The Puzzle of China's Township-Village Enterprises: The Paradox of Local Corporatism in A Dual-Track Economic Transition

Management and Organization Review 1:2 197–224
1740-8776
The Puzzle of China’s Township–Village

Enterprises: The Paradox of Local Corporatism in
a Dual-Track Economic Transition
Peter Ping Li
College of Business Administration, California State University, USA
abstract This paper seeks to reconcile and synthesize the diverse views about the
township–village enterprises (TVEs) and local corporatism in the context of ongoing
institutional changes in China as a transition economy. Specifically, I attempt to
integrate the economic, political, cultural, and social explanations for TVEs,
especially the two competing views of market competition and political corruption. I
focus on the puzzle of TVE efficiency as well as the paradox of local corporatism as
a government–business partnership with both a positive function of public alliance
for wealth creation and a negative function of private collusion for wealth transfer. I
argue that the key to both the puzzle of TVEs and the paradox of local corporatism
lies in China’s dual-track reform paradigm (i.e. a market-for-mass track and a state-
for-élite track). Lastly, I discuss the critical implications for theory building and
policymaking regarding economic transition in general.
There has been a growing academic interest in the economic and organizational
issues in China (Tsui, Schoonhoven, Meyer, Lau, and Milkovich, 2004). This is in
© Blackwell Publishing Ltd 2005. Published by Blackwell Publishing, 9600 Garsington Road, Oxford, OX4 2DQ ,
UK and 350 Main Street, Malden, MA 02148, USA.
198 P. P. Li
large part stimulated by China’s apparent success in its economic transition and
also spurred by China’s fast growth in its domestic market and its international
competitiveness. Furthermore, given its unique context as a distinctive cultural,
social, political, and economic system, China seems to be an excellent place to test
the theories that are built on the evidence of the developed market economies in
the West (Tsui et al., 2004). More importantly, the success of China has been a
puzzle and challenge to various conventional theories, ranging from the theories
of the firm and property rights to those of the political basis for economic devel-
opment and institutional development (Boisot and Child, 1996; Cao, Qian, and
Weingast, 1999; Fan and Grossman, 2001; Putterman, 1995; Rawski, 1995;
Whyte, 1995). The initial success of China’s gradualist approach, characterized as
marketization without privatization and democratization, has been the focus of
debate over the policy for economic transition (see Megginson and Netter, 2001;
Woo, 1999; Zahra, Ireland, Gutierrez, and Hitt, 2000 for reviews).
The most puzzling aspect of China’s economic reform is the phenomenon of
township–village enterprises (TVEs) in rural China. Anomalous from the per-
spective of some Western theories, the phenomenon of TVEs has often been cited
in the debate over the necessity of privatization or democratization for economic
transition (e.g. Putterman, 1995; Rawski, 1995; Walder and Oi, 1999). From the
perspective of ownership, there are three basic categories of firms in China: (1)
the state sector, (2) the collective sector, and (3) the private sector ( Jefferson,
Rawski, Wang, and Zheng, 2000). The state sector is comprised of those firms that
are owned by all Chinese citizens but controlled by various government agencies
at the levels of the central state, province, city, and county. The collective sector
consists of those firms that are owned by all the local residents of an urban dis-
trict or neighborhood and a rural township or village but controlled by the gov-
ernment agencies at those levels. If located in the rural areas, the collective
enterprises are referred to as TVEs. The private sector includes those firms that
are owned and controlled by the citizens as sole proprietorships, private partner-
ships, and private shareholding corporations with domestic or foreign investors.
The significance of TVEs is that they seem to have performed as efficiently as
China’s private firms, at least until recently (Dong and Putterman, 1997; Jefferson
et al., 2000; Zhang, Zhang, and Zhao, 2001), although TVEs are communal coop-
eratives with ill-defined property rights (Chen, 2000a; Li, 1996; Weitzman and Xu,
1994).
According to several surveys (see Table 1), the collective sector and the TVE
sub-sector had an operating efficiency higher than that of the state sector, and as
high as that of the private sector. Furthermore, the collective sector consistently
had the highest productivity growth among the three sectors (see Table 1). Related
to its high efficiency, the collective sector, especially the TVE sub-sector, has con-
tributed greatly to the economic reform and economic growth in China since 1978
(Ma, 2000; Oi, 1999). For example, the contribution of the TVE sector to the
© Blackwell Publishing Ltd 2005.
Local Corporatism in a Dual-Track Economic Transition 199
Table 1. Relative efficiency of various ownership statuses
Empirical Evidence POE Efficiency COE/TVE Efficiency SOE Efficiency
Zhang et al., 2001

Technical Efficiency 66.78 68.77 55.34
Jefferson et al., 2000
TFP 3.2 3.1 1.9
Dong and Putterman, 1997
TFP 13.3–20.9% higher
than that of POE
Jefferson et al., 2000
TFP Growth in 1988–1992 2.11 3.13 2.11
TFP Growth in 1992–1996 3.14 4.29 -1.11
Zhang and Parker, 2002
TFP Growth in 1990s 11.0 20.8 9.8
Notes: POE refers to privately-owned enterprises; COE refers to collectively-owned firms; SOE refers to state-
owned firms; technical efficiency is a measure of efficiency in terms of the difference between the real output
and the potential output based on a stochastic production frontier model; TFP stands for total factor productiv-
ity as a measure of efficiency in terms of the ratio of the real output over all the inputs used in production.
gross industrial output of China rose from just 9% in 1978 to 42% in 1994 (Tong
and Chan, 2003). Furthermore, while the average annual growth rate of China’s
gross industrial output between 1985 and 1995 was 20.8%, the average annual
growth rate of TVE gross output was 72.2% (Tong and Chan, 2003). According
to Perotti, Sun, and Zou (1999), the industrial TVEs contributed up to half of
China’s total industrial value added, profit, and output by 1995. The employment
in the TVE sector rose from 30 million in 1980 to 135 million by 1996, and the
share of TVE export in China’s total export also rose from 16.9% in 1988 to
46.2% by 1997. All the evidence seems to suggest that TVEs were successful as a
form of business organization. TVE success seems to imply that a free-market
economy may be established without privatization (Oi, 1999), as also suggested
by the successful existence of various types of cooperative firms in various
countries.
Most researchers (e.g. Nee, 1992; Oi, 1999) evoke the notion of local corpo-
ratism (i.e. a close partnership between government and business at the local level)
to explain the puzzling source of TVE efficiency, but they differ in their charac-
terization of local corporatism. Their views seem more convincing in explaining
the initial efficiency of TVEs than the later privatization of TVEs (see Oi, 1999
for a review). Furthermore, a few researchers attempt to explain TVE privatiza-
tion, but they disagree about the forces behind the dramatic change of local cor-
poratism from the initial positive function of enhancing TVE efficiency to the
negative function of eroding TVE efficiency (e.g. Chen, 2000a; Hu, 2002; Jiang,
200 P. P. Li
2000; Oi, 1999). Consequently, researchers have different conclusions about the
policy and theory implications of TVEs and local corporatism. This is tied to the
larger debate over the superiority of the gradualist versus rapid approaches such
as ‘big bang’ or ‘shock therapy’ (Rozelle and Swinnen, 2003; Woo, 1999; also see
Megginson and Netter, 2001; Zahra et al., 2000).
This paper seeks to reconcile and synthesize the diverse views about TVEs and
local corporatism in the context of ongoing institutional changes in China as a
transition economy. Specifically, I attempt to integrate the economic, political, cul-
tural, and social explanations for TVEs, especially the competing views of market
competition and political corruption. I focus on two closely related research ques-
tions: (1) the puzzle of TVEs in terms of how the communal cooperatives with ill-
defined property rights could achieve a level of efficiency as high as private firms,
thus driving the initial economic growth in China; (2) the paradox of local cor-
poratism in terms of how the government–business partnership has shifted from
a positive function of public alliance for wealth creation to a negative function of
private collusion for wealth transfer, thus threatening the long-term success of
China’s reforms.
THE PUZZLE OF TVE SUCCESS

