Organizational Dynamics of Market Transition: Hybrid Forms, Property Rights, and Mixed

Economy in China
Author(s): Victor Nee
Source: Administrative Science Quarterly, Vol. 37, No. 1 (Mar., 1992), pp. 1-27
Published by: Johnson Graduate School of Management, Cornell University
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 Dynamics This paper underscores the importance of hybridforms
Organizational
of MarketTransition: in the currentmarkettransitions in state socialism
an examination of the emergence of marketized
HybridForms,Property through
firmsand cadre-entrepreneursin China. The paper
Rights,and Mixed develops a new-institutionalistanalysis of the
EconomyinChina organizational dynamics that propel markettransitionin
VictorNee
CornellUniversity
? 1992 byCornellUniversity.
.00.
0001-8392/92/3701-0001/$1
Anearlierdraftwas presented at the
annualmeeting oftheASAat
Washington, DC,August11-15,1990.
Brettde Bary,RonaldBreiger, Rachel
Davis,JohnFreeman,PeterGideon,
ThomasLyons,Marshall Meyer,Bruce
Reynolds,ScottRozelle,Dorothy
DavidStark,DavidStrang,
Solinger, Sijin
Su, SidTarrow, Frank Young,Xueguang
Zhou,andthreeanonymous ASO
reviewersprovided helpfulsuggestions
Specialthanksto Kim-chi
forrevision.
Trinhand PingXinqiaoforresearch
assistance.A fellowshipfromthe
American CouncilforLearnedSocieties
andSocialScienceResearchCouncil
supportedworkon thispaper.Directall
correspondence to VictorNee,
Department ofSociology, Cornell
Ithaca,NY 14853.
University,
reformingstate socialism. Under conditions of partial
reform,marketizedfirmsenjoy a transaction cost
advantage over alternative governance structures.
Changes in the institutionalenvironmentstemming from
the spread of markets and the changing structureof
propertyrights,however, increasinglyfavor private
firms.Nonetheless, a mixed economy characterized by a
diversityof organizational forms and a pluralityof
propertyrightswill be a persistentfeature of transitions
from state socialism. Analysis of the interactionbetween
government,enterprise,and marketforces illustrates
how the new-institutionalistperspective is applied to a
dynamic model of markettransitionin China.'
China's transitionfromcentralplanninghas assumed a
trajectoryquite differentfromthatof Eastern Europe and the
Soviet Union.Whereas Eastern Europe and the Soviet Union
rejected communismforWestern-styledemocracies and
initiatedrapidstate-guidedtransitionsto marketeconomies,
China has steadfastlyrefusedto carryout reformof its
and has fixedits course to remake the
politicalinstitutions
economic institutions of state socialism not by revolutionbut
by reform.As a result,China,which was perceived as
innovativeand daringin the 1980s, today is viewed as a
bastion of communistreactionto the changes sweeping
throughEastern Europe and the republicsof the former
Soviet Union.
Despite the politicalretrenchment in China,the market
reformsimplementedin the 1980s have lasting
consequences thatare not easily reversed,even witha
hard-lineconservativefactionin controlof state power.
Economic reformfrom1978 to 1989 broughtabout changes
in power relationshipswithinthe state structureand in
society,which in turngave rise to new alignmentsof
intereststhatchampionmarketization. First,fiscaland
organizationalreformscarriedout in the 1980s led to a
significant devolutionof power fromthe centralstate
apparatus to provincialand local governments(Tong, 1989).
Despite Beijing's effortsto recentralizefiscalcontrol,over 50
percentof the Chinese state budget is now in the hands of
officialsin the provinces.Second, over the years, forboth
privateproducersand industrialenterprises,dependence on
agencies has lessened, as
verticalties to state redistributive
markettransactionshave assumed greatersignificance(Du,
1988; Nee, 1989b, 1991; Solinger,1989; Lardy,1991). Here
redistributiverefersto the collection,storage, and
redistributionof goods and services by administrative fiatin
state socialism (Szelenyi,1978). Peasant households and
firmsin particularhave gained more autonomyas they
shiftedproductionfroma near-exclusiverelianceon staple
food crops to more diversifiedcommodityproductionforthe
marketplace.By contrastto the Maoist emphasis on local
self-sufficiency,specialization-stimulatedby
37 (1992): 1-27
Science Quarterly,
1/Administrative
commercialization-has broughtto the marketplacea wide
arrayof commodities,both agricultural
and lightindustrial
(Nee and Su, 1990: 9-11).
Market-oriented growthin the 1980s was centered primarily
in the coastal provincesin China (Vogel, 1989), with inland
regionsundergoingthe least change. This market-oriented
growthwas most pronouncedin the collectiveand private
sectors, which emerged as the most dynamicwithinthe
Chinese economy,with ruralindustriesexperiencing
explosive growththroughthe 1980s (Byrdand Lin,1990;
Naughton,1991). The center of gravityof the collectiveand
privateeconomies is in the countryside,in towns and
villages,where the state initiatedmarketreformsin 1978
and bequeathed marketsthe broadest license forexpansion.
Despite the unauthorizedinterferenceof local cadres, rural
marketsexperienced rapidgrowth(Watson, 1988), largely
unrestrictedby formalstate interventions. Followinga brief
recession (1989-1990), the Chinese economy resumed its
high-speedgrowthtrajectory, with industrialgrowthin 1991
at 12 percent.The coastal provincesof southeasternChina
now encompass the most rapidlygrowingmarket-driven
economy in the world.
The transitioneconomy has given birthto a new diversityin
organizationalformsand a plurality of propertyrights.The
spectrumspans the continuumfromthe formaland
hierarchicalstate-ownedenterprisesto small family-owned
firmsrunby peasant entrepreneurs.Among the
consequences of rapidmarket-oriented economic growthin
the 1980s was the incrementaltransformation of collective
enterprisesintoa hybridorganizationalform-the marketized
redistributive firm(hereafter,marketizedfirm).Marketized
firmsrepresentan intermediatepropertyformshaped by
new pressures forefficiencyand flexibility in rapidly
changingenvironmentsin which marketforces incrementally
replace the state redistributive
mechanism (see Powell,
1988). Theirstructureof ownershipis in flux.For example,
when townshipand villagegovernmentslease collective
enterprisesto privateoperators,these firmsbecome a
mixed propertyform,with local governmentand private
operatorsclaimingpropertyrightsover them. Like hybridsin
advanced capitalisteconomies, the hybridsof the transition
economy are organizationalformsthat "use resources and/or
governance structuresfrommore than one existing
organization"(Borysand Jemison,1989: 235). Similarly, as
in capitalisteconomies the advantage of hybridsin the
transitionaleconomy is theircapacityto reduce uncertainty
in interorganizationalrelationshipsinvolvingbilateral
dependency (Pfeffer,1972; Pfefferand Nowak, 1976).
Transactioncost economics explains the emergence of
hybridformsas a means to economize on transactioncosts
in interorganizationalrelationshipswhen "parties to the
transactionmaintainautonomybut are bilaterally dependent
to a nontrivialdegree" (Williamson,1991: 271). Fromthe
perspectiveof transactioncost economics, hybridsare
discrete governancestructuresthatfallbetween marketand
hierarchyand possess theirown institutional logic.What
distinguisheshybridsfromalternativegovernance structures
is an elastic contractingmechanismthatfacilitatescontinuity
2/ASQ,March1992
MarketTransition

and efficientadaptation.Accordingto Williamson(1991), the

neoclassical contractregimeand excuse doctrine,which
relievepartiesfromstrictenforcement,providethe
mechanismthat backs hybridforms.
institutional
Characterizedby Llewellyn(1931: 737) as "contractas
framework,"the neoclassical contract"almost never
accuratelyindicatesreal workingrelations"but, instead,
providesapproximateguidelinesand specifies the rulefor
appeal, should the relationshipbreakdown.
Criticalto the neoclassical contractregimein market
societies is the maintenanceof legal autonomybased on
clearlyspecified propertyrights.This providesthe basis for
litigationwhen losses incurredexceed the level specified by
the excuse doctrineof the neoclassical contract.By contrast,
hybridsin reforming state socialist societies lack a
well-specifiedstructureof propertyrightsand, therefore,
effectiveautonomy(e.g., Stark,1989). For this reason, the
socialist hybridsmust relymore on personal ties than on
legal contractsto provideassurances thatthe terms of a
transactionwill be met by both parties(Carroll,Goodstein,
and Gyenes, 1988). The need forintense investmentin
personal connections(guanxi),stemmingfromhavingto
cope withwidespread uncertaintiesin the institutional
environment,providesthe impetus behindthe rise of local
corporatismin China.
In China at present,the marketizedredistributive and private
sectors sustain potentinterestsin market-oriented economic
growth,which is oftennurturedby directlinksto urban
centers and the worldeconomy throughsubcontractingor
"puttingout" arrangementsand joint-venture projects (Su,
1992). These interests,moreover,are oftensupportedand
articulatedby local governments,which have become
increasinglyrelianton revenues gained fromthe marketized
redistributivesector, as well as the privateeconomy. The
new alignmentof interestsstructuredby marketforces and
dynamicsof partialreformhas given rise to
the institutional
neolocalism,a formof corporatismbased on a coalition
between local government,the marketizedfirm,and private
enterprise,oftenagainst the encroachmentof the central
state. Far frombeing unitaryhierarchies,local government,
marketizedfirms,and privateenterpriseconstitutea loosely
coupled coalitionof interestgroups, in which interestsand
group cohesion are continuouslyshiftingand reconstituting
themselves in new combinationsaccordingto changing
environmentalconditions(Pfefferand Salancik, 1978).
Local governmentinvolvementin ruralindustryhas been
interpretedas a distortionof partialreformthat undermines
the efficiencygoals of economic reform(Wong, 1986, 1987,
were
1990). The claim is thatthe causes of inefficiency
unwittinglytransferred fromcentralministriesdown to local
governments,where theywere compounded by the
antimarket, protectionistconservatismof local officialsand
the Maoist legacy of closed local economies. AlthoughI do
not disagree withsalient aspects of Wong's analysis, I
analysis in which
propose an alternativenew-institutionalist
the relationshipbetween local governmentand industryis
arrangement
terms,as an institutional
viewedincorporatist
a solutionto the problemofweak market
thatrepresents
3/ASQ,March1992
structures and incomplete markettransition. Local
governments assist collectiveenterprises,whichreceive
littlefromthestate,to securereliableaccess to factor
resourcestheyneed,especiallythose inshortsupply.They
also overseelocallabormarketsand appointmanagersto
collectiveenterprises notleased to privateoperators, serve
as intermediaries incriticalnegotiationswithbanksfor
access to credit,fixlocalpriceson select numbersof
commodities, and approveand coordinate investment of
extrabudgetary fundsundertheircontrolforprojects
proposedbycollectiveenterprises. Although such
microinterventions bylocalgovernment exerta softening
effecton thefirm'sbudgetconstraint, localcorporatism can
enhancethefirm'scompetitiveness indomesticand world
marketsbyoffering horizontal
subsidies,facilitating and
verticaleconomicintegration, providing access to credit
capital,and investing ininfrastructuresuch as schools,
roads,publictransportation, and otherservices.Inshort,
localgovernments mayprovidethe backingand resources
needed byentrepreneurs to competeeffectively inan
economycharacterized bypartialreform, inwhichthe
still-dominantredistributive interact
institutions withmarket
forcesina mannerthatsubordinates marketinstitutions.
The transitioneconomy,characterized byweak market
structures,poorlyspecifiedproperty rights, and institutional
uncertaintyincreasesthe relative cost of redistributioneven
whilerendering costlymarket transactions (Nee, 1992).This
characteristicconditionofpartialreform createsan
environment
institutional inwhichhybrid formsenjoya
transactioncost advantageoveralternative governance
structures.A continuing shiftfromredistribution to markets,
however,induceschangeinthecomparative costs of
governance. As marketinstitutionsbecome moredominant
inthetransition economyand as the institutional foundation
ofa marketeconomyis incrementally constructed, these
parameter changesresultina relativeincreaseinthe cost of
hybridgovernancestructures and reduction inthecost of
transactingforprivate firms.The organizational dynamicsof
markettransition, I maintain,
are drivenbysuch parameter
changesinthe institutional environment (North, 1986, 1990;
Williamson, 1991). Keyfactorsthatexplainthe rapidgrowth
of hybridformsand privateenterprise are the expanding
scope of marketinstitutions
relative incoordinating the
economy,changesinthestructure of property and
rights,
the incremental shiftfroma redistributive to a regulatory
state(Nee, 1989a).These institutional changesexplain
improvements ineconomicperformance inChinaafterthe
of economicreform
initiation in 1978 (Nee and Su, 1990).
Changesinthe institutional environment accountforwhy
state-ownedenterprises undergodeclining economic
performance, whilemarketized and privatefirmsexperience
rapidgrowth.

THE INSTITUTIONALENVIRONMENT
Evenpriorto marketreform, the extentofcentralplanningin
Chinawas considerablyless thaninthe SovietUnionand
EasternEurope.The planning processinvolvedmultiple
levelsofdecisionmaking,fromthe centralministriesto the
4/ASQ,March1992
MarketTransition

province, city,county, and township, witheach levelofthe

statestructure redistributing substantialresourceswithinits
area ofjurisdiction (Lyons,1990).Only6 percentof Chinese
industrialenterprises were classifiedas large-or medium-
scale. These state-ownedenterprises formedthe coreofthe
firmsdirectly supervisedbycentralministries and provincial
bureausunderthecentralplan.Seventy-eight percentof
Chineseenterprises were small-scale,labor-intensive
organizations registered undercollectiveownership(Kueh,
1985).These and smallerstateenterprises were controlled
bylocalgovernments.
Itmightbe arguedthatthe preponderance ofsmallfirmsin
China'spre-reform industrial economymayaccountforwhy
the Chineseindustrial economyrespondedmorefavorably to
economicreform thanthe Sovietand EasternEuropean
economies,wherethe ratioof largeto smallindustrial plants
was the reverseof China's.As Lawrenceand Lorsch(1967)
haveargued,no generalorganizational formis best suited
forall institutionalenvironments. Formalized and hierarchical
formsof classicalstatesocialismare wellsuitedto a
homogeneousand stableenvironment. Butduringperiodsof
rapidchangeand institutional uncertainty,organizational
formsthatare moreflexible, informal, and open to
entrepreneurship exhibitsuperioradaptivecapacity(Piore
and Sabel, 1984; Storper,1989).
The centerpiecesof industrial reform inthe 1980s involved
thedecentralization ofpowerto theenterprise and local
government, reflected mostclearlyinprofit retention and
sharingarrangements. Byaugmenting theirdecision-making
power,thestatesoughtto provideindustrial enterprises
withtheflexibility and incentives forimproving economic
performance (Zhangand Zhang,1987).Accordingly,
enterprises were permitted to retain70 percentof
extrabudgetary funds,whichtheycouldinvestinthe plant's
fixedcapitalor distribute to workersand staffthrough annual
bonusplans.Simultaneously, thestatetransferred to local
governments greaterbudgetary and fiscalpower(CASS,
1989). Liketheenterprises, localgovernments couldretain
surplusrevenueafterpayinga negotiatedshareof local
taxesto thecentralgovernment. The aimwas to overcome
administrative rigiditiesassociatedwithcentralplanning and
to stimulate enthusiasmon the partof localgovernment to
supportand pursuemarket-oriented economicdevelopment.
The accompanying revenue-sharing arrangements forgeda
virtual partnership betweenlocalgovernment and industry.
Decollectivization ofagriculture and thesubsequentreform
of localgovernment raisedthequestionof property rights
overruralcollectiveenterprises. Collectiveenterprises, the
legacyofthe GreatLeap Forwardindustrialization drive,
couldnotbe readily disentangled fromvillageand township
governments. Neitherpublic(state-owned) norprivate, the
collectivefirmembodiesa community property form,so
that,intheory, the property belongsto allwho livewithin
thejurisdiction ofthe localgovernment. Thislefttownship
and villagegovernments withthestrongestclaimover
profits fromcollectiveenterprises, whichsoon became their
majorsourceof revenuethrough taxes,levies,and
revenue-sharing arrangements.
5/ASQ,March1992
The close interorganizational relationshipbetween collective
enterprisesand local governmentnot onlyis based on the
structureof propertyrightsbut is reinforcedby bilateral
dependency. First,in a shortage economy, collective
enterprises,which are at the bottomof the hierarchyof
industrialfirms,must relyon connectionsprovidedby local
governmentto secure needed resources and credit.
Similarly,local governmentsbecame increasinglydependent
on revenues fromcollectiveenterprises.Second, local
corporatismeconomizes on transactioncosts when the
institutional arrangementsunderpinning marketsare weak. In
the absence of contractuallaw hardened by routine
compliance and enforcement,marketizedenterprisesneed
politicalallies to go to bat forthem in negotiatingand
enforcingcontracts,especiallywithdominantstate agencies
and enterprises.Because a state-ownedenterpriseor
foreignfirmmightshow littlecompunctionforstrong-arm
tactics and guile in directdealings withsmallercollectiveand
privatefirms,it may be to the advantage of collective
enterprisemanagers to use jointnegotiationsinvolvinglocal
authoritiesto enhance theirnegotiatingposition.State
enterprisescan be veryslow in payingsmallercollective
firmsforsubcontractedparts; such debts pose severe
problemsforlocal industriesin meetingcurrentsalaries and
expenses. Anothercommon complaintis the abrupt
abrogationof contractswithoutcompensationforpossible
losses sufferedby subcontractors.Obtainingbusiness
contractswith local governmentbackingmay reduce
transactioncosts forstate enterprisesand foreignfirmsas
well, by providingofficialassurance thatthe terms set by
the contractwill be fulfilled in a timelymanner.In addition,a
foreignor domestic firmsubcontractingthe productionand
assembly of a trademarkcommoditywillwant assurances
thatthe collectivefirmwill not resortto opportunismby
sellingexcess brand-nameproductsindependentof the main
firm.

Fueled by a decade of explosive growthof ruralindustries

and by growingcompetitionwithstate-owned enterprises
forfactorresources and markets,neolocalistgovernments
eventuallyassumed an assertive stance in relationto the
centralgovernment,strongenough to meritthe center's
attention.Publicattacks on neolocalism emanated fromhigh
places. Centralistspointedto the potentialforthe
disintegrationof the nationaleconomy intothousands of
fieflikecountyand provincialeconomies, each withstrong
autarkictendencies. Others pointedto the problemof
federalismwithouta constitutional frameworklikethatof the
UnitedStates, capable of holdingtogetherpowerful
centrifugalforces set in motionby neolocalistlocal
governments.Fundamentally, the controversyhas involved
the loss of redistributivepower by the centralstate
apparatus to marketinstitutions and local government.This
is reflectedin a widelycirculatedCentralCommittee
document: "The power to distributecapital,foreign
exchange and resources is too decentralizedand the state's
controlseriouslyeroded. Enterprisesand individualshave too
great a share in the distribution
of nationalincome"
(People'sDaily,
January
11, 1990: 1-3).
6/ASQ,March1992
MarketTransition

THE MARKETIZED FIRM AND CADRE-ENTREPRENEUR

In a redistributiveeconomy,centraldecisions distribute
goods and services througha verticalhierarchy(Polanyi,
1957). What characterizesredistribution at each level of this
hierarchyis the structuredcentricity of economic
transactions.Whetherat the local, provincial,regional,or
nationallevel,the circulationof goods and services in a state
economy involvescomplex resource
socialist redistributive
transfersfromthe firmto state agencies, which in turn
allocate factorresources back to firmsand distributeoutput
to consumers. Withinthis system,the redistributive firm
(whethera collectiveor a state-ownedenterprise)operates
as an appendage of the state, respondingto commands sent
down fromthe centralministry, provincialbureau, or local
government.In the case of the marketizedfirm,the
hierarchicalcentricityof the classic redistributiveeconomy is
replaced by a mixed regimecharacterizedby increased
marketdependence. Withthe expansion of markets,
horizontalmarkettransactionsincrease in significancewhile
dependence on verticalties lessens, as the firm'ssurvival
and growthbecome more contingenton marketexchange.
Despite the protectionist tendencies of local governments,
the behaviorof largercollectiveenterprisesis oriented
towardextralocaltrade. Because collectiveenterprisesfall
outside the centralplan,which encompasses state-owned
enterprises,theirgrowthbecame increasinglydependent on
markets.Althoughcollectiveenterprisesrelyon local
governmentto gain access to resources allocated through
the plan, such resources are limited.For this reason, they
must turnto specialized marketsto purchase manyfactor
resources. This ofteninvolvesimporting outside (domestic
and foreign)investmentsand technologiesto sustain
economic growth.Similarly, productsproduced by collective
enterprises,aimed not forlocal consumptionbut for
extralocalsales, are more readilysold in regionalmarkets
than absorbed by state redistributive agencies. An additional
marketincentivestems fromstate agencies fixingpurchase
prices at lower than marketprice formost commodities.
Enterprisesthatcould purchase factorresources at
subsidized state prices and sell partof theirproductsat
highermarketprices developed a keen interestin arbitrage.
Collectiveenterprisesquicklyorientedtheirproductionto the
marketplaceand contributedto the rapidexpansion of
marketsin China.
By 1990, ruralenterprises(collectiveand private)numbered
18.4 million,employed 92 millionworkers,accounted for45
percentof total industrialproduction,and broughtin annually
about $10 billionin foreignexchange. Figure1 reveals the
rapidrelativegrowthof outputfromcollectiveand private
enterprisesafter1978. Jointventureswithforeignfirmsare
listedas "other." From 1978 to 1990 the outputvalue of
state enterprisesdeclined,while thatof collectiveand
privatefirmsgrew from23 to 45 percentof the outputvalue
of China's industrialeconomy. The transformation of
collectiveenterprisesto marketizedfirmsis shown in Figure
2, which indicatesthatthe main source of hybridformshas
been collectiveenterprises.Priorto reform,privatefirms
inthe Chineseeconomy.Below,I
nonexistent
were virtually
7/ASQ,March1992
Figure1. The structureof industrialoutputvalue.*

100

80
*-State

o 60

40
40 *-S Collective

20
Private
Other
0
1978 1980 1990
Startof Reform
* Source: State StatisticalBureau(1991: 447).

compare the attributesof nonmarketized,marketized,and

model of the
privatefirmsand develop an institutional
dynamicsof markettransitionin China.
Organizational Dynamics of MarketTransition
Table 1 presents a typologyof governance structuresthat
identifiesthe characteristicfeaturesof alternativeownership
formsof nonmarketizedfirms(NF), marketizedfirms(MF),
and privatefirms(PF) underpartialreformalong multiple
behavioraldimensions.This is an ideal-typeanalysis,first
developed by Max Weber (1949), which contrastsempirical
cases with imaginarycases representinga theoretically
derivedillustrationof a phenomenonof interest(forrecent
applications,see Bonnell,1980; Raginand Zaret, 1983). The
followingdiscussion is based on theoreticalhypotheses
about the attributesof the industrialenterpriseand on field
research I conducted in China fromMarch throughAugust
1985, when I and my researchassistants (principally Bertha
Dong, SijinSu, and Peng Lian) conducted semi-structured
in-depthinterviewswithfactorymanagers and workersin a

firm,marketized
Figure2. Dynamictransitionmodelof nonmarketized
firm,and privatefirm.
PRE-REFORM MIXED ECONOMY

State -. NonmarketizedFirm

Collective - MarketizedFirm

' Private Firm

8/ASQ,March1992
Market Transition

Table 1
Comparisons of Nonmarketized Firm (NF), Marketized Firm (MF), and
Private Firm(PF)*

Attributes NF MF PF

Enterpriseautonomy 0 + + +
Neolocalistorientation 0 + + +
Soft-budgetconstraint + + + 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.

state and a collectiveenterprise,local officialsin 30 villages

and townshipgovernments,economic bureaucratsin one
countygovernment,and 25 privateentrepreneursin Xiamen
cityand periurbancounties. The aim of the comparative
analysis reportedin Table 1 is to providemodels
institutional
of the organizationaldynamicsof markettransitionin the
industrialeconomy of China.The models are consistentwith
and supportedby the richempiricalstudies conducted by a
World Bank researchteam, which I read afterwritingthis
article.Readers of this articlemightwant to consult Byrd
and Lin (1990), who edited the manyresearch reportsin the
World Bank study.
The last column in Table 1 indicatesthat privatefirmsenjoy
more formalautonomythan nonmarketizedfirms.However,
in the absence of well-definedprivatepropertyrights,private
firmsare vulnerableto unauthorizedinterferenceby
redistributorswho impose illicitlevies on them, enforce
regulationsin a mannerthat may discriminateagainst private
enterprises,and restrictthe access to criticalfactor
resources allocated by state agencies. The greaterautonomy
enjoyed by the privatefirmcomes at the expense of high
transactioncosts (Nee and Young, 1990).
Privatefirmsoperate underhard budget constraints,as their
survivaldepends on marketperformanceand profitability.
This has the effectof imposingthe constraintof market
action on investmentdecisions and operations.However,
entryand exit are not entirelyregulatedby markets,as the
privatefirm'scapacityforsurvivaland growthis also
constrainedby difficultyof access to capitaland raw
materialscontrolledby the redistributivesector. In a socialist
redistributiveeconomy, state banks and officialsources of
creditgenerallyofferloans more on the basis of political
considerationsthan economic ones (Walder,1991). Private
firmslack the legitimacyand necessary politicalbackingto
enjoy reliableaccess to capitaland thus must depend on
private-and often,informal-sources of credit,which are
limitedand are available onlyat substantiallyhigherinterest
in a shortage economy in which state and
rates. Similarly,
collectivefirmscompete forstrategicraw materials,private
firmsmay be forcedout of business forlack of raw
materials,despite strongmarketdemand fortheirproducts.
The onlyfactorresource that is available to the privatefirm
9/ASQ, March 1992
in abundance is labor; yet here, too, the firmis vulnerableto
the enforcementof governmentregulation,which imposes
limitson the numberof workersprivatefirmsare permitted
to hire.

Due to these restrictions on factorresources and the

continuingpariah-like status of capitalistsand merchantsin a
socialist state, privatefirmsremainsmall and
undercapitalized.Moreover,the pariah-like status of the
privateentrepreneursencourages short-term investment
decisions aimed at fast returns,liquidity, and a low rate of
reinvestment -inthe firm'sgrowth.To compensate fortheir
marginalstatus, manyprivatefirmsseek close ties with local
government,oftenpayinga "management fee" for
assistance in obtainingreliableaccess to factorresources
and politicalprotectionor registering as collective
enterprises.Local authoritiesmay be more willingto
overlookviolationsof governmentregulationsand tax
evasion ifthe privatefirmhas successfullycultivatedgood
connectionswith local government,althoughsuch fees and
levies increase substantiallythe transactioncosts involvedin
doing business. The majorconstrainton the competitiveness
of privateenterprise,however,is the lack of clearlydefined
and routinelyenforcedprivatepropertyrights.

As shown in the middlecolumn of Table 1, marketizedfirms,

by contrast,lack formalautonomyto the extentthat local
governmentsexercise controlover them. Despite the aim of
enterprisereformto providegreaterdecision-makingpower
to managers,the relationshipwith local governmentrenders
local industriesvulnerableto directbureaucratic
microinterventions that,as Kornai(1989) has argued, weaken
the beneficialeffectsof marketson the firm'sperformance.
Rationalauthoritieswill have an interestin promoting
efficientgrowthto the extentthey perceive that profitable
enterprisesprovideforincreased revenues. But local
governmentsalso have an interestin protectinginefficient
collectiveenterprisesfromcompetitionby restricting the
flow of goods fromoutside. By virtueof theirsocialist
ideology,they have an interestin seeking fullemployment.
In theirzeal to promoteeconomic growth,local governments
oftenfindit difficult
to refrainfrommicrointerventions into
the managementof collectiveenterprises.These latter
characteristicsexacerbate problemsof inefficiency.

But suppose local governmentshould serve in a role

analogous to thatof the board of directorsin the capitalist
firm;then the question of autonomyappears in a different
light(Gi, 1991). Justas the board of directorsembodies the
center of ultimate-authorityin the capitalistenterprise,so
mightlocal governmentin the case of the marketizedfirm.
Local governmentprovidesvaluable networksforthe
marketizedfirm,networksthat representthe firm'ssocial
capital. Like the chiefexecutive officerof the capitalistfirm,
the manager of the marketizedfirmis accountable to local
governmentbut remainsin charge of operations.

Unlikethe state enterprise,the marketizedfirmoperates

underhardenedbudgetconstraints.
Although
local
1O/ASQ,March1992
MarketTransition

governmentmay attemptto protectinefficient marketized

firmsthroughmarketinterventions, the capacityof local
governmentto supportunprofitable firmsis much more
limitedthanthatof the centralstate. Whereas state firms
make up only6 percentof industrialenterprises,marketized
firmsare a legion of small-scale,low-capitaloperations; if
any one goes under,thereare manyothers to providea
continuingrevenue base forlocal government.Moreover,to
startup a new firmthattargetsa more lucrativemarketmay
not be thatcostlyan investment.Overall,the hardened
budget constraintand oftenintense marketcompetition
faced by the marketizedfirmenhances efficiency.
Underpartialreformthe majoradvantage of the marketized
firmover the privatefirmis its betteraccess to factor
markets.Local governmentmay actuallyplace higherpriority
on assisting the marketizedfirmin gainingaccess to capital,
raw material,and laborthan it does state enterpriseslocated
in its jurisdiction,
forthe structureof propertyrightsin
collectiveownershipties local governmentin a virtual
partnershipwiththe marketizedfirm,a partnershipthat is
sealed in a common neolocalistorientation.The growthand
profitabilityof the marketizedfirmhave a greaterand more
directimpacton maximizingthe revenue streams of local
governmentthan do those of eitherthe nonmarketizedor
privatefirm.Not onlydo the marketizedfirmshave access
to the free marketsystem, but theyalso can markettheir
productsthroughstate supplyand marketingchannels. But
because the collectiveenterpriseis ancillaryto state-owned
enterprisesin the state marketingsystem, local authorities
oftenactivelyencourage the marketizedfirmto be oriented
toward marketcompetitionand growthto circumvent
regulatoryconstraintsimposed by the centralministries.
Despite the policyof decentralizationof decision-making
power to the enterprise,nonmarketizedfirmsdepend on
verticalties to redistributive
agencies fromwhich they
receive resource transfers(Walder,1989). Likewise,their
outputis directedto state and municipalagencies that
redistribute it underthe centralplan. For these reasons,
managers in nonmarketizedfirmsare less likelyto share the
neolocalistorientationof managers of collectiveenterprises.
As state-ownedenterprises,nonmarketizedfirmsenjoy
priorityin access to raw materialand investmentcapital
allocated underthe centralplan. Onlyafterthey meet the
productiontargetstipulatedby the plan can theyproduce
goods forsale in the market.Thus theirmarketaccess is
limitedand restrictedby the planningmechanism.Although
the supplyof laboris in theoryplentiful, workersare
assigned to the nonmarketizedfirmthroughthe planning
process. Whereas marketizedfirmsare able to hire
temporaryworkersfromnearbyvillages who can be laid off
and returnedto farmworkaccordingto the firms'needs,
nonmarketizedfirmsrelyprincipally on permanentworkers
assigned by the state personnelbureau. As a result,the
nonmarketizedfirmdoes not enjoy the same flexibility as
does the marketizedfirmin regulatingthe size of its labor
force.This resultsin alternatingcycles of shortages and
surplusinthefirm'slaborforce.Shortagesalso are a
recurrentprobleminthefirm'ssupplyof rawmaterials,as
11/ASQ,March1992
these are similarlysubject to bottleneckscaused by rigidities
in the planningmechanism (Kornai,1980).
In the area of workers'compensation,the salaries and
bonuses of marketizedfirmshave increased at substantially
higherrates thanthose in the state sector. In Guangdong,
which has experiencedveryrapidmarket-oriented growthfor
the past decade, stimulatedby the Hong Kong economy,
workers' salaries in the marketizedsectors have increased
dramatically, so thatthe standardof livingin the Guangdong
provinceis now the highestin the nation.Industrialoutputof
townshipenterprisesin Guangdongincreased 345 percent
and thatof villageenterprisesby 600 percentfrom1978 to
1986, while thatof state enterprisesgrew by 210 percent;
collectiveand privateenterprisesproduced 43 percentof the
total industrialoutputin 1986 (Vogel, 1989: 456). In the
southeasterncoastal provinces,and especially in the special
economic zones, the salaries and benefitsof workersin
marketizedfirmshave soared relativeto workersin the
nonmarketizedstate sector. The discrepancyin salaries of
high-school-educated workersin marketizedfirmsand
university graduates withjobs in the state sector has grown
so enormous that low morale has become a serious problem
in elite state units.As a result,workersin the state sector
are eager to transferto the privilegedmarketizedsector.
Young people I interviewedin 1990 voiced preferencefor
gettinga job in the marketizedsector aftergraduatingfrom
highschool ratherthan applyingforadmission to a
university.Popularidioms heard among the street-wiseare
"a surgeon makes less than a barber" and "a university
professorearns less than a hotelwaiter." The growthof the
marketizedsector thus has increased interregional and
intersectoralincome inequality.
Ifthe analysis reportedin Table 1 provides realisticmodels
of behavioraldifferencesbetween private,marketized,and
nonmarketizedfirmsunderthe conditionsof partialreform,
then the system will remainin dynamictransitionas long as
there is discrepancybetween efficiencyand access to
capitaland factorresources. State enterprisesenjoy favored
access to state-allocatedcapitaland factorresources
regardlessof performance;theyoperate inefficiently, under
soft-budgetconstraints.Privatefirmsoperatingunder
hard-budgetconstraintsdisplayhigherproductivity through
economizingon productioncosts, yet theiraccess to formal
sources (i.e., state-owned banks) of capital and factor
resources is least favorable(see Kornai,1990). This lack of
fitbetween efficiencyand access to resources is the
underlying structuraltension of partialreform,generating
pressure forinstitutionalchange.
Underthe conditionsof partialreform,marketizedfirmshave
a distinctcompetitiveadvantage over both the privateand
nonmarketizedfirms.They operate in marketenvironments
with hardened budget constraints,are more efficientthan
nonmarketizedfirms,have betteraccess to factorresources,
offermore rapidlyimprovingworkers'compensations than
eithernonmarketizedor privatefirms,enjoy more local
support,and have bettermarketingoutlets. Overall,the
firmdisplaysbetteradaptivecapacityinan
marketized
12/ASQ,March1992
Market Transition

economy thatstands between the plan and the market

because its structurallocationallows the marketizedfirmto
double dip in the redistributive
and marketsectors of the
economy.
Table 2 reportsresultsof ideal-typeanalysis comparing
factorydirectors(FD) in nonmarketizedfirms,cadre-
entrepreneurs(CE) who manage the marketizedfirms,and
privateentrepreneurs(PE) along multiplebehavioral
indicators.Cadre-entrepreneurs also can include local
authorities(e.g., the partysecretaryof a township
government)not directlyengaged in the managementof the
firmbut who play a role analogous to the chairmanof the
board of a conglomeratefirm.The overallanalysis indicates
thatcadre-entrepreneurs are more similarto private
entrepreneursthan to factorydirectorsin nonmarketized
firms.While privateentrepreneurshave the greatest amount
of autonomy,cadre-entrepreneurs enjoy more operational
autonomythanfactorydirectors.In partthis stems fromthe
social and spatial proximityof local government,which
fostersa styleof informalconsultationand consensus
makingbetween managers and officials.Cadre-
entrepreneursand local officialsshare a common neolocalist
orientationand are oftenwillingto cooperate to furtherlocal
development.The shared neolocalistorientationand greater
consensus on goals have the effectof promotingsolidarity
and trust,which in turnallow the cadre-entrepreneur a
degree of operationalautonomyand, therefore,scope for
entrepreneurship.

Table2
Comparisonsof FactoryDirector(FD), Cadre-entrepreneur
(CE) and
PrivateEntrepreneur
(PE)*
Behavioralindicators FD CE PE
Autonomy 0 + + +
Risktakingand innovation 0 + ++
Entrepreneurial
incentive 0 + ++
Profit
maximizing 0 + ++
* + + = strong; + = semi-strong;0 = weak.

By contrast,factorydirectorsin nonmarketizedfirmsbehave
more likebureau chiefs accountable to local governmentand
more distantcenters of power and authority. Theirgoal is to
fulfill
the planned productiontargetson schedule withthe
factorresources allocated to them. They striveto increase
the allocationof resources throughbargainingand lobbying
effortswithinthe state bureaucracy(Walder,1991). They
seek to cultivatea good relationshipwiththe partysecretary
in theirfirmand are cautious in theirinterpretation
of policy
guidelinesissued by the partyand state ministries,lest they
jeopardize theirpoliticalreputation,which remainsa crucial
formof capitalwithinthe nonmarketizedredistributive sector
of the economy. Moreover,theyare carefulto maintaina
good relationshipwithworkersand staff,lest theyprovoke
the oppositionof the partyapparatuswithinthe enterprise,
which championsthe interestsof workers.As professional
bureaucratsin a nonmarketenvironment, factorydirectors
13/ASQ,March1992
are risk-aversein theirmanagementof the enterprise.There
is littlepremiumplaced on innovationand risktakingwhen
the evaluativeprocess emphasizes meetingproduction
targetssent down fromhigherauthoritiesand when access
to increased allocationsof capital,raw material,and labor
depends on politicalratherthan economic considerations.
Cadre-entrepreneurs, by contrast,have positiveincentives
forrisktakingand innovation,thoughtheyare more
risk-aversethan privateentrepreneurs,who stand to profit
mightily fromsuccessful ventures(and lose greatlyfrom
failure).For cadre-entrepreneurs,success in the marketplace
does not lead to enormous personal wealth, except through
illicitmeans. Like corporateexecutives in capitalist
corporations,cadre-entrepreneurs striveto advance their
careers, to gain higherbonuses, and to expand their
organizationalpower and influence.Faced with intense
marketcompetitionand operatingunderhardened budget
constraints,cadre-entrepreneurs know theycannot avoid
takingrisksand innovatingwithoutjeopardizingtheirfirms'
prospects forsurvivaland growth.Cadre-entrepreneurs
realizethatthe capacityof local governmentsto underwrite
unprofitable and inefficient
firmsis limited,unlikethatof the
centralstate, a considerationthe rash of bankruptciesof
collectiveenterprisesduringthe economic retrenchment
(1988-1990) reinforced.
Privateentrepreneursnot onlyhave strongerproclivitiesfor
risktakingand innovation,but theirprofit-maximizing
orientationand hard-budgetconstraintsencourage more
exactingcost-benefitcalculationsin theirinvestment
decisions. Because profitsaccrue directlyto them,
entrepreneurial incentivesare fargreaterthan those for
cadre-entrepreneurs. They are growth-oriented,to be sure,
but less so than eitherthe cadre-entrepreneur or even the
factorydirector,who operate undersofterbudget
constraints.Privateentrepreneursface greateruncertainties
due to the continuinginstability of fundamentalrules of the
game involvingthe marketeconomy (Nee and Young, 1990).
They thereforeare reluctantto make long-terminvestments
in the growthof theirenterprisebecause, in the absence of
adequate legal protectionof privatepropertyrightsand
possible hostility directedagainst them in a futurepolitical
campaign,theyworryabout possible appropriation of their
assets. Instead,theyinvestto gain rapidreturnson their
capital,emphasize liquidity, and spend theirprofitson
conspicuous consumptionsuch as new housingand
importedluxurycommoditiesratherthan investingin fixed
capital. In this sense, theirbehaviorresembles more that of
middlemenminorities(Bonacich, 1973) than thatof modern
capitalists(Schumpeter,1942).

Cadre-entrepreneurs, by contrast,are more orientedtoward

growththan are privateentrepreneurs.Though theirfirms
operate underharderbudget constraintsthanthe
nonmarketizedfirm,theyare subsidized by local government
throughtax reductionarrangements,access to raw materials
at below-marketprices,and cheap credit.Moreover,as
profitsdo not directlyincrease theirpersonal wealth,
cadre-entrepreneurs
have less incentive,
comparedwith
14/ASQ,March1992
Market Transition

naturalowners, to economize on wages and bonuses. For

this reason, the largestportionof extrabudgetary fundsgoes
to increase salaries and bonuses or intosocial investments
such as employee housing.Thus cadre-entrepreneurs who
manage marketizedfirmsare less discriminating in their
investmentdecisions than privateentrepreneursand favor
rapidgrowthas a strategyto enhance theirpower and
prestigewithinthe local elite.
Nonetheless, the cadre-entrepreneur is more orientedto
profitmakingthanthe factorydirector.The local government
can be likenedto the majorshareholderwho has an interest
in maximizingprofitabilityand dividendsand who expresses
interestthrougha controlling voice on the board of directors.
Whereas the factorydirectoracts to conceal profitor absorb
it in operationcosts, cadre-entrepreneursbenefitfrom
managinga profitableenterpriseinsofaras this maximizes
the revenues of local government,increases their
organizationalpower, and advances theircareers.
The above analysis needs qualification,however,to provide
forgreaterrealism.First,it may seem to suggest thatthe
centralgovernmentdoes not supporteconomic reform.This
inferencewould be inaccurate.The economic retrenchment
of 1988 to 1990 has sought to reinstitutegreaterrelianceon
mechanisms,and this has undercutsome
redistributive
reformprogramsespoused by the radicalreformfaction;but
the conservativefactionin command of state power has
refrainedfromattackingthe overallobjectives of economic
reform.Instead, differencesbetween the conservativeand
radicalreformfactionsare based on opposing strategiesfor
realizingthese broaderaims (Liu, 1989).
the post-1988 economic retrenchment
Ironically, policies
have probablymade marketizedand privateenterpriseseven
more competitivethan beforethe currentconsolidation.
Whereas veryfew state enterpriseshave closed down,
despite inefficiencyand chroniclosses, in 1989, 800,000
collectiveenterprises,underpressure fromthe state's
austeritypolicies,declared bankruptcy. Another2.2 million
eithermerged withotherenterprisesor restructured their
operation.Recessionaryconditionsin the domestic economy
have drivenmanycollectiveenterprisesto orientproduction
even more to the world economy. Reflectingthe speed of
response to changingmarketconditions,export-oriented
collectiveenterprisestripledin numberin 1989 to 45,000
firms.Althoughthe growthrate of collectiveenterprises
slowed down frompreviousyears, it stillregisteredan
increase in gross value of goods produced of 7.3 percent
duringthe firstsix monthsof 1990, while state enterprises
recordednegativegrowthrates. Even more impressivewere
privateenterprises(China Daily,August 13, 1990: 13), which
reboundedfromthe state-imposedausteritypolicies witha
growthrate of 43.7 percentin May 1990 (China Daily,July
10, 1990: 4). As one local officialquipped, "Township
enterprisesare incredibly vital.Ifyou encourage them,they
grow fast; ifyou tryto slow them down, theystillgrow fast.
They can always findmoney to investand marketsto sell. If
wage cuts
necessary,you'llsee workerstakingvoluntary
Theywillsurvive."
and makingloansto theirfactory.
Another remarked,
official "Workersand management both
15/ASQ,March1992
know that ifthe venturefailstheywill have to go back to
the fields.This is a verystrongincentiveforcooperation
between managementand labor-one which state
enterprisesdon't have" (Far Eastern Economic Review,
September 14, 1989: 65).
Second, the model assumes that local governmentssupport
marketreform.Yet this assumption probablydoes not hold
outside of the regionsthatexperienced rapidmarket-
orientedgrowthduringthe 1980s, mainlythe coastal
provincesfromGuangdongto Shanghai and ruralcounties
near large commercialcities. In inlandregions,local
governmentsoftenin fact oppose marketreform,harass and
extortfledgingprivatebusinesses, and practiceprotectionist
measures that resultin economic autarky.In these regions,
local authoritiesseek to controlmarketinstitutions and limit
the extentof marketreformto stem the erosion of
power caused by the expansion of free
redistributive
markets.Because privateenterprisesrepresentalternative
and potentiallyrivalpower bases, local authorities
accustomed to monopolizingpower may bullyprivate
entrepreneursto keep them in line,reminiscentof the way
scholar officialstreated merchantsin traditionalChina.
Where local industriesare unable to compete with
manufacturedproductsof the marketizedand economically
developed regions,ratherthan let theirindustriesgo under,
local and provincialgovernmentsestablish "inspection"
stationson theirbordersto blockthe in-flowof their
competitors'products.
In these regionsand localities,the centralization of the
economy and the enhanced regulatory and enforcement
power of the centralgovernmentmay actuallyenable market
institutions to penetrateconservativelocalisteconomies.
This involvesthe promulgationand greaterrelianceon
constitutional and civillaws thatdefinethe fundamental
rules of the game and the structureof propertyrightsand on
the indirectmacroeconomicregulationof the economy (Nee,
1989a). Recent examples of regulatoryand legal measures
pursued by the centralgovernmentin an attemptto
overcome malfeasance and illegalinterventions by local
authoritiesinclude(1) the passage in April1990 of the
Administrative Procedure Law, China's firstlaw thatenables
privatecitizensto sue governmentadministrations;(2)
continuedeffortsto enforceregulationsand laws that
sanctionofficialswho leverage redistributive power (e.g.,
controlover factormarketsand business licenses) in order
to gain illicitprivateadvantages; (3) upgradingthe
educational requirementforgovernmentofficials;(4)
improvinglegal protectionforprivatepropertyrights,
especially forforeigninvestors,and intellectualproperty,
througha new copyrightlaw; (5) creatinginstitutional
arrangementsthatenable the marketization of increasing
numbersof commodities(e.g., a new commodityfutures
marketin grain);and (6) providingincreased creditcapital for
ruralenterprises.In short,recentralization of fiscalcontrols
and regulatorypower may be a needed adjustmentto
balance the growingpower of regionaland local fiefsand
the threattheypose to economic integration and
interregional markets(Boisot and Child,1988).
16/ASQ,March1992
MarketTransition

To the extentthat retrenchment resultsin more effective

regulationof boundarytransactionsacross the redistributive
and marketsectors, it providesa more sustainable basis for
piecemeal, open-ended reformstrategy,the hallmarkof
Chinese economic reform(Lin,1989). Closing down "trading
companies" operated by cadre-entrepreneurs thatspecialize
in arbitragebetween the redistributive and marketsectors, in
which commoditiesare sold forexorbitantprofitson the free
market,has been an importantobjective of economic
retrenchment. Such tradingcompanies involveillegal
collusionwith local authorities,aggravatethe problemof
corruption,and exacerbate inflation.
Further,my models assume that,althoughtheyshare
various characteristics,collectiveand privateenterprisesare
distincttypes. However, manycollectivefirmsare actually
familybusinesses whose owners registeredtheirfirmsas
collectivein orderto gain access to factorresources, bank,
loans, markets,politicalprotection,and tax subsidies and to
circumventregulatoryhurdlesthatdiscriminateagainst
privatefirms(Ma, 1988). In exchange, these "red hat" firms
pay a percentage of theirprofitto local governmentas a
"management fee." A typical"management fee" mightbe
as highas 30 percentof the profit;yet this may representa
fairfee forservices renderedby local government.By
registeringas collectiveenterprisesthese firmscan avoid
payingtaxes to the centralgovernment.To the extenttheir
profit-sharingarrangementwith local governmentis less
than theirtax, "red hat" firmseconomize on transaction
costs. However, by registering as collectiveenterprises,they
dilutetheirpropertyrightsto theirenterpriseand become
vulnerableto legal complicationsarisingfromthese blurred
propertyrights.Reflectingthe increasinglyblurreddistinction
between collectiveand privateenterprises,ruralenterprises,
whethercollectiveor private,are officially labeled "township
and villageenterprises"(xiangzhenqiye).
Illustratingthe convergence of collectiveand private
enterprisesis the Wenzhou model in Zhejiang province,
which has attractedattentionforits relianceon developing
the privateeconomy. In fact,64.13 percentof firmsin
Wenzhou are registeredas collectivelyowned, 34.96 percent
as state-owned,and only.24 percentas privatelyowned
(State StatisticalBureau, 1987: 404). Yet the 1987 Statistical
Yearbