysis is short-sighted. If those private
entrepreneurs are in a track of fast growth, they would change their investment strategy to the long-term
goal of investment in fixed capital, as some in the high-tech-oriented internet industries and stocks.

In N ees view, however, Cadre-entrepreneurs, by contrast, are more oriented toward growth than are
private entrepreneurs. Though their firms operate under harder budget constraints than the
nonmarketized firm, they are subsidized by local government through tax reduction arrangements, access
to raw materials at below-market prices, and cheap credit. Moreover, as profits do not directly increase
their personal wealth, cadre-entrepreneurs have less incentive, compared with natural owners, to
economize on wages and bonuses. For this reason, the largest portion of extrabudgetary funds goes to
increase salaries and bonuses or into social investments such as employee housing. Thus cadre-
entrepreneurs who manage marketized firms are less discriminating in their investment decisions than
private entrepreneurs and favor rapid growth as a strategy to enhance their power and prestige within the
local elite. Nonetheless, the cadre-entrepreneur is more oriented to profit making than the factory
director. But the fact is since the 1990s, the COEs share in the G D P has relatively declined, whereas the
share of private enterprises has drastically increased.

69. cf. Chinas star rises - The countrys economy is growing strongly again and there are signs that
structural reforms will help to sustain the recovery by James Kynge in Financial Times, p. 16, Tues. July

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25, 2000: ...there is evidence of transformation in the state corporate sector. Mu Suixin, mayor of
Shenyang in the Eastern rustbelt, says the private sector now contributes 48% of local GDP, compared
with less than 20% at the start of 1988. The process is painful and undignified for many of those involved.
But it has allowed the closure of thousands of state factories that are Chinas worst destroyers of capital.

70. The differences between them, as Boisot and Child 1996 discussed (612), The first is that private
companies in China are normally still small-scaled organizations, unlike some centrifugal firms [as Whitley
presumed in 1994]. Thus the diversity of their operations is limited, and they achieve a relatively high-
level of international integration under the close personal control of their owners. T h e second is that,
because the ownership of property in China does not furnish unambiguous legal property rights, such
rights continue to depend importantly on the sanction of local governments and their officials. Even the
private sector in China thus continues to be shaped partly by governmental institutions.

71. cf. Boisot and Child 1996, 614: 'Within this system, economic power is decentralized to firms...partly
because there is a lack of stable institutional procedures (especially laws) governing economic relations. Nor
can firms in this sector expect much support from intermediaries like the Chinese banks which, having
hitherto remained as government agencies, continue to offer loans as much on the basis of political as
economic criteria, favoring state and large collective owned firms."

72. Boisot and Child had similar perspectives (1996, 612) that in China such alternative connections more
rely upon the ties with local government agents, or institutional collusion, than upon the ties with other semi-
autonomous enterprises and other intermediaries, since private property rights haven't fully yet legalized in
China, cf. Boisot and Child 1996, p. 612: "Many private firms in China attempt to compensate for these
disadvantages by seeking close ties with local government, but they cannot take support from that quarter
for granted, they often have to pay a 'management fee to the local authority for assistance in securing
access to resources and political protection, or they have to register as collective enterprises to obtain greater
support. This mode of compensation parallels a characteristic of the centrifulgal business system posited by
Whitley, namely, that in the absence of stable institutional procedures and well developed private
intermediaries, the managers of fines have to use personal connections. A difference is that the key personal
connections in China lie with local government officials rather than with other firms."

73. S ee a report about Internet entrepreneurship as one of the venture-capital projects in the vibrant
private sector, cf. A Dot-Com Revolution in China - Venture capital backs talented young entrepreneurs;
the private sector could become a potent force in a Marxist country by Craig S. Smith in The N ew York
Times, B1, B2 in Business Day, Sat. July 15, 2000: While most private companies in China cannot
raise money easily, a number of Internet companies have attracted foreign investors...hundreds of
millions of American investment dollars have fattened the bank accounts of Chinas young Internet
entrepreneurs over the last year, making dot-com companies the most vibrant part of the countrys
fledgling but still struggling private sector. And despite the high-technology stock slump in the US, as
much as $1bn more in venture capital, most of it from America, is hovering overhead waiting to dive into
Chinas fast-developing Internet industry, venture capitalist say. The torrent of cash into private hands is
without parallel here under Communist Party rule. It also is particularly conspicuous given the enormous
financing difficulties that many budding Chinese entrepreneurs confront in a society that still officially
discourages real capitalism...But if the money keeps coming, the impact could be as big as the breakup
of the countrys Maoist communes 2 0 years ago. A capital-backed private sector may be the economys
best hope for survival as hundreds o f millions of workers spill from sinking state-owned enterprises, and
foreign competitors eagerly await Chinas market opening after it joins the W TO . For the first time since a
fledgling private sector reappeared in the late 1970s, a group of private businesses here are
accumulating capital. 'China is seeing a core entrepreneurship being established that is different from the
old one, which never really grew because it didnt have access to capital, says Dong Tao, an economist
with Credit Suisse First Boston in Hong Kong...But as Chinas old Marxists know, capital is power and if
the countrys young Internet entrepreneurs can hang onto their assets and make them grow, they could
emerge as a potent force shaping the countrys economic - and political - future. So far, the big capital
formation is limited mostly to Internet companies, though China is exploring ways to m ake it easier for a

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business's original investors to cash out when it goes public. Chinas regulators are considering a second
board on the countrys stock exchanges that might allow share sales by companies before they are
profitable, for example. And Chinese start-ups can, in theory, list their shares on a second board already
operating in Hong Kong. Several domestic venture capital funds have even appeared, though they are
mostly government controlled. If that model takes hold, it could fundamentally alter economic life in China,
where, despite 20 years of changes that have made the economy more flexible and market-driven, the
ever-present state still decides how resources are allocated...For now, few of Chinas Internet companies
are seriously considering raising capital at home. Current listing requirements make that impossible and
the approval to go public is a political favor that private companies rarely win. And most of the foreign
investment in Chinas Internet sector remains technically illegal under rules barring foreign ownership of
value-added telecommunications services. In June, Chinas stock market regulators issued a new rule
requiring companies that want to list abroad to first submit to Beijing documents detailing their ownership
structure and showing that the structure adheres to Chinese law ...Yet, with China expecting to join the
W T O later this year, a feeling of invincibility - some say hubris - has permeated the industry. 'T h e same
deference isnt being paid to the ministries and bureaucrats as was paid in the past,...Even if the current
trend does die without transforming Chinas economy, it has taught a group of bright, ambitious young
people the basic tools of capitalism...

74. Ibid. 510-1: In his more recent work, Williamson (1985, 1987) recognized a number of transactional
governance structures that fall between the extremes of pure hierarchy and pure market. These can be
categorized broadly as forms of either periodic or continuous contracting. The transactional relationships
involved are contractually based but also involve a degree of particularism, or limited information
diffusion, to the set of partners in question. Other recent analyses have also identified intermediate
modes of organizing transactions along the hierarchy-market continuum, such as federations (Daems,
1983), networks (Thorelli, 1986), and other forms of coordinated contracting (Child (1987a). These
extensions, however, continue to locate transactions primarily, if not exclusively, in the codified domain.
They focus on variation along the diffusion dimension of Figure 1 as a function of the monopolistic
possession of information, with hierarchically governed processes involving restrictions on the diffusion of
information and the classical market relying on the absence of restrictions on access to relevant
information...To do so would point to the possibility that rationality itself could be bounded by the
idiosyncratic and customary nature of particularistic relationships (fiefs), in which impacted, uncodified
information can promote noneconomic forms of opportunism, or that economic opportunism may be
constrained by clan-like networks such as the Mafia or the Green Gang in Kuomintang China (Seagrave
1 98 5)...Williamsons discussions of 'atmosphere...enters into his joint work with Ouchi (Willaimson and
Ouchi 1981), which recognizes the existence of 'soft contracting in which informal noncodified, trust-
based relationships provide an additional governance support. It remains, however, to be given as central
an analytical place as variance on the information-diffusion dimension.*

75. Ibid. 525: A transactional continuum along the lines suggested by Williamson would lead one to
predict that such a massive disinvestments in bureaucracy [in China's transition] would move the country
toward market governance. In both the commercial and the light industrial sector, modest moves toward
market governance indeed seem to be taking place. The explanation seems to lie both in the greater
remoteness of these sectors from the bureaucracy and in the greater competition from fast-growing rural
industries that between 1982 and 1986 have grown by 266% and are today almost beyond bureaucratic
control. Yet our own hypothesis is that markets in the PRC at present compete with fiefs for the
governance of the uncommitted transaction and that in the urban industrial sector the dynamic of the
reforms is pushing toward fiefs as the dominant transactional mode. Patrimonial values have reasserted
themselves and are once more imposing a well-tested cellular structure on the Chinese industrial
landscape. Our brief examination of the reform process at work in state-owned enterprises has illustrated
this dynamic at the organizational level...Not only does a deeply rooted cultural preference for
personalized hierarchical relations push toward fiefs. The lack of an adequate physical infrastructure that
might integrate markets and hence lower transaction costs also favors localism and small-numbers
bargaining...* (brackets and emphasis mine).

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76. See Samuel Brittans book review of David Simpsons Rethinking Economic Behavior. By that
Simpson expounds the market role in terms of his process economics, in which he contends that
whereas market functions as a mechanism for economic coordination, it makes economic forecasts in
non-linear systems nearly impossible, cf. Brittans What is really wrong with todays economics in
Financial Times, p. 13, Thurs. Dec. 21, 2000: ...A group of dissenters, originally emanating form Austria,
see the role of q market rather differently from the 'neoclassical mainstream. Its aim is not to bring
about an equilibrium or an optimum but to act as a signaling device to enable information scattered
among millions of people to be diffused and to act as an incentive to action...economy is a complex
adaptive system that never approaches a stable equilibrium but is characterized by self-organization and
evolution.

77. As they found (512), China today inherits a distinct cultural legacy characterized by (1) a respect for
hierarchy, (2) a collective orientation, (3) a preference for personal relationships and connections, and (4)
a strong sense of national identity (Lockett 1985; Pye 1985; Domenach 1986; Knutsson 1986; Qian
1986). Behavior is regulated by appeals to the law, and consequently, the move from 'status to 'contract
that Sir Henry Maine (1986) discerned in Europe at the end of the Middle Ages has yet to occur. Cultural
values of this kind imply a preference for face-to-face transactions based on personal trust and mutual
obligation. Ibid.: ...Formal, natural barriers to communication turned the Chinese bureaucracy inward
toward the court, leaving the countryside largely free of direct rule and control by superior authority and
creating a cellular society of low transactional complexity cemented together by loyalty to the emperor
and a simple bureaucracy that was patrimonial rather than rational-legal in character. As Reischauer put
it, 'the government thus was a relatively small, highly centralized body that floated on a sea of isolated
peasant communities' (Rodzinski 1984: 48).

78. As mentioned before, the environments of institutions are identified by the ways in which information is
structured and shared. Each economic order or transacting governance in a certain period could be identified
by the corresponding dominant institution in charge of information structuring and sharing.

79. Ibid. The search was to be less constrained by socialist ideology, which had tended to channel all
transactions, whatever their characteristics, into the bureaucratic mode. Providing that the primacy of
bureaucratic transactions, i.e., planning, was not questioned, peaceful co-existence between alternative
forms could now be envisaged.

80. Iron laws of fief, for example, give rise to the above-mentioned external dependency problem or
the problem of vertical interdependence of supervising bureaucracy and industrial enterprise, i.e.,
mother-in-law problem (ibid. 518-9): The pattern that emerges thus far is one of the hierarchical
exercise of personal power that is characteristic of fiefs.

81. Boisot and Child went on (ibid.): The central role of law in modem societies illustrates the importance of
abstraction to the notion of modernization. The modernization hypothesis assumes that there is a shift from
particularism to universalism and from substantive to procedural rationality. Thus the ability to move toward
higher levels of codification, and to stay there, requires a greater disposition for abstract thought than
Chinese culture has shown up until now. Remove abstraction from efforts at codification and one obtains little
more than ritual and mock bureaucracies (Gouldner 1954), low institutional stability. Sooner or later under
these conditions, transacting gravitates back toward the lower regions of the C-space...

82. Ibid. : It should be borne in mind that codification and diffusion are descriptors rather than
explanators, albeit that their four main configurations are posited here as necessary conditions for the
operation of given transactional modes.

83. The nudging evidences could refer to 1. their comments on the FSU s bureaucracies as the legacies of
old Russian bureaucracies, which predated the advent of Marxism-Leninism, and, as assumed, are more
consistent with Western sensed rational-legal bureaucracies, and 2. their observations on Japanese
counterparts, as assumed, guided by the Western liberal model, and 3. their arguments on those problems

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potential to Chinas transition in lack of impersonal abstract order throughout its history that could come along
with its current decentralization to markets (pp. 604-5), as well as 4. their contention on Chinas transition:
The Chinese authorities themselves experience this law without being able to articulate it or incorporate
it in their policies. They implicitly adopt the unidimensional perspective of the markets and hierarchies
approach - albeit at a macro-economic level - when they explain the economic reforms they have
undertaken since 1978, in institutional terms, as a restructuring of the system from bureaucratic to market
governance... (ibid. 605-6). If their predictions on Chinas institutional reforms were right, then, Chinas
recent updated endeavors, such as on its market capitalization and privatization, would be futile ones. But
as they admitted, all these debatable points could challenge those conventions built on Western notion of
modernization. But as all these instances could stir potential controversies and surface to challenge the
Western academia, it could suggest a need for some new perspectives to account for these historical
precedents and the transitional uptrend.

84. Ibid. 525: If the 'iron law of oligarch loosely describes one form of market failure...then the 'iron laws
of fiefs covers those bureaucratic failures that can be traced to the same causes, namely, the absence of
a transactional infrastructure that can sustain a high degree of codification and hence an adequate level
of formal rationality. Both 'laws are illustrated schematically in Figure 3, and clearly neither is derivable
from Williamsons continuum.

85. Yet to compare with this fief mode, Chinas iron laws of clan might gain more leverage for bargaining for
power and information sharing from Chinas transition through decentralization and a hybrid economy (ibid.
525), albeit Boisot and Child cast no lesser doubts on Chinas hierarchical decentralization than its
bureaucratic failures under the fief mode. Ibid. p. 522: ...the economic reforms in the industrial sector, by
mishandling delegation and decentralization issues have, if anything, reinforced the transactional bias in
favor of fiefs.

86. cf. B&C 1996, 613: Richardson (1972) came close to recognizing the phenomenon of relational
transacting in his discussion of cooperative interfirm relationships, and Williamson (1985) has brought it
into his perspective. While these contributions diverge importantly from neoclassical market analysis, they
still regard relational transacting as falling within the domain of codified transactions at an intermediate
point between hierarchy and market. The Chinese system of networked transactions, however, is
relatively uncodified, and it is based on trust and longstanding personal connections.

87 Ibid. 602: In theoretical terms, the paper extends the markets and hierarchies debate initiated by
Williamson (1975) in a new direction. As it evolved, the markets and hierarchies formulation established a
unidimensional continuum, with market coordination at one end and hierarchical coordination at the other.
Clan or federal forms of governance (Ouchi 1980; Butler 1983) and relational contracting (Williamson
1985) could then be located at notional points along this continuum - not quite markets but not quire
hierarchies either.

88. Such as, a research agenda like this (ibid.): A local focus is justified by the emergence of the non
state sector, to which many state enterprises are becoming increasingly tied through subcontracting and
alliances (Su 1994). It is the sector from which much of the bottom-up momentum of the reform has
derived and within which new business networks are emerging with local government support. Questions
of ownership, financing, trading, and regulation need to be investigated as components of a wider
regional commercial system, and with regard to its historical antecedents, and this comprehensive
perspective can only be practically accomplished on a local basis. Some localities should furnish records
relevant to a reconstruction of the pre-1949 economic system, and it should be possible to question those
influential in establishing the new system as to their design templates and the normative framework that
informed them (cf. Jiang 1992).

89. cf. B&C 1988, p. 522: Since 1949 the pursuit of formal rationality in the PR C was ideologically
confined to the bureaucratic region of the culture space where, at best, it managed to create 'mock
bureaucracies (Gouldner 1954) in Marxist-Leninist garb. The limited degree of formal rationality achieved

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was confined to higher levels...Formal rationality was not always the goal of the leadership...Only
recently has the search broadened to include market forms of governance as well...Substantive
rationality, providing it can be suitably clad, will thus be allowed to keep its seat at the high table. Those
who fram e the problem of modernization as an exclusive choice of governance structure in the
formalized, codified regions of the culture space - bureaucracy for socialists, markets for capitalists - will
balk at the search for transactional modes sui generis that is implicit in current Chinese policies. Also
ibid. 525: At any one time, upward of a million people are traveling across China on trains in search of
raw materials or other scarce inputs for their firms. They lack nationally available information on where
these might be found, and it can take up to several days to effect telephone calls within the country.
Nevertheless, even if information on supplies were available, would-be purchasers could only secure
some after a slow process of relationship building. A written order or a telephone call serves little
purpose, and suppliers are unwilling to formalize their commitments by setting them down on paper. Only
a face-to-face relationship will clinch the deal. Impersonal contracting is out. When contractual
relationships have been made, they are hard to enforce...In the land of fiefs, interpersonal trust is the
lubricant that oils exchange relationships, and trust is not built in a day. It is for this reason that many
state-owned enterprises are allowed to maintain a 'relationship expenses budget and that those selling
scarce consumer goods will allocate up to 10% of their total output to those suppliers with whom they
need to keep on friendly terms.

90. Ibid. p. 522: ...In the culture space, therefore, formal rationality drives markets and hierarchies, and
substantive rationality drives fiefs and clans.

91. Ibid. 624-5: Western capitalism in its mature form has directed its codifying efforts toward increasing
efficiency and managing risk. It has striven toward order and predictability through both the codification of
law outside enterprises and the codification (formalization) of management structures and systems within
them. This is a path that an increasing number of Western writers are now urging corporations to
abandon in favor of modes o f organizing that are more consistent with the concept of networking, such as
subcontracting and temporary alliances (e.g., Kanter 1983; Hastings 1993; Miles and Snow 1994). Peters
(1992) has called this the 'necessary disorganization for the nineties. While this emerging thinking might
be more accurately described as the search for the self-learning and self-reconstituting organization, the
significant point is that networking is increasingly being seen as a necessary way of achieving this end.

92. Perhaps they felt that their limited observations up to 1996 could not provide sufficient evidence
supporting their arguments and assumptions.

93. Ibid. 623: ...China thus demonstrates that a modernizing economic order is able to operate in the
less codified domain of the C-space.

94. Cf. Boisot and Child 1996, 621-2: The Western path to modernization, involving first an increase in
codification toward rational-legal administrative systems (i.e., bureaucracies) and then a decentralization
toward market order, created the institutions of modem 'm arket capitalism. Such a path, at least when
codification has been achieved, is consistent with the unidimensional markets and hierarchies
perspective. The Chinese path to modernization since 1949, by contrast, involved first an abortive move
up the codification scale (state planning), punctuated by wild oscillations toward mass mobilization, and
then, after a reversion into fiefs, a subsequent decentralization, coupling with traditional systems in the
lower reaches of the C-space. In the absence of effective codification, and given traditional Chinese
social organization, such decentralization leads not to markets but to clans and permits the more local
and personalized institutional order, which, following other observers of Asian economic institutions
(Biggart and Hamilton 1992; Geriach ad Lincoln 1992; Berg 1994), we shall label network capitalism.

95.That is, those institutions that are background-minded (i.e., the lower reaches of the C-space,
according to Boisot and Child, ibid, 622).

96. cf. B&C 1996, 623: Redding (1990: 95) has noted how living 'in a collectivist and group-dominated

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society is a cultural tradition for the Chinese. The roots of networking as an institutionalized practice are
ancient and extensively developed in China. The fundamental contrasts in the institutional constitution of
property rights and transactional safeguards between Western (especially Anglo-Saxon) societies and
China also imply that the nature of the social processes sustaining networking in China are also quire
different from those in Western countries.

97. Ibid.: Two broad questions there arise. The first is what kind of economic order is merging in China, an
answer to which is complicated by the countrys size and heterogeneity and by the uneven spread of its
economic reform...The second is how far Chinas emerging economic order can be analyzed in conventional
Western terms. The ability of Western neoclassical economic theory to account for the nature and success of
other Asian business systems has already been put in doubt (e.g., Biggart and Hamilton, 1992).

98. As one investor said, Strong political control and robust economic growth are not mutually exclusive,
as the example of Singapore has shown. cf. Catching the China wave before it gets away by Desmond
M acRea in Financial Times, p. 24, W ed. Aug. 15, 2001: With a sixth of the worlds population and a
gross domestic product of $4,500bn - half that of the US - growing at an annual rate of about 7%, China
may become the worlds biggest economy within 20 years. The countrys administration is doing all of
it...'Transformation to a market economy, which began in 1979, will be completed when China enters the
W T O , he adds...Chinas growth will be led by domestic consumption and non-government investment
aided by the governments expansionary fiscal policy...

99. See a recent report about how Western companies could break through the labyrinth tangled by the
regulatory rules, personal relationships, and pedigree: China's tangled broadband revolution - Foreign
investors trying to break into the worlds biggest cable T V market face a maze of regulation" by James
Kynge in Financial Times, Thurs. Aug. 2, 2001: A riddle inside a puzzle wrapped in an enigma. A puzzle
in a fluid state - foreign businessmen in Beijing are fond of using such phrases to describe the China
market...the lure of the china dream as Beijing prepares to join the W TO exerts a powerful pull...This will
unify fixed-line telecoms, the internet and cable T V so that all can be received down one high-capacity,
broadband line. Such convergence has already created fierce competition in the worlds most advanced
economies. But in China the battle is mirrored by a struggle between rival regulators that are also the
owners of the dominant companies...The rival camps have staked out their turf. The Ministry of
Information Industry, which owns China Telecom, the dominant fixed-line company, has ruled that cable
T V companies are not allowed to offer voice and internet services unless they have an Mil license. The
State Administration of Radio, Film and TV, which at the local level owns a network of cable T V operators
nationwide, has countered by ruling, in effect, that no telecoms company can offer video content unless it
is approved by SA R FT...Faced with SA R FTs brazen forays into its regulatory territory, the Mil has tried
to frustrate cable T V companies development by issuing edicts against their use of offshore investment in
upgrading their networks. M il is also retaliating: in the southern province of Guangdong, corporations
affiliated to the telecoms authority offer cable T V over broadband connections. For foreigners, it is
important to keep out of the M II-SARFT crossfire. To do this, they must devise skilful strategies to enter
the market and, above all, forge a trusting relationship with the right Chinese partner. But this is not easy.
If the foreign company has designs on becoming an operator of basic telecoms, internet and cable TV,
then it must tie up with a telecom company (W TO rules permit foreign equity stakes in telcos) or find ways
to circumvent a ban on direct foreign investment in cable T V operators. Although risky, several
companies have plumped for the second option. Instead of directly investing, the foreign partner leases
equipment, knowhow and content to the Chinese cable company which, in return, hands over a share of
the revenue. One such company is DVN, a listed Hong Kong company that has recently started supplying
technology to cable T V operators in 13 locations throughout China. The alternative is to seek partnerships
with Chinese telecoms companies. This sounds simple, but it is not. There are six actual or would-be
fixed-line telcoms In China, each with a partial broadband network. The favored company so far is China
Netcom, a newcomer considered to be insulated from regulatory risk because it boasts Jiang Mianheng,
the eldest son of president Jiang Zemin, as one of its directors. It has signaled its desire to become a
provider not only of telecom services but also T V by recently buying up broadband cable from local cable
T V companies. Such attributes have attracted News Corp, the international media group led by Rupert

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Murdoch, to invest in a Netcom entity registered in Hong Kong. The Hong Kong registration provided a
convenient way to circumvent a ban on direct foreign investment in mainland telecom companies before
W TO entry. AOL Tim e Warner, the US media and internet company, have chosen a different route.
Through AOL, they have taken a 49% stake in a $200 m Hong Kong internet portal venture with Legend
Holdings, Chinas leading computer maker. The venture is intended to serve as a stalking horse for entry
into the mainland market once post-WTO regulations allow. AOL Time W arner and Viacom are also
seeking to make money from beaming television channels into mainland China from Hong Kong.
Negotiations are proceeding, even through it is technically illegal for foreigners directly to supply T V
content to Chinese companies, executives say. Breaking into a converging - and inconsistently regulated
- Chinese communications market is a complex task. But given that domestic companies - and even
regulators - are breaking the rules and getting away with it, it is difficult not to be sympathetic with foreign
companies that are coming up with creative solutions of their own.

100. Boisot and Child went on: In some forms, government and family work constitute a fieflike
relationship, as with some large enterprises that report directly to a ministry or with business ventures that
have been started by the children of senior party members or by the Peoples Liberation Army. In other
forms, like many township or village collective enterprises, government and community organizations
work together with firms in a more extensive clan-like network. In both instances, there is an evident
contrast with the Western market capitalism model in which government codifies the rules and monitors
adhere to them from outside the transactional arena. The distinction between the inside and the outside
remains itself uncodified and hence subject to arbitrary interpretation by power holders (ibid.).

101. Ibid.: If Peters (1992) is correct in seeing Western capitalism as exhibiting conditions of increasing
impermanence and fickleness, with businesses joining in more and more temporary alliances, then it
clearly is not developing toward the long-term dan-like relationships of Chinese network capitalism.
Rather, Western networking is likely to be characterized by short-term expediency that will increase rather
than cope with uncertainty and in which there may well be an increasing resort to litigation to deal with
disputes arising from broken business marriages. These differences between the emerging Chinese and
Western economic orders point dearly to the influence of the institutional systems in which they are
respedively embedded.

102. ibid, "local government...[is] a major player as resource provider, fadlitator, and tax colledor (see Pye,
1995). These transadional arrangements, 'weak' in Western terms (Granovetter 195), appear to have
considerable latent strengths. Thus the institutionalized use of negotiation between enterprises and local
authorities appears to introduce flexibility into regional property rights and to allow for the reconstitution of
transadions to meet new opportunities and changing drcumstances."

103. In the case of bureaucracies, for instance, Boisot and Child pointed out that ...Transadional
coverage - the ability to subsume a large number of particular cases under a general coding scheme - is
achieved at the expense of transadional nuance and richness. The depersonalization associated with
codified transadions merely refleds the difficulty of maintaining a dense network of interpersonal
obligations as small-numbers transading gives way to large-numbers transading. What Williamson
(1975) termed 'atmosphere is lost as exchange loses its 'embeddedness (Granovetter 1985).

104. Also cf. Qian and Xu 1993a, p. 542: Disinguished from Eastern Europe and the USSR, sustained
entry and expansion of the non-state sed o r in China during the reforms were forceful and fast enough to
reach a critical mass by the end of the 1980s. The non-state s e d o r has in fa d become the most
important engine of growth in China. The unexpeded, and perhaps unintentional, growth of the non-state
sedor is critical for the success of Chinas economic reforms."

105. As Boisot and Child elaborated, one could count on modernization theory. That is, Chinas transition
started from a very low base of industrialization (ibid. 607),

Most of its growth is the result of bringing into play fadors that had hitherto been

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underutilized, rather than of any effort to reorganize them. According to this explanation,
reorganization has a part to play, but it hardly drives the process.

According to Boisot and China, this account could be workable only for Chinas growth in the 1980s, but
not for that in the 1990s. Because by the World Bank new PP P estimation, Chinas G D P per head had
already reached the level of middle income country in the world. As the economic development of a
country attains such a level, according to Western criterion,

...low [institutional] base vanishes, as do the arguments that are used to support. At this
income level, many economies have already acquired the rudiments of a rational-legal
bureaucracy as well as those of efficient market institutions - hence their claim to be
modernizing (ibid. 607).

Another explanation could take the iron laws of fiefs to account for the dilemmas between those state-
owned sectors and non-state-owned sectors and between hierarchy and market. One enigma that Boisot
and Child posed might center on the non-state-owned sector: how to explain how the non-state sector
could boom faster than the state sector; but the market boom did not go through the fonmal bureaucracy
of rational-legal codification that their 1988 framework imposed,

These considerations indicate that the non-state sector in China is not pushing toward
the codified areas of our framework. Rather, it is having once more to fend off, or at least
manage, the personalized impositions of ostensibly formal governmental organization as
it had to in late-imperial times (Mann 1988). Bruuns (1993: chap 5) ethnographical
account of private household businesses in contemporary Chengdu richly illustrates this
phenomenon (ibid. 608).

That is, the social facts in Chinas transition were what they had observed,

W e are thus left with a country representing over a fifth of the worlds population that is
achieving an unprecedented level of economic performance through a relatively
uncodified system of ownership and transacting...In effect, Chinas rapid growth and
development over the last 15 years challenges our concepts of modernization initially as
an institutionalization toward greater codification (cf. Durkheim 193; Tdnnies 1955;
Habermas 1970) followed by a decentralization toward a market order, (ibid.).

In view of the evidence, one must say either that fast growth can happen without modernizing or one
must reconceptualize the process of modernization (ibid.) The first option is certainly not convincing in the
case of China The second option is the only plausible one. Chinas transition has never tried the
Western model; it has always followed its own way,

W e are then left with the need to rethink the concept of modernization itself and to extend
it beyond its Western conception. This opens up the possibility that China is not even
trying to move further up the transactional framework toward a more codified rational-
legal order as a precursor to a less troublesome decentralization - that it is not
attempting to build a Western type of economic order. If Chinas rapid development is
being pursued through its own model of economic and social organization, can more be
said about the distinctive features of this model? W e attempt this, in terms of China's
business system and markets, capitalism, and government within that system (ibid.).

Analysis of the contrast between China and Europe is facilitated by reference to the C-
space (Boisot, 1986, 1987), a conceptual framework that relates the extent to which
transactionally relevant information can be diffused, and hence shared, within a target
population to how far it has been codified. Codification, the selection and compression of
data into stable structures (Shannon 1948), is a matter of degree... (ibid. 602)

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It is very critical, because

An institutional order can be thought of as the center of gravity of a scatter of transactions


in the C-space and a change of institutional order as a shift in the center of gravity...In
reality, all the institutional forms depicted in Figure 1 are likely to find a niche within a
given institutional order, even if one of these forms predominates (ibid.).

106. Because of the presence of Chinas administration in its economic order, its codification of economic
transactions remains not well up to the level of Western bureaucracy; its limited increase remains
incomparable with a rapid increase of its diffusion of economic transactions. Ibid. 623: Despite this
limited reliance on codification, there is an increase in the diffusion of economic transactions within
Chinas economy.

107. According to Boisot and Child, the network can be called a quasi-market because it is not codified,
and it is divergent from Western industrial networks in conception and practice (ibid. 613): T h e Chinese
system of networked transactions, however, is relatively uncodified, and it is based on trust and
longstanding personal connections. It doest not therefore fit with Western analyses, nor is there reason to
suppose that the Chinese system is merely in transition to a Western model; quite the contrary. For
instance, the rapid spread in China today of modem technology for personal communications (such as
mobile phones) is actually reinforcing the system by removing some of the constraints on the diffusion of
personalized transacting previously imposed by low levels of clan-type networks that achieve a measure
of market coverage through relatively uncodified, personal means. It facilitates the extension of economic
fiefs into clan-type networks that achieve a measure of market coverage through relatively uncodified,
personal means.

108. The local operations of such networks for Chinas development are described by Boisot and Child as
follows (ibid.): In the cases known firsthand to the writers, the initial moves in establishing these alliances
were made by the enterprise director approaching persons from his home town in other units who were
acquainted with him personally. Later on, endorsement from the relevant government ministry became
necessary to ensure the support of local government departments and encourage coordination between
them. Once in operation, integration between the constituent units of these alliances appears to depend
heavily on close personal relations among senior managers and, to some extent, the interlocking of roles
between the units.

109. By that the control over the SO Es is internalized mainly through the networks, characteristic of fief
like organizations, whereas the control over the non-SOEs is more reliant upon a wider network of
external organizations, characteristic of clan-like organizations.

110. Namely, their findings on Chinas unique networks could stimulate further research probes into what
types of institutions really affect transitions and how Western conventions on privatization and property
rights play nay role in economic development. How can one address the North and Thomas 1973 Model
(ibid. 614; i.e., which insists that private property rights provided the incentive and economic rationality for
the West, and therefore are the ultimate driver for modem economic development)? And how can one
compare these contexts? Ibid. 614: Arguably the seminal text in the modem debate is that of North and
Thomas (1 9 7 3 :1 5 7 ),who maintained that the key factor explaining the 'rise of the Western world was the
evolution of 'a set of property rights that provided the incentives necessary for sustained growth; they
attributed economic failure, including that of 'much of Latin America, Asia and Africa in our times to
'inefficient property rights. A large literature has emerged, arguing on both theoretical and practical
grounds that, with certain exceptions, state ownership of industrial assets is incompatible with efficient
operation. This argument has shaped the policy advice received by developing countries, often as
condition of further aid from the Bretton Woods organizations...

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111. In this regard, the inquiry we could refer to might be very fundamental and comprehensive such as:
Is the structure moving toward privatization and, if so, how? What is the structures of institutional base?
How likely is it to succeed without going through rational-legalized and formal bureaucracy? What is the
nature of Chinas marketization, and Chinas privatization? How can one refer to capitalism without
referring to privatization? As revealed in Figure 2.12a, so far it has been hard to find strong support for a
close association between re-privatization and transitional performances or efficiency improvement
among the erstwhile planned economies of the post-1989 era. In this respect, Boisot and Child retained
their suspicions of the legitimacy of many institutional forms that emerged during Chinas transition.

112. Ibid. 619: The combination in contemporary China of decentralization from central authorities with
the bottom-up dynamic provided by township and village enterprises leads to a perspective on the role
that government can play in facilitating business networks at the local level that is quite different from
Western experience. Tu (1993: xi) observe that the collusion of state and entrepreneur made for a
peculiar economic strength: The interdependence of economy and polity is such that the state plays a
vitally important role at all levels in removing structural impediments to development and building
necessary infrastructures for manufacturing industry, commerce, and trade. The mixed pattern is certainly
not a socialist planned economy, nor is it a Western capitalist system. The so-called township village
enterprise is a new animal, a species in economic development that has yet to be properly defined.

113. Note: Biggart and Hamilton's 1992 propositions are:

Proposition 1: The markets and hierarchies perspective, when applied to the modernization
process, assumes that policy options are located along a single dimension with the state
(bureaucracies) at one extremity and autonomous firms (markets) at the other. This
perspective assumes, therefore, that decentralization involves a transition from
bureaucracies to markets. A C-space analysis indicates that it is also possible to
decentralize at a lower level of codification than it implied by the markets and hierarchies
perspective. In that case, the move will be from fiefs to clans (my note here: the benefit from
this view is that it may avoid a conventional stereotype that transition to capitalism must
through a revolution in state bureaucracy for privatization, since it may be realized come
through information and network resolution in infrastructure, and other aspects).

Proposition 2: China offers an instance of such decentralization, and in so doing, it is moving


not toward a market order, as it claims, but toward a form of economic organization that can
be labeled network capitalism and that to a large degree appears to be characteristic of East
Asian societies.

Ibid. p. 624.

114. Such as, Whitleys theorem like "control over economic resources is decentralized to private owners,"
ibid, p. 609; also cf. Whitley 1994.

115. cf. Chinas hot economy on pace for 7% growth by Steve Fries Special to USA Today in USA
Today, 13B, Wed. Sept. 12, 2001: ...T he government spent the 1990s pushing a litany of reforms now
starting to take hold, from allowing the urban public to buy property to liberalized rules on how foreign
companies can operate here to privatizing government-owned conglomerates...'In another 10 years, this
will not be a state-owned economy, he [Kim Woodard, chairman of Javelin Investments, a consulting firm
advising mid-size US companies on China] says. 'This normalization is the reason why you see this surge
in foreign investment.

116. Ibid. 115 (emphasis mine): The local government-driven process of privatization and
restructuring...raises important questions: W hat are the economic and political foundations on which this
reform rests? W hat are the incentives of local governments to privatize and restructure the firms under
their supervision? W e argue that federalism, Chinese style - a result of the decentralization of

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government in Chinas earlier reform (Montinola, Qian, and Weingast 1995; Qian and Weingast 1996) -
has provided an adequate foundation and created appropriate incentives for local governments to
undertake this reform. Federalism. Chinese style, is therefore a key to the understanding of economic and
political dynamics underlying privatization in China...W e begin by defining a specific form of federalism
called market-preserving federalism. This type of federalism requires that, first, local governments have
the primary authority and responsibility for their local economies: second, they are subject to hard budget
constraints: and third, they are unable to insulate their economies from outside competition (Weingast,
1995; Qian and Weingast 1996). As compared with the central government, local governments are more
likely to be subject to hard budget constraints (McKinnon 1997). They may also possess less regulatory
power under the mobility of goods and factors.

117. According to Cao, Qian, and Weingast (1 9 99 ,1 05 ), privatization and restructuring of SOEs in China
are new phenomena and are quite different from other transition economies.... Ibid, 123: Our main
thesis is that privatization, Chinese style, rests on an economic and political foundation of federalism,
Chinese style. Local government privatization works reasonably well because these governments are in a
better position to address economic and political issues through localized privatization programs. More
importantly, we also argued that the federal structure provides the local governments with the incentives
to privatize. Hard budget constraints, combined with increased competition from the non-state sector,
yield strong financial pressures for many local governments to address S O E problems.

Ibid. 106: ...federalism, Chinese style (Montinola, Qiann, and Weingast 1995; Qian and Weingast 1996),
has created an adequate economic and political foundation for the earlier reforms in China. In this paper,
we argued that federalism, Chinese style, has also induced what we call privatization, Chinese style.
Ibid. 116: Hardening the budget constraint has been a major object of the reform. In Eastern Europe and
the former Soviet Union, reformers attempted to use privatization as a way to harden budget constraints
of enterprises. In China we observe a different path: the hard budget constraint of local governments
induces privatization of enterprises under their supervision. W e emphasize that both fiscal and financial
reforms between 1994 and 1996 in China have played important roles in hardening the budget
constraints of local governments. These reforms effectively corrected some problems arising from the
decentralization of the 1980s (Qian and Weingast 1996). Yet, the fundamental feature of decentralization
remains: local governments continue to assume primary responsibility for managing the local economies
and have their own revenue sources.

118. cf. Cao et al. 1999, 125: This pattern of reform also demonstrate a fundamental change in the role
of the central government before and after reform in China. Under Mao, the central government forced all
regions in the country to copy the same model, such as Qiliying Peoples Commune of Henan province
during collectivization in the 1950s and D azhai Production Brigade of Shanxi province for agricultural
development in the 1960s and 1970s. This 'one size fits all approach allowed no independent
experimentation, no adaptation, and no local government autonomy of choice. This approach to
institutional change failed miserably. After 1978, reform took place within the framework of federalism,
Chinese style. This system has altered the roles of the central and local governments in fundamental
ways. First, in the various reform episodes after 1978, the central government did not attempt to establish
'the model of reform, let alone force local governments to copy it. Second, local governments have had
the authority to decide on the form and speed of the reform and to adapt reform to local needs. Given
hard budget constraints and an open economy, local governments cannot afford to make big mistakes for
an extended period of time. From the perspective of cross-country comparisons, economic reform,
Chinese style, also differs considerably from economic reform in Eastern Europe and the former Soviet
Union, which is far more centrally driven...we note here that the pattern underlying economic reform,
Chinese style, is not an accident. There is a political logic for it. Again, the initiatives of local governments
and the tolerance of, and later promotion by, the central government are predictable consequences of
federalism. The federal perspective provides important insights to the economic and political dynamics
underlying privatization, as well as other reforms, in China. Indeed, reform in China depends on the
incentives of local governments, large numbers of which seek to promote economic gain and remove
sources of economic inefficiency.

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119. Also cf. Qian and Xu 1993b, p. 135: Recently, there has been a revived interest among economists
in Chinas economic reforms. Since 1979, economic reforms in China have generated a significant growth
across the board: the overall performance of the Chinese economy has been better than its own past
record, better than most developing countries at similar development levels, and also better than Eastern
Europe and the former Soviet Union, both before and after their radical transformations in 1989. It
appears that China had no coherent reform programs, no commitment to private ownership, and no
changes in the political system, and Chinas economy was still not fully liberalized. From both the
theoretical and policy perspectives, Chinas different reform strategies and outstanding reform
performances are particularly interesting and puzzling.

120. Shanghai is now becoming the most successful reforming center in China. This might suggest that
fast growth in some regions cannot be even explained by whether or not these regions were once
strongly controlled by the state government. Rather, the growth is most likely attributable to Chinas
institutional reforms led by the state. Thus we would argue that it has been the states reforms that have
generated Chinas fast growth in transition.

121. cf. 1999b, 136: What is more important, but tends to be neglected, is the economic stagnation in
Eastern Europe and the Soviet Union in the decade of the 1980s before the radical changes. According to
official statistics, the average growth rate of GDP in Hungary was 1.8% between 1981 ad 1985 and almost
zero in 1988 and 1989. In Poland, the average GDP growth rate was less than 2% between 1981 and 1989.
The situation in the Soviet Union was no better. Also cf. 1993a, 542: The Eastern European radical
transition came after deep troubles or failures of many years of gradual reform. If Chinas gradualism is a
success, why has it worked in China but not in Eastern Europe?

122. Also cf. 1993b, 140 (emphasis mine): From 1978 to 1991, the share of the non-state sector in national
non-agriculture employment increased from about 40% to 57%. However, this happened not because of
privatization or conversion of state enterprises to non-state enterprises. It is mainly due to entry and
expansion of new non-state enterprises. In fact, employment by the state sector increased from 75 million
in 1978 to 107 million in 1991. Its share declined because employment in the non-state sector grew even
faster: from 21 million to 44 million in the urban area and from 28 million to 96 million in the rural area
during the same period.

123. Also cf. 1993b, 141 (brackets and emphasis mine): ...the substantial entry and expansion fof the
non-state sectorl occurred not because of an intentional design of a reform program from the central
government: on the contrary, it came largely from local initiatives. The central government's tolerance is
mainly because it solves unemployment problems without much financial support from the state.

124. cf. Qian and Xu 1993b, 138: The U-form referred to the unitary organizational form of the firm along
functional lines in the second half of 1800s and early 1900s, while the M-form referred to the multi
divisional form of the firm organized by product, by technology, or by geography, which emerged since
the 1920s. Compared with departments in the U-form firms, divisions in the multi-divisional firms are more
self-contained and their responsibility for coordination and profit inside the division is high. The regional
governments in our multi-layer-multi-regional structure economy share these features. However, our
concept is not simply an application or an extension of the Chandler-Williamson concept from firms to
economies. There are important differences between the two concepts. In a multi-divisional firm,
decentralization occurs exactly at the level of general office and the divisions, and each division is often
organized by functions. In contrast, in our concept of the M-form economy, decentralization occurs at all
levels of the hierarchy, that is, the M-form is deep. This is critically important..."

125. Also cf. Qian and Xu 1993b, pp. 142-3: The phenomenal entry and expansion of the non-state
sector distinguishes Chinas reform from the Eastern European reforms. Among many reasons which may
explain these phenomena are the institutional differences between the (deep) M-form organization in
China and the U-form organization in Eastern Europe and the Soviet Union, and the subsequent Chinese

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reform policies of further decentralization along regional lines which had a major influence of both the
transition path and performance.n

126. Also cf. Qian and Xu 1993b, 142: In Eastern Europe and the Soviet Union the economies were
organized in the U-form in which hierarchical information flow and control were organized into a unitary
form by functional or specialization principle. Most enterprises were grouped by industry and under the
direct supervision of ministries, and regional governments were primarily subordinates of the centre and
their roles were limited to collecting information from below and implementing plans from above without
much autonomy. In order to utilize fully economies of scale and to avoid conflicting operations, there was
little overlapping of functions among ministries in a U-form hierarchical economy. Enterprises were highly
specialized and their sizes were extremely large. This lead to extraordinary industrial concentration.
Because of the strong interdependence between enterprises across different regions, comprehensive
planning and administrative coordination between ministries at the top level of the government were
crucial for the normal operation of the U-form economy in the absence of the market. To show the
complexity, for example, in the late 1970s there were 62 ministries under the Gosplan in the Soviet
Union.

127. Ibid. (brackets mine): When the M-form economy was further decentralized along regional lines in the
reform and the constraints on local government were gradually removed, the bottom level [of] regional
governments (i.e., townships and villages in the rural areas, and districts and neighborhoods in the urban
areas) gained substantial autonomy in developing their own regions. They established enterprises outside the
state sector and outside the plan...

128. Ibid. 155: During the administrative decentralization in 1958 and 1970, a large number of small non
state enterprises emerged under local governments' support. Because those enterprises were outside the
scope of planning, the market price on top of the planned price had to be tolerated for these enterprises
survival. In the Cultural Revolution, the central planning system was crippled, and input allocations to
many state-owned enterprises were not guaranteed by the plan. Thus, horizontal cooperation (hengxiang
xiezuo) between regions and between enterprises, including semi-legal black markets and barter trading,
started to develop within the state sector.

129. Here Qian and Xu added their endnote (26): 'O ur territory is so vast, our population is so large and
the conditions are so complex that it is far better to have the initiatives come from both the central and the
local authorities than from one source alone. W e must not follow the example of the Soviet Union in
concentrating everything in the hands of the central authorities, shackling the local authorities and
denying them the right to independent action. ' The central authorities want to develop industry, and so
do the local authorities. 'T h e central authorities should take care to give scope to the initiative of
provinces and municipalities, and the latter in their turn should do the same for the prefectures, cities,
districts and townships; in neither case should the lower levels be put in a strait-jacket (Mao 1977) (ibid.
160).

130. cf. Qian and Xu 1993b, 147-8: ...the organizational features of the multi-layer-regional form of
hierarchy in China are (i) organization mainly by territorial principle in addition to functional or
specialization principles; (ii) each region is relatively self-contained and interdependence between regions
is relatively weak; (iii) coordination at all levels is important but at the top it is not particularly critical: (iv)
the size of enterprise generally is small and industries are less concentrated; and (v) the above features
extend to many levels down to the very bottom... One of the differences between M-form economy and M-
form firm is...the M-form economy in China is a multi-layer one, or it is deep. Ibid. 148: ...C hinas multi-
regional form shares several essential properties of multi-division firms: each operating unit (division in a
firm and region in an economy) is self-contained, much of the coordination is delegated to the operating
unit, performance evaluation of each unit is based on comparisons of performance between units.

Also cf. 1993a, 544: ...a multi-layer-multi-regional form, in which each geographic region at each layer can
be regarded as an operating unit. Each unit is further divided along geographic lines and at the same time the

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unit controls its own enterprises along functional lines. Operating units (regional governments) are semi-
autonomous and relatively self-sufficient in terms of functions and supplies in production...The hierarchical
structure of each region at each level is a copy of that of the central government. For example, a county has
about 10-20 townships. The county government controls the enterprises affiliated to the county government
by functional like and specialization principle (e.g., finance bureau, textile industry, etc.), and it also oversees
township governments within its territory. Similarly, a township controls its own enterprises in addition to the
oversight of its villages..."

131. Ibid. 146: Consider, for example the fiscal sharing schemes between the central and provincial
(local) government. There are two categories of revenue incomes in any province: central revenues and
local revenues. Division between the central and local revenues is by source (for example customs duties
are central revenue and turnover takes are local revenue) and by affiliation of enterprises (for example,
profit taxes from centrally-controlled enterprises are central revenue and those from provincially-controlled
enterprises are local revenue). Only local revenue is subject to revenue sharing, and there have been
four major types of sharing schemes (Wong 1992): (A) To remit a lump sum (possibly with an annual
increment) and retain the rest. (This was applied to only two experimental southern provinces,
Guangdong and Fujian, first); (B) To remit a portion which is fixed for four to five years. (This is for the
majority of provinces); (C) To remit a portion which is set annually. (This is applied to the three cash cows
if industrial cities (which have provincial ranks) of Beijing, Shanghai and Tianjin); (D) To receive a fixed
amount of subsidies. (This applied first to four poor provinces in the Northwest, and later to a total of nine
provinces). Starting from 1988, most provinces shifted to schemes (A) and (D), which have the strongest
incentive effects. For example, Shanghai entered into a contract with the central government to remit a
fixed 10.5 billion yuan since 1988.

132. See Section 5.2 in our Chapter 5. Those important measures taken by the state include: a. financial
decentralization: the Central Bank in 1984 created a 2-tier system (i.e., a public establishment of the
division of labor between central and local banking institutions in their respective rights and
responsibilities for revenues and expenditures), with more rights decentralized to the local governments
for financing the new entries of local enterprises (such as TVEs); b. fiscal decentralization: the state
ratified tax reforms that created 4 new indirect taxes, including VAT, the enterprise taxation (enacted in
1984-5), i.e., profit remittance to the state being replaced by partial taxation at negotiated rates of profits
with depreciation, and post-tax profits retained by enterprises (enacted in 1986), through which the
central government enters into "fiscal contract responsibility system" with local governments.

133. cf. 1993a, 542: Although the reasons for the rapid expansion of the non-state sector in China may
be many, we argue that one of the keys in understanding the phenomenal expansion of the non-state
sector in China is the organizational structure of the hierarchy prior to the reforms. Also cf. 1993b, 137:
W e argue that the difference in the initial institutional conditions concerning the organizational structure
of the planning hierarchy plays an important role in the different transition paths of China and Eastern
Europe and the former Soviet Union.

134. 1993a, p. 547: ...the community governments ability to mobilize financial resources are very
limited. The low bargaining power of community governments disables them from bailing out loss making
community enterprises, thus enabling them to commit to terminating troubled enterprises. Therefore, the
budget constraints for non-state enterprises are actually much harder than for the state-owned
enterprises.

135. 1993a, p. 546: At bottom levels, without much investment funds allocated from above, the
community governments turn to set up or support non-state owned enterprises. Both the weak bargaining
power and the semi-autonomous position deeply affect the incentives and behavior of local governments.
With less gains in bargaining within the hierarchy, local government officials pay less attention to
bargaining with the authorities above them. With more chances to earn money in the market, more
attention is given to community enterprises.

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136. cf. 1993b, 137-8 (emphasis mine): O f course, administrative decentralization induces, at the initial
stage, costs of regional conflict, market protection, wasteful duplication, inefficient small scales of
production and increased administrative intervention by local governments. W e do not argue against
these opinions but we would like to focus on a neglected but important aspect of the benefits of a multi-
laver-multi-reaional form of organization, that is. the flexibility of the system for experiments and hence for
institutional changes, and the opportunity provided to facilitate entry and expansion of the non-state
sector outside the plan."

137. Cao and Qian et al. added here that There are no nationwide statistics for the extent of
privatization. As they explained in the footnote, ...figures in various issues of China Statistical Yearbook
do not reflect the true picture, because after privatization enterprises may take many different corporate
forms and they may still be recorded as SO Es in many cases (ibid. 109).

138. cf. 1993b, 137: Under the M-form organization in China, interdependence between regional economies
is not as strong as that of the U-form organization in Eastern Europe and the Soviet Union, because each
region is relatively self-contained." Unlike in Eastern Europe and the Soviet Union, regional governments in
China (be they province, county, or township, village) have had considerable responsibility for coordination
within the region. In particular, a large number of state-owned enterprises, including many in heavy industries,
were subordinated to the regional governments even before the economic reforms. Hence, each region was
relatively self-sufficient, the scale of an enterprise was small and industries were less concentrated. In this
environment, regional experiments can be carried out in a less costly way because the disruptive effect to the
rest of the economy is minimal. A successful experiment in one region also has greater relevancy to other
regions since adjacent regions are similar.

139. 1993b, 149: ...U-form economy is more fragile to external shocks. In contrast, with many duplications
and a weak interdependence between units of the M-form hierarchy, the adverse effects of an external shock
to one or several units on the whole organization will likely spread in a slower and weaker way. That is, the
effects of shocks in an M-form hierarchy can be localized. cf. 1993a, 546: Different forms of organizations
have also different responses to exogenous shocks. When an exogenous shock (say, a supply disruption or
a change of rales) hits one unit of the U-form organization, the trouble of that unit may spread to the whole
organization due to strong complementarities. In contrast, when the operation of one or several units in an M-
form hierarchy is affected by exogenous shocks with a weak interdependence between units of the hierarchy,
the adverse effects will be spread to the whole organization in a slower and weaker way. That is, the effects
of exogenous shocks on an M-form hierarchy may be localized. This is another reason why the M-form
hierarchy is more suited to regional experiments.

140. Ibid.: The effects of region-specific shocks and industry-specific shocks to the U-form and M-form
economies are also different. In the U-form economy, regional shocks affect not only the local economy but
also affect the whole economy through strong regional interdependence. The adverse effects of the collapse
of the CMEA is a good example.

141. Ibid. 156-7: Denationalization is a transformation process which includes successful-non-state


enterprises taking over or merging with state enterprises; state enterprises are converted into joint
ventures with either domestic or foreign non-state enterprises; state enterprises are reorganized into joint-
stock companies etc. In either case, the transformation may include the sale of small-sized state
enterprises or sale of parts of large- and medium-sized state enterprises. In fact, recently takeovers and
mergers by the non-state enterprises have already emerged in China and reorganization to joint-stock
companies has also become a fashion...It is decentralized because non-state properties are not owned
by the central government; it remains socialism because properties are owned by organized communities
like townships or villages (von Mises 1981). W hat is less clear at this point is whether this type of
decentralized socialist ownership is a mere transition phenomenon, or whether it is sustainable for a long
time. In any event decentralized market socialism is clearly a unique outcome of Chinas gradual
transition process.

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142. Ibid. For this reason, Chinas experience cannot, and should not, be simply copied to other
economies in transition.

143. See our Chapter 4 about theoretical assumptions and methodological issues of the variations across
transitions and Chinas background-characteristic transition.

144. Note: This recognition is actually consistent with Cao, Qian et al.s 1999 version on relaxation of the
ideological constraints by Chinese central government and in their treatise about the late privatization of
Chinas SOEs. In this work, they also addressed the political logic behind Chinas decentralization reforms -
federalism, Chinese style.

145. Here is the Qian and Xus original endnote (37): During the 1990 retrenchment, the central
government tried to remove fiscal revenue sharing schemes and to re-centralize investment decisions,
but encountered strong opposition from the governors of provinces led by the Guangdong Governor and
gave it up (ibid. 161).

146. Ibid. 152: The M-form organization is directly responsible for fast entry and expansion of the non-state
sector under the condition that the existing hierarchy is not destroyed in one stroke.

147. Ibid. A municipality is treated as one of the levels of province, prefecture or county, with a majority
being at the level of a prefecture.

148. According to them, M any urban collectives are subsidiaries of state-owned enterprises which
receive some transferred assets from the parent firms and hire their surplus employees or the employees
spouses and children. The advantages of subsidiaries being registered as collectives under the
supervision of lower level government are less government control and more business flexibility. (1993b,
139).

149. Here Qian and Xu added their endnotes (45): It is estimated that there are about 70 million 'floating
migrants' every year in recent years in China looking for temporary jobs (People's Daily, Overseas
Edition, p. 8, March 10, 1993)" and (46): For example, specialized banks in the Zhongshan municipality
of Guangdong province borrowed about 2.1 billion yuan through inter-bank loans from other regions (Qian
and Stiglitz 1993). In 1992, total bank deposits in Hainan province (now a special economic zone) were
20bn yuan, increased by 142.6% over the previous year and most of the increase were deposits from
other provinces (Peoples Daily, Overseas Edition, p. 2, March 3 ,1 9 9 3 ) (Ibid. 161).

150. As for the dual price system, for instance, Qian and Xu elaborated (ibid. 155; emphasis mine) that W e
focus on a different effect of the dual price system. If for some reason the price cannot be liberalized at one
stroke, introducing legalized markets for ajl goods (an important distinction between Chinese reforms and
Eastern European reforms before 1989) has a critical benefit for facilitating entry and expansion of the non
state sector, although it is at the margin and is imperfect. This is because a necessary condition of fast
growth of the non-state sector is the existence of markets for intermediate goods which include capital goods
and materials. Although the state sector faces two prices for one product, the non-state sector faces only one
price, the market price. In a more or less competitive environment with market price signals, the non-state
enterprises are likely to be more efficient than the state sector, which is essential for fast expansion of the
non-state sector.

151. Ib id .: W e deliberately avoid the issue of the state sector. Evaluation of the reform in the state-sector
has been controversial among China experts and Chinese economists.

152. Because as Komai might insist, how could one conceive of these economies on their own
generating and reproducing efficient mechanisms of resource allocation while annulling indispensable
market institutions?

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153. Ibid. p. 621: "It is important always to recall that in China government straddles several hierarchical
levels, and the resolution of the relationship between these levels in economic governance is inherently
problematic".

154. In comparison, we may cite the parallel arguments by M. Meisner in 1996 about TVEs and the
socialist nature of the current institutional reforms in China, which, I think, reveal something hidden
behind Qian and Xus convictions, cf. M. Meisner 1996, p. 518: In recent years, the hope that the existing
system can be reformed in a genuinely socialist fashion has focused on local rural industries and what is said
to be their collectivist, communitarian, and democratic potential. The importance of township and village
enterprises (TVEs) is undeniable. They constitute by far the most dynamic sector of the Chinese economy,
the value of their extraordinarily diverse output having increased at an astonishing annual rate of about 30%
since 1980. The TVEs employ well over 100 million workers and it is this rural industrial sector, not
agriculture, that has been the main source of rural household income growth, especially since 1985. Yet,
however economically successful, there are numerous considerations which counsel skepticism about the
socialist potential of rural industry. While rural enterprises are officially described as part of the collective
sector of the economy, the meaning of 'collective is ambiguous and actual ownership and control of the
TVEs is obscure. While a small number of rural industries are collectively owned and operated by their
workers, and a substantial number are privately owned, the great majority are owned or controlled by local
governments. A considerable number of the latter, however, are contracted or leased to private capitalists,
both foreign and domestic, and have become de facto privatized; others are operated under complex
partnership and share-holding arrangements where ownership and control are particularly ambiguous. But
the great majority of rural industries are owned and managed by local government organs. It is by no means
clear who the real beneficiaries are. There is not yet sufficient evidence to judge if this is a successful form of
'municipal socialism, as characterized by one observer, or another manifestation of bureaucratic capitalism
where the greatest profits go not to the local community but rather to the officials who govern the community.
In either case, rural enterprises operate in a larger market economy and must conform to the rules of the
capitalist market, including the exploitation of wage labor. And it is precisely the commodification of labor-
power, as Ellen Meiksins Wood has forcefully pointed out, that 'places the strictest limits on the 'socialization
of the market and its capacity to assume a human face. While there is considerably less naivete today about
the magic of the market than there was in the early 1980s, there is a strong reluctance among Chinas
remaining socialist intellectuals to acknowledge fully the deleterious social consequences of market
relationships. They would prefer to believe, now that the Dengist regime has gone so far in erecting a
capitalist economy, that it is possible to utilize the economically beneficial aspects of the market without
suffering its destructive social and ecological consequences. It must also be noted that the belief in the
socialist potentialities o f rural industry, even supposing that the TVEs actually have all the collectivist virtues
sometimes attributed to them, assumes the cooperation of a beneficent state...

155. cf. China sells the scenery - Nation lets private companies develop natural wonders; critics foresee
desecration; Jade Peak Gorge aims to set up a panda-research center. 'Foreigners like pandas, an
official says by Peter Wonacott, staff reporter in Jade Peak Gorge, China for the Wall Street Journal in
Wall Street Journal, B 1, B3, W ed. May 23, 2001 (myself add the underlined): A long and winding trail
here in Chinas first privately operated nature reserve leads from the top of a 110-foot rock face to a
crashing waterfall below, but few visitors use it. Instead, they head for an elevator that takes them to the
waterfall and back - and the parks operator, Ten Million Cash Holdings, rakes in $2.40 per passenger for
each round trip. Ten Million Cash, realizing that people generally prefer convenience to leg cramps - and
will pay for it - is nothing if not s a w y about the business of tourism. That acumen, drawing hundreds of
daily visitors to this area of evergreen forests and mountain rivulets, has prompted the Sichuan Tourism
Bureau to back a proposal to hand over another 10 parks to private developers; if that works out, an
additional hundred scenic sites could follow. All over China people are watching Sichuans lead. Already,
foreign and Chinese companies are exploring investments at some of the countrys landmark reserves,
one of which, Sichuans Jiuzhaigou Valley, has been designated a World Heritage Site by the United
Nations Educational, Scientific and Cultural Organization. The moves highlight how fast and far the
privatization ethos in China has spread - and also its costs. In fact, Chinese leaders attempt to fuel
growth in the nations most impoverished western areas has sparked a roiling debate over how the nation

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manages its national parks and scenic treasures...Selling development rights to parks represents a
logical step in a nation rapidly - and sometimes chaotically - shifting assets into private hands. Backers
of the Sichuan plan believe private businesses can better develop tourism. And by screening developers
and limiting their numbers, the government hopes to contain commercial sprawl. Critics, however, worry
that hundreds of scenic spots will be sacrificed and China's natural and cultural heritage will be
trampled...'You cant boost tourism and have absolutely no impact on the environment,' says Wang
Xiaogang, a researcher who advised the Sichuan government on the park plan. 'But if the rural economy
doesnt grow, people dont eat....The commercialization of Jade Peak Gorge has its roots in well-
intentioned policy. Beginning three years ago, local residents saw their income from lumber sales - the
main source of livelihood, for 80% of the local population - shrivel in the wake of a nationwide ban on
logging. The ban halted widespread deforestation, which had exacerbated summer floods. But it also
made a poor area poorer...Economically, Jade Peak Gorge is an unqualified success. Last year, after its
first full year of operation, Ten Million Cash had an after-tax profit of $3million. During this years week-
long May Day holiday, the reserve reported 138,000 visitors, up 30% from last year.

156. Ibid. (emphasis mine): 4.3.1 Relaxation of the ideological constraints: role of central government.
The process of privatization and restructuring in China has been mainly driven by local government. This
does not mean that the hand of the central government is absent. After all, the central government retains
ultimate ownership rights to all SO E assets (Qian 19961: changes in SO E property rights therefore reguire
the central governments (sometimes tacit) endorsement. The willingness of the central government to do
so is driven by the local governments. To a lame extent, the central governments ideological constraint
has become relaxed because of the local incentives. This is evident from the recent endorsement of
privatization by the Fifteenth Party Congress, which is a result of the widespread practice which has taken
place at the local level for several years. Relaxation of the ideological constraint in turn encourages local
governments to push privatization even further because it reduces the costs of privatization due to
political risks.

4.3.2 Inside control of SOEs: the role of SOE managers. The SOE reform of the 1980s, attempting to
expand enterprise autonomy under the 'contract responsibility system, produced an important legacy for
the 1990s. It created a tendency toward what is known as 'inside control. That is, enterprise managers
(often colluding with workers) used their effective control over the assets of SOEs to benefit themselves
at the expense of the state (Qian 1996). In the extreme form, managers steal money and assets from
enterprises. Indeed, the so-called 'state asset stripping problem has increased at an alarming rate in the
past few years (Qian 1996). W e observe that increased inside control of SO Es reduced profitability of
SOEs even without increasing their inefficiency. This source of losses consequently reduces the benefits
for local governments to maintain these SOEs. The local governments know that these SOEs are likely to
become profitable if managers are converted to owners and their incentives are subsequently changed.
This makes privatization more attractive to local governments. A related possibility is that managers of
SOEs bribe the local governments to support privatization. The increased agency problem of managers
alone may not be sufficient to provide the local government with enough incentives for privatization for
two reasons. First, although the aoencv problem reduces the profitability of SOEs. without competition.
the government can still eniov considerable monopoly rents, as in many monopoly SOEs under the
supervision of the central government. Second, without a hard budget constraint, governments may still
have little incentive to private loss-making firms.

157. Ibid. 123: In summary, local governments incentives for privatization and restructuring depend on
the costs and benefits of the alternatives. Local governments can be an inducement for efficiency-
enhancing privatization and restructuring when they are under hard budget constraints and facing market
competition."

158. Ibid. 125 (emphasis mine): Part of the reason we project that the central government will eventually
privatize some the largest SOEs is that it too faces the same financial incentives as local governments:
Once the central government gives up its monopoly in the key industries, maintaining inefficient
enterprises is too expensive. And once local governments have shown the way - especially shown that

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workers do not become destitute - there will be far less political resistance. O f course, the central
governments task is made easier in China than Eastern Europe and the former Soviet Union because
there are so many fewer large SOEs. Nonetheless, if this project pattern holds. SOE reform will provide a
strong case in favor of our thesis that federalism. Chinese style, underlies the process of economic reform
in China.

159. Ibid. 125: From the perspective of cross-country comparisons, economic reform, Chiese style, also
differs considerably from economic reform in Eastern Europe and the former Soviet Union, which is far
more centrally driven. A more detailed comparison from this perspective awaits further research (see
Qian and Xu 1993). But we note here that the pattern underlying economic reform, Chinese style, is not
an accident. There is a political logic for it. Again, the initiatives of local governments and the tolerance of,
and later promotion by, the central government are predictable consequences of federalism. The federal
perspective provides important insights to the economic and political dynamics underlying privatization,
as well as other reforms, in China. Indeed, reform in China depends on the incentives of local
governments large numbers of which seek to promote economic gain and remove sources of economic
inefficiency.

160. Cao and Qian et al. added their endnote here that The third area of reform contains more difficult
economic and political problems facing the central government, Some of the reform practices (such as
merger and conglomeration) may not even be in the right direction (World Bank, 1997)" (ibid. 105). But
the current data show this trend along with Chinas soon impending access to the W TO.

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Chapter 3

Criticisms of the Three Institutional Models of Chinas Transition

his Chapter will give our evaluation and some of our criticisms of the three models of Chinas

economic transition presented in Chapter 2. In Chapter 4 I will propose an alternative model of

Chinas economic transition.

3.1 A brief review of the three institutional models

3.11 Sum m ary o f the three institutional m odels

Table 3.11a summarizes the main features of the three models presented in Chapter 2:

Table 3.11a: Sum m ary o f th e th ree m odels o f C h in a s transition

Nee: 1 9 8 9 ,1 9 9 2 B&C: 1996 Q&X: 1993

Perceived m acronn- Market-oriented Network-linked Hierarchy-induced


stitutional dynamics

Theses on Chinas
Institutions
in Transition

Transition of Rebuilding of market Transition of information Regionally-based


institutions institutions; networks from fiefs to decentralization &
clans; denationalization;

Dilemmas of State vs. market binary; Information codification vs. U-form vs. M-form
institutions information diffusion; hierarchy;

Thrust on Irreconcilable dilemmas Duality conducive M-form hierarchy prompting


dilemmas between market and to transition with local initiatives competing
in China's state with mixed momentum in informal between formality and
transition consequences; soft sector; repugnant informality; dilemmas
budget problems in dilemmas reconcilable; reconcilable;
formal sector;

Thematic focus Privatization of SOEs Centrality of network Devolution of formal


Efficiency concerns; & informal sectors sectors & boom in TVEs;
to market transition;

Core feature of Overall re-privatization; Communal form of Primacy of COEs, TVEs;


ownership in property rights;
transition

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(Table 3.11a to be continuous)

Nee: 1989,1992 B&C: 1996 Q&X: 1993

Information Toward least Toward personal Toward a localized mix


access in personalization in relationships in (semiformal);
transition charge of codification charge of diffusion
(formal); (informal);

Key mechanism Hard budget constraints Switch of network Economic devolution &
to transition & incentive structure; relationships for access to regional coordination;
information and resources;

Transitional Arms-length market Information flow & Hierarchical decentralization


dynamics competition; relational network; for local initiatives;
rule of law; quanxT as social
embeddedness;

Theses on Chinas
Hybrid Economy

Alternative Marketized vs. non- Private, non-state Central SOEs vs.


classification marketized sectors vs. state sectors local & rural COEs
TVEs, and privates;

SOEs Dilemmas in binary Not focused; Ongoing reforms


market-hierarchy in a M-form
relations (-); hierarchy (+);

COEs Not focused; Duality between Primacy in the


(TVEs) market competition & current transition
state dependence in (+);
transition (+);

Private Primacy in the Momentum in the current Significant (+) but


sector future economy (+); economy (+); restricted by current
system;

Label: + Positive; - Negative.

The above summary by no means exhausts all the many different current views regarding

Chinas economic transition, but they do provide a good starting point.

All three models call attention to macro-institutional environments and the plurality of China's

present economic order" (Boisot and Child 1996, 610). But none of them ask if such a plurality of economic

order could hatch a "civil society in China, be the civil society" democratic or semi-democratic [1].

Arguably, Chinas hybrid economy that started up from its non-state-owned secondary economy might

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pave the way for such a transformation to civil society. This could occur irrespective of whether the

economy goes mainly through arms-length market competition, as Nee envisioned, or mainly through

network paths in terms of clan-like reciprocity inside and outside state enterprises, as Boisot & Child

assumed, or through the local-govemment-driven competition along with Chinas decentralization in an

M-form hierarchy, as Qian & Xu proposed. The lack of evidence suggests that possibly a democratic

future for China will come through a path of industrial pluralism rather than through a path of privatization.

All three models with variations suggest that Chinas S O E reforms boil down to marketization, or

even to privatization. But all three models fail to perceive the historical context and the inherent dilemmas

in such SO E reforms, i.e., dilemmas shaped by the complex reciprocity between scale economy and

scope economy that Chinas transition inevitably entails. Chinas scale economy has been embodied in its

large-sized SOEs, whereas its scope economy is more concentrated on its diversified and localized mid

sized or small-sized SOEs, COEs, TVEs, and private enterprises. Nee neglects this point in his

discussion of Chinas market transition from a planning regime, as do Qian and Xu in their development

of Chinas M-form hierarchy. Figures and tables in Chapter 2, Sections 2.4, 2.5, and 2.6 show that among

those non-SOE sectors in the 1990s, the private sectors grew fastest, whereas the S O E s share in

Chinas total industrial output actually shrank. The changes occurred because, under the pressure of

accelerated marketization on China's economy [2], many non-performing and badly-performing SOEs

wound up in bankruptcy, while market competition become fiercer, as it was instituted, enforced, and

regulated by the reforming state governments and the banking institutions.

Many of these SO Es were sold to non-SOEs or divested in joint ventures with those non-SOEs or

foreign ventures, or through M&As (i.e., merges and acquisitions by others). This trend, as reported,

continued in breadth and depth. Reformers could not cover up their curiosity and their worries: how far

would this trend go? Could all SOEs ultimately be squeezed out and swamped by growing collective

enterprises such as urban COEs and rural TVEs as well as private enterprises? In 1993 Qian and Xu were

open to such alternatives. While proposing Chinas decentralization and denationalization, they argued that,

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Denationalization is a transformation process which includes successful-non-state
enterprises taking over or merging with state enterprises: state enterprises are converted
into joint ventures with either domestic or foreign non-state enterprises; state enterprises
are reorganized into joint-stock companies etc. In either case, the transformation may
include the sale of small-sized state enterprises or sale of parts of large- and medium
sized state enterprises. In fact, recently takeovers and mergers by the non-state
enterprises have already emerged in China and reorganization to joint-stock companies
has also become a fashion. With the crowding-out effects of takeover, mergers and
transformation of ownership, the economy will eventually rely more on the non-state
sector. This is perhaps an alternative wav to privatization and a less painful path of
transition for China (1993b, 156; emphasis mine).

The unexpected, and perhaps unintentional, growth of the non-state sector is critical for
the success of Chinas economic reforms (1993a, p. 542).

But the data sets of the fast growth of Chinas non-state sectors that Qian and Xu collected were

only up to 1991. After that the expansion of COEs and TVEs decelerated and finally ceased in 1994,

when China accelerated its privatization of the state sector. W hat led the state to accelerate its processes

of privatization? What relationships emerged between state sectors and non-state sectors in the 1990s?

And what roles might SO Es play in Chinas future?

Here I would like to explore the states motivation. China might believe that its SO E reforms have

to deal with not only the urgent efficiency issues and short-term tactics, but also with the long-term goals

through strategies, such as. acquiring core technologies and competences from the capital-intensive

infrastructure, knowledge-intensive industries, and other basio-inputs sectors, etc.. many of which are

considered as public goods f3]. And this is what Chinas scale economy and the politics behind are all

about, insomuch they had often puzzled Chinas reform planners for economic streamline f4]. The state

has to deal with a dilemma between its desire for reforms and its desire for scale economy. Scale

economy could help development with the advantages of large capital and skilled labor pools (cf. Geng

Xiao 1990). A country like China might not want to forfeit its existing advantage of size, for example, for

its currency stability I5], its R&D programs, etc., while streamlining its inefficient SOEs. Redundancy is

often indispensable in such a big economy j6]. When Chinas core industries and competent sectors

consist mainly of large-sized SOEs, transitional China might not want to hurt or possibly even lose those

promising programs by cutting its larger SOEs, even if their performance were relatively poor [7], Even if

inefficient SO Es are cut, sold, or suspended, the state might still have to check its need potential for

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public goods, economic upgrading, and technical advances in the future. Without its scale economy, the

state might feel it has to act like those small or inferior countries that must rely upon their flexible

adjustments to the contingencies in larger environments as well as upon their other advantages, such as

their geo-structural formation, their access to capital- and knowledge-intensive programs, their

infrastructures, and the industries they badly want. But while committing itself to hold up its strategic edge

with scale economy, the state simultaneously had to bear the brunt of huge costs and risks.

One might acquire some historical vision of Chinas SO E reforms and the dilemma the reforms

might face by looking at Chinas recent history. Under China's former planning regime, state-owned

enterprises and/or public firms were long used as major instruments and large reservoirs for Chinas

capital accumulation. This fact could not be ignored by those planners for Chinas transition as they

sought ways to streamline their SOEs. In the eariy years of Chinas planned economy, when its industrial

base was fragmented and rudimentary, it had developed its economy mainly by establishing larger

enterprises. In the 1960s and 1970s the large-sized SOEs had once absorbed about 40-70% of the

economys gross investment and a huge amount of human capital.

Even when Chinas national economy was no longer reducible to those large SOEs, their status

as m ajor players remained significant to the economy. They could still guide the states economic policies

and direction, and significantly influence the behavior of other sectors of Chinas economy in

management, finance, and production. Chinas transition planners knew that too much streamlining SOEs

too quickly might reduce national prosperity and security and generate massive layoffs. The costly

aftermath could be huge unemployment, extensive public expenditure, etc. Such worries gave them a

reason to delay at least temporarily large-scaled industrial restructuring and structural changes.

Transitional planners knew that the final outcome would have to be a rational compromise of delicate

trade-offs between efficiency and legitimacy, keeping in mind considerations of both scale economy and

scope economy. W e will return to these points in our Section 4.2, Chapter 4.

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From the perspective of political economy, social relations within and across firms and firms more

formal relations to the state, according to Fligstein in 1996, are pivotal to understanding how stable

markets might emerge f t . They are also pivotal to understanding how complex the choices are between

which planners must choose. Firm competition is based not only on social embeddedness, but also on

the state of the political economy f t . Firm competition has often taken place in non-competitive ways [10].

In 1991 Campbell, Hollingsworth, and Lindberg said that the social structures of markets and the internal

organizations of firms are often best viewed as attempts to mitigate the effects of competition with other

firms. This rationale is as well suited to transitional economies as it is to market economies. For instance,

privatization could meet very high and very unexpected institutional barriers. Too rapid SOE reforms

might generate an economic free fall, against which the state might want to secure safety net ["]. The

state might want to be circumspect in order to keep SO E reforms from retracting the scale economy in

return for a myopic trade-off promoting local entrepreneurship and petty commodity production [12]. But in

so doing, the state might generate problems of Soft Budget Constraints" (SBC), i.e., redundant or

excessive subsidization reducing SOEs performance and slowing down the pace of reform.

In 1993 Cui Zhiyuan argued with J. Komai (in Vedat Milor. ed. 1993. "Privatization and Public

Sector Reform") that "Soft Budget Constraints" (SBC) have long existed in the West, visible in the

problems of credit money of private firms and incomplete capital markets [13J.

One of the complications that causes SBC in a private ownership monetary economy is
the fact that modem banking systems have the ability to create credit money. Under the
fractional reserve system, the banks can loan more money than they receive in deposits
For example, if the reserve requirement is 20% , the bank with $20 in deposits can lend
out $100. Moreover, the bank can lend out money it does not hold: it simply opens a
creditor account from which the customer may draw up to the amount he or she promises
to pay. This is called loans make deposits. Clearly, Komais definition of SBC -
nonexistence of 'strict relationship between expenditure and earning does fit the modem
banking system based on factional reserve (ibid. 306).

Even Komai admitted in his latest book that any static interpretation would provide a
highly simplified picture of the intricate social phenomenon termed here the softness of
budget constraint. It depicts a static problem of choice, whereas this is clearly a case of
dynamic process in which an expenditure flow is opposed to an income flow. [cf.] Jnos
Komai, The Socialist System, 1 99 2:14 3. From a static perspective, SBC is bad, so there
are proposals for establishing 100% reserve banking. However, from a dynamic
perspective, a proper degree of SBC is necessary for economic growth. For a fuller
discussion of static vs. dynamic perspectives in the context of socialist economic reform,

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see Cui, 1991: Market Incompleteness, Innovation, and Reform, Politics and Society,
No. 1, (March 1991): 59-69 (Ibid. p. 324, Endnote 49; brackets mine).

Some degree of Soft Budget Constraints is unavoidable and even allowable in any type of

modem market economy in general, and in private firms in particular [14]. From a dynamic perspective,"

SBC is indispensable to subsidize R&D programs within firms, industries, and economic sectors. Cui

particularly discredits some Schumpeter's insights, appreciating the importance of monetary factors (in

contrast to some real input or supply factors) to the market economies in general. But the rationales he

elaborates could also be informative and instrumental in helping to analyze the problems in transitional

economies. For example, as shown in Chinas current transition, what ultimately succeeds hinges on the

activism of the public sector, financial institutions, and other associated reforms, rather than exclusively

on a rush to privatize everything owned by the state. And the scale of the economy and the reforms of

SO Es would be unavoidably affected by these concerns. In the meanwhile, policies with excessive use of

SBCs could generate serious stagnations. Too circumspect macro economic strategies and policies could

paradoxically incur more side-effects, curbing reform and thwarting overall endeavors to hasten

marketization, economic streamlining, transparency, local flexibility, and managerial discretion. As O.

Williamson 1975 explained, even in the West,

"radial expansion of the firm eventually exhibits diminishing returns...[as] large size is
associated with greater opportunities for discretion" (127-8) n .

In China, it was up to the state transitional planners to develop a strategy that included market

efficiency, social security, legitimacy, and scale economy, based on accurate and adequate empirical

data. The planners had to calculate what would be reasonable economic relaxations at different stages of

development, and what would be a proper growth rate to absorb sufficient employment from Chinas huge

labor pool in order to prevent increasing unemployment [16].

In regard to the above dilemmas between scale economy and market efficiency, in 1995 F.

Fukuyama, wrote a book on T ru s t that claimed from the angle of network organization that

The relative importance of scale, and consequently small vs. large companies, may well
change in the future, and in unpredictable ways. [Since] Future scale economies will

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163
depend on technological developments that have not yet occurred and are therefore
impossible to predict...In the light of these kinds of uncertainties, it is possible to argue
that in the future the optimal form of industrial organization will be neither small
companies nor large ones but network structures that share the advantages of both (ibid.
341; brackets mine) [17].

Network organizations can take advantage of scale economies while avoiding the
overhead and agency costs of large, centralized organizations (ibid).

According to Fukuyama, analyses of network organizations would bring high social trust or

"spontaneous sociability on economic life" back on to the table of "a natural advantage [18]. Network

organization analysis could even become a predominant form of future organization, particularly in high-

tech, high-value-added areas and industries.

A country like China has had a range of options for tackling the dilemmas between scale

economy, scope economy, and market efficiency. Through institutional reforms China could tap sundry

and hybrid strategic alliances with core SOEs for R&D programs, backed by both central and local

governments. The state could build giant equity partnerships and collaborative research projects with

large scale research consortia. Some of Chinas giant state-owned or state-sponsored research projects

are currently paving the way for even larger emerging forms of market-oriented R & D collaboration.

These rising big collaborations in turn could shape the new network constituencies with more innovative

links with ever larger, generalist firms and specialized entrepreneurial start-ups. A noteworthy example is

Zhongguancun Science Park (dubbed the "Scientists' Village").

Zhongguancun Science Park" emerged in the 1980s and 1990s in the residential communities

near the complex of research institutions and universities concentrated on the outskirts of Beijing (see

Figure 3.11; cit. from The Wall Street Journal, R12, Mon. Sept. 25, 2000). In some ways is equivalent to

Silicon Valley in California, USA. The idea behind the establishment of Zhongguancun Science Park

was that through such a concentration of capital, technology, and knowledge, scientists and researchers

could establish their own communities and academic environments that could generate dose interactions

that might promote innovations and core competencies, and thus enhance China's R&D in breadth and

depth.

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Zhongguancun Science Park has already been valuable in eliminating costly, duplicative R & D ,

in achieving efficient economies of scale and in diversifying the search for solutions to assorted technical

problems [19].

Figure 3.11: Zhongguancun Science Park fact sheet

Name: Zhongguancun Haidian Science Park


Location: Beijing City, Haidian District
Size: 5 miles long in central district
Established: May 1988
Companies: more than 5,000
Universities and Colleges: 73
Sales by companies in the park (1999): $7.7bn
Exports by companies in the park (1999): $548million
Ownership structure of companies in the park:

Private company Collective


0% company
14%

Joint-Stock
Company Foreign Joint
43% Venture
Company
20 %

State-Owned
Company
23%

Source: Administrative Committees of Zhongguancun Haidian Science Park; cit. The Wall S te e t Journal,
R12, Mon. Sept. 2 5 ,2 0 0 0

W hen exploring the rationales behind China's fast growing non-state sectors, Boisot and Child

took Chinas network of information governance seriously in their description of a transition from personal

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165
type (fief) networks to relational type (clan) networks. In doing so, they essentially treated Chinas network

organizations as informal; they ignored the growing salience of those formal, larger research network

consortia like Zhongguancun Science Park. Boisot and Child ignored the fact that those networks

governing mega-information and transaction flow were more formal, were built under rational-legal

bureaucracies, and were regulated by China's state institutions. They were not acting like fiefs and clans.

In Zhongguancun Science Park larger business and industrial conglomerations could create

their own novel strategic partnerships by shifting the very base of corporate competition from rivalry of

firm vs. firm to rivalry of intra- and inter-national groupings of collaborators. Such entrepreneurial pursuits

and innovative moves, through institutional/organizational collaborations and collusions, have always

contained some risky trade-offs and tough choices. To stay in R&D associations, each partner has to

abrogate its own identity; otherwise it might face disciplinary actions from the R&D association through

incentives and disincentives [20]. Disciplinary actions imposed by network organizations are designed to

prevent individual opportunism, organizational slack, inertia, and group inefficiency. But concomitantly

they can also incorporate collusive retardation of R&D programs on behalf of the status quo and the

vested interests [21], The "Scientists' Village" emerging in China drew largely from the subsidies of the

state government and the sponsorship of the state-owned industrial conglomerates. Silicon Valley in the

US was pushed by entrepreneurial momentum and trickle-up venture capital. These two types of network

research consortia differ in their origins and trajectories. They may be more similar in their outcomes.

Nee stressed that Chinas reforms substantially involved remaking the economic institutions

outside the state sector [22]. Nee did not go further to see that before 1995 China's nationwide

entrepreneurship had been boosted mainly by local initiatives. It was the rural COEs and TVEs, not the

SOEs, that ignited and nurtured national entrepreneurship. This raises the questions about the main

dynamics behind Chinas economic transition. Hungary illustrated the fact that remaking post-socialist

institutions could start from a booming non-state sector rather than from state-led superstmctural reforms

j23]. Chinas reforms were initially pushed mainly by Chinas burgeoning non-state sectors in the local

economy, sectors that had formerly been appended to the planning economy. But in time Chinas state

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166
institutions stressed hybridization and further reforms in the state sector.

To a large extent, Chinas early COEs and TVE s consisted mainly of smaller enterprises and not-

very-large enterprises. Their burgeoning proliferation brought about the ensuing dynamic milieu and

socio-cultural ethos throughout China that precipitated the later SO E reforms. These eventually brought

about the restructuring of Chinas economy incorporating a new level of entrepreneurial momentum.

In 1993 Qian and Xu suggested that when Chinas reforms faced unprecedented uncertainties,

China might accelerate its institutional learning curve and adopt more flexible approaches to the

acquisition of complicated and localized knowledge. Chinas use of such an approach might avoid

replications of costly mistakes experienced by other transitions and enable China to discover innovative

way to reconstruct institutions [2A].

Table 3.11b summarizes the attributes of Chinas transitional industrial and/or business system in

the year 2000 [25],

Table 3.11b: Attributes of Chinas transitional industrial/business system in 2000 [26]

Attributes C haracteristics

Ownership pattern Hybrid ownerships;

Intra-group network Internal trust within localized firm hierarchy;

Inter-group network Coordination through banks, government, & multi


tiered and regional industrial organizations;
cross-investment by local hybrid sectors

Subcontracting Highly flexible, mainly informal;

Investment pattern Diversification under vertical & horizontal integration;


localized fund raising and subsidization by the local
government and banks;

Growth pattern Semiformal-financing & cross-shared growth by hybrid


sectors; incremental and relatively balanced.

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In the 1990s China still had a long way to go to catch up with the global edge through building

innovative infrastructures and institutional environments. Yet its economic momentum had already been

cultivated by its M-form hierarchy, its trickle-up entrepreneurship, and a number of institutional reforms.

Together, these became a driving force that could help solve the dilemmas between scale economy and

scope economy, between size and hybrid forms, and between economic efficiency and social legitimacy.

In turn, all these helped China build its core competencies and ultimately its globalization.

3.12 Transition as social action

A more effective critique of the current institutional scholarship on Chinas transition is based on a

higher level of epistemology - sociologically-grounded. I think an institutional account of transition as social

action could provide such an epistemological tool to tackle a number of dilemmas which all three institutional

models described in Chapter 2 failed to unearth. Before proceeding further, it may be useful to review Nees

description in 1989 of what he called new institutionalist paradigms. Nee stated that

Over the past decade, 'new institutionalist paradigms have been developed in every one
of the social science disciplines, brought about in political science because internal
developments in public choice theory undermined rational choice models lacking
institutional constraints; in economics because market failures could not be explained with
the standard analytic tools; and in sociology because efficiency models failed to explain
economic behavior and patterns of organizational survival in the institutionalized sectors
of the economy. These diverse 'new institutionalisms share a critique of the limitations of
neoclassical economics, an emphasis on the interpenetration of economic organizations
and social institutions, and a commitment to represent complex relationships in formalized
modes. These same traits, rather than fsic.l an allegiance to any one of the particular
neoinstitutionalisms. characterize the recent institutional analysis in the study of state
socialism (cf. Nee and Stark 1989, pp. 11-12; emphasis mine).

It is clear here that Nee attempted to broaden the social domains of new institutionalism [27]

beyond the limits of any particular kind of neoinstitutionalism. Nee indicated that institutional searches

cannot be confined only to the current institutional theses. They need to investigate society as a whole,

and particularly the involved relationships between state and society. Thus Nee tried to bring in sociology

to help account for some of the complexities of Chinas transition, albeit he himself fell short of applying

sociology to its fullest advantage. As Boisot and Child criticized, N ee s scheme of market-hierarchy

relations stays within Williamsons theorems of unidimensional market-hierarchy continuum."

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Following N ees breakthrough, Boisot and Child, in their institutional model, recognized social

embeddedness in Chinas network organizations. Qian and Xu were quite conscious of the political logic

and state commitment to decentralization reform under Chinas M-form hierarchy. All three models, more

or less, acknowledged the importance of institutions. However, they all treated institutions as static

conditions, as fait accompli. All three models recognized that efficiency was an institutional construct. But

all three failed to explore more dynamic and social sources with which China rebuilt its institutions as part

of its economic transition.

In this study I propose to use an institutional perspective of social action to account for Chinas

economic transition and to compare Chinas transition with other economic transitions. I shall consider

any transition to require strategic action, entailing risky and costly choice-making. I shall look at

institutions more as choices than as conditions. I shall combine both subjective and objective aspects of

institutions to account for Chinas transition. Transitions require institutional changes, and institutional

changes cannot be made without subjects being willing to change and sometimes to change themselves.

According to Lanes earlier definition (see Section 2.5, Chapter 2), new institutionalism needs to analyze

institutions in terms of social actors, social actions, and historical contexts. An economic transition is a

strategic action, made by social subjects. One needs to relate economic transitions to social actors' frame

re-alignments in changing historical contexts. Economic transitions involve ensembles of social actors

identities, reconfigurations of their identities, and re-alignments of their frames of reference. For example,

in China, previously-subordinate private entrepreneurs after embarking on the economic transition

became their own masters, obtained new identities, and became new actors [28]. New social actors could

determine the pace and process of reform by their own balanced judgment and by their own desire to

ward off social chaos. All reforms would still remain uncertain inasmuch as the state government could

still hedge, suspend, or veto the reforms if they judging them as not good public.

Based on this sociologically-grounded cognition, Figure 3.12 positions the three models from

Chapter Two according to their institutional perspectives.

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169

Figure 3.12: Institutional perspectives of three models of Chinas economic transition

Pre-transitional era Transitional era


1950-70 since 1980

Perceived general Central focus Perceived dynamic Perceived major actors


Deficiencies in Chinas of concern by Institutional arrangements or players
planning economy selected institutional for transition
models

Efficiency -------------- Market-oriented --------------- Private enterprises and


(Nee) individual entrepreneurs
Soft budget
constraints --------------- Effectiveness ------ Hierarchy-approached Central and local
(Qian and Xu) state institutions

Social trust------------- Network-based Local groups in collusion


(Boisot and Child)

As shown above, in the pre-transitional era, early institutional discourse recognized the problems

of soft budget constraints generic to erstwhile socialist economies. In the 1980s the focus of institutional

discourse began to diverge from the earlier uniform focus on efficiency to those institutions that might

contribute most significantly to efficiency. Qian and Xu suggested that hierarchical form was critical for

Chinas economic transition. Boisot and Child argued for the centrality of social embeddedness and trust

relationships in governing Chinas economy. Accordingly their respective perceptions about the major

social actors differed. Nee favored private individual entrepreneurs, Boisot and Child focused on local

enterprises in collusion with the local governments, whereas Qian and Xu concentrated on the state

governments of all levels. Each of these three models focused to greater or lesser degree on some forms

of social action. Hence each of them might be addressed systematically from a sociological perspective.

My perspective is historical as well as sociological. I do not believe that states, hierarchies,

markets and networks exist without being embedded in given social nexus and without being derivative

from given historical contexts [29j. It is from these two theoretical perspectives that I shall spend the

remainder of this chapter identifying the shortcomings of Nee, Boisot and Child, and Qian and Xu.

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3.2 Limitations of the three models of Chinas transition

3.21 Limitations of Nees model

N ees model (referring mainly to his essays in 1989) was most deeply embedded in the neo

classic formula of a unidimensional market-hierarchy being generic to all transitions. Even while calling

for a new institutional search, Nee identified market-approached efficiency as the most compelling item

on Chinas agenda. Nee was less attentive to the social complexities behind market competition, while

calling attention for his project of rebuilding economic institutions f30].

One can identify two flaws in N ees reductionism. One is his lopsided unidirectional claim of

market competition. Another is his failure to recognize those intermediary areas, often with mixed

consequences. Nees unidirectional claim about transition towards market economy is represented by the

solid line in our heuristic Figure 2.2 in Chapter 2. Nees thesis requires full re-privatization as a

prerequisite for market competition (note: this is indicated by the solid line diagonal arrow from the top-left

to the bottom-right in the figure) [31]. Nee claims that

Organizational failures in state socialism are rooted in the relationship between the firm and
the state, that is, in the allocative processes of central planning (1989,11).

According to Nee, Chinas inefficient allocation of resources and the associated soft budget"

problems are rooted in state ownership, which is presumedly detrimental to efficiency and competition.

The solution therefore requires market-oriented re-privatization in place of state bureaucratic intervention

[32]. In Boisot and Childs view, Nees approach was typical of the early institutional discourse about

transitions from socialism with the belief that the transition required primarily a switch of choice-makings,

pivoting on the dichotomy between bureaucratic and market transaction-govemance structures... (Boisot

and Child 1988, 507) t33]. That is, economic governance had to be directed by market-oriented re

privatization, not by state bureaucratic intervention. Nee saw state socialism and planned economies as

systemically discontinuous from the capitalism f 4]. On the macro-institutional" level, the essential

distinction between socialism and capitalism were their different market-state configurations [35].

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Nee argued that state socialism contained self-reproducing institutional mechanisms, distinct from

those of the market economies I36]. Nee claimed that

it is not only market economies that have an 'invisible hand': the economies of state
socialism, too, have self-reproducing institutional mechanisms" (1989,11).

In a socialist society, a typical bureaucratic error, committed by a state institution such as a

government agency, could entail an irremediable and severe blunder, because it could spread out to the

entire structure. According to Nee, a transition in China or in any other planned economy could be judged as

complete only if it forfeited its socialist self-reproducing institutional mechanisms. In N ees phrase, this

could mean only a shift from [planned] redistribution to markets (Nee 1992, p. 4) [37].

On closer scrutiny, N ees heuristic demarcation of a systemic shift is nothing more than a

polarized metaphor of state socialism vs. capitalism - a typical neoclassic paradigm. N ees cross-

systemic comparisons, as he liked to call them (1989, 13), contrasted binary categories such as state

monopoly vs. market-society autonomy, as well as their ramifications in the forms of private vs. public

interests, private vs. public property rights, and soft vs. hard budgetary constraints, etc. In the end, Nees

institutional analysis was little more than an ideologically-bent sermon. Nee called for sweeping re

privatization and a complete rescission of SOEs, etc. Nee viewed re-privatization as the critical

transitional template without taking into sufficient consideration the institutional complexities and

mechanisms identified by Cao, Qian, and Weingast (1999) t38]. Because of Nees perspective, he never

addressed which soft budget constraints and which bureaucratic subsidies might become indispensable

to economic growth under increasing public welfare, nor did he specify where and when they would

become unaffordable to an economy (cf. Cui 1993). Nor did he explore how to make a feasible transition

away from a planned economy. H e could not make a distinction regarding what soft budget constraints

were unaffordable and what soft budget constraints were unproductive. Once he failed to do so, Nee

found it even harder to find a plausible institutional base for market-hierarchy relations existing in

transitional economies. Even capitalist economies had their own soft budget constraints. This would

weaken Nee's original criticisms of state socialism and perhaps even m ake them untenable, since even a

transition to a full-fledged market economy could not assure a satisfactory solution to the problems of

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state intervention or guarantee a complete avoidance of budget constraints that were supposedly specific

only to state socialism [39].

Broadly speaking, the problems under the state socialism could not be simply reduced to the

micro-interventions of bureaucracy per se, for such interventions prevail in non-socialist societies as well.

Bureaucratic interventions have their roots in modem divisions of labor, as W eber suggested in his

metaphor of capitalisms bureaucratic "iron cage" (cf. Weber. 1968. Economy and Society). Nee failed to

discern how the bureaucratic problems across economies are different in kind. He might have mentioned

that state bureaucratic hyper-active interventions are unique to centrally-planned economies. In such

economies state interventions can become regular and extensive problems, encroaching on public and

private lives, and dampening civil activism, and/or individual and organizational entrepreneurship. Nee

could also have pointed out that so-called organizational failures are apparently more severe in centrally-

planned economies, where all their bureaucracies are exclusively controlled and monitored by state

governments.

In short, although Nee highlighted the salience of remaking economic institutions during the

transition from socialism to market economies, his logic became opaque when he identified hierarchy as

the opposite of markets or assumed state hierarchy to be opposed to market expansion (cf. 1989, p. 16:

Hierarchies and Markets). Nee was also opaque when he ignored the roles of the transitional institutions

in tackling those thorny issues and institutional dilemmas associated with transition, and when he ignored

the roles of social groups and forces other than workers and peasants. In his mind economic reform

seemed to boil down to a logical reversal of market forces vs. bureaucratic mles. Which one could prevail

depended on whether a society were in a pre-transitional era or transitional era. In the former, the

economy was bureaucratically ruled, whereas in the latter, the economy was reconfigured for market

competition. Institutional comparisons using those dichotomous categories such as N ees could miss

many more links between the dichotomies such as institutional parameters, dimensions, and alternatives

such as networks, a variety of hierarchical forms, industrial associations, NGOs, coordination mediated by

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middlemen, political negotiations, and social bargaining, etc., all of which can play important parts in

transition in their own rights f40].

Unlike Boisot and Child and Qian and Xu, Nee believed that re-privatization was the only way to

initiate Chinas economic transition, market competition, and the subsequent streamlining I41]. N ees

approach failed to acknowledge the variants of planned and market-driven structures existing in their

particular contexts. Nee also failed to see that the existing market economies were also in transitions I42].

Nee also never recognized the diversity of Chinas ownership patterns during its transition, nor did he

recognize how the changing role of state ownership had been dynamically affected by ownership diversity

and how that had in turn dynamically affected Chinas transition I43]. As it later turned out, Nee simply

failed to discern the unique institutional mechanism and organizational dynamics that were available to

China to help with its transition J44].

North (1990) and Aoki (1995) contend that the kernel of marketization resides in the

organizational mode of hierarchical governance. Peter Hall 1986 also emphasizes (p. 46; cit. from

Lindberg, Campbell, and Hollingsworth 1991, p. 17) that markets in capitalist economies are embedded in

institutions through particular organizational forms (competitive, oligopolistic, oligopsony, monopolistic,

and monopsony as such) that can structure the relations between economic actors in certain ways. Even

when markets are organized informally, market exchanges abide by the certain rules (of pricing and

contracting) that are stipulated and regulated by state institutions and government agencies, and that can

be biased in favor of vested interests and distorted by current power structures. Between control and

contract there are diverse and mid-ground institutional arrangements and practices, either hierarchy-like,

market-like, or network-like, such as obligatory agencies, promotional networks, industrial associations,

and monitoring-typed interlocking firms that deviate from the institutional forms associated with typical

market contracting or corporate hierarchies. An array of institutional arrangements can be organized in

more flexible and less codified ways to deal with uncertainties in market transactions and with

uncertainties created by non-economic factors and environments. In Chinas case, as Boisot and Child

observed, personal relationships could play a critical role in sharing information and diffusing risks for

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economic transactions and governance, albeit the transactions and governance may still follow certain

formal procedures and legal codes stipulated by the state governments. In both formal and informal

cases, therefore, whatever arrangements are made according to hierarchies, or markets, or networks can

be seen as reciprocal trade-off alternatives or complementary to each other when other arrangements

appear vulnerable or absent.

While Nees first flaw is his lopsided focus on market competition, his second flaw in his

methodological reductionism that omits and erases those vital institutional underpinnings that serve as

intermediaries between markets and hierarchies and between institutions and their precedents. Although

Nee recognized the significance of those hybrid entities, he did not fully and seriously take them into

account in China's transition. Yet no matter how markets contract or hierarchical decisions are processed,

they have to go through certain routine institutional channels and filtering processes. Moreover, there

always exist alternative forms beyond market and hierarchical arrangements. This was why Powell in

1990 criticized Williamsons theorems for failing to identify "networks as a distinctive form of coordinating

economic activity. According to Powell, Williamsons theorems on transacting cost merely noted that,

economic changes can be arrayed in a continuum-like fashion with discrete market


transactions located at one end and the highly centralized firm at the other...(1990, 298).

Yet Powell clarified that while Moving from the market pole, where prices capture all the relevant

information necessary for exchange, there exist various kinds of repeated trading, quasi-firms, and

subcontracting arrangements; and while moving toward the hierarchy pole, there exist franchising, joint

ventures, decentralized profit centers, and matrix' management (ibid). Thus

the various intermediate or hybrid forms of organization [exist in between these two
poles],..(ibid.; brackets mine).

R. Burt (1995) and R. Boyer (1998) were also interested in those dynamic intermediaries between

market and hierarchy and those dynamic arrangements beyond. According to Burt (1 9 9 5 ,2 6 1 ),

The sociological analysis is keyed to network data, which will let us estimate reputation
effects, and so reveal social structural primitives to inform economic analysis t45].

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And Boyer wrote:

In this context, the notion of hybridization becomes significant, not just as a mere short
term adaptation to environmental resistance, but as a principle of transformation, indeed
of genesis, of industrial models themselves, through their interaction with social and
economic systems which are different from those in which they first developed (Boyer
1998: 27; emphasis mine) f46].

Hybridization could also be cited as a principle of transition, not just as a transient adaptation to

institutional environmental resistance. To many observers, Chinas hybrid economy portrayed a

paradoxical silhouette of its transition. The burgeoning of Chinas hybrid economy has been driven by and

is reflective of reciprocity between SO Es and non-SOEs. Nee overlooked these complexities. He also

failed to recognize that each sector in Chinas economy had its own dilemmas, and each sector varied in

terms of its magnitude, growth rate, and trend. During the transition, many intermediary activities cropped

up beyond the reaches of the markets and the state/hierarchies; in some sectors they provided a buffer

between market and hierarchical failures. In principle, hybridization accentuated the dilemmas of a

transitional economy, but also hybridization could lead the economy forward, as could it do backward I47!.

Nee maintained that Chinas early reforms had generated plenty of ambiguities for economic governance.

However, he failed to forecast that the latest development of Chinas hybrids had been attuned to a

transitional upgrade through institutional reforms such as those of restructuring ownership structures.

Nee dismissed hybridization and any other form of decentralization as equivalent to an

incomplete economic transition. From his position he was unable to fathom the developments of both

state enterprises and non-state enterprises, or to understand the latest privatization of state enterprises.

Qian and Xu, Aoki, Gelb et al. and Pei, unlike Nee, all sensed and attempted to develop the concept of

dynamic reciprocity within Chinas economy. In 1993 Qian and Xu argued that M-form hierarchical

arrangements gave rise to pressures in China for decentralization and denationalization reforms I48]. To

Nee, with his methodological reductionism, however, these alternative forms of diversity, mix, hybrid, etc.,

could be defined simply as half-way products doomed to failure. N ee asserted that

With the correct mix of plan and market, the market mechanism would not generate
spontaneous economic adjustment processes but instead would serve as an instrument to
reduce the transaction costs of central planning...the early reformers believed that the most

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efficient governance structure for socialist economies was a combination of market and
central planning (1989, p. 17).

Nee insisted that public ownership in SOEs and COEs could hobble Chinas full transition toward

market economy, since these enterprises might still be owned and controlled by the state bureaucracy. Nee

stated that

Public ownership, Komai argues, fosters paternalism on the part of central planners.
Ultimately responsible for the well being of the economy and of the enterprises put under
their care, central planners want organizational instruments to allow them to steer production
directly when necessary. The problem is that once the tools for central management are
available, they tend to be used. The hyperactive role that comes with public ownership and
the resulting multitude of direct microinterventions on the firm have the effect of distorting the
regulation of the firm's survival and growth. Moreover, central planners undertaking these
interventions are disadvantaged in making rational allocative decisions because prices set
by bureaucratic procedures cannot convey detailed information on changing conditions
(ibid., p. 16; brackets mine).

Nee believed that,

A central contradiction of reform efforts in socialist economies derives from the reform
leadership's failure to cut back sharply or dismantle entirely the bureaucracy that managed
the command economy (ibid, p. 26) f 9].

In the final analysis, Nee deeply suspected that under its current leadership China could never

change the paternalist nature of its economy. The Chinese hierarchy would continue to inhibit any

genuine form of market economy.

By sticking to his methodological reductionism, Nee essentially dismissed the comparability of

economic institutions across national borders. He was unable to see that institutional variations have

existed not only between transitional and capitalist economies but also in between and within the market

economies, or between and within the Oriental economies and Western economies. R. Whitleys series of

East Asian studies of social institutions, business systems, and films took a sharply differing view from that of

Nee f ]. Whitley tried to relate the key characteristics of East Asian business systems with such factors as

their surrounding cultural homogeneity, cultural isolation, hierarchy-market relations, etc. in an effort to predict

different growth modes. Nees reductionism and his insistence on the market-hierarchy dichotomy

prevented him from seeing the relationships Whitley was able to identify.

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In summary, although the earlier institutional studies had brought state-society relationships back

in account for transitions and had challenged the old clinches of cold-war- ideologies, they essentially

failed to capture the underlying relationships as institutionally-specific to their particular settings. Although

Nee highlighted society as new dimension for the transitional scholarship, and although he requested a

paradigmatic switch from state into society, his focus did no more than redraw state-society dichotomous

boundaries (Nee 1989, 1992). All the early studies dismissed the intermediary areas interplaying between

hierarchy and market [51], This led them to overlook what makes institutions become dynamic, and how

social actors unleash reforms and drive changes - institutional and organizational - during periods of

transition [52].

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3.22 Limitations of Boisot and Childs model

In contrast to Nee's more or less dichotomous and reductionist scheme f53], Boisot and Child model

of network capitalism I54] challenged the irreconcilability between market and hierarchy, and focused on

China's principal forms of ownership and information flows during Chinas economic transition. Boisot and

Child discussed such factors as risk diffusion, trust ties, symbols, tosh I55], and other intangible assets and

relations. Qian and Xu also challenged the irreconcilability between market and hierarchy (see above Table

3.11a), but then their analysis went in a different direction from that of Boisot and Child.

Boisot and Childs network approach paid special attention to access to resources, information, and

social trust, accentuating those functions de-linked from hierarchical authority and market bargaining. Boisot

and Child felt this approach could help understand China's unique transition toward a quasi-market economy.

But like Qian and Xu, Boisot and Child did not spell out how these networks could emerge and dynamically

channel Chinas economic transition. Boisot and Child treated networks as an ensemble of "background-

characteristic institutions (i.e., institutions existing in a pre-industrialized society) instead of as "proximate-

characteristic institutions (i.e., institutions playing dynamic roles in shaping industrialized societies), if we

borrow Whitley's terminology (cf. Whitely 1992, 1994) f56]. Yet Boisot and Childs network approach

attempted to tap the innovative role of shifting regimes of information and transacting governance through

reciprocal processes of formality and informality (e.g., through social trust) in China's transition so that they

could address blurring boundaries between formality and informality and thus help account for the boom of

Chinas non-state sector in its emerging hybrid economy. In this way Boisot and Childs network perspective

identified new alternative dynamics within China's institutional environments, dynamics that were not limited

to two polarized poles - formal market and hierarchy [57].

As we outlined in Chapter 2 (section 2.3), in 1996 Boisot & Child explored Chinas institutional

dynamics in their frame of cultural space I58]. According to Boisot and Child, Chinas bureaucracy before and

during its transition was never as formal as bureaucracies had been in the former Soviet Union and the West

I59]. Boisot and Child also focused their attention on families, communities, and things like social trust. They

looked for informal structures (unlike much recent scholarship that has focused on formal structures). From

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Boisot and Childs view, much of Chinas transition occurred in the informal terrain (i.e., low regions in the

information matrix within Chinas cultural space), as Chinas network relations had switched from personal-

based (fief type) networks to relational-based (clan type) networks during the transition. Implicitly, this

perspective questions whether or not Chinas modernization could live up to the contemporary standards of

the commercial world. A problem with the perspective is its inability to be prospective (ex ante). It could at

most be retrospective (ex post). In the future, after China seriously enters the new era of information

technology, China will more likely adopt formalized network governance (see above Figure 3.11) in order to

manage more effectively mass information flow and more complicated transactional activities. This will come

along with recently increasing reliance on long-term institutionalized trust, formal contracts, and

rationalization of institutional environments for doing business. And this places some limitations on the

relevance of Boisot and Childs observations for post-transition China. These limitations may haunt or even

discount Boisot and Childs contentions about Chinas network transitions in the future.

Boisot and Child also underscored the social embeddedness of Chinas network governance. But

in their paraphrase, it mainly referred to their observation that Chinas transition would be essentially

caught up in China's cultural space. But such reference is vulnerable to treating culture as sui generis,

defined by itself. It comes close to being a tautology, sometimes with adjectives such as, "mysterious"

(borrowed from Whitley in 1994) or "invisible" (borrowed from Aoki in 1995). Boisot and Child never

specified how culture and social embeddedness interplay through network and how networks affected

changes in governance j60]. Culture was too broad an explanation j61]. Boisot and Childs model led to

little further inquiry and ultimately to reductionism.

Perhaps Boisot later (in 1998) sensed this problem and converted his C-space" to l-Space

(information-space) j62]. But this did not end the problem of culture being an independent variable. In

some cases it forfeited or annulled further inquiry into cultural constraints and dynamics. In some ways it

could even be transfigured into an anti-scientific sanctuary or asylum. In 1991 Orru, Biggart, and Hamilton

(1991: 365) said:

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cultural explanations and anthropological arguments ...mislead us in focusing on
'primordial constants that undergird everything, since this would also "lead to prediction
of nearly total homogeneity in organizational forms [across societies]. Both the cultural
and the economic approach err in adopting a unidimensional view of the environment
(either as a culture or as a market) to explain organizational forms, which are subject to
more articulated and detailed environmental factors. [In this respect,] The new
institutionalism is more sensitive to the details of environments because it escapes
reductionism in either direction... (emphasis and brackets mine).

The more articulated and detailed environmental factors they referred here were first of all

concerned with social embeddedness of the East Asian business systems they examined f63]. According

to Orru, Biggart, and Hamilton in 1991 (386-7) and Whitley in 1992, East Asia contains many different

institutional environments, economic governances, and business systems. Furthermore, as Swedberg et

al. said in 1992 (9),

The network approach helps avoid not only the conceptual trap of atomized actors but
also theories that point to technology, the structure of ownership, or culture as the
exclusive explanation of economic events.

It is clear that Swedberg et al. called for disengaging the network approach from some conceptual

trap and cultural reductionism. Nevertheless, Boisot and Childs network analyses seem vulnerable to

treating cultural cohesion as sui generis, something prone to being autonomous from social

embeddedness. Boisot and Child did not demarcate the extent to which culture and social relations could

or could not separate.

W e have further concerns about Boisot and Child's network thesis in terms of trust relationship.

Our question now is more ontological than epistemological: Are network organizations identical to trust

relationships as Boisot and Child identified (1996, 604)? In Zuckers view in 1986, trust relationships

could be both personal and institutional. But in whatever form trust relationships take shape, they are

ultimately contingent and situational. In this light, trust relationships are not like networks. Networks are

constants etched in the social structure of given institutions. The forms of trust relationships can change

when social situations change. But network organizations might not continue in the same way. Obviously,

trust relationships are not identical with networks. And misconstruction of the association between

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network and social trust as such could obstruct people like Boisot and Child from shedding much light on

the institutional dynamics of China's economic transition I64].

Plausible linked with this misconstruction, Boisot and Child had some misconceptions of the

reciprocity of formality and informality behind social trust. Their framework of cultural space" (cf. Boisot

and Child 1996, p. 602, Figure 1) overlooked the dynamics of the formal sector to Chinas transition. Here so-

called formal (upper regions of the figure) might refer to those cultural segments in the public with explicit

codifications, and those institutions "proximate" to market and hierarchy with warranted codifications, such as

bureaucratic routines and procedures, as well as legitimate market contracts for hedging off risky

uncertainties, etc. Although Boisot and Child in some ways excluded the formal sector from their discussion

of the institutional dynamics, changes and mutations of formal institutions have been palpably evident in

Chinas transition during the 1990s. Formal/legal links of economic activities and organizations have grown

among non-state sectors including COEs, TVEs, and private firms like joint ventures (JVs) with foreign

capital. Much of the momentum has come from Chinas larger-scaled marketization and privatization in

dealing with the uncertainties of changing legal environments and the growing engagement of capital

internationalization I65]. For instance, the unprecedented capital stock markets in Beijing, Shanghai, and

Shenzhen have constantly pushed the state government for effective regulation against market failures and

malfeasances for greater reinforcement of innovative pro-business-minded legal codes j66]. Moreover, along

with Chinas rapid growth will come an increasing demand for formally defining property rights as well as

greater pressure to stretch informal "tosh," trust, and clan-like networks. Obviously, Boisot and Child were

unable to see all these developments when they were writing in 1996.

Boisot and Childs perception of formality could plausibly lead them to misinterpret informality and

its formation. Boisot and Child failed to see that the dynamics of Chinas informal sector has fashioned

and sustained through a reciprocal and concurrent process between informality and formality in a larger

institutional environment. Although Chinas non-state sector generated a tremendous momentum in

Chinas economy, its activism could be seen as legally (formally) instituted and socially (informally)

constructed. In their 1993 thesis, Qian and Xu understood this better than Boisot and Child. The

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reciprocal process of informality and formality reflected the interplay among Chinas local governments,

banking institutions, COEs, and the local communities, as well as among the private sectors within

China's changing legal system. The accompanying heuristic figure might help illustrate the dynamic

reciprocity (see Figure 3.22),

Figure 3.22: Social embeddedness of


non-state sector expansion in transitional China

Local community:
Non-state employment &
enterprises
(collectives)

Local government & Private:


banking institutions ---------------------------------- Rural cooperatives,
joint ventures, private firms,
& subcontracting (individuals)
Label:

Strong reciprocity (social trust relationship)


Moderate reciprocity (network relationship)
Less moderate support (hard budget constraints)
W eak response (hard budget constraints)

Points for illustration:

1. The momentum of the non-state sectors has been boosted by Chinas decentralization in M-Form
economy, regionally-based;
2. Heavy arrows indicate strong reciprocity (between local governments and communities) or inter
dependence (between private firms and local communities or C O Es and TVEs); solidarrows
indicate moderate or less moderate support (of local community for private sector or of
government for private sector); dashed arrows indicate weaker response of private sector to
governments and banking institutions due to their budget constraints hardening toward the private
sector);
3. The economic coordination is initiated and affected by
a. growing cohesion and reciprocity along with horizontal integration,
b. greater local feedback sustainability (earning returns, and growth),
c. reliable responses to adversity, shirk, breach, and risk diffusion;
d. assurance of contract stability (under the contract responsibility system"),

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e. hard budget constraints and financial planning based on convergent expectations, and
f. less externalities and environmental shocks.

Note: limited to the scope of this study, we might not want to go for more details elaborating this figure.

As we said in Chapter 2, the "secondary" or informal sectors identified by Nee and Stark referred to

the non-state sector including those urban COEs, rural TVEs, private enterprises, and joint ventures in

China's hybrid economy. In the early 1990s they were no longer viewed as secondary, but were now seen as

a primary source of Chinas G D P growth and industrial growth (Qian and Xu 1993a, 542). Along with Chinas

increased vertical integration and horizontal diversification, Chinas non-state sector continuously expended

in conjunction with widespread SOE's subsidiaries and their network affiliates, facilitated by regional

decentralization reforms. This kind of new development further strengthened Chinas hybrid economy starting

from the 1980s, involving an economic mix of both public and private properties. In time Chinas economic

hybridization brought changes in the formal sectors moving toward the rule of law. In turn, China's hybrid

structures were no longer treated just as "midway houses" alternative or perfunctory excuses for Chinas

resistance to its political and economic integration into the world economy.

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3.23 Limitations of Qian and Xus model

In contrast to Boisot and Child's focus on the primacy of informality, Qian and Xu noted the presence

of dynamic reciprocity between formality and informality. Qian and Xus informal sectors were almost

identical with non-state sectors, such as COEs, TVEs, and private enterprises, most of which were

concentrated at the local levels - villages, townships, and small cities. Qian and Xus formal sectors were

nearly identical with SOEs and were concentrated mainly on the mid- and large-sized cities. Qian and Xu

believed that the existing formal state structures in China could boost non-state sector initiatives f67]. As

Qian and Xu explained (1993, 548),

The Eastern European transitions have shown that the massive and fast privatization of
the state sector is rather costly. Given the initial condition of the M-form organization in
China, the evolutionary approach of developing the non-state sector is perhaps an easier
and less costly way at the initial stage of transition. Eventually, with the continuation of
this process, the state sector will be forced to share a minor role in the national economy.
Moreover, the rapid expansion of the non-state sector has important implications for
denationalization of state enterprises for further reforms in China: successful non-state
enterprises will eventually take over state enterprises.

In 1993 Qian and Xu suggested that Chinas state/hierarchies might contribute to the non-state

sector boom in particular in China through reducing central controls and promoting market activities.

Chinas decentralization reforms in an M-form hierarchy had created dynamic institutional environments

conducive to regional-specific triat-and-enror experiments. Chinas M-form economy might be seen as rational

in the sense that it could maximize the benefits of the reforms while minimizing the risks and the costs of the

limited numbers of bad performers. Yet Qian and Xu did not further elaborate how China could dynamically

fashion such a hierarchical form in the existing context. They left unexplained Chinas M-form hierarchy,

and treated it as a given condition. In 1999, Cao, Qian, and Weingast added a political logic, attributing

Chinas sticking to an M-form economy as a continuation of the states commitment to federalism,

Chinese style." In 1999, as SO E reforms loomed large, Cao, Qian, and Weingast put the boom of China's

non-state sector (mainly COEs and TVEs) under its hierarchical reform as a stopgap measure toward

formalized privatization of the SOEs I68].

But when we noted Boisot and Childs ignorance of the dynamic role of formal organization, we were

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referring that their view that Chinas transition was essentially not proactive. Chinas transition was once

thought as a strategic adjustment to the worldwide economic pressures (as emergent environmental

shocks). Today Chinas strategic adjustment is considered more pro-active with changes through

institutional reforms driven by social actors and devising institutional mutations evolving from China's

particular circumstances and contexts. Many of these strategic adjustments appear capable of sustaining

to Chinas momentum and upgrading its transition I69]. Mere normative adaptation to the changing

environment through, for example, trust relationships and networks, would not be sufficient to uphold a

structural transformation. For a transition has a lot to do with actors themselves as subjects in trust

relationships and networks and with their dynamic changes. In a genuine sense, a transition incarnates

and reflects the changes of institutions as social actors, insofar as the enactments of ftheirl socially

acceptable economic behaviors are concerned (the parlance is borrowed from Orrii, Biggart, and

Hamilton; brackets mine) [70]. In my analysis I will try to tap these actors and their proactive reforms in an

effort to account for Chinas transition [71J.

Many of the early institutional studies and the current institutional scholarship on transitions remain

vulnerable by ignoring the fact that transition involves the changes and mutations of institutions as actors.

Many ofthese early studies misinterpret cultural dynamics, separating them from the activism of social

actors. As M. Granovetter pinpointed (1992, 4-5),

These highly elliptical and often tautological culturalist and functionalist accounts become
superfluous once the social construction of institutions is properly understood" [72].

Another count is their misconstruction of institutional fitness. In comparison with the early institutional

studies on transitions, an intellectual progress made by the current institutional models is that both

institutional adaptation and institutional change are equally treated as indispensable for Chinas transition and

as inseparable. However, they do not explicitly theorize that: institutional adaptation and institutional changes

are indispensable prerequisite for each other. If the fitness or adaptation become lopsided and lack impulse

to drive the institutional changes, then the adaptation acts in a reverse way, entrenches institutional inertia,

and eventually contributes little to transition. Institutional adaptation can go in two opposite directions.

Overemphasis of the adaptation and the fitness could misguide people to overlook institutional reforms

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against institutional barriers [73]. Much of the current discourse on Chinas transition has justified the

institutional legitimacy of the transition or has confirmed the current regime of institutions (e.g., Boisot and

Child in 1996) or has justified the organizational fitness in the current regime (e.g., Qian and Xu in 1993).

Much of institutional discourse on Chinas transition had paid little attention to the institutional changes in a

dynamic way, driven by the social actors who made the changes and by the changes of social actors [74].

Although both institutional adaptations and institutional changes were assumed as complementary, it was

obvious among the current institutional models that Chinas transition was more institutional-conditions-driven

than institutional-actors-and-their-choices-driven. As it turned out, the transition was essentially treated as a

process of institutional adaptation separated from an enactment of institutional changes. More precisely, in

Boisot and Childs thesis in 1996, Chinas transition in terms of network switch (from fief type to clan type)

seemed a normative adaptation to Chinas changing environments. Path dependence (in terms of

background institutions and informal sectors) was overstated in account for the institutional dynamics driving

Chinas transition. In Qian and Xus thesis in 1993, institutional changes were credited to the fitness of

previous institutions (in terms of their M-form hierarchy) into the current regime so that that could justify its

social legitimacy (in terms of transition being initiated by Chinas existing regime) and make sure Chinas

transition as an incremental social evolution.

From our perspective, the fitness of the contemporary institutions is playing an active and

constructive role in generating impressive growth in China. In turn, the innovative institutions must retain

institutional fitness. As Aoki underscored in 1995, institutional fitness can help generate alternative strategies

for dealing with competitiveness across economies, as well as with the rountinization of rules, provisions, and

procedures regarding market firm performances and national developments [75]. I shall discuss some of these

matters in greater detail in the remaining sections of this chapter.

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3.24 Transition as social construction: Institutions as social actors

All three of the institutional models we have been critiquing more or less recognized the dynamic

roles of institutional environments and arrangements in effecting Chinas economic transition. But each

model had limitations. When Nee talked about rebuilding economic institutions, he did not note that the

pre-existing institutions from which new institutions were evolving had themselves been in transition. Nee

did not say much about the contradictory nature of these institutions. He did not mention that some of

these institutions could be active in Chinas rebuilding process, incubating institutional dynamics that

could drive Chinas transition forward. Boisot and Childs arguments of network adaptation were equally

vulnerable in terms of a passive or static nature [7S]. Boisot and Childs thesis essentially failed to specify

how Chinas network-typed regimes could effectively facilitate the additional flow of information and

transactions, except for looking at how Chinas information regimes in different time periods gained from

having thick personal connections or dense network relationships. One point made by R. Burt in 1992

was that a network might gather to itself as many redundant or wasteful connections as it could in order to

get access to information and power; and these redundant connections could impede the networks

performance.

How a network becomes efficient does not depend on its type, a thesis R. Burt explored; or its

density, as Boisot and Child assumed. It has a lot to do with the actors inside the network and how they

can become innovative and vigorous. Qian and Xu also did not ask why China could not boost its growth

and improve local initiatives prior to its transition, even when it had already strategically chosen the M-form

hierarchy. Obviously, the factors lowering or raising economic momentum do not come from hierarchical form

alone. Without sufficient account of social subjects, it might be hard for Qian and Xu to explain Chinas growth

and local initiatives during Chinas transition even in terms of Chinas M-form hierarchy and its

decentralization reform. Similarly, we could seriously challenge Boisot and Childs typology (i.e., information

matrix) of institutions in Chinas cultural space, since institutions (in terms of variously-typed networks) not

only demarcate the environments (in terms of the corresponding transacting governance regimes), but

also are designed by social actors [77J.

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Social actors are players in existing and newly emerging social and economic institutions and

organizations [78]. And the state institutions are certainly the first echelon of such critical actors [79]. Yet all

three institutional models we have been critiquing were inclined to attribute bureaucratic failures to the

state institutions, ignoring the dynamic roles these state institutions could and did play in Chinas

economic transition f80]. For instance, when Qian and Xu traced the path-dependent nature of Chinas M-

fonm hierarchy prior to the reform, they treated Chinas state institutions essentially as static, lifeless, and

disconnected. They tried to identify in this way what geo-political, ideological, or other sources generated

Chinas M-form economy. For example, they elaborated Maos unique strategy to deal with Chinas

hierarchical form before and after 1958. Unlike Boisot and Child, Qian and Xu did not perceive Chinas

hierarchy per se as changing over time. Qian and Xu conceived of the M-form economy as sui generis

persisting through the Cultural Revolution and Chinas subsequent transition [1]. In many ways Chinas

decentralization in its transition could be treated as an institutional mutant of Mao's decentralization under his

central planning regime. If Chinas hierarchy before Maos decentralization in 1958 was a non-M-form

hierarchy, it was certainly not a U-form hierarchy as were the hierarchies in the FSU and the FEE. And if

whatever was in China before 1958 did evolve into an M-form hierarchy, why and how did China achieve M-

form decentralization more successfully than any other nation did? While addressing the importance of these

M-form hierarchies in Chinas hybrid economy, Qian and Xu in 1993 failed to perceive the emerging

hybrid economy as the embodiment of the changing state. As the state role was taken for granted, the

discussion of its activism in transition was dismissed I82]. Albeit Qian and Xu acknowledged the boom of

the non-state sector and saw it as local-govemment-driven, they attributed it to the state governments

inability to exercise its control and thought it was induced by Chinas unique institutional environments under

M-form hierarchy. But if the state had no strong commitment to decentralization reform, how could the boom

of non-state sector be local-govemment-driven? And how could Chinas transition be sustained for so long,

especially when it involved a changing repertoire and the construction of complex institutional codes,

procedures, etc.?

Chinas fast growth was made possible because of its institutional learning experiences and trial-

and-enror experiments. But such learning experiences and experiments were launched and regulated by

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state institutions. Through decentralization and denationalization, China managed very rapid economic

growth for a span of virtually two decades. And both decentralization and denationalization were initiated

by the state relaxing its policies in order to boost local initiatives. On another level, without the states

commitment China's joining W TO would be unconceivable f 3]. Throughout Chinas transition, the state

has never taken a hands-off posture toward business and the economy. Government involvement has

always played an important role I84]. According to Boisot and Child,

The state has...played a far more directive role in the industrialization of countries such
as Japan and South Korea. China adds an interesting dimension, with its tiered system of
governmental involvement creating an interdependence of economy and polity down to
the bedrock of local communities. As Tu (1993) observed, this mixed pattern is neither a
socialist planned economy, nor a Western capitalist system (1996, 621).

Contrary to Boisot and Childs assumptions, however, Chinas current hands-on governance

accentuates the increasing activism of state-level bureaucratic formality as well as local-level hierarchical

informality I85]. In Chinas current transition the growing activism of the central government is blatant in many

key areas, including currency exchange rate and price control, allocation of the massive inflow of foreign

investment, population control, public expenditure on welfare programs, and current construction of the rule

of law, etc. The Chinese state is playing a major role in rationalizing Chinas economy to enable it to be

integrated with the world economy I86].

China in its early transition took decentralization and denationalization as its main method of

reform. Since the mid-1990s, particularly in conjunction with joining the W TO , China has speeded up

overall privatization. Cao and Qian et al. in 1999 noted the incentives derived from the states

commitment -- federalism, Chinese style in their vernacular. As Cao and Qian et al. stated,

Economists often assume that privatization programs result from an exogenous political
event, ignoring the issues of government incentives to initiate reform (ibid. 106).

Such a political logic is imperative to both decentralization and privatization I87]. Without the

states commitment, re-privatization would virtually be unconceivable in China, since that would require a

near-total reverse from Chinas-once-firmly-declared socialist road. Without the states commitment,

China could not have reached its current level of privatization (cf. Cao et al. 1999). The magnitude of the

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states commitment suggests how important state privatization is and has even prompted the state to

deliberate further its political reforms f88]. According to Cao and Qian et al. (1999, 125; emphasis and

brackets mine):

[Chinas] This pattern of reform also demonstrates a fundamental change in the role of the
central government before and after reform in China. Under Mao, the central government
forced all regions in the country to copy the same model, such as Qiliying Peoples
Commune of Henan province during collectivization in the 1950s and Dazhai Production
Brigade of Shanxi province for agricultural development in the 1960s and 1970s. This 'one
size fits all approach allowed no independent experimentation, no adaptation, and no local
government autonomy or choice. This approach to institutional change failed miserably. After
1978. reform took place within the framework of federalism. Chinese style. This system has
altered the roles of the central and local governments in fundamental wavs. First, in the
various reform episodes after 1978, the central government did not attempt to establish 'the
model of reform, let alone force local governments to copy it. Second, local governments
have had the authority to decide on the form and speed of the reform and to adapt reform to
local needs. Given hard budget constraints and an open economy, local governments cannot
afford to make big mistakes for an extended period of time.

Federalism, Chinese style, highlighted the state's commitment to institutional changes through

trial-and error experiments with the commitment left to local discretion through hard budget constraints.

However, in 1993 Qian and Xu perceived the state to be more an institutional barrier than a contributor to

decentralization and denationalization:

To avoid interfering with the normal operation of the economy, these regions should be
located outside the old industrial bases and far away from the central control, as was
done in China. Alternatively, after decentralization and deconcentration of the state
sector, the economy will be more suitable for local experiments (1993b, 158).

Because of their stance, Qian and Xu could not foresee even those regions with old industrial

bases and strong central control could pursue reforming experiments of their own. Shanghais transition

was living proof that a committed state could do a lot to assist reform. Qian and Xu recognized (cf. Qian

and Xu 1993b, 141) that Shanghai as Chinas economic hub used to be strongly controlled by the state in

implementing the central governments plans. And yet by 2002, under the states reforming policies,

Shanghai had become Chinas financial center with great discretion for the daily handling of colossal

(domestic and global) amounts of moving capital I89]. Seen in this light, Chinas state-led decentralization of

its M-form hierarchy allowed for semi-autonomy that boosted local initiatives that facilitated horizontal

competition, a non-state sector boom, and fast market expansion. All these in turn eventually prompted the

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privatization of the state sector.

At the same time many COEs and TVEs induced by state policies were already converting into

private enterprises. Many of the COEs and the TVEs, mainly smaller and not-very-large enterprises, had

been private enterprises since the early 1990s. Since then, these non-state sectors have been the primary

source of Chinas GDP growth (see Figure 2.23, Chapter 2). Had the state role been inept, Chinas hybrid

economy could never have expected such a turnaround. None of the three institutional models we have

examined predicted Chinas remarkable development. Even in 1996 Boisot and Child did not foretell, their

publishing year, the rush of SOEs to privatize (particularly those large-sized SOEs concentrated in big cities)

f90]. They could not foretell the expansion of private investment from overseas along with Chinas access to

the W T O I81]. Similarly, Qian and Xu in 1993 could not foresee the expansion of private enterprises and the

latest decline of the COEs or TVEs in Chinas economy after the mid-1990s (cf. Qian and Xu 1993a, 542;

1993b, 140). Many critics of Chinas transition, Nee in particular, were unable to recognize that the

momentum for China's reform came not only from the entrepreneurship of non-stated enterprises but also

from the entrepreneurship of larger state-owned enterprises f92]. Now both SOEs and non-SOEs made no

secret of their striding forward in tandem toward marketization and privatization I93]. The privatization of SOEs

entailed even stronger linkages for upgrading Chinas transition under the rule of law I94]. Large-businesses

were more concerned about business integrity and compliance with the regulations than were smaller

businesses f95].

In 1996 Boisot and Child predicted that SOEs would contribute less to Chinas economic transition

than would non-SOEs because non-SOEs operated more informally and therefore could more easily be

reformed. Boisot and Child did not anticipate that SOEs, recognizing their problems of formality, aggressively

adopted rational-legal reforms to enable themselves to participate in the transition I96]. All three institutional

models failed to recognize that it was just those existing problems in the SOEs that prompted their finding

their own solutions to their problems I97]. Since 1995, non-SOEs have aggressively adopted more legal-

rational arrangements; but the reformed SOEs have been in the drivers seat for transforming the entire

economy. The state was never a passive bystander, but instead it was a critical participatory actor.

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Reforms of the state sectors and reforms of the non-state sectors have proceeded at different paces.

In the early stages of transition, the reforms of the non-state sectors, such as the rural-industrial TVEs, went

first and faster than those of the state sectors. The early reforms were fragmented, fragile, and small, and

occurred primarily in secondary sectors throughout China. As the Household Responsibility System" was

carried out and agricultural productivity enhanced, the massive surplus of rural laborers flocked into cities and

townships, where they could find new lives with the spawning TVEs. Thus Chinas industrial structure

became more diversified than ever [98].The expansion of informal sectors and rural diversification in local

economies in turn boosted urban entrepreneurship, SOEs marketization, and even reforms in the state

hierarchies. Although Boisot and Child might insist that Chinas formality was still a far cry from Western

formality, they could not ignore the tendency in China toward increasing formality of both state and non-state

sectors under the rule of law ["].

In 1993 Qian and Xu suggested that through M-form decentralization reforms China could find some

way to avoid bureaucratic inertias and economic inefficiency. Later, in 1999, Cao, Qian, and Weingast

labeled this decentralization federalism, Chinese style (i.e., favoring local incentives and competition without

forfeiting central control). But could reform go further than decentralization? Here all three models failed to

see that more and more SOEs actually put their property rights into stock and equity markets in the forms of

IPOs, debt-equity swaps, buy-outs (merges and acquisitions - M&A), etc. All three models failed to

understand how Chinas marketization could become more complex in breadth and depth and could get such

paradoxical outcomes, such as massive layoffs alongside economic and bureaucratic streamlining (a result of

the state dropping inept enterprises and non-performing and badly-performing enterprises), during which the

state ownership devolve more and more on private investors and shareholders, domestic and overseas. As a

result, property rights in the state sector itself became further diversified, and Chinas ownership structure

became more ambiguous. And in this process Chinas transition became more innovative, resilient, and

dynamic.

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While exploring Chinas emerging hybrid economy as a strategy for changing ownership structure, all

three models overlooked the dynamic effects on both the state sectors and the non-state sectors of China's

economic scale. China relied primarily on large-sized SOEs to balance its development strategies and

receive cost advantages in its R&D programs, and attain other long-term goals without being derailed by

short-term interests and myopic trade-offs [100]. From the beginning of Chinas transition, Chinas elite

reformers used scales of economy as development strategy. These reformers felt that they might face a

predicament if they quickly dropped those non-performing and bad performing SOEs and things went wrong

(cf. S. Yusuf 1993). Many COEs and TVEs had actually been backed by large-sized SOEs for sustainable

growth and for access to resources, information, and technical personnel [101]. It would be risky to erode the

uptrend of the COEs and the TVEs quickly without the presence of the core SOEs. It was up to the state to

implement its desired balance in both promoting reasonable efficiency for robust growth and protecting the

vested interests of the state employment - preserving their status quo for the time being. The state would

rather protect its reforms from the worst scenarios of lopsided and vacillating choices ~ between promoting

growth and protecting vested interests that could bring instability to the economy.

The institutional discourse on Chinas transition has lately focused on the reforms of the local

SOEs, mainly medium-sized and small-sized SO Es (see our Table 2.42c, Chapter 2; cit. from Cao et al.

1999: Table 1, p. 108). According to federalism, Chinese style," the state promotes the local

governments with more incentives to improve their behavior and the performance of local SOEs. Hard

budget constraints on the local finance come into play as real economic mechanism operate through

state decentralization reforms so that the local enterprises have to perform better to compete in the

marketplace, when they can no longer rely on state subsidies. As Cao, Qian, and Weingast said in 1999

(122; emphasis mine),

The local governments decision about whether to privatize SO Es depends on its costs
and benefits. W e argue that the two factors discussed in the previous section have
changed many local governments calculation in favor of privatization. In other words, it
has become in the local governments own interests to privatize or restructure SOEs.
Harder budget constraints of local governments and increased competition from the non
state sector have made it increasingly costly to maintain these inefficient enterprises.

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Cao et al. recognized that keeping inefficient SOEs in operation cost Chinas economic transition

heavily, since it deterred the nationwide creation of new job opportunities and diverted the attention of local

governments from being good regulators of their local economies [102]. The opportunity cost were very high

for local governments to keep localized, smaller, and inefficient SOEs in operation [103]. The deterioration of

the SOEs' financial performance throughout China during the 1990s made their privatization an even

more pressing issue [104] (see following Table 3.24).

Table 3.24: State-owned industrial enterprises operating at a loss

1988 1989 1990 1991 1992 1993 1994 1995 1996

Share in number 0.12 0.16 0.32 0.30 0.25 0.30 0.33 0.34 0.38

Loss/after-tax 0.09 0.24 0.90 0.91 0.69 0.55 0.58 0.81 1.74
profit

Source: China Statistical Yearbook, 1996; A Statistical Survey o f China, 1993-1997; cit. from
Cao et al. 1999: Table 6, p. 122.

Competitive pressures for privatization had always existed in the marketplace. Concentrating on

hard budget constraints alone might not have been sufficient to explain how the local governments and

SO Es could change their institutional inertias and poorly-performing units. One needed to take an inside

look at local governments and inefficient SOEs [105J. But all three models in their institutional search fell short

of such an inside look. Nees analysis was more like ex ante prospective, and lacked consideration of the

given contexts and the preexisting conditions of Chinas transition [106]. Boisot and Child and QianandXus

analyses were more like ex post retrospectives or afterthoughts, and lacked any perspectiveon Chinas

future. It seemed hard for these models to address the issues in a panoramic way, integrative of retrospect

and prospect. Not until 1992 did Nee attempt to tap Chinas local and cultural heterogeneous complexities,

when he began to look at some new developments of Chinas transition. By then, Boisot and Child had

launched their search for the new economic order evolving from within China. And Qian and Xu seemed to

convey more practical sense than either Nee or Boisot and Child could have. As Qian and Xu saw it, any

transition of an erstwhile planned economy had to start from its own existing structure and move with feasible

and incremental institutional changes. They saw China steering a path toward market socialism, i.e., staying

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with its old socialist end, instead of addressing the transition as a mutant in a new orbit moving toward a

quasi-market economy.

In summary, this section criticizes the current institutional scholarship that treats institutions as

though they contained pure unconscious objectivity sui generis. All three institutional models we have

examined failed to capture the uptrend of Chinas privatization of its SOEs [107] and the growing salience of

bureaucratic formality in social construction of Chinas transition under the rule of law [108]. It is my hope that

the new institutional perspective I apply will cast additional light on how China has gained its institutional

dynamics in its economic transition.

3.25 Transition as historical derivative: Generality (convergence) vs. particularity (divergence)


across transitional economies

In the last section, we criticized three current institutional models, each of which failed to pay

sufficient attention to historical contexts and given circumstances [109]. Particularly in the case of China,

preexisting and existing institutions have no doubt left their heavy imprints on the minds of its reforming

planners and participants. China's transition raises both structural and piecemeal/incremental questions

n.

In explaining Chinas fast economic growth, all three of our institutional models identified two

main processes: a. the declining role of state sectors, and b. the expansion of market relations with the

world economy. One thing these models missed is a historical vista, a bigger picture, or a panorama. W e

have to give credit to all three models for trying to include historical dimensions in their explanations.

Chinas recent economic transition might have more to do with some internal mechanisms beyond

markets and hierarchies and beyond even some institutional conventions. This might particularly be the

case because of Chinas largely internal-demand-driven continental economy. A key explanation might be

rooted in Chinas history and social systems [111]. Some alternative factor or factors being capable of

supporting Chinas economic governance in transition and supplementing China's deficient market and

hierarchies" might have evolved from Chinas past. Boisot and Childs portrait of formality and informality

provided a possible alternative (1988, 526), when they attempted to identify an information matrix to

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explain the variations existing within the market and hierarchies continuum and beyond. But when

people probed more into Chinas history, society, and institutions, Boisot and Childs network-bound

hypothesis did not seem able to explain Chinas transition. Their information matrix of formality and

informality (or, formal rationality and substantive rationality) might prove to be too narrow.

In a relatively short time period, China engineered a structural transformation of its whole

spectrum of unfitted codes, rules, routines, procedures, and corporate structures, making Chinas

bureaucratic governance and legislative bodies more effective and flexible. As Qian and Xu and Boisot

and Child all noted, Chinas transition toward globalization demonstrated an array of institutional reforms

introduced into China's preexisting institutions. Chinas assimilating process incorporated historical

continuity [112].

Chinas social and economic transition as a development case cannot be separated from its

previous institutions. It has been true even when its previous state-led institutions were fraught with many

deficiencies that Komai and his associates as well as all three institutional models identified. One must go

back to the founding years of the PRC with its early attempts to integrate those scattered and fragmented

local industries left by the KMT government. Chinas new regime established those nascent national

standards and economic norms, national currency, integrative monetary system, and central financial

institutions. These central financial institutions included the Federal Reserves, the Customs, as well as

capital-intensive infrastructures like transportation and communication networks, as well as modem

education and health care systems, and other public services, such as the countrys R&D programs. All of

these institutions reflected Chinas early efforts at modernizing its economy [113].

Chinas TVEs and/or COEs that were driving Chinas hybrid economy until the early 1990s were

mainly the legacies of rural industrialization and the Peoples Commune System during the Great Leap

Forward in 1958-60 (cf. Nee 1992, 5) [114]. Transitions in Chinas rural private sectors could be thought of

as evolving from their early 1960s. Chinas rural private sectors were rejuvenated in response to the

failure of the Great Leap Forward in 1958, a peak year of the CCP's radicalism. Dynamic entities created

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during Chinas transition were joint ventures (JVs) mostly concentrating on the coastal areas. They took

shape because of an urgent need to attract advanced technologies and massive FDI into the target

industries. Chinas SO Es had prevailed during the two decades from the 1950s to the 1970s, the years of

Chinas Cultural Revolution (see Figure 2.23, Chapter 2). Most of the components of Chinas new social

and economic institutions established in transition were actually re-constructed by the changing state

institutions and co-opted with the features of the changing state sector. This process was endorsed by the

states Enterprise Law" that combined local activism with social embeddedness. Social embeddedness

referred to the process in historical continuity meshing old establishments with new establishments (as for

the social construction of non-state sector through social embeddedness, see above Figure 3.22 in this

chapter). Chinas use of embeddedness was never passive but always was active. It gave rise to a new

dynamic stream of market-oriented reforms in the 1990s, reforms that went much deeper than those in

the 1980s.

Based on its past experience, China might not want to develop an economic model universally

adaptable to all circumstances; nor might it want to develop a model grafted from other countries (e.g., an

Anglo-Saxon model or a Japanese model, or a Hungarian model, or any kind of Western capitalist model),

nor an indigenously-based model from Chinas past (such as the previous Da-zhai" model in Chinas

agriculture and Da-qing model in Chinas industry, popular before and during the Cultural Revolution) [115].

As Cao et al. in 1999 found, China now would rather adopt any model fitting in with its given local contexts

[116]. There is no general pro forma formula for efficient performance found yet to fill in all of Chinas local

niches and fully cover Chinas all these variations [117].

I like to argue that a sweeping efficiency concern was just the Achilles heel of the early scholarship

on transitions. Komai as well as Nee saw soft budgets as the major ill-fated practice in those former

planning economies. But their analyses stopped short of offering comparisons specific to local contexts and

institutional complexities. Komai proposed evocative prototypes of socialist systems" in 1992, based on

his formulations of general regularities" (pp. 15-6, 19). Yet such classified socialist systems appeared

problematic when the realities in socialist systems were not only far cry from the classic caliber of true

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socialism, as were their various transitions [118J. According to Komai and his associates, they would rather

consider it fruitful to take a more general approach than emphasize the uniqueness of each country,

society, and culture, and consider it futile to look for general regularities or the expression of general

historical laws (ibid. p. 4) [119]. As Komai said,

Let me begin...by taking an example: present-day C hina...M any researchers are studying
it, and every one of them feels how difficult it is to know and understand so vast, stratified,
and complex a country...1. The Communist party has been in power in China for more
than four decades. This has left its mark on all spheres of society, politics, and the
economy. 2. China is part of the 'Third Worid....3 . Geographically, China is part of Asia.
Numerous typically Asian attributes are therefore displayed in its history, its cultural
heritage, its religious and philosophical traditions, and its peoples way of life and relations
with one another. 4. Whereas the previous three points concern similarities that China
bears to the different groups of countries (other countries under the control of Communist
parties, other developing countries, and other Asian countries), there are many things in
which China is unique and cannot be compared with any other country. It differs in scale:
its more than one billion inhabitants make it the most populous country in the world. It has
a several-thousand-year-old culture, which was also the cradle of several other Asian
cultures. The history of China, like the history of any country, is unique, individual, and
markedly different from any other countrys. The same applies to the history of the last
decades, Mao-Zedong was not the same as Stalin or Tito, and Deng Xiaoping is not the
same as ...Mikhail Gorbachev. At every state, the policy of China has differed appreciably
from the policy pursued by any other country, socialist or otherwise (ibid. p. 3).

Komai maintained that although he would rather consider it fruitful to take a more general

approach, he also attempted to

eschew[s] single-factor explanations of any kind, deeming it decidedly necessary to make


a multicausal, multifactoral analysis of society. To build up a comprehensive picture of
China today and attempt an explanation of the existing situation and the developments
likely to emerge from it, one should consider all the factors listed above, plus a great
many features and influences that have not been mentioned (ibid. p. 4; brackets mine)

A more general approach required a structural and multicausal analysis. Komai went on:

Although the indispensability of mutifactoral analysis cannot be underlined too strongly, the
books attention will be confined nevertheless to a single group of factors: those covered by
the first point in the list [note: i.e., the factors on those generalities applied to all transitions].
The purpose is to study more closely the phenomena, causal relationships, and regularities
that are similar in China, the Soviet Union. North Korea. Yugoslavia, and in general all
countries where a Communist party was or still is in power. No one can argue...that this
method yields explanations for all the aspects of China or the Soviet Union or Albania. But
one can certainly say that identification of these similarities, kinships, and common
regularities can serve as an important analytical instrument (alongside other, eouallv useful
instruments) for studying these countries (ibid. brackets and emphasis mine).

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Despite adding some modifications, Komai remained overwhelming concerned about generalities

(or in Komas phrase common regularities") [120] (cf. Komai 1992, 3; Komai et al. 2001). Komai

recognized that general regularities could function only through the operations of particular mechanisms,

each of which was culturally bred, historically derived, and socially constructed (note: the formation of

Japanese kaisha inter-firm networks is based on uniquely Japanese horizontal-hierarchical relationships

[121]). W ere it not for these particular mechanisms, it would be hard to explain why transitional economies

had different outcomes and reform paces, and why they had diverse approaches, paths, and directions

[122]. It is evident that the so-called common regularities Kornai identified have not yet worked

consistently across the transitional realities in Russia, China, and other former planning economies.

Komai aroused much attention from the scholars of transitions and energized new research. This was

particularly true in the post-1989 era, when scholars had already become more attentive to those

variations. Rather than staying within the confines of neo-classic formulations to elaborate transitional

realities, sociologists searched for variables with greater explanatory power, while most economists failed

to apprehend more subtle variations, complex particularities, and causal relationships [123].

When transitions could be viewed according to their various processes, outcomes, paths,

approaches, and directions, they could be more appreciated in relation to their initial conditions and

strategic choices of institutions. As more details began to emerge, those earlier pro forma prescriptions in

healing the central planning economies might become obsolete. Komai and Nee raised some interesting

questions. People could now wonder if a reduction of bureaucratic size or central control [124] could really

induce economic efficiency and effective governance. If so, why did a great cut in bureaucratic size and

central control in the FSU and the FEE apparently generate a bureaucratic collapse and economic

depression rather than add momentum and streamline their economies [125]? Similarly, could privatization

alone bring greater economic efficiency and performance [126]? If so, how could one explain the indefinite

and inconsistent relationship between degrees of aggressive re-privatization and the respective GDP

performances in the FSU and the FEE (as shown in above Figure 2.12a, and Figure 1,2.1k, Table 1.2.1b

(2) in our Chapter 1) [127]? W hen privatization was introduced into all the erstwhile socialist economies,

how common and salient a role did privatization play in all these transitions? And how could the

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institutions other than property rights come into play in these transitions?

To answer these questions, scholars had to look at individual case rather than at pro forma

totalities responding to sweeping formulas because of their common regularities [128]. Boisot and Childs

model of Chinas cultural space exemplified an alternative economic configuration that differed from Whitleys

and Nee's models drawn from neo-classic economics and other Western models. According to Boisot and

Child,

...the assumed conjunction between market relations and capitalist (or at least non-state)
ownership, made by both Nee and Whitley and drawn from the Western model, does not
necessarily apply to China (Boisot and Child 1996,610).

In Whitley and Nee, the non-state sector was apt to marketize first because it was more closely

affiliated with private ownership than was the state sector. Thus privatization was assumed to be the ultimate

driving force for all transitions from planning economies. According to Boisot and Child, however, the

transition to capitalism was convertible into a matter of marketization in a way separate from privatization [12S].

At least in Chinas case, one might expect the privatization not to be a prerequisite to marketization. As Boisot

and Child argued, a more costly process of privatization would not be appreciated or expected in China.

China appears to show how a clan-based system of transactions can function successfully
based on a communal definition of property rights, rather than these being defined externally
and from above through a legal system that identifies property rights based on individual
ownership (cf. Boisot and Child 1996,623).

According to Boisot and Child, Chinas marketization or market transition could proceed in a separate

way from privatization or with lesser light on privatization [130]. As Boisot and Child (1996) reasoned, it is

implausible that Chinas transition would go through a stage of rational-legal bureaucracy in the Weberian

sense; it is instead plausible that Chinas marketization would evolve its own capitalist development path

different from the Western path. Boisot and Childs information matrix (of codification/diffusion) referred to a

network switch from iron laws of fie f to iron laws of clan. It suggested that Chinas transition had no

functional imperative for full privatization of ownership by way of a typical rational-legal bureaucracy, and so

on. Chinas structure of property rights and economic order are so deeply socially embedded that China will

need to proceed on its own path including its property rights and economic order [131]. Even though Boisot

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and Child were not ready to rebuff the mainstream perception that privatization through legal-rational

bureaucracy was an inherent attribute of capitalism, their assertion did send a clear signal. By mainstream

convention, privatization was neither an appendage to marketization nor a completely independent entity

apart from marketization. Privatization and marketization were not interchangeable terms for capitalism [132]. If

this indeed is true, then Chinas transition should not be forced into the trajectory of capitalist development

according to Western standards.

Privatization programs have been strongly recommended by the IMF as critical to the economic

recovery and capitalist development in indebted or debtor countries [133] as well as in transitional economies,

since supposedly it would make efficient market available for national development. W e could see such an

implicit recommendation in Nees model. Although Boisot and Child did not call for re-privatization to rebuild

China's economic institutions, their portrait of Chinas transition did not clarify their points about why Chinas

marketization could be separated from rational-legal-bureaucracy-based privatization and about why such a

separation was available in China. Tilings in China drastically changed after the mid-1990s from what Boisot

and Child had perceived in their 1996 article; and their prediction based on the earlier data could not cover

what happened after the mid-1990s. But more seriously what Boisot and Child lacked was a deep historical

vision of Chinas bureaucratic transition, and they neglected the role of the state in Chinas transition. Boisot

and Child recognized that non-state enterprises had flourished without a well-developed formal-legal frame of

property rights (also cf. Gelb et al. 1996; Pei 1996). They were unclear whether or not during Chinas

transition, Chinas bureaucracy could be rebuilt along with a formalized rational-legal framework. They also

did not make a further demarcation of the boundaries between Chinese communal property rights,

marketization, and privatization. They did not clarify how these boundaries were conflicting, separating,

overlapping, complementing, or coupling. Their presentation of Chinas bureaucratic regimes was descriptive

rather than explanatory. The problem for us is how to evaluate Boisot and Childs model of Chinas transition.

If we examine their model for Chinas transition, it is obviously inconsistent with Chinas development in the

latter 1990s, as China was proceeding toward privatization of the state sector in a socially embedded

manner. Boisot and Childs arguments might help us explore the nature of Chinas transition, so long as we

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are aware that the transition is occurring in a much bigger context than that covered by Boisot and Childs

thesis (e.g., including Chinas bureaucratic reforms in the mid- and late-1990s).

W e can discover similar weaknesses in Qian and Xus model of an M-form economy in China

contrasted with the U-form economies in the FSU and the FEE. Qian and Xu stated,

In those economies [of the FSU and the FEE] enterprises were highly specialized and their
sizes were extremely large (1993a, 544; brackets mine).

The U-form economy was designed to explore scale economies through technology
engineering and through specialization and division of labor. The U-form organization is
effective in mobilizing scarce resources and concentrating on a few high priority objectives.
Enterprises in the U-form economy consistently have the following three features: a large
scale of operation, a narrow scope of products, and a high degree of vertical integration.
This leads to two significant features of the U-form economy: a high degree of industrial
concentration and a high level of regional specialization (1993b, 148).

But Qian and Xus observations could counter some historical evidence. Many European economies

other than the FSU and FEE are also U-form economies, e.g., the Finnish economy includes industrial

behemoths concentrated mainly in the forest industry and in telecommunications such as Nokia. Compared

to the FSU and FEE economies, these economies have maintained moderate-fast growths during their same

time period. Furthermore, not all hierarchies in the FSU and FEE were U-form structures; some of them were

M-form structures. The boundaries between M-form and U-form hierarchies in the FSU and the FEE were not

straightforward or clear-cut. Selection of the economic strategy was left up to the given social ambiances and

historical circumstances. Although China organized M-form economy, its large sized SOEs shared the same

size and soft budget problems as the large scale operations in the U-form economies. But Chinas large

sized SO Es did matter to the states scale economies, especially concerning the states balanced strategy

and the cost advantages to the states R&D programs. In Chinas case, the U-form hierarchies and M-form

hierarchies were not incongruous but were complementary, providing strategic alternatives for developing a

national economy. Hence Qian and Xus elaborations that fewer larger sized SO Es in China than in the

FSU and the FEEs did not provide a sufficient explanation for Chinas fast growth. Hierarchical form does

not hold the key for explaining Chinas institutional dynamics. In 1999 Cao et al. pointed out that Chinas

largest privatized SO Es were becoming a dynamic force driving Chinas institutional reforms and

ultimately its transition (1999, 125). Previously Chinas decentralization reform and privatization had not

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been in synch. In the end, privatization might replace decentralization [134]. But whether or not this

happens will become apparent only with the passage of time.

In summary, this section has addressed three flawed institutional models of Chinas economic

transition. Some of the flaws were similar to the flaws of historical amnesia associated with neo-dassic

economics [135].

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3.3 Summary of the shortcomings of the three institutional models

In this chapter, we have examined three institutional models with their alternative theses for

rebuilding Chinas social and economic institutions. Qian and Xu recommend reform through hierarchical

decentralization reform (e.g., China and Hungary in the 1980s). Boisot and Child recommend network

transformation (in East Asia and China). Nee recommends market-oriented re-privatization (e.g., in the FEE

and the FSU). The different recommendations underscore different interpretations of what has been

happening in China and why. Each model has been built on its own institutional thesis and particular strategy

for rebuilding institutions in Chinas economic transition. Yet each model is more ore less vulnerable to the

lack of historical consciousness of Chinas transition. Like Komai, Nee was preoccupied with efficiency

concern and market competition. Boisot and Child, and Qian and Xu identified other institutional mechanisms

they considered conducive to transition. Both Boisot and Child and Qian and Xu started their theses on

Chinas transition from how to appreciate a social fact that it has an administration system much stronger

than its legal system. Boisot and Child searched its institutional dynamics from the outside of market-

hierarchy relations, whereas Qian and Xu found Chinas institutional dynamics from its hierarchical form. In

Qian and Xu, Chinas administration system was better than its legal system; or, it could assume a surrogate

role in place of its legal system. No doubt, all these new searches of institutional dynamics brought a new

dimension into studying Chinas transition. But they fell short of referencing any existent institution and

institutional change to its own genesis, progress, and contextual factors. Thus what important is not which

particular institutional thesis, hierarchy or network, would be better to serve illumination as such. For an

institution and its change are time- and space-specific, and are available through its social embeddedness,

social construction, associated with social expectations. The intrinsically historically-specific nature of

institutions jettisons simple reductionism or economic determinism that takes efficiency and market

competition for granted or as a panacea for healing ailing planned economies. This further clarifies that

efficiency can never be taken for granted or even considered as the singular criterion for success or failure,

because means (alternative choices) and ends (efficiency) have to interplay in the same structure [136].

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In the last sections of this chapter, I particularly explored a socially constructive perspective and an

historical derived perspective on Chinas transition. I would like now explore briefly the dialectics between

social construction and historical derivation in analyzing China's transition. Comparison can be made

between institutional homogeneity vs. heterogeneity, institutional convergence vs. divergence, and

institutional endogeny (dilemma as diversity) vs. exogeny (dilemma as contradiction) across economies and

within [1cl']. The categories of endogeny vs. exogeny in use here might refer to the selective process of

alternative strategies [13u], Such an institutionally-based historical comparison might be formulated in the

following way:

First is about institutional fitness into such a historical process of social construction. Some

institutionalists (e.g., R. Scott 1995) declare that each institution occupies a unique structural niche or perch

in every society. However, the structures of institutions vary over time and are specific to given

circumstances. For instance, in the social construction of a transition, economic coordination and social

cohesion are crucial to economic governance and the improvement of efficiency. But corporate structures

and their effectiveness vary across societies. And the structural attributes of the institutions cannot be

separated from the intrinsic idiosyncrasies of the economic players, which are historically specific. For

example, economic players typically draw their expectations from certain historical contexts, related to larger

environments, and from their own experiences, related to those of their predecessors and of previous

generations. The effectiveness of corporate structures cannot be separated from the collective expectations

of an ensemble of these players and agencies living and working in their historical circumstances [139]. Their

corporate effectiveness could further be appraised by requiring their economic efficiency and organizational

effectiveness to dovetail with the social expectations of multiple players including individual members,

agencies, organizations, and institutions, all of which are relevant social actors in given cultural ambiances

and historical circumstances. Corporate effectiveness is essentially socially constructed and historically

derived.

Second is about social embeddedness consistent with such a historical process of social

construction. Social embeddedness concerns the degree of social cohesion of institutions and the patterns

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by co-opted institutions as their economic systems and characteristics are integrated into society. All of these

patterns are in constant change, in fact now they are putatively moving toward integration into the global

community. Yet given the perspective of historical institutionalism, this pro forma globalization poses its own

dilemmas. The considerable variability of institutions severely limits their standardization across economies

and over times. Any country could even contest through public discourse the pro forma assumptions of

globalization and could claim that in its case a particular one or more of its institutions challenged the

globalization model.

At this point I would like to introduce a third theorem: that institutional divergence (variations)

ought to be concurrent with institutional convergence (complementarity). I do not find any kind of

dilemma or oxymoron in the conjunction of divergence and convergence. Historical dialectics allow one to

treat institutions as both deviant from each other and complementary to each other, rather than contradictory.

Historical dialectics can present the whole complexion of institutions associated with an ensemble of

complexities between divergence and convergence. Historical dialectics lead us to propose institutional

comparability across economies and societies. But to understand such comparability, one needs to recognize

dialectical nature of socially constructed institutions.

The institutions effective in particular contexts cannot be judged merely as dichotomous to or

antagonistic to each other. This feature is discernible in the influence of one institution on another

institution (cf. R. Whitley 1992, 1994). Institutional isomorphism is undeniable; change comes from other

institutions inside the sam e social structure or from outside institutions in the larger environments. In

reality this just reflects a process of institutional learning through error-trial experiments that can generate

institutional reforms and changes. And institutional learning itself epitomizes a kind of organizational

activism to adopt different and possibly more innovative forms of institutions (cf. R. Axelrod1984).

Institutional complementarity essentially echoes historical derivation of institutions and thus historical

disparity of institutions. Institutional convergence and historical divergence run in couples. Each institution

has its own distinctive characteristics drawn on its own social system, economic organization, and

characteristic cultural practices. Such a dialectic epistemology is contrary to the neo-classic reductionism

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in favor of perfect market competition and uni-dimensional market transition. Such a dialectic

epistemology can not only overhaul institutional establishments and their key features, but also ask where

they have come from, how they have shaped in their social surroundings, and what effective mutants they

may have bred. In the case of transition, we could examine how institutions and organizations frame their

subsequent expectations and pattern their behaviors in ways that they might prompt institutional reforms

and changes.

W e could further envision such dialectics in institutional non-reversibility vs. transferability among

different economic and social systems. Given corporate structures as a variable across economies and

societies, one might wonder whether and to which extent an effective business system in its given context

could be successfully transplanted and inserted into another different context. To what extent can such

transplants or insertions happen, and can they happen to an entire economy, to a particular sector of the

economy, to some industries within the economy? For instance, why have some partial practices or

operations of Japanese systems been effectively transplanted into their counterparts in the US and the

Britain, but not vice versa? In our study, one can ask is how Russian transition is incompatible with the

Chinese one and to what extent they are incompatible. W e want to know what specific conditions or

determinants facilitate and constrain such institutional isomorphism. These questions all spark new searches,

looking into feasible strategies of business operations and management and government practices extending

across different economies. Thus they open a new chapter for an inquiry into both market economies and

transitional economies and how they relate to each other.

In this regard, Whitleys studies in 1992 and 1994 were quite informative. Whitley compared the

natures, the economic institutions, and the organizations of business systems in Europe and East Asia.

He asked how institutions, established in pre-industrialization periods, evolved with industrialization,

generating their links with political and social norms and expectations, and with their public commitment

to changes in the business community and in their social environments. He inquired how they could make

successes through their economic coordination and cooperation, and how they could do this in the face of

external exigencies, such as wars, international pressures, and other shocks, e.g., productivity shocks

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(also cf. Aoki 1996), etc. All these factors make the institutions more appreciated as regulator and

facilitator of competition [140].

A dynamic account of Chinas transition might need to recognize its social construction in such a

dialectic way that could dovetail with its historical contexts; namely, its social construction could be thought of

as being historical derived. First, such a social construction does happen in a special time period. It does not

happen at one stroke and follow a reverse way or topsy-turvy logic. A transition can be either incremental or

radical, though. Each institutional arrangement in a transition can be considered as temporal and historically

specific. Long time periods and repeated practice have had profound impacts on the social actors in the

current transition. Our historical institutional perspective enables us to compare variations of institutional

arrangements and environments across territories and overtime, whilst addressing the comparability not only

of their disparities, but also of their similarities across these territories in terms of economic structures and

social cohesions [141]. Here again, such an institutional-based historical comparison might encounter

reductionism in the neo-classic economics. But our approach to transition essentially underscores an

institutional demarcation of hierarchy-market relations, through sets of institutional parameters drawn on

certain social expectations and affiliated with social relations drawn on given historical circumstances. Thus

the causal linkage of institutional changes ought to be traceable to the changing social expectations and

relations, in which a transitional economic system is embedded [142].

This chapter underlines that our search needs to start from where all three institutional models were

inadequate. It is imperative to bring more social dimensions into our institutionally-based historical

comparison. W e shall in the next chapter extend our interrogation to include three more sociological

dimensions, social expectation (as subjectivity and rationality), history (as spatio-temporal factors), and

institutions (as institutional pre-conditions and changes) as dynamic sources of change. Ultimately we shall

combine them to theorize about transitions.

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Endnotes of Chapter 3:

1. cf. Far from Beijing, a semblance of democracy by Elisabeth Rosenthal in The N ew York Times, A3,
Fri. March 8, 2002: ...A s China now convenes its legislature, the National People's Congress, it is clear
that the pyramid of local congresses that underlies the national body is changing, becoming more
responsive to popular sentiment, if still far from democratic. The congresses at provincial and local levels
have become increasingly activist since new laws expanded their powers a decade ago. Today, in many
places, they are reinventing themselves as agents of change or at least guardians of good government.
'Ten years ago, whatever the local government submitted to us we would approve, said Li Yujing, deputy
secretary general of the standing committee of the powerful Guangdong Peoples Congress, which has
led the change. 'Even if we saw great need for a certain type of legislation, all we did was wait. 'N ow not
only do we review laws, weve started to write laws on our own. W e call in outside experts. W e hold open
hearings. W e demand to see budgets. Some modest advances nonetheless represent a big change in
China. While the Peoples Congresses have long been charged with government oversight, in practice
they inevitably served as applause machines for the party-controlled government. 'The major function of
the invigorated provincial Peoples Congresses - and it is an important one - is monitoring the provincial
governments, wrote Roderick MacFarquhar of Harvard, an expert on Chinese politics. 'Politically it acts
as a brake on the untrammeled power of the provincial government. The results are particularly obvious
in Guangdong where, among other triumphs, the Peoples Congress recently forced the provincial
government to reverse a rise in the price of drinking water and demanded the resignation of powerful
officials in the environmental protection office for their failure to close polluting factories...In Guangdong
Province, where the vast majority of the 775 delegates are also party members, candidates can be
nominated by the party, by other 'authorized social groups or by more than 10 members of country
congresses. In general, delegates represent interest groups rather than places: in Guangdong, 36
percent represent workers, peasants and other laborers, 21 percent represent the interests of Communist
Party cadres, 22 percent represent intellectuals, and so on.

2. cf. China likely to see economy expand 7.7%" by James Kynge in Beijing in Financial Times, p.2,
Weekend, June 3 /4 ,2 0 0 0 : ...Despite the continued structural inefficiencies in the economy, there is no
doubt that China has made progress over the past two years in crucial reforms toward some 300,000
state-owned enterprises. The dynamic private sector is also emerging at a relatively rapid rate, a factor
that may raise the aggregate efficiency of the economy in coming years.

3. Such as AIDS drugs that would require massive capital investment in doing research. If research funds
and resources are fully controlled by few private enterprises that want to m ake considerable profits, then,
these private enterprises could tend to manipulate the medicine price, and that would make the A IDS
drugs unaffordable to those ordinary patients. In this matter, therefore, China has recently planned to
treat making of AIDS drugs and related research programs as public goods, avoiding or rejecting the
approach of privatization. That is, making of drugs is publicly allowed to be copied (in terms of generic) in
order to be sold cheaper to the unlimited users, cf. China opens door to generic drugs to counter A ID S
by Leslie Chang in The Wall Street Journal, A12, Mon. Sept. 9, 2002 (emphasis mine): Beijing - China
could soon permit generic production of AIDS drugs, showing the nation is waking up to the urgency of a
burgeoning epidemic that government estimates has infected about one million people. At a news
conference Friday, Qi Xiaoqiu, director-general of the department of disease control at the Ministry of
Health, said the government was lobbying multinational drug makers to lower the prices of patented drugs
that can slow the spread of HIV, the virus that causes AIDS. But if the talk dont bear fruit 'by the end of
the year or early next year, he said, China would change tack and start granting license for local drug
firms to manufacture and sell the medicines far more cheaply, though in violation of the companies
patents. 'W e would like to do as Brazil and India have done, to have compulsory license so the drugs can
be much cheaper, Mr. Qi said. He also noted Chinas international agreement to protect intellectual
property, but added: 'W e feel that any government must be responsible when peoples lives, health and
interests are concerned. The W TO , in which China recently became a member, allows countries to
bypass patents and manufacture generic version of patented drugs in case of national health
emergencies. For years, Chinese officials denied the seriousness of A ID S in China, even as its main
victims - poor rural dwellers who contracted the virus either through sharing needles of selling blood to
unsanitary blood stations - began to sicken and die with little recourse. Seeking a cheaper drug supply is

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in some ways the easiest part, compared with politically sensitive or logistically difficult tasks like
implementing school sex-education programs or working with such high-risk groups as prostitutes and
drug users...

In my view, some other areas that similarly need the state governments help to cover most associated
expenses, such as of insurance protection, which are unaffordable to private sectors, are environmental
shocks, disasters, and wars. cf. America uncovered - Congresss failure to end the deadlock on
terrorism insurance could cost the couniry dear by David Hale in Financial Times, p. 11, Thurs. Sept. 12,
2002 (emphasis mine): ...The US is unusual among the leading industrial nations in having no coherent
government policy to help the private sector insure against terrorism. Most insurance companies have
suspended all coverage for terrorism unless their clients buy a policy specifically focused on that risk.
Such policies are usually far more expensive and restrictive than previous policies. If there were another
attack, it is likely that there would be no significant insurance overage for either the destruction of property
or the cost of business disruption. The Bush administration recognized the need for the government to
play a grater role in insuring against terrorism risk last October. It proposed to congress that the
government would help to cover 80% of the cost of terrorist attacks after the first $1 Obn of losses: the
private sector would cover the remaining 20% . The House voted to lend insurance companies money to
cover their losses after the first $1bn. The Senate followed the original White House plan. Despite the
differences there was strong support for government intervention until the issue reached an impasse over
the question of tort - or litigation - reform. The House Republicans want to limit the ability of tort lawyers
to sue both the government and the private sector for punitive damages resulting from terrorists' attacks.
Senate Democrats, by contrast, will accept some protection for the government in punitive damage cases
but not the private sector - Democrats do not want to accept constraints on punitive damages because
they depend heavily upon the tort lawyers for campaign contributions. It is a remarkable commentary on
the power of US litigation lawyers that they have been able to delay development of an effective policy for
insuring against terrorism risk. The insurance industry needs help because the high cost of September 11
and the falling stock market have produced a huge decline in its policyholder surplus: the surplus fell by
$18bn during 2000 because of the equity market and has fallen another $40bn because of September 11.
The surplus could easily decline again this year because of the lagged costs of September 11 and the big
losses that insurance companies are experiencing on their portfolios of both equities ($155bn) and bonds
($519bn). As a result, there is only $80bn of capital left to support commercial risk exposure. The industry
has announced big price increases during the past nine months in order to restore its financial health. In
modem times, property/casualty insurance premiums have fluctuated between 3% and 4% of gross
domestic product. Between 1999 and 2001, they were just over 3% of GDP. If the industry is to restore its
balance sheet strength, premiums will probably have to rise back to at least 4% of GDP - close to
$400bn, compared with $3Q0bn last year...There is no simple way for American politicians to resolve this
conflict because of its links to the much bigger political issue of tort reform. But they are still likely to
compromise, for one simple reason. If there were another terrorist attack that produced losses on the
scale of the World Trade Center, the country would hold Congress responsible for the fact that very few
would have any insurance protection."

4. See a report by Foo Choy Peng in Shanghai and Christine Chan in Southern China Morning Post,
Wednesday, July 21, 1999: a recent party internal document about SOE reform declares that the listed
companies for privatization and going to stock markets (i.e.. a handful of the 900-odd companies listed on the
Shanghai and Shenzhen stock exchanges) do not include those strategic industries of public goods and
defense industries. Overseas listed state-owned firms are also not included in the list.

Even in the West today, all-round privatization is not unproblematic, cf. British reopening the debate over
privatization - Energy losses lead some to ask if business can do everything better. Picture illustration: A
British Nuclear Fuels installation in Cumbria, in northwestern England. Some of that companys reactor
contracts could be transferred as part of an effort to bolster the finances of the struggling British Energy by
Suzanne Kapner in The N ew York Times, Thurs. Aug. 2 9 ,2 0 0 2 (emphasis mine): London, Aug. 28 - Sizable
losses by one of Britains largest nuclear power companies have reopened debate here over the limits of
privatization. The company, British Energy, is the latest example of the problems Britain has had with its
privatization program. Facing declining energy prices and tough regulations, British Energy has lost millions in

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the last two years. Last October, the Railtrack Group, which owns the nations railroad tracks, signals and
stations, was declared insolvent and effectively re-nationalized through a public-private partnership. In
addition, the former air traffic control monopoly has struggled since it was privatized last year. In the 1980's
under Prime Minister Margaret Thatcher, Britain started turning state-owned entities into private companies,
often by selling shares to the public. Private business, the thinking went, would be more efficient than the
government at running businesses and providing services, and opening industries to competition seemed like
the ideal way to pass savings on to consumers. Analysts say that for the most part, that thinking holds true.
They maintain that most of Britain's privatized industries - ranging from telecommunications to coal and steel
- have worked. But they also say that the recent trouble underscores important lessons that will serve as a
bellwether not just for Britain, but for other European countries in the process of privatizing their industries.
'W e ve learned that not everything is right for privatization, said Philip Collins, director of the Social Market
Foundation, a research institute here. For British Energy, which was privatized in 1996 and produces 230% of
the countrys electricity, the limits came largely in the form of regulation that put nuclear generating
companies at a disadvantage to other energy producers. Nuclear plant owners are required to pay a share of
a climate control tax intended to limit cartxjn dioxide emissions, even though they do not produce the gas.
And they also pay higher rates on property leases than fossil-fuel plants do. British Energy has been lobbying
for exemption from the tax and for revised property rates, which if changed could result in savings of 100m
(about $154m) a year, analysts said. Partly as a result of these restrictions, British Energy is losing money at
its eight plants in Britain. Over all, the company lost 39m ($59.9m) in the most recent fiscal year, after losses
of 23m the year before. The financial situation took on fresh urgency this week, when the company shut
down two reactors in Scotland after problems with gas circulators were discovered. Two other plants in
England are closed for scheduled maintenance. The total cost of the shutdowns could approach 80m, the
company said, though insurance will probably pay some of it. Such losses are unsustainable, analysts said,
especially if British Energy is to put away enough money to shoulder the cost, estimated at 14bn over the
next 15 years, of taking older plants off line. The problems at British Energy come amid a broad review of the
nations energy policy. Although electricity prices initially fell sharply, recent results have been mixed. A report
by Credit Suisse First Boston estimates that since 2000. wholesale electricity prices, the prices at which
British Enemy sells its power, have dropped 36%. vet domestic retail prices remain flat - a poor scorecard for
a free-market system that is supposed to benefit consumers. Advocates of privatization said there was
typically a lag between changes in wholesale and retail prices. But even free-market advocates agreed that
the government would probably have to act if British Energy was to remain solvent. Analysts said
renationalizing the company would be an embarrassment, particularly after the Railtrack debacle. But there
are less direct ways the government can help. One option is to transfer some reactor contracts from another
company, British Nuclear Fuels, to British Energy, bolstering its revenue. The two companies said they were
discussing such a proposal. But if wholesale electricity prices remain low, additional steps may be needed.
'Its almost inconceivable that the government would let British Energy go into receivership, Roger Reynolds
of Credit Suisse First Boston said. Eamonn Butler, director of the Adam Smith Institute, said that for free-
market advocates, the solution is to limit politicians involvement. But for others, issues of free markets are
inextricable form matters of social justice. 'Whose responsibility is it when a commercial company doesnt
provide for things that are socially necessary in the public realm? Mr. Collins of the Social Market Foundation
asked. Where there are public goods at stake, a private market on its own hasn't delivered. He and others
suggest that the solution lies in public-private partnerships, like the model being tested with the railway
system. In such a case, the company remains private, but the money it earns is put back into the services it
provides. The Railtrack model is being scrutinized, analysts said, by Germany and the Netherlands, both of
which are restructuring their rail systems. Still, there is no guarantee that joint ownership will work. Mr. Collins
said, mainly because it removes a pillar of free-market efficiency - the threat of bankruptcy."

5. cf. Chinas star rises - The countrys economy is growing strongly again and there are signs that
structural reforms will help to sustain the recovery by James Kynge in Financial Times, p. 16, Tues. July
25, 2000: W hen China sneezes, Asia catches a cold...The last time the worlds most populous nation
entered a new growth cycle was in the early 1990s. That boom, which lasted until 1996, was powerful
enough to help drive vibrant growth throughout the region. Some economists believe that history may be
about to repeat itself. Fund managers have begun to increase Hong Kongs weighting in regional
portfolios, and the search is on for credible stocks with exposure to growth in mainland China. 'The bull
case for Asia is at present more soundly based on China than Japan, says Christopher Wood, chief

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global emerging markets strategist at ABN Amro Asia. 'China is looking better than at any time since the
early 1990s."

6. cf. Barry Bluestones presentation in UW-Madison, Sociology Dept., Feb. 7, 2002. Bluestone
mentioned economic redundancy very often indispensable to the m aiket economies.

7. cf. Worlds big banks weigh taking small China stakes - Investing offers scant control but builds
relationships with local regulators" by Karby Leggett in The Wall Street Journal, A15, Tues. Dec. 11,
2001: ...Chinese bank regulators have long been wary of allowing foreign investors into an industry
considered central to economic security. Foreign banks in China face a slew of restrictions ranging from
where they can open branches to capital controls and the clients they are allowed to serve. But Chinas
membership in the W TO , which will phase out all restrictions on foreign banks operations in China over
the next five years, is starting to change that.

Also cf. China begins career as a W T O member - Pacts stipulations offer cover to reformers; state
interests linger* by Peter Wonacott in The W all Street Journal, A14, Tues. Dec. 11, 2001: Chinas W T O
entry wont force Beijing to abandon its strategy of backing favorites altogether. At a weekend
government conference, Vice Premier Wu Bangguo said China would help 50 state-owned giants to fend
off foreign competition in such sectors as petrochemicals and telecommunications..."

8. Ibid, "I outline a political cultural approach and I use the metaphor 'markets as politics to discuss how
these social structures come into existence, produce stable worlds, and are transformed.

9. For instance, SOEs have political leverage in competition. Hence, as Fligstein emphasizes (ibid), firm
competition is an issue of political economy.

10. cf. Fligstein 1996, pp. 656-7: These latter perspectives have been buttressed by studies on comparative
industrial organization (Hamilton and Biggart 1988; Chandler 1990; Gerlach 1992) that show how state-firm
interactions in various societies have produced unique cultures of production. Industrial countries are not
converging toward a single form (Fligstein and Freeland 1995). Instead a plurality of social relations has been
observed that structure markets within and across societies. These observations have challenged the
neoclassical economists' view that markets select efficient forms which, over time, converge to a single form."

11. cf. "China's Leaders Face "Grim Reality of Skidding Economy" by James Cox in USA Today, 5B,
Monday, August 10,1998: "by sliding exports and consumption, China is pulling back on its drive to downsize
unprofitable state-owned companies, privatize housing, clean up banks and cut government by half...They're
facing a grim reality. They have no choice but to slow down their ambitious reform program and pump in
more (government) money to heat up the economy...Beijing worries that the economy is not growing fast
enough to absorb state sector employees being laid off as a result of its reforms...The government has
responded by easing pressure on state firms to fire unneeded workers and on banks to stop lending to
money-losing state companies. Plans to eliminate housing subsidies by raising rents and encouraging
occupants to buy their apartments have been delayed indefinitely. Top leaders say the economy must hang
on at an 8% growth rate to avoid the risk of widespread unrest among growing legions of unemployed
Chinese. The plan: prime the pump by accelerating a three-year, $750 billion infrastructure program that will
pour billions into bridges, roads, dams and power piants.Jntemal wrangling has stalled Premier Zhu Rongji's
campaign to cut up 4 million civil servants nationwide, combine ministries, and split the business interests and
administrative functions of government branches."

12. cf. Qian and Xu 1993, p. 154.

13. Ibid Chapter 9 Can Privatization Solve the Problem of Soft Budget Constraint? - 'M onetary vs.
'R e a l Perspectives on East European Reforms.

14. See a recent case of K-marts bankruptcy protected by the U S legal system, cf. Kmarts directors
back Chapter 11 filing - action in Bankruptcy Court, possible today, to follow curbs from key suppliers by

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The Wall Street Journal staff reporters Mitchell Pacelle, Amy Merrick and Scott Kilman in The Wall Street
Journal, A3, Tues. Jan. 22, 2002: Crippled by a dismal holiday seasons and halts in shipments from key
vendors, Kmart Corp. is expected to file as soon as today for bankruptcy-court protection, people familiar
with the situation said. The board of the nations No. 2 discount retailer authorized the filing in a meeting
late yesterday afternoon, after efforts to secure bailout funding from its bankers fizzled, these people said.
The discounter is expected to use the process of filling under Chapter 11 of the US Bankruptcy Code to
shut down underperforming stores and restructure about $4.7bn in debt...The Chapter 11 process gives
troubled companies a temporary reprieve from creditors so that they can devise a plan to restructure.
Kmart was in negotiations yesterday afternoon to secure as much as $2bn in debtor possession financing
from a group of lenders including J.P. Morgan Chase & Co., Fleet Boston Financial Corp., and General
Electric Co., according to someone familiar with the situation. Such financing, which is senior to most of
the companys other debts, will enable it to continue operating in bankruptcy court. A provision of
bankruptcy law that will be especially helpful to Kmart is a formula that sets a ceiling on the liability to
debtor companies for walking away from real-estate leases. A slew of movie-theater companies used the
Chapter 11 process to dump their weakest leased theaters. Analysts believe Kmart needs to close as
many as 500 underperforming stores, about 25% of the total chain...Under Chapter 11 protection, Kmart
is expected to shut down other underperforming stores. Under bankruptcy law, Kmarts liabilities will be
capped at the greater of either one years rent or 15% of the remaining rent for a maximum of three years.
O f utmost importance is that Kmart keep its shelves stocked. Nothing in the law stops Kmarts suppliers
from halting shipments, but bankruptcy court does give vendors some incentives to keep shipping. For
instance, vendors who ship after the filing receive priority-payment status. Because the primary purpose
of Chapter 11 filing is to keep a company operating while it reorganizes its debts, both the judge and the
company typically strive to avoid alienating customers and hereby damaging the franchise. In the case of
Kmart, it is so large a customer that most suppliers will want to keep its business. It accounts for about
25% of Flemings revenue, for example..."

15. Ibid, p. 128: "...Where the leadership exercises these opportunities by permitting slack and indulging
in corporate personal consumption, size limitations necessarily follow - especially if lower-level
performance varies directly with higher-level example, which normally is to be expected."

16. cf. Tiger China pussyfoots around growth by John Thornhill in Financial Times, p. 28, June 3, 2002
(emphasis mine): ...Chinas growth rates - unlike most of those in south-east Asia - have been boosted
by large-scale government spending during the past five years. There is also a huge amount of off-
balance-sheet funding that has bolstered parts of the economy. CLSA, the international investment bank,
has calculated that China's true public debt to gross domestic product ratio is 139% - rather than the
23% publicly stated - once the state-owned banks and companies debts and obligations are taken into
account. This may not be a problem if the economy continues to expand at a reasonable rate but it could
crush the economy, if growth stalls. In any event, it is clear that much of the countrys capital spending
has been wasted. While Chinas investment rate of 40% of G D P produces economic growth of 7% a year.
Indias investment rate of 25% generates G D P growth of 5% . Is there, in fact, something fundamentally
flawed with the Chinese economy, which is impeding faster growth? But my argument is that the
question here might not reside in the states large-scale government spending per se but in that how the
state could properly treat its large-scale government spending. To my understanding, the right question
here ought to be: is such large-scale spending wasteful to sack Chinas economy or indispensable to
transform the economy in a way of sustaining faster growth rate than its Indian counterpart. A fact facing
Chinas economic transition, as John Thornhill correctly pointed out, was that it is also [an economy]
moving from a planned economy to a market economy. This is a negative constraint on growth and that
massive, state-owned enterprises need to restructure their entire businesses without sacking millions of
workers and shredding the corporate welfare net (ibid.). W hat is unique to such a transitional economy is
the fact that Chinas huge part of formal employment of industrial sectors has amassed in its large-sized
SOEs. How could one expect China could absorb millions of formal workers immediately while
accelerating its economic streamlining? Instead, only huge investment in public sector and infrastructure
could help China both improve its economic efficiency and avoid massive layoffs, since massive layoffs
would create even greater social instability, very self-destructive to Chinas transition and economic
restructuring. In addition, Chinas scale economy (consisting mainly of large-sized SOEs), which has been

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concerned with the core of its R&D programs, is also dependent on the huge public investment. Put
differently, the currently massive public investment has been indispensable to Chinas transition, 'if you
take all these challenges into account (ibid.).

I think that the real problem facing Chinas state leaders and reform planners is that how China could
steer a balancing path between economic streamline and social legitimacy to address the underlying
efficiency concerns, while still managing its sustainable fast growth in transition, rather than how China
could run a huge percentage in public spending, a figure that is reflected merely in paper as if Chinas
economy were even less efficient than Indias in allocation of resources. The balancing act is going to be
a very tough challenge facing China. In this regard, contrary to John Thornhills claim, a real problem in
Chinas recent transition has been a constant decline of governmental tax revenues and public
expenditures (to the level of only 12% of its GDP growth, compared to that of 30-40% of the G D P growths
in most advanced industrial countries). In my view, this fact is contrary to the assumptions by those
advocators for greatly reducing public spending and restraining public investment in Chinas transition.

17. He argued that "No one could have known ahead of time that IBMs massive R&D advantage would
be undermined by its slowness in making decisions or that the development of continuous casting
steelmaking technology would make possible mini-mills that could steal market share from the traditional
large, integrated producers. It is possible that scale economies will increase in some sectors and
decrease in others at the same time... Ibid.

18. With a greater elaboration, however, Powell 1990 adds that it is the nature of information technology (IT)
to facilitate the inter-organizational collaboration in place of scale economy. Since these configurations
evolved in high technology, they can process information in multiple directions, and thus create complex
webs of communication and mutual obligation to enhance the spread of information (Powell 1990: 316).
Thereby those IT-based firms may combine their strengths and even overcome weakness in collaboration:
the advantages they could gain are much broader and deeper than those with typical marketing joint ventures
and technology licensing that used to be prevalent.

19. In the West, however, most qualified centers of specialized excellence find themselves increasingly
being located outside the boundaries of the large corporations. At the same time, some research firms
dependent on large corporations are becoming less able to obtain the support they need to sustain their
advance of science and technology necessary to fuel growth.

20. Notre Dame's debates in recent years about joining the Big Ten Athletic Conference serves as an
example of a Western academic consortium and its decisionmaking procedures. If Notre Dame acquired
athletic membership in the Big Ten's and University of Chicago's academic consortium, it would automatically
be eligible to share all of the gigantic resources and facilities owned by its Committee on Institutional
Cooperation (CIC). On one hand that would enhance Notre Dame's research level from a rating merely as an
undergraduate institution to a rating as serous graduate center. On the other hand, while the schools Faculty
Senate applauded such a decision, the board of trustees became worried about Notre Dame losing its
national and catholic identity, that is "Notre Dame's long-held and carefully protected image." "Of course,
[even if it joined the conference,] it would continue to be a Catholic University," the Rev. Bill Miscamble, an
associate professor of history and Notre Dame alumnus, said. cf. USA Today, 2C, Thurs. Feb. 4 ,1999.

21. Janusz A. Ordover and Robert D. Willig 1985 did report on the ways in which joint ventures (RJVs)
delayed R&D, as well as incentives and competition (cf. p. 332).

22. cf. Nee 1989, 22: "Alternatively, the boundary is not only redrawn by state policy makers; it is also
reshaped by society, by the activities of peasants, manual workers, and other employees who are not
functionaries in the bureaucracy."

23. Some reformers aware of orthodox Leninism and dogmatist Marxism might presume so. The transitions
in the FSU and the FEE might be affected somewhat by such orthodox and dogmatic ideas. Superstructure,
a Marxian term, refers to an ensemble of political institutions, legal systems, ideologies, and cultures, etc.

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Also according to Mao, a socialist state should continue its revolution, mainly in regard to its superstructure.
Such a philosophy led him to launch Chinas Cultural Revolution in the founding years of the PRC.

24. cf. Qian and Xu 1993, p. 158: "given the unprecedented and complicated nature of the transition from
centralized to market economies, an experimental approach may be a less costly way of learning to establish
and to use market institutions in transition. Economic theory does not provide sufficient guidance for the
transition. Other countries' experience may be relevant, but must be adapted to each country's own situation.
By the decentralized nature of market economy and by the very nature of the transition, a large amount of
bottom-initiated institutional experimentation is needed to acquire knowledge in transition. Although the U-
form structure is not suitable for large scale experiments...it is still possible to establish some special areas for
the purpose of experimentation. To avoid interfering with the normal operation of the economy, these regions
should be located outside the old industrial areas and far away from the central control, as was done in
China. Alternatively, after decentralization and de-concentration of the state sector, the economy will be more
suitable for local experiments."

25. This table adapts the ideas from "Organizational Isomorphism in East Asia" by Marco Orru, Nicole
Woosley Biggart, and Gary Hamilton in The N ew Institutionalism in Organizational Analysis, eds. Walter
W . Powell and Paul J. DiMaggio 1991, p. 386.

26. For further discussion of these issues, readers might check arguments in organizational studies. For
instance, Thompson and Thore 1992 (89) contend in that organizational efficiency becomes indeterminate in
light of any single form but may be suboptimal in a combination of diverse forms, away from the optimally
efficient frontier. Thus firm efficiency optimization can only be realized in the mix of several forms or input
factors corresponding to organizing and managing the production process. Early in 1978, Chames, Cooper,
and Rohodes proposed a more complex data envelopment analysis (DEA) of the multiple-input-multiple-
output situation. Then in 1998 Kenneth I. Spenner et al. in their micro-organizational analysis of Bulgarian
SOEs' reform and macro-economic policies further tested and developed Chames et al.'s hypotheses. They
found that efficiency enhancement is not always determined by production function or/and a linear
combination of some input factors; efficiency enhancement is less significantly correlated with firm size,
and/or organizational change than with path dependence and industrial environments, etc.

27. cf. Nee 1989, 22: "Alternatively, the boundary is not only redrawn by state policy makers; it is also
reshaped by society, by the activities of peasants, manual workers, and other employees who are not
functionaries in the bureaucracy."

28. In this light, transition could be seen as initiated and affected by social actors' identity crisis during the
transition and before.

29. For instance, Powell 1990 criticizes Williamsons theorems for failing to identify "networks as a
distinctive form of coordinating economic activity. According ot Powell, Williamson maintains that
"economic changes can be arrayed in a continuum-like fashion with discrete market transactions located
at one end and the highly centralized firm at the other...[ignoring]the various intermediate or hybrid forms
of organization" in between these poles. "Moving from the market pole, where prices capture all the
relevant information necessary for exchange," there exist "various kinds of repeated trading, quasi-firms,
and subcontracting arrangements"; "toward the hierarchy pole," there are "franchising, joint ventures,
decentralized profit centers, and matrix management" (Ibid. 298).

30. cf. Nee 1992, p. 3: Local government involvement in rural industry has been interpreted as a
distortion of partial reform that undermines the efficiency goals of economic reform (Wong 1986, 1987,
1990). The claim is that the causes of inefficiency were unwittingly transferred from central ministries
down to local governments, where they were compounded by the antimarket, protectionist conservatism
of local officials and the Maoist legacy of closed local economies."

31. This figure might work in reverse, as suggested by the dotted line of the diagonal from left-bottom up to
right-top, that could present the flip side of the story - the current transition of the market economies from

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laissez-faire capitalism toward the social welfare state. The question is how to explain this thesis rather than
Nees. What are the relationships between these two theses? Why do the institutional reforms in transitional
economies and market economies have divergent forms? W hat are their boundaries? Do they ever
converge? Does each system of reform have an antithesis or a contradictory thesis? What are the natures of
the institutional reforms to both kinds of economies? From above figures we can see market-hierarchy
relations in a continuum beyond their binary poles that Williamson expressed in his theorems of transaction
costs. The hierarchy-market continuum still is unidimensional, yet it could present their variations and
mutations. Answers to any of these questions will lead us into a more complicated inquiry than Nees
straightforward concern about unidirectional market transition. For a more detailed discussion, the reader
may refer to our further illustration in Section 5.21, Chapter 5.

32. In this matter, as Boisot and Child stated in 1988 (511), The unidimensional hierarchy-market
continuum underlying Williamson's analysis implies that a response to market failure will lie in the
substitution of hierarchical coordination, while a response to bureaucratic failure will lie in greater reliance
on the market mechanism. In both capitalist and socialist countries during the past decade there have
been strong voices proclaiming bureaucratic failure and the need to give greater play to the m arket...The
current [Chinas] economic reforms can be seen in one sense as the leaderships response to
bureaucratic failure, and the fact that it is exploring market forms of governance would appear at first sight
to speak in favor of Williamsons continuum...As Williamson (1985: 392) himself noted, however, the
study of bureaucratic failure remains very primitive and the associated literature is relatively
underdeveloped. One recommendation for dealing with bureaucratic failure that has in recent years
gained favor in the West, named to place greater reliance on organizational 'cultures' fostered by top
management (Deal and Kennedy 1982), clearly points to movement toward a fief mode rather than
toward the market.

33. Also cf. Boisot and Child 1988, p. 524: Berger (1987) distinguished between governance choices that
favor markets or hierarchies and those that simply favor modernization...Seen in this light, system reform in
the Soviet Union genuinely boils down to a choice of first type, and the challenge it faces is to reposition
some transactions along Williamsons continuum toward market forms of governance. Even so, the move up
the culture space toward greater codification that accompanies modernization may only be a partial one, as
the continued presence of bureaucratic fiefdoms in the Soviet Union and the quasi-feudal nature of much
Japanese managerial practice (Boisot 1983) serve to remind u s...

34. Nee pointed out that China's market conditions had the same flaws in 1992 that it had in 1989, despite
modifications.

35. See Theresa K. Lant and Joel A. C. Baum's critique of this deficiency of macro-institutional analysis
(1996, pp. 15-6).

36. Nees 1989 work justified the merits of the New Institutionalism that poses a framework "based on the
assumption that state socialism represents a distinctive social formation that has its own institutional logic
and dynamics of development." Nee pinpointed its presence as "defined in opposition to the earlier theories
of totalitarianism and modernization." He stated that "This [state socialisms] logic is not derived from
capitalist development, either as its polar opposite or its convergent future", but taking "into account the
institutional arrangements specific to state socialism" (1989, pp. 30-31; brackets mine). His statement might
be thought of as opposed to modernization theory, the one which, as Nove early in 1983 outlined,
optimistically projects that market reform and its social consequences would ultimately accompany
homogenization of social, economic, and political institutions between state socialism and capitalism. Nee
however points out here that "far from convergence as a likely outcome of market reform in state socialist
economies, the societies of China and Eastern Europe are giving rise to a new diversity in social life that
stems from dynamics peculiar to state socialism...[despite] juxtaposing elements of socialist realism with
Western commercial culture, traditional cultural forms with contemporary practices...The plurality of
property forms in reforming socialist societies thus is giving rise to a hybrid version of socialism that
accepts practical compromises and mutually contradictory principles as a given condition of social life" (cf.
Nee, 1989: 30-1). No doubt, his arguments in light of the New Institutionalism convey some active

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progress with the acknowledgement that the dynamics for change and the future development in these
economies will be derived from the existing environments and arrangements peculiar to their histories
and the realities rather than be grafted from outside, although these economies are "juxtaposing [their]
elements" with Western cultures.

37. cf. Nee 1992, p. 1: Despite the political retrenchment in China, the market reforms implemented in
the 1980s have had lasting consequences that are not easily reversed, even with a hard-line conservative
faction in control of state power. Economic reform from 1978 to 1989 brought about changes in power
relationships within the state structure and in society, which in turn gave rise to new alignments of
interests that champion marketization." Ibid., p. 4: A continuing shift from redistribution to markets,
however, induces change in the comparative costs of governance...Key factors that explain the rapid
growth of hybrid forms and private enterprise are the expanding relative scope of market institutions in
coordinating the economy, changes in the structure of property rights, and the incremental shift from a
redistributive to a regulatory state (Nee, 1989b)...

Also ibid. p. 7: In a redistributive economy, central decisions distribute goods and services through a
vertical hierarchy (Polanyi 1957). What characterizes redistribution at each level of this hierarchy is the
structured centricity of economic transactions. W hether at the local, provincial, regional or national level,
the circulation of goods and services in a state socialist redsistributive economy involves complex
resource transfers from the firm to state agencies, which in turn allocate factor resources back to firms
and distribute output to consumers. Within this system, the redistributive firm (whether a collective or a
state-owned enterprise) operates as an appendage of the state, responding to commands sent down
from the central ministry, provincial bureau, or local government. In the case of the marketized firm, the
hierarchical centricity of the classic redistributive economy is replaced by a mixed regime characterized
by increased market dependence. With the expansion of markets, horizontal market transactions increase
in significance while dependence on vertical ties lessens, as the firms survival and growth become more
contingent on market exchange.

38. I.e., those institutional mechanisms designed to reduce the ex ante resistance to privatization and to
increase the durability of reform ex posT. W e might refer the form er to the function of hard budget
mechanisms, and the latterto the creation of new political environments (ibid. pp. 1 1 1 -2 ,1 2 5 ).

39. It is so because state intervention is thought of as a problem exclusive to state socialism or a


sweeping deficiency of state socialism.

40. For example, to illuminate the rising NGOs in Chinas economic transition. See A shoppers friend:
Consumer protection in China - Wang Hai goes after the cheats in The Economist, p. 41, Asia, November
17th, 2001: In a small, dimly-lit office in the northern outskirts of Beijing, a new Internet venture is trying to
cash in on the growing demand among Chinese consumers and businesses for protection of their legal
rights. One of the companys investors is Wang Hai, who has become something of a hero in China as a
campaigner. Wang Hai Online Information & Consulting hopes that Mr. W angs fame will attract clients willing
to pay for legal help. Wanghai Online is a commercial spinoff from a growing body of individual activities and
non-governmental organizations (NGOs) that has begun to emerge in China as the Communist Party retreats
from its once all-pervasive involvement in public affairs. The 'W ang Hai phenomenon, as some Chinese
newspapers call it, began in 1995 when Mr. Wang discovered a little-publicized section of Chinas new
consumer-protection law. Clause 49 says that business operators found to have committed fraud in providing
goods or services must compensate the consumer with a sum double the amount paid. Mr. Wang bought a
number of fake products - which abound in China - then demanded compensation from the shops that sold
them. The media ad public lionized him. Fearful of reprisals from angry shopkeepers, Mr. Wang took to
wearing dark glasses. They have now become his trade mark. The Communist Party had no reason to
discourage Mr. Wang. Such activism has helped China to convince the public and especially the outside
world that it is serious about protecting intellectual-property rights. Demonstrating such commitment was an
important part of Chinas bid to join the W TO , which was finally approved last weekend [in 2002], after 15
years of talk. But activism such as Mr. W angs is changing China in even more important ways than simply
helping the countrys downtrodden consumers. It is the driving force behind the development of autonomous

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NGOs that are trying to fulfill the needs of citizens as the party becomes less able or less willing to do so
itself. While Mr. Wang is engaged in making money - albeit with the stated motive of helping and educating
consumers - many others like him have established organizations which belong more clearly in the NGO
category. They are engaged in a wide range of activities, from advising women to campaigning for
environmental protection. Chinas fledging NGOs avoid confronting the party, which may be grateful for some
of their services but is still extremely wary of any organized force...The government sponsors a group called
the China Consumers' Association, which approves of Mr. Wangs efforts..."

41. It was not until 1995, when privatization of the state sector became a preferred method to navigate
the transition.

For most of the transitional economies, re-privatization has underscored the old problems inherited from
the old regimes before the socialist revolutions. It was initially instituted by the restitution of those re
claimed lands and property rights to the old owners or heirs or other claimants, most of whom were bom
in the pre-WWH period and now are 80-90 years old. The complexities of the asset restitution could have
involved many factors, like historical, religious, political, geographic contingencies, archival evidence,
multiple asset transfers, etc., and particularly those institutional barriers. And the public polls in the
economies do not show the keen interests in recreating the new social divisions and in promoting the
stakes of old vested interests, and of those high-profiled aristocratic claims. In Chinas case, therefore,
privatization has so far proceeded not in the way of re-privatization, but mostly the forms of those recent
upstarting individuals and enterprises as well as the newly emergent sectors, such as joint ventures with
overseas private capital. See an article analyzing the difficulties for such re-privatization in transitional
economies, cf. Lost property of a generation - Private homes in Poland were seized first by the Nazis,
then the communists - and then the countrys borders were moved. It all makes the task of unraveling the
claims of conflicting owners seemingly impossible" by Stefan Wagstyl in Financial Times, p. I, Feb. 10/11,
2001: ...T he restitution problem in Poland is incomparably more complex than elsewhere. Can this
problem be resolved completely? Probably not. Should we try? Yes...Successful claimants would find
themselves sharing ownership with the present owners, often municipal authorities. W here restitution
proves impossible...the government would offer alternative property or financial compensation in the form
of public bonds...[that] would cost about $10bn, the most the economy can bear...the [restitution] plans
are 'seriously flawed and...[wait] ominously for the Polish government..."

42. Boisot and Child 1988 captured such a contrast between China and the West in their observation of
the changing organizational forms of network information, which could provide their alternative
explanation about Chinas transition (511), ...whereas uncodified and more personalized transactions
are sought as complements and counterweights to bureaucratic ones that have become inefficiently
entrenched and hegemonic in large Western organizations, in the PR C they are re-emerging as
opportunistically available traditional alternatives to a bureaucratic order that fails to stabilize for want of
formal rationality (W eber 1968). It is essential therefore to heed Granoveters (1985) critique of
Williamson for failing to take account of the social embeddedness of economic transactions. Williamsons
reliance on economic efficiency for explaining the choice of transaction made not only depends on the
assumption of the universal motivational primacy of economic considerations; it also overlooks the extent
to which a country's social relations, as the behavioral and structural expressions of its culture and
development, support or detract from the efficient operation of different transaction modes." W hat the
underlying point here is that whereas the W est tends to prefer more formalized institutionalization and
marketization, Chinas current hybrid economy and decentralized hierarchy tended to more favor
uncodifled and personal information, socially-embedded, which is fitted well to China's transition.

43. Stark and Nee 1989, p. 11: 'These allocative inefficiencies of central planning led early reformers in state
socialist societies to advocate incorporating the market mechanism into central planning. The socialist state
would control the commanding heights of the economy, regulating the market mechanism by manipulating
investment credits, amortization rates, depredation allowances, interest rates, prices, wage structures, and
other macroeconomic controls."

44. Nee himself called for embarking on such an undertaking in 1992, while proclaiming that the

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organizational mechanisms in forms of hierarchy and property rights for marketization in transitional
economies are distinct from those in market economies.

45. Under this general guidance, Burt emphasizes how critical it is to balance network size and diversity
for effectiveness (ibid. p. 67). Also cf. Figure 2-5, ibid. p. 71. For Burt, how to make transmission is a
matter of network as medium. Accordingly, researchers ought to pay sufficient attention to how such
transmission could be affected by a network of agencies and organizations delivering varyingly accurate
information (Burt 1995, 259).

46. For Boyle, the transmission as intermediaries could underscore the plural nature of any kind of
industrial model and the associated social and historical traits cf. Boyer 1998, p. 27: ...This vision of a
'one best way implies that there is a single optimal industrial model whatever the context or period, and
that, except for non-economic obstacles (which are viewed as irrational), firms and countries should
converge towards nearly identical configurations. On the other hand, recognition of the relative character
of superiority in production opens the way for a plurality of models to coexist because they are better
adapted to various contexts, to the point that durably divergent trajectories may characterize the evolution
of industrial models.

47. W hat researchers need here is to distinguish these two kinds of trends, backward and forward,
downhill and uphill, and inert and dynamic, in different time horizons, clarify them by nature, and to inquire
into the complexities and mechanisms working in the whole complexion.

48. Campbell et al. 1991 contend in an inverse way that competitive markets could stimulate demand for
protectionist measures or hierarchical allocation of resources on behalf of threatened enterprises and sectors
of the economy.

49. Also cf. Nee and Stark 1989, pp. 17-8 (emphasis mine): T h e outcome of market reform in Eastern
Europe has been largely disappointing, especially in light of the early reformers extreme confidence in the
harmonious, mutually correcting duality of plan and market. Instead, partial reforms both perpetuated
problems of prereform economy created new distortions and imbalances. As Komai suggests, the naivete of
the early reformers was to believe that in combining central planning with the market mechanism they could
achieve the best of both worlds. They failed to consider fully the possibility that partial reform would result in
the worst of both worlds. The command economy turns to a hybrid economy, which Komai argues operates
in a condition of 'dual dependence' in which the economy is coordinated by both vertical bureaucratic and
horizontal market relationships. The essence of dual dependence, however, is the continued dominance of
hierarchical forms of coordination over the socialist firm and the debilitation of the market mechanism by
persistent and pervasive bureaucratic micnointerventions. This is the dilemma of partial reform, that despite
giving a greater role to the market, all of the critical decisions - entry, exit, investments, prices and wages,
output, credit - still depend more on processes internal to the planning governance structure than on the
market. As a result, the problems of the soft budget constraint, shortage economy, and investment fever of
the prereform socialist firm persist in the post reform economy. Komais analysis of the reforming socialist
economy reveals the relative weakness of the market mechanism when confronted with an intact
bureaucracy accustomed to controlling economic action. Whether the actual mechanism of bureaucratic
control is direct or indirect, the effect on the firm is to weaken its responsiveness to the market and
perpetuate the conditions of inefficiency associated with central planning. Komai concludes from the
Hungarian experience of partial reform that without a decisive shift from plan to a structure of market
governance, characterized by hard budget constraints and market competition, there can be no escape from
the dilemma of dual dependence."

50. As Whitley writes, "In the West, as in East Asia, effective ways of coordinating and controlling economic
activities in market economies depend on, and are closely connected to, particular institutional arrangements
of the kind and will not be as effective in situations where these differ markedly. The comparative analysis