As mentioned earlier, there are three basic ownership statuses in China: (1) the
state sector, (2) the collective sector, and (3) the private sector. According to the
extant property rights theories (Alchian and Demsetz, 1972) and the agency
theories ( Jensen, 2000), one should find striking differences in efficiency between
the firms across these ownership categories. First, one would expect a relatively
low efficiency in the state sector because it has the worst-defined ownership and
the greatest agency problem. Second, one would expect a relatively high efficiency
in the private sector because it has the best-defined ownership and the smallest
agency problem. Third, one would expect a mid-level efficiency in the collective
sector because it is a hybrid form between the state and private ownership. While
there is ample evidence to support the first expectation about the state firms,
neither the second nor the third expectation receives much empirical support. The
overwhelming evidence shows that TVEs match or even exceed private firms in
efficiency (see Table 1).
The puzzle of TVEs is how and why they can achieve high efficiency against
the basic tenets of the property rights theories and the agency theories (Chang
and Wang, 1994; Li, 1996; Oi, 1999; Tian, 2000; Weitzman and Xu, 1994). For
a typical TVE, there are neither formal owners nor formal agents as defined by
the property rights theories (Putterman, 1995). There are several reasons for the
absence of formal TVE owners (Li, 1996; Weitzman and Xu, 1994). First, TVEs
are collectively owned by all the residents of a local community, but such owner-
ship is mandatory and by default rather than voluntarily and deliberately chosen,
because the ownership comes automatically with local residency without any cost.
This ownership, however, is non-transferable. A resident automatically loses
his/her ownership rights without any compensation if moving out of the local
community. Consequently, there are no formal ownership rights for local residents.
Second, local residents can only receive the benefits of TVEs in the form of
general communal welfare. The major portion of the profit generated by TVEs is
used for the local administrative budget. As a result, there are no formal claim
rights for local residents. Third, because there are neither free elections nor free
media, both exacerbated by the weak rule of law, local residents cannot hold local
officials accountable for their de facto ownership rights and claim rights (Cai, 2003).
Hence, there are no formal control rights for local residents. This separation of
rights from obligations (e.g. the obligations to invest in property rights and bear
the risk of property loss) as well as the lack of formal rules will result in a distorted
property rights structure. Local officials become privileged owners (with strong rights
and weak obligations), while local residents become deprived owners (with strong
obligations and weak rights) (Chen, 2000b; Yao, 2002). Similarly, TVE managers
are not formal agents. Some are privileged agents as a result of their special ties with
local officials, while others are deprived agents because of weak ties with local
officials (Hu, 2002).
The Competing Explanations of TVE Success

There are four major explanations of TVE efficiency in particular and TVE
success in general. First, some explain TVEs as the second-best political solution
(Chang and Wang, 1994; Naughton, 1994). They argue that the Chinese state sup-
ports TVEs because it is regarded as the best way to develop the economy without
jeopardizing public ownership and state control, which are the twin pillars for the
rule of the Communist Party. The efficiency of TVEs may derive from the state
policies of political decentralization and economic deregulation. The two policies
have opened the door for the fast growth of TVEs as a result of the direct support
from the newly empowered local governments. Second, others explain TVEs as
the best cultural solution (Weitzman and Xu, 1994; Whyte, 1995). They argue that
China’s culture is dominated by the values of collectivism and family. The value
of family is reflected in both the spirit of family-based entrepreneurship and the
prevalence of guanxi (i.e. a private network of family, kinship and other personal
ties for the exchange of particularistic favors, Wank, 1999). Third, still others
explain TVEs as the second-best ownership solution (International Finance Cor-
poration, 2000). They argue that collective ownership is preferred not only because
private entrepreneurs must disguise themselves under the ‘red hat’ of TVEs by
registering their firms as fake collective firms to avoid the political discrimination
against private ownership (International Finance Corporation, 2000), but also
because the officials need the convenience of abusing public assets for private gains
202 P. P. Li
by controlling TVEs as the de facto private firms (Chen, 2004; Hu, 2002; Jiang,
2000; Lin and Chen, 1999; Putterman, 1995; Ruf, 1999; Walder, 2002a). The ‘red
hat’ is needed for political protection and resource access, while the de facto private
property rights are convenient for corruption in terms of abusing public assets for
private gains. Lastly, most explain TVEs as the second-best transaction solution
(Chen, 2000a; Jiang and Hall, 1996; Nee, 1992; Oi, 1999; Tian, 2000; Woo, 1999).
They argue that China’s institutional context is characterized by the underdevel-
oped formal institutions of law and market as well as the deeply rooted informal
institution of guanxi. As a quasi-private hybrid form in the context of both state
and market failures, TVEs would have a lower total cost than state firms because
of the lower agency cost and than private firms because of the lower transaction
cost (Chen, 2000a; Nee, 1992; Oi, 1999), largely as a result of the close involve-
ment of local government in TVE operations. Local government seems more
effective in developing local economies than the central state because of a better
alignment of public and private interests and rights at the local level, thus having
lower agency costs, and a stronger effect of market making and market interven-
tion at the local level, thus having lower transaction costs (Oi, 1999).
Diverse as they seem, two shared themes can be identified among the four expla-
nations. First, they are all rooted in the framework of institutional theories. The
first two views can be seen as the macro-institutional perspectives (i.e. the former
emphasizing the formal institution of state, and the latter emphasizing the infor-
mal institution of culture), while the last two views can be seen as the micro-insti-
tutional ones (i.e. both emphasizing the interplay between formal and informal
ones). Second, they all share the theme of direct involvement of local officials in
the business activities of TVEs, in both the formal form of public policies and the
informal form of private guanxi ties. This theme can be best characterized as local
corporatism in both a political-economic sense (i.e. the interplay of the state and
market) and a social-cultural sense (i.e. the interplay of formal rules and informal
routines) (Chen, 2000a; Jiang and Hall, 1996; Jin and Qian, 1998; Nee, 1992; Oi,
1999). The basic distinction between these views lies in their different evaluations
of local corporatism as primarily positive for public interest or as primarily nega-
tive for private interest. Based on the framework of formal-informal institutions
and the theme of local corporatism, one can develop an integrated explanation
for TVE success in general and TVE efficiency in particular.
An Integrated Explanation of TVE Success

I refer to formal institution as a set of social rules that are exogenously imposed,
explicitly specified, and rigidly regulated by vertical authorities in a depersonal-
ized process, while informal institution as a set of social routines that are endoge-
nously cultivated, implicitly assumed, and flexibly maintained by horizontal peers
in a personalized process (Li, 2004; Helmke and Levitsky, 2003; Morand, 1995;
North, 1990; Scott, 2003). Based on the above definitions, one can broadly define
local corporatism as a quasi-formal government–business partnership at the local level
in a special context of weak formal institutions and strong informal institutions.
In other words, local corporatism is a special institutional design to govern both
formal and informal relationships between local officials and TVE managers.
According to this definition, one can regard TVEs as a quasi-formal governance
form for the application of local corporatism.
I argue that the primary source of TVE efficiency and success lies in the four
special features of local corporatism as a quasi-formal public alliance between local
officials and TVE managers (Bai, Li, and Wang, 2001; Jiang and Hall, 1996; Nee,
1992; Oi, 1999; Whiting, 2001). The first two features derive from the function of
local government as a quasi-formal parent company by treating TVEs as its own
subsidiaries. Local government can serve as a quasi-formal corporate board (e.g.
to perform the tasks of strategic planning, management selection, incentive design,
and performance evaluation of TVEs) as well as a quasi-formal market maker (e.g.
to develop the local public utilities and facilitate resource access for TVEs). Several
field studies provide the evidence of the function of local government as a quasi-
formal parent company. In his study of Zouping County in Shandong Province,
Walder (1998) finds that the county government resembles an industrial corpora-
tion where revenue generation is paramount and the entire local government oper-
ates as a firm in a competitive environment. In her extensive study of rural
industrialization, Oi (1999) finds that the changes in fiscal incentives allow local
government officials to play the key function of local government entrepreneur-
ship in fostering the local industrialization by serving as the board of directors for
TVEs. This view is supported by a study of Guanghan County in Sichuan
Province (Blecher, 1991). In addition to its entrepreneurial function, local govern-
ment also performs the developmental function of creating the local market and
economic infrastructure. In a study of Shulu County in Hebei province, Blecher
and Shue (1996) find that local government promotes the local economy by devel-
oping the physical environment, the access to capital, and the link to the external
markets. Park and Shen (2003) provide the evidence that local government per-
forms a pivotal function for the access to bank loans. They find that almost all
rural enterprise lending went to TVEs, and even by 1997, the bank loans to TVEs
still accounted for 84.7% of the total rural enterprise loans; the function of local
government was mainly in the form of loan guarantor, so TVE loans had the fea-
tures of joint liability lending, especially its informal features (Park and Shen,
2003).
The other two features derive from the function of local government as a quasi-
formal business guardian by treating TVE managers as its protégés. Local gov-
ernment can serve as a quasi-formal political shield against the predatory central
state (e.g. to interpret the government policies and regulations favorably and
implement them selectively at the local level, including tax collection) as well as a
204 P. P. Li
quasi-formal business leader (e.g. to act as a referee, mediator, guarantor, and
broker for the local business community). The evidence of the last two features of
local corporatism can be found in the research on the so-called ‘red-hat’ firms
(International Finance Corporation, 2000), in which private firms disguise them-
selves under the ‘red hat’ of TVEs in order to avoid the political discrimination
against private ownership. Furthermore, there is evidence about local government
as a political shield against the predation from the central state. Oi (1999) finds
that local officials have been able to circumvent the control of central state in order
to pursue their own interests, especially in the areas of bank loan and tax collec-
tion. For instance, as a result of tax evasion, the collective sector only contributed
17% of the total government tax revenue in 1995, even though the TVE sector
accounted for more than 30% of China’s GDP in that year; in contrast, the state
sector had a share of 71% of the total tax revenue while its GDP share was only
44% (Perotti et al., 1999). However, the state sector had an overwhelming advan-
tage in terms of access to bank loans. For instance, the state sector accounted for
about 88.9% of the total short-term bank loans, whereas the collective sector only
had about 7.5% in 1995; by 1999, the state sector still had about 84.8% in con-
trast to the 9.6% for the collective sector (Bai et al., 2001). The balance between
tax and loan is clearly in favor of state firms against collective firms. Furthermore,
Jin and Qian (1998) find that the predominance of TVEs over private firms is
more evident in the regions where the influence of the central state is greater, the
power of the local government is stronger, and the level of marketization is lower.
This evidence supports the view concerning the features of local corporatism as
political shield and business leader.
It appears that the above four features are more effective at the local level because
the influence of informal routines is largely confined to a local level, especially for
the function of business guardian. Similarly, these functions are more effective for
TVEs than for private or state firms, because the direct involvement of local gov-
ernment is more legitimate and effective for TVEs, especially for the critical func-
tion of parent company. Furthermore, quasi-formal institutions have a limited scope
of influence. Although it is possibly applicable to all levels of jurisdiction, corpo-
ratism seems the most effective at a local level (Dougherty and McGuckin, 2002),
particularly in the rural areas where the formal rules are much weaker and the infor-
mal routines are much stronger (Whyte, 1995). Similarly, although it may be applic-
able to all firms in different ownership categories, including state firms (Cao et al.,
1999) and private firms (Oi, 1999), local corporatism seems to function best for col-
lective firms ( Jiang and Hall, 1996; Nee, 1992). This may arise from the local own-
ership and local government control, thus creating a condition most conducive to
local corporatism. However, local corporatism is susceptible to corruption, which
refers to an abuse of public power for personal gain ( Johnston, 1996). As suggested
by several researchers (e.g. Cai, 2003; Chen, 2004; Hu, 2002; Jiang, 2000; Lin and
Chen, 1999; Putterman, 1995; Ruf, 1999; Walder, 2002a), local corporatism is
directly related to hidden corruption, ranging from special official perks to outright
asset stripping. Nevertheless, it seems that the level of corruption is relatively low in
the initial phase of economic transition, thus rendering the positive function of local
corporatism as illustrated by the high efficiency of TVEs and the overall success of
the TVE sector (Oi, 1999; Ruf, 1999). In sum, TVEs seem to be the most proper
organizational form for the application of quasi-formal local corporatism, given the
unique institutional context of both state and market failures no matter how one
defines the failures, so local corporatism is responsible for TVE success in the initial
phase of China’s economic transition.
The Institutional Roots of Local Corporatism

Despite a general acceptance of local corporatism as the source of TVE efficiency,
there is an ongoing debate over the institutional roots of local corporatism. Most
scholars evoke the concept of path-dependent change of traditional institutions as
the context of local corporatism, but they differ in the selection of institutions to
emphasize. Many focus on the top-down macro-level formal state policies as the basic
institutional root of local corporatism (Li and Lian, 1999; Oi, 1999; Whiting,
2001). They argue that government federalism (i.e. the swift decentralization of
the state authorities with the related changes in the fiscal system) and market lib-
eralization (i.e. gradual deregulation of selective industries for the market entry of
non-state firms and foreign investors) can direct the interest of local officials to
a predominantly economic agenda. The reason for this is that the reforms would
result in more autonomy and harder budget constraint (with bigger stakes and
incentives for local officials), thus both the pull and the push for the economic
agenda. For instance, de-collectivization in rural China has forced the local offi-
cials to seek revenues from new sources other than the traditional farming activ-
ities (Oi, 1999).
Some focus on the bottom-up micro-level informal social custom as the basic insti-
tutional root of local corporatism (Chen, 2000b; Jiang and Hall, 1996; Lin and
Chen, 1999; Nee, 1992; also see Wank, 1999; Whyte, 1995 for local corporatism
in the urban region). They argue that guanxi ties and family values are both essen-
tial for China’s economic transition, because of the weak formal institutions of law
and market. However, not all guanxi ties can serve as the institutional context of
local corporatism; rather, only those special guanxi ties between local officials and
entrepreneurs provide this basis (Nee, 1992; Wank, 1999). They also point out that
corporatism is most effective at the local level because of the scope limitation of
informal personal ties (Whyte, 1995). This argument is supported by the view of
cultural value as an informal institution (Nee, 1992; Weitzman and Xu, 1994).
Others emphasize the mid-level quasi-formal local collective ownership as the basic
institutional root of local corporatism (Chen, 2000b; Nee, 1992; Pei, 1998). They
argue that the local collective ownership is key to the functions of local govern-
206 P. P. Li
ment as parent company and business guardian (Nee, 1992), especially with regard
to the collective ownership of local land after the de-collectivization of farming
(Pei, 1998). They identify the paradoxical nature of quasi-formal local collective own-
ership. On the one hand, the local collective ownership is explicitly specified and
tightly enforced as the exclusive property rights for local residents as an insider
group, in contrast to the non-residents as an outsider group, thus there is a dis-
tinct ownership boundary between insiders and outsiders. On the other hand, the
local collective ownership is implicitly assumed and loosely enforced as the inclu-
sive property rights for local residents as each individual in relation to other resi-
dents, thus there is a blurred ownership boundary between insiders (Chen, 2000b).
The local collective ownership can serve as the institutional basis for community-
based economic functions, such as internal resource pooling, profit redistribution,
and local interfirm alliance (Chen, 2000b; Pei, 1998). They also point out that
local collective ownership is much more salient in the rural regions than the urban
areas, primarily as a result of the collective ownership of local land and the low
mobility associated with China’s local residency system (Rozelle, Li, Shen,
Hughart, and Giles, 1999). Long-term stable local residency tends to foster strong
and sustainable guanxi ties within the local community as the informal institutional
source of interpersonal trust (Chen, 2000b; Whyte, 1995). Furthermore, the argu-
ment for local collective ownership is indirectly supported by the view that local
corporatism is a bottom-up response to the exogenous failures of imperfect state
and market with an endogenous adjustment of local collective ownership rights
(Che and Qian, 1998; Chen, 2000a) as well as the view that the cultural value of
collectivism is critical to TVE success (Weitzman and Xu, 1994).
Still others emphasize the multi-level informal corruption as the necessary institu-
tional root of local corporatism, primarily in the form of the de facto privatization
(Putterman, 1995; also see Basu and Li, 2000; Chen, 2003; Fan and Grossman,
2001; Johnston and Hao, 1995; Lu, 2000 for corruption in general). They argue
that the ultimate drive for local officials to favor local economic development lies
in the opportunity to gain politically (i.e. to advance personal political careers,
which becomes less attractive over time) as well as economically (i.e. to benefit
financially from business involvement, which becomes more attractive over time),
both of which are often accompanied by various types of corruption (Basu and
Li, 2000; Chen, 2003; Fan and Grossman, 2001). Corruption may be linked to
the weakened formal institution of state (e.g. the seriously weakened control by the
state over the local agents, Oi, 1999) and the underdeveloped formal institutions
of law (Cao, 2000; Williams, 2001) and market (Nee, 1992; Tian, 2000). This is
further compounded by the erosion of the informal institution of ethics (Ding,
2000; Johnston and Hao, 1995). Though insufficient to account for local corpo-
ratism alone (Oi, 1999), informal corruption is so intertwined with other institu-
tional forces across all levels (Basu and Li, 2000; Chen, 2003; Fan and Grossman,
2001; Johnston and Hao, 1995) that it cannot be left out of the institutional context
for local corporatism, and it should not be left out of the overall explanation for
local corporatism.
I suggest that all four institutional factors (i.e. formal state policy, informal
custom, quasi-formal collective ownership, and informal corruption) affect local
corporatism in one way or another. They jointly form a complete institutional
context for local corporatism, especially the interplay between the political, eco-
nomic, formal, and informal components. I will explain in the next section how
the interplays of the four institutional forces result in a functional shift of local
corporatism from positive to negative.
THE SHIFT OF LOCAL CORPORATISM FROM POSITIVE

TO NEGATIVE
Despite its success in the initial phase of China’s economic reforms, local corpo-
ratism seems to be losing its magic power, as indicated by the deteriorating per-
formance of TVEs as well as the massive privatization of TVEs in the mid-1990s
(Brandt, Li, and Roberts, 2001; Chang, McCall, and Wang, 2003; Dong, Bowles,
and Ho, 2002; Dong, Putterman, and Unel, 2004; Hu, 2002; Jiang, 2000; Li and
Rozelle, 2003; Park and Shen, 2003; Oi, 1999; Shi, Zhao, and Chang, 2001;
Sonobe and Otsuka, 2001; Sun, 2000). For instance, the ratio of after-tax profit
over assets for TVEs steadily decreased from more than 30% in the early 1980s
to about 7.5% in 1995 and 1996 (Sun, 2000). According to a survey in the south
region of Jiangsu Province (with the most prominent TVE sector in China), the
average gross profit margin in the mid-1980s was about 20%, but it went down to
5% in the mid-1990s; in contrast, the average debt ratio was nearly 62% among
the TVEs in the city of Suzhou in 1995; a related survey of 111 TVEs (Shi et al.,
2001) found an average debt ratio of more than 70% in the same year; another
report shows that the contribution of TVE sector in Jiangsu to the gross indus-
trial output in the province went up from 18.5% in 1978 to the peak of 66.7% in
1995 and then down to 61.2% in 1997 (Shi, Zhao and Chang, 2001). According
to another survey in 1998 (Park and Shen, 2003), the returns to revenues for TVEs
were 2.4% in 1994, 1.9% in 1995, -0.3% in 1996, and -3% in 1997, while those
for private firms were 2.3%, 2.9%, 1.2%, and -0.8%, respectively. Furthermore,
an empirical study (Tong and Chan, 2003) finds that the technical efficiency of
TVEs was declining from 1988 to 1993 with an average of 2.6% per year. Lastly,
related to the TVE debt and increasing competition, the loss of TVEs began to
mount since the mid-1980s. For instance, the losses from the village-level TVE
sector shot up from merely 300 million yuan in 1985 to 1.2 billion yuan in 1990,
and then increased further, to 4.2 billion yuan in 1995 (Oi, 1999).
Closely related to the declining efficiency and profitability, there has been a
trend toward massive TVE privatization since the mid-1990s. According to several
surveys (see Table 2), around 72–93% of TVEs were privatized by 2001. Further-
208 P. P. Li
Table 2. The extent and process of TVE privatization
Empirical Studies The Extent of TVE Privatization
Li and Rozelle, 2003 86% of the sampled TVEs as privatized

[A sample of 390 TVEs with 1993–1999 data]
Dong et al., 2002 87% of the sampled TVEs as privatized
[A sample of 45 TVEs with 2000 data]
Shi et al., 2001 93% of the sampled TVEs as privatized
[A sample of 85,000 TVEs with 2000 data]
Empirical Studies The Process of TVE Privatization
Li and Rozelle, 2003 8% of TVEs being privatized during 1993
[A sample of 390 TVEs with 1993–1999 data] 30% of TVEs being privatized during 1997 &
1998
Dong et al., 2004 0% of the sampled TVEs as privatized in 1995
[A sample of 95 TVEs with 1994–2001 data] 72% of the sampled TVEs as privatized in 2001
Private equity as 0.06% of total TVE equity by
1994
Private equity as 68.9% of total TVE equity by
2001
Li and Rozelle, 2003 92% of privatized TVEs being sold to insiders
[A sample of 390 TVEs with 1993–1999 data] 70% of the private equity in TVEs being
owned by management insiders
Dong et al., 2002 85% of privatized TVEs being sold to insiders
[A sample of 45 TVEs with 2000 data] 96% of the equity of privatized TVEs being
owned by insiders
78% of the equity of privatized TVEs being
owned by management insiders
Dong et al., 2004 78% of the equity of privatized TVEs being
[A sample of 95 TVEs with 1994–2001 data] owned by insiders 61% of the equity of
privatized TVEs being owned by
management insiders
more, as shown in Dong et al. (2004) and Li and Rozelle (2003), the process of
privatization has been accelerating over time. In addition, a unique feature of TVE
privatization is that the equities of TVEs are sold almost exclusively to insiders
(e.g. management) rather than outsiders (Dong et al., 2002, 2004; Jiang, 2000; Li
and Rozelle, 2003). Lastly, the evidence of the effect of privatization on perfor-
mance is mixed (cf. Chang et al., 2003; Dong et al., 2004; Li and Rozelle, 2003;
Sonobe and Otsuka, 2001). In sum, the emerging evidence seems to suggest that
TVEs are primarily a transitory form.
The Competing Explanations for TVE Privatization

There are two competing explanations for TVE privatization. First, most scholars
evoke the economic rationales of exogenous market competition and endogenous
private ownership as the key causes of TVE privatization. Many researchers empha-
size the exogenous factors driving TVE privatization, including the state policy shift
in terms of less discrimination against private firms (e.g. Cao et al., 1999; Dong et
al., 2004; Oi, 1999; Sonobe and Otsuka, 2001); the loss of tax benefits for TVEs as
a result of the fiscal reforms in the mid-1990s (e.g. Bai et al., 2001; Whiting, 2001);
the loss of access to soft credit as a result of fiscal reforms in the mid-1990s (Brandt
et al., 2001; Cao et al., 1999; Dong et al., 2004; Li, 2003; Park and Shen, 2003); the
increasing market competition (e.g. Sun, 2000; Tong and Chan, 2003); and the
mounting TVE debts and losses (e.g. Oi, 1999; Shi et al., 2001). They argue that
the exogenous factors are responsible for a shift in power balance between govern-
ment officials and business managers in favour of the latter (e.g. Chang et al., 2003;
Chen, 2000a; Jin and Qian, 1998; Li and Rozelle, 2003). In contrast, other
researchers focus on the endogenous factors driving TVE privatization, including
the inherent inefficiency of public ownership and the inherent efficiency of private
ownership (e.g. Bai et al., 2001; Perotti et al., 1999; Sun, 2000). They argue that the
exogenous factors are just the external catalysts rather than the root problems of
TVEs and local corporatism, so the endogenous factors of inherent advantages
of private ownership ultimately determine TVE privatization (Bai et al., 2001).
Second, besides the economic view, some researchers evoke the political rationale
of élite corruption as the ultimate endogenous driver behind the process of priva-
tization as the result of China’s overall strategy for economic transition – economic
reforms (marketization and privatization) without political reforms (the rules of law
and democracy) (e.g. Cai, 2003; Chen, 2004; Hu, 2002; Jiang, 2000; Lin and Chen,
1999). They argue that economic reforms can never be truly achieved without po-
litical reforms (Yao, 2001; cf. Oi, 1999). The economic view tends to regard the pro-
cess of privatization as largely legitimate, fair, and transparent for public interest,
whereas the political view tends to regard it as largely illegitimate, unfair, and opaque
for private interest.
Despite their clear distinctions, the above two views share a common theme –
TVEs as an organizational form and local corporatism as an institutional system
are transitory in nature, so one should differentiate the initial phase of China’s eco-
nomic transition from its later phase. Built on this shared theme, I argue that both
economic and political forces as well as both formal and informal forces are nec-
essary for a successful completion of economic transition, so an integration of all
four forces may account for TVE privatization in particular and economic transi-
tion in general.
The Economic Logic of Market Competition: Helping Hand versus

Grabbing Hand
I argue that the function of local corporatism has shifted from positive to
negative largely as a result of the changing institutional context of increasing
210 P. P. Li
marketization. First, the higher mobility of capital and residents across regions has
eroded one of the key foundations of local corporatism – the dependence of local
residents on local collective ownership for incomes and jobs (Bai et al., 2001;
Rozelle et al., 1999; Sun, 2000). Second, the real balance of power has been shift-
ing from local officials to TVE managers and entrepreneurs as the result of a more
open market access and a less hostile political climate (Chen, 2000a; Sun, 2000;
Whiting, 2001). The process of marketization in terms of market competition and
further reforms in the banking and taxation systems has greatly reduced the depen-
dence of TVE managers and private entrepreneurs on local officials for a special
access to key resources. This is especially true when local officials have lost their
ability to provide the access to capital as the result of both the growing profit ori-
entation of the state banks and the heavier debt burden on local government for
TVEs as loan guarantors (Brandt et al., 2001; Park and Shen, 2003), as well as
their ability to evade the state taxes as a result of the tightened rules for state tax
collection in the mid-1990s (Whiting, 2001). For instance, Park and Shen (2003)
find that in the more competitive environment, banks prefer private firms for indi-
vidual firm lending rather than TVEs for joint liability lending. In addition, a less-
hostile political climate with more favorable policies for private firms has greatly
reduced the need for political shelter from local officials, as in the case of ‘red-hat’
TVEs (International Finance Corporation, 2000).
Third, the increasing conflict of interest between local officials and TVE man-
agers has been exacerbated by the excessive intrusion by local officials into the
affairs of TVEs (Perotti et al., 1999; Shi et al., 2001; Sun, 2000). Local officials
often force TVEs to invest in many loss-making political pet projects to advance
the political career of local officials (Chen, 2003). Furthermore, local officials often
force profitable TVEs to provide loans to loss-making TVEs (Oi, 1999; Sun, 2000),
and local governments increasingly rely on TVEs to fill in the budgetary hole fol-
lowing the fiscal and tax reforms in the mid-1990s (Whiting, 2001). These prac-
tices are largely responsible for heavy TVE debt burden, but the debt has often
been guaranteed by local government – an extra burden on local government (Park
and Shen, 2003; Shi et al., 2001; Sun, 2000). The analysis suggests that marketi-
zation has eroded the positive function of local corporatism and the power of local
officials. However, because of the nature of collective ownership and the lack of
political reform, local officials are still able to intrude upon TVEs in many criti-
cal aspects, especially the hiring and firing of TVE managers (Chen, 2004).
Furthermore, the so-called ‘red-eye disease’ (i.e. Chinese-style envy and jealousy
rooted in the cultural value of absolute equality in China) may also have a nega-
tive effect on the relationship between the local officials and TVE managers
(Barnard and Shenkar, 1997). The local officials may become so jealous of the
increasingly wealthy TVE managers that they start to withdraw their support for
TVEs by reducing capital flow into TVEs, amortizing more community expenses
onto TVEs, and tightening-up the previously generous financial incentives in TVE
management contracts. In sum, it is the institutional context of marketization that
has changed the function of local corporatism from a ‘helping hand’ into a ‘grab-
bing hand’ on the part of local government.
I suggest that the shift of local corporatism from a helping hand to a grabbing
hand has triggered the increasingly powerful TVE managers to actively seek
formal property rights via privatization (Perotti et al., 1999; Shi et al., 2001; Sun,
2000). It is obvious that the exogenous factor of marketization has resulted in an
endogenous shift in the balance of power between local officials and TVE man-
agers, which has enhanced the bargaining power of TVE managers to seek
complete property rights via privatization. In addition, the exogenous factor of
marketization has exposed TVEs to the same agency problems of state firms as a
result of the endogenous cost of public ownership (Perotti et al., 1999; Sun, 2000).
The evidence shows that when contractual incentives lose their effect, TVE man-
agers will demand the ultimate incentive of full property rights (Chang et al.,
2003). Furthermore, growing evidence suggests strongly that the level of marketi-
zation is positively related to the levels of privatization and economic growth, but
negatively related to that of local corporatism (Jin and Qian, 1998; Li, 2003;
Whiting, 2001). The two worsening problems of TVE debt burden and ‘TVE-
resembling-state-firm disease’ have forced local governments to privatize TVEs (Li,
2003; Li and Rozelle, 2003; Shi et al., 2001; Sun, 2000). In sum, the interplay
between the exogenous factor of market competition and the endogenous factor
of public ownership has been a legitimate, transparent, fair, and public economic
driving force behind the trend of privatization.
The Political Logic of Elite Corruption: Public Alliance versus

Private Collusion
I argue that the functional shift of local corporatism from helping hand to grab-
bing hand in an economic sense is directly related to its functional shift in a
political sense – from a public government-business alliance to a private
official-manager collusion. Contrary to the largely legitimate, fair, and transpar-
ent features of public alliance for economic growth (thus responsible for the initial
success of TVEs and local corporatism), the illegitimate, unfair, and opaque fea-
tures of private collusion for systemic corruption are responsible for the later
failure of TVEs (Cai, 2003; Chen, 2004; He, 1998; Hu, 2002; Jiang, 2000; Lin
and Chen, 1999; Ruf, 1999). Based on the definition of corruption as an abuse of
public power for private gain ( Johnston, 1996), I refer to systemic corruption as an
institutionalized (either organized or individually at a large scale) corruption (cf.
Fan and Grossman, 2001; Johnston and Hao, 1995; He, 1998; Holmstrom and
Smith, 2000; Li, Smyth and Yao, forthcoming; Lu, 2000; Yao, 2002). Corruption
becomes systemic when it is institutionalized in two possible ways. First, corrup-
tion is institutionalized when it involves organized crimes and other organized
212 P. P. Li
groups. For instance, a survey of corruption and economic crimes in China reveals
that nearly 60% of economic crimes prosecuted between 1995 and 1997 involved
various government agencies (Lu, 2000). Second, corruption is institutionalized
when it involves a large number of individuals as a widespread trend. As suggested
by empirical studies, corruption is widespread among China’s government officials
(e.g. Cai, 2003; Chen, 2004; Ding, 2000; He, 1998; Lin and Chen, 1999; Lin and
Zhang, 1999). In contrast to the positive functions of public alliance, private col-
lusion performs the negative functions of a corruption facilitator and a corruption
shelter by local officials for TVE managers. I suggest that corruption has the poten-
tial to affect TVEs negatively. First, corruption could suffocate the profit poten-
tials by distorting the incentives for managers and employees, and it can also lead
to the under-reporting of actual profits for the purposes of tax evasion and under-
valued asset sale, both of which have contributed to TVE failure (Li and Rozelle,
2003; Lu, 2000).
I further argue that systemic corruption can take both informal and quasi-
formal forms. Informal corruption refers to the de facto privatization via illegitimate
and illegal means, which tends to occur at a relatively limited scale (Basu and Li,
2000; Cai, 2003; Ding, 2000; Lin and Zhang, 1999; Nee, 1992; Putterman, 1995;
Ruf, 1999; Wank, 1999), while quasi-formal corruption refers to the formal pri-
vatization via illegitimate informal means under the cover of legitimate formal
means on a rampant scale (Chen, 2004; He, 1998; Hu, 2002; Jiang, 2000; Lin and
Chen, 1999; Yao, 2002). Furthermore, informal corruption can be divided into
three categories: (1) private consumption of public properties (e.g. free private use
of public facilities or funds); (2) private compensation for public services (e.g. taking
bribes or bribing with public funds); (3) private conversion of public assets (e.g.
outright embezzlement; self-bribery as a dual-career official–manager, or infor-
mally stripping public asset via fraudulent business deals as a dual-career official–
manager or a hidden partner of private business). In contrast, as a special type of
systemic corruption, quasi-formal corruption only occurs in the form of private
official–manager collusion in the process of formal privatization. For instance, the
most common type of quasi-formal corruption occurs when local officials sell TVE
assets exclusively to TVE managers at heavily discounted prices relative to the
book values (Li and Rozelle, 2003) or relative to the heavily under-valued book
values (Chen, 2004). Lastly, informal and quasi-formal corruptions typically occur
in three schemes (Li et al., 2004): (1) the change-of-career: local officials turning
into entrepreneurs while keeping the previous guanxi ties with the former govern-
ment colleagues; (2) the public dual career: local officials turning into hybrid
official–managers without quitting their governmental posts; (3) the private
dual career: local officials turning into hidden partners of private businesses
without quitting their governmental posts.
The uniqueness of TVE privatization can be highlighted by comparing it to
that of state and collective firms in the urban regions (Dong et al., 2004). First,
while the process of privatization in the state sector has been gradual and cau-
tious, the process in the TVEs has been relatively fast and radical. For instance,
the share of private ownership of urban firms went up from less than 4% in 1994
to more than 25% by 2001, in contrast to that of rural firms from less than 1%
to nearly 69%; in the same period, the share of privately controlled firms among
all urban firms went up from 0% to nearly 17%, in contrast to that of rural firms
from 0% to nearly 73%; also, the shares of management ownership and employee
ownership were nearly 37% and nearly 34%, respectively in the privatized urban
firms, in contrast to more than 61% and less than 23% in the privatized rural
firms. Second, while less-profitable small and medium-sized state firms have been
selected as the first targets for privatization, more profitable TVEs have become
the first targets by the local governments. Third, while the effect of privatization
on performance in the state sector has been largely significantly positive, the effect
in the TVE sector is at best mixed – another unique feature of TVEs (Dong
et al., 2004).
While some studies find positive effect of privatization on post-TVE perfor-
mance (e.g. Chang et al., 2003; Sonobe and Otsuka, 2001), there is some evidence
of no effect or negative effect (e.g. Dong et al., 2004; Li and Rozelle, 2003). Fur-
thermore, there is a negative association between the post-privatization perfor-
mance and the level of discount in the selling prices of TVE assets for TVE
insiders (Li and Rozelle, 2003). The negative evidence of insider privatization sug-
gests that the political force has the biggest influence over the process of privati-
zation (Dong et al., 2002). The evidence also suggests that TVEs are more
susceptible to both informal and quasi-formal corruptions than both state and
urban collective firms, largely because of its ‘local’ nature (the core of local cor-
poratism) in the sense that TVEs are relatively far from the influence of the central
state, small in asset size. With ambiguous property rights it is much less formally
supervised and under much less public scrutiny, thus more vulnerable to both infor-
mal and quasi-formal corruption (Chen, 2004; Jiang, 2000; Lin and Chen, 1999;
Putterman, 1995; Ruf, 1999). In sum, it is the systemic corruption that has facili-
tated the functional shift of local corporatism in China from positive public
alliance to negative private collusion.
An Overall Logic of Dual-track Paradigm: Wealth Creation versus

Wealth Transfer
I suggest that both the economic logic of market competition and the political
logic of élite corruption are necessary for a full explanation about TVEs and local
corporatism. I further argue that the ultimate driving force behind the whole
process of economic transition is the balance between interactive institutions (e.g.
the balanced interplays between formal and informal institutions as well as
between economic and political ones). I refer to this perspective as the overall logic
214 P. P. Li
of dual-track paradigm. This perspective echoes the argument that the corruption
in transition economies is the symptom of the weaknesses in economic structures
and institutions in those countries (Abed and Davoodi, 2000).
According to the overall logic, the functions and effects of local corporatism as
well as the levels and forms of systemic corruption can be easily differentiated and
integrated along two contrasting phases of economic transition. I refer to the initial
phase of economic transition as a phase of wealth creation for the successes of TVEs
and local corporatism with limited informal systemic corruption, whereas the later
phase as a phase of wealth transfer for the failures of TVEs and local corporatism
with rampant quasi-formal systemic corruption. The two-phase view can be best
illustrated by the two patterns of relationships between TVE performance, local
corporatism, and élite corruption.
First, there is a curvilinear or inverted U-shaped relationship between élite cor-
ruption and local corporatism (Chen 2004; Johnston and Hao, 1995; Lin and
Chen, 1999). When élite corruption is not systemic, it is unlikely for local corpo-
ratism to occur because there is a lack of personal incentive for public–private
partnerships; when corruption is systemic at a moderate level (e.g. informal cor-
ruption to a relatively limited extent), it is highly likely for local corporatism to be
a positive government–business public alliance, where the public interest of local
community is well balanced with the private interest of officials and managers for
a fast development of the local economy; when systemic corruption is rampant at
a high level (e.g. quasi-formal corruption to an epidemic extent), it is highly likely
for local corporatism to be a negative official–manager private collusion, where
private interest is served at the expense of public interest for a swift transfer of
public asset into private hands, thus impeding the further growth of the local
economy. Though the private collusion of local corporatism has been in existence
since the start of China’s economic transition, it has become the predominant
function of local corporatism in the later phases of economic transition (Cai, 2003;
Chen, 2004; Dong et al., 2002; Hu, 2002; Jiang, 2000; Lin and Chen, 1999; Ruf,
1999). As the expected result of both quasi-formal and informal corruption, the
process of economic transition seems parallel to that of transforming the pre-
reform political élite into the post-reform economic élite in the rural region (Chen,
2004; Lin and Chen, 1999; Walder, 2002a, 2002b) and the urban region (Ding,
2000; Lin and Zhang, 1999; Wank, 1999).
Second, there is a linear relationship between systemic corruption and transi-
tional process (Cao, 2000; Chen, 2003; Chen, 2004; Johnston and Hao, 1995).
The limited informal systemic corruption is evident in the initial phase of wealth
creation, whereas the rampant quasi-formal systemic corruption is evident in the
later phase of wealth transfer. The linear relationship is due to two different
agendas of the élite in two different phases of economic transition. In the initial
phase of economic transition, the priority of the élite was to create wealth because
there was little stock of wealth. Furthermore, economic development was critical
for the survival of China’s élite at a time of crisis due to the political disillusion-
ment and economic collapse at the end of the decade-long ‘Cultural Revolution’
(Li and Lian, 1999; cf. Oi, 1999; Whiting, 2001). The élite realized that economic
growth was paramount because it would benefit the mass economically so as to
preserve the political privilege of the élite. This was exactly the motive for the ini-
tialization of China’s economic transition. Consequently, there was a high com-
patibility between the public interest of the mass and the private interest of the
élite in the initial phase of economic transition, thus informal corruption to a
limited extent. In the later phase of economic transition, however, the priority of
the élite has shifted from the goal of wealth creation to that of wealth transfer.
This is not only because a substantial public wealth has been created, but also
because the élite find it tempting and urgent to transfer public wealth into their
private hands, resulting in a sudden surge of systemic corruption and the dramatic
trend of massive privatization across China.
I suggest that the élite’s urgency for wealth transfer and the resulting surge of sys-
temic corruption in the later phase of economic transition in China may derive from
three basic factors. First, the urgency may be created by an intra-élite competition
for the lion’s share in the game of wealth transfer and also for the best deals at the
lowest cost. Second, the urgency may be created by the expectation that the game
of wealth transfer would not last long and therefore the public assets must be trans-
ferred into the private hands quickly before the general public could stop it. Third,
the urgency may have been created by the ‘red-eye disease’. It is possible that the
political élite are so envious of the emerging economic élite that they want to become
rich in a quick and easy way. The urgency for wealth transfer may be further exac-
erbated by the ‘red-eye disease’ of the local élite for others across different regions,
thus resulting in a special isomorphism among China’s élite. Fourth, the urgency
may be created by the need to reinforce the political base of the élite by opening up
the game of wealth transfer to a selected group of newcomers in exchange for their
political support. My argument is supported by the emerging view that the former
Communist élite would be the first to be the new capitalist élite via corruption in
the process of economic transition (see Holmstrom and Smith, 2000; Hu, 2002;
Williams, 2001; Yao, 2002). According to a national survey in 1996 (Walder, 2002b),
there are two significant trends in the process of China’s economic transition:
(1) the local officials, as the local élite, are the most likely to become TVE managers
in the initial phase of economic transition; (2) TVE managers are the most likely to
become private entrepreneurs in the later phase. Furthermore, when public assets
are small and dispersed, the élite find them unattractive, as is the case of wealth
creation; however, when public assets are large and concentrated, the élite find
them attractive, as is the case of wealth transfer (Walder, 2002b).
The argument for the two phases of economic transition is echoed by the view
that the de facto privatization via informal corruption was enough for the local élite
in the initial phase, but it has become insufficient in the later phase, so the élite
216 P. P. Li
have begun to seek formal privatization via quasi-formal corruption (Chen, 2004;
Hu, 2002; Jiang, 2000; Lin and Chen, 1999). The shift from contractual incentive
to equity incentive supports the argument (Chang et al., 2003). The argument is
further collaborated by the evidence that none of the formal privatization schemes
are based on transparent and fair market competition; on the contrary, all of the
schemes are opaque and unfair, in favor of inside managers at discounted prices
(Chen, 2004; Dong et al., 2002, 2004; Jiang, 2000; Li and Rozelle, 2003; Lin and
Chen, 1999). In addition, whenever they can, the local élite block the development
of open markets for scarce resources, including bank credits (Brandt and Li, 2003),
land use rights (Cai, 2003), and local product markets (Li, Qiu and Sun, 2003). In
sum, the shift of the élite’s priority from wealth creation to wealth transfer is the
driving force behind the surge of systemic corruption and the consequent func-
tional shift of local corporatism.
Most importantly, systemic corruption is rooted in the institutional interplays in
China. We argue that China’s systemic corruption has been not only tolerated but
also supported by the state as the core of the élite’s twofold quasi-formal political
agenda: (1) to tolerate informal corruption for political loyalty from officials
through economic incentives (Basu and Li, 2000; Chen, 2003; Fan and Grossman,
2001; Johnston and Hao, 1995) and political disincentives (e.g. the threat of selec-
tive punishment for corruption, Fan and Grossman, 2001); (2) to support quasi-
formal corruption for the extension of the élite privilege from political arena to
economic arena (Chen, 2004; Ding, 2000; He, 1998; Hu, 2002; Jiang, 2000; Li et
al., 2004; Lin and Chen, 1999; Lin and Zhang, 1999; Lu, 2000; Ruf, 1999;
Williams, 2001; Yao, 2002), thus transforming the old Communist privilege into
a new capitalist privilege (Holmstrom and Smith, 2000; Walder, 2003). In sum,
China has both informal and quasi-formal corruption at both local and central
levels for the political agenda of its ruling élite.
To achieve the twofold political agenda as well as the quasi-formal economic
agenda of fast growth, the élite has adopted two sequential goals for China’s
economic transition. The first is wealth creation in the initial phase of economic
transition; the second is wealth transfer in the later phase. These two goals can be
accomplished by four approaches in terms of four types of interplay between
formal and informal institutions as well as between political and economic insti-
tutions (Hu, 2002; Lu, 2000).
1. The strong informal institution of guanxi (in the form of informal corrup-
tion) supplements the strong (for political control) yet ineffective (for economic
growth) formal institution of state for the initiation of a quasi-formal mar-
ketization; this interplay (in the form of local corporatism as public alliance
in the phase of wealth creation) benefits both the élite and the mass (thus
positive in terms of public interest), even though more for the élite than for
the mass.
2. The strong informal institution of guanxi (in the form of informal corrup-
tion) substitutes the underdeveloped weak formal institutions of law and
market, in addition to the weakened informal institutions of ethics (the
moral vacuum is primarily due to the drastic collapse of the communist
ideology and the gradual erosion of the Confucian values), for the further
growth of marketization; this interplay (in the form of local corporatism as
public alliance in the phase of wealth creation) benefits both the élite and
the mass (thus is positive in terms of public interest), even though more for
the élite than for the masses.
3. The strong informal institution of guanxi and the strong formal political insti-
tution of state (in the form of quasi-formal corruption) sabotage the weak
formal institutions of law and market for the ‘legitimate’ transfer of public
properties into private hands; this interplay (in the form of local corporatism
as private collusion in the phase of wealth transfer) benefits the élite at the
expense of the masses (thus is negative in terms of public interest).
4. The strong informal institution of guanxi and the strong formal political insti-
tution of state (in the form of quasi-formal corruption) suppress the further
development of the weak formal institutions of law and market for the long-
term élite privilege in both political and economic arenas; this interplay (in
the form of local corporatism as private collusion in the phase of wealth
transfer) benefits the élite at the expense of the mass (thus is negative in
terms of public interest).
I argue that the supplementary and substitutive interplays tend to be balanced fits,
thus positive from the perspective of compatible public–private interests, whereas
the suppressing and sabotaging interplays tend to be imbalanced deadlocks, thus
negative from the perspective of incompatible public–private interest. For instance,
in the case of public alliance, informal guanxi ties serve as social capital for wealth
creation, which benefits both the masses and the élite; in the case of private col-
lusion, informal guanxi ties serve as personal cronyism for wealth transfer, which ben-
efits only the élite at the expense of the masses (Li and Chang, 2000). The evidence
of the economic privilege of political élite can be found in the net income advan-
tage over the process of economic transition (Walder, 2002a). Furthermore, there
is also evidence that the political élite hold on to their privileges regardless of the
specific phases of economic transition as long as there is no political reform; this
is the case in all transition economies, including China (where corruption is limited
and informal in the initial phase, but rampant and quasi-formal in the later phase)
as well as Russia (where corruption is rampant and quasi-formal in the initial
phase, but limited and informal in the later phase) (cf. Holmstrom and Smith,
2000; Walder, 2003).
Lastly, the functional shift of local corporatism, the surge of systemic corrup-
tion and the deadlock of institutional imbalance all directly derive from China’s
218 P. P. Li
dual-track reform paradigm (cf. Jin and Haynes, 1997). As the core of China’s
experience of economic transition, the dual-track reform paradigm serves as the
overall reform strategy for both economic marketization via competition (thus
wealth creation in the initial phase) and political control via corruption (thus wealth
transfer in the later phase) (Cao, 2000; Chen, 2004; Ding, 2000; He, 1998; Holm-
strom and Smith, 2000; Hu, 2002; Li et al., 2004; Lin and Chen, 1999; Yao, 2002).
The paradigm consists of two tracks: (1) a fast-changing ‘market-for-the-masses’
track of quasi-formal marketization via competition for economic growth, espe-
cially effective in the initial phase of wealth creation with primarily legitimate, fair,
transparent and public features, and (2) a slow-changing ‘state-for-élite’ track of
quasi-formal control via corruption for privilege preservation, especially effective
in the later phase of wealth transfer with largely illegitimate, unfair, opaque, and
private features. The most significant result of the dual-track paradigm is the trans-
formation of the Communist élite into the capitalist élite (Chen, 2004; Holmstrom
and Smith, 2000; Hu, 2002; Walder, 2003). The most salient long-term
consequence of the dual-track reform paradigm is the marketization of political
power, where public power is traded for private gain (Chen, 2004; He, 1998; Hu,
2002; Williams, 2001; Yao, 2002), thus creating the first-generation capitalist élite
(Holmstrom and Smith, 2000). The interplay of the two tracks has created both
the necessity and feasibility of a political ‘power’ market. The surge of systemic
corruption and the resulting functional shift of local corporatism derive directly
from this political ‘power’ market. In an extensive field study in the provinces of
Jiangsu and Fujian between 1996 and 2002, Chen (2004) finds evidence about
how the rural élite has evolved from a political élite into an economic one via a
mix of informal and quasi-formal corruptions. Further evidence shows that the
deep involvement of political élite in local economy (as the core of local corpo-
ratism) is negatively related to the rate of economic growth and the level of mar-
ketization, exactly the opposite of the effect of local corporatism in the initial phase
of economic transition ( Jin and Qian, 1998; Li, 2003; Whiting, 2001). In sum,
China’s dual-track reform paradigm holds the master key to both the puzzle of
TVEs and the paradox of local corporatism as the paradigm dictates the
functional shift of local corporatism and the surge of systemic corruption. I
summarize my overall argument into an integrated framework as illustrated by
Figure 1.
CONCLUSION
This paper has reconciled and synthesized the diverse views about TVEs and local
corporatism in the context of ongoing institutional changes in China as a transition
economy. It includes economic, political, cultural, and social explanations, espe-
cially the competing views of marketization and corruption. My central argument
is that the key to the puzzle of TVE efficiency and the paradox of local corporatism
Antecedents Content-process Consequences
Market-for-the-masses track
Quasi-formal economic agenda Initial phase of wealth
Quasi-formal market competition creation
TVE success
Positive local corporatism
Institutional Systemic Local
interplay corruption corporatism
Initial Phase: Initial Phase: Initial Phase:

Supplement Limited Helping Hand
Substitute Informal Public Alliance
Later Phase: Later Phase: Later Phase:

Sabotage Rampant Grabbing Hand
Suppress Quasi-Formal Private Collusion
Later phase of wealth
transfer
State-for-élite track TVE failure

Negative local corporatism
Quasi-formal political agenda
Quasi-formal state control
Figure 1. An integrated framework of TVE and local corporatism
lies in the complex interplays between different institutions in the context of a dual-
track reform paradigm. TVE success and failure can be explained by the functional
shifts of local corporatism from a helping hand to a grabbing hand as a result of
quasi-formal marketization as well as from a public alliance to a private collusion
because of quasi-formal élite corruption. The functional shift of local corporatism
was paralleled by the surge of systemic corruption from limited informal corrup-
tion to rampant quasi-formal corruption. The surge of systemic corruption derives
from the interplays between the ‘market-for-the-masses’ track and the ‘state-for-
élite’ track for the élite’s political privilege in the initial phase of wealth creation,
and the élite’s economic privilege in the later phase of wealth transfer.
The primary policy implication of TVEs is that the dual-track reform paradigm
may enjoy short-term benefits in the initial phase of economic transition, but it
may suffer from long-term problems in the later phase. This perspective can shed
new light on the heated debate over the superiority of China’s reform approach
(i.e. the ‘gradualist’ approach versus the ‘big-bang’ approach, see Spicer, McDer-
mott, and Kogut, 2000 for a review). Recognizing the strengths and limitations of
each competing view, my analysis suggests a possible third view that considers both
approaches as equally valid for two different phases (cf. Rozelle and Swinnen,
2003). As suggested by my analysis of TVEs and local corporatism along the theme
of dual-track reform paradigm, it is reasonable to argue that the gradualist path
may be more appropriate for the initial phase of economic transition, while the
big-bang path may be imperative for the later phase. In this sense, my argument
echoes the views that it is irrelevant (Oi, 1999), simplistic (Rozelle and Swinnen,
2003) and misleading ( Jin and Haynes, 1997) to consider the gradualist and big-
220 P. P. Li
bang policies as mutually exclusive. China’s experience seems to suggest that an
integration of both gradualist and big-bang approaches may be necessary, with
the gradualist policy for the initial phase and the big-bang policy for the later
phase, rather than two mutually exclusive paths. This perspective can also shed
light on the ongoing debate over the necessity of privatization and democracy for
economic transition (Oi, 1999; Rawski, 1995). I argue that both reforms are im-
perative for the long-term overall success of economic transition (Yao, 2001), if
not in the initial phase, at least in the later phase. One must recognize the inher-
ent limitations of dual-track reform paradigm in terms of growing conflicts
between the two tracks. In sum, while the dual-track reform paradigm may be
proper for economic transition in its initial phase, an integrated-track reform par-
adigm (i.e. balancing economic and political reforms as well as informal and
formal institutions) is imperative for economic transition in its later phase. Fur-
thermore, a different paradigm (e.g. the ‘big-bang’ paradigm in Russia) would have
a different sequence of economic transition (e.g. wealth transfer in the initial phase,
and wealth creation in the later phase).
For the primary research implications of TVEs, I call for more attention to the
nature and effect of informal institutions (e.g. guanxi, corruption, and ethics), espe-
cially holistic, dynamic and dialectical interplays between different institutions in
the context of economic transition (Pejovich, 1997). The holistic aspect is concerned
with the need to conduct research in a comprehensive and systematic manner (e.g.
the integration of all key elements, including formal, informal, political, and eco-
nomic factors); the dynamic aspect is concerned with the need to conduct research
in a change-oriented and time-sensitive manner (e.g. the change of all key ele-
ments, including the functional shift of local corporatism, the surge of systemic
corruption, and the process from wealth creation to wealth transfer). Lastly, the
dialectical aspect is concerned with the need to conduct research in a balanced and
interactive manner (e.g. the integration and interplay between opposite elements,
including the political-economic interplay, the formal-informal interplay, the
public-private interplay, and the élite-masses interplay). Further research in this
direction is desirable. For example, we need more comparative studies of state,
collective and private firms; more longitudinal studies of economic transition (e.g.
the effect of different sequences of wealth creation and wealth transfer on the long-
term success of economic transition), and more systematic studies of the co-evo-
lution of formal and informal institutions as well as economic and political forces
during economic transition (e.g. the strategy for long-term well-balanced fit among
all institutions).
NOTE
I wish to express my gratitude to Dr. Marshall Meyer and the two anonymous reviewers for their
highly constructive comments and suggestions.

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Peter Ping Li (ptpli@toto.csustan.edu) is a Professor of Management at

California State University at Stanislaus. He received his Ph.D. in
International Business from the George Washington University. His primary
academic interest lies in the development of holistic, dynamic, and dialectical
frameworks with regard to the impact of culture and change on the strategic
management of multinational corporations. In particular, his recent research
focuses on re-examining the extant theories of international business and
strategic management from the cultural and social perspective of China and
East Asia, especially the issue of informal networks for economic exchanges.
Dr. Li has published in various academic journals, including Organization
Studies, Management and Organization Review, Asia Pacific Journal of Management,
Journal of Organizational Change Management, Journal of Global Information
Management, Advances in International Comparative Management, International
Executive (currently Thunderbird International Business Review), and Advances in
Chinese Industrial Studies, among others.
Manuscript received: October 13, 2003

Final version accepted: March 14, 2005
Accepted by: Marshall W. Meyer

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Management and Organization Review 1:2 197–224

The Puzzle of China’s Township–Village

Empirical Evidence POE Efficiency COE/TVE Efficiency SOE Efficiency

Zhang et al., 2001

THE PUZZLE OF TVE SUCCESS

The Competing Explanations of TVE Success

An Integrated Explanation of TVE Success

The Institutional Roots of Local Corporatism

THE SHIFT OF LOCAL CORPORATISM FROM POSITIVE

Empirical Studies The Extent of TVE Privatization

Li and Rozelle, 2003 86% of the sampled TVEs as privatized

The Competing Explanations for TVE Privatization

The Economic Logic of Market Competition: Helping Hand versus

The Political Logic of Elite Corruption: Public Alliance versus

An Overall Logic of Dual-track Paradigm: Wealth Creation versus

Initial Phase: Initial Phase: Initial Phase:

Later Phase: Later Phase: Later Phase:

State-for-élite track TVE failure

Figure 1. An integrated framework of TVE and local corporatism

© Blackwell Publishing Ltd 2005.

© Blackwell Publishing Ltd 2005.

© Blackwell Publishing Ltd 2005.

© Blackwell Publishing Ltd 2005.

Peter Ping Li (ptpli@toto.csustan.edu) is a Professor of Management at

Manuscript received: October 13, 2003

© Blackwell Publishing Ltd 2005.

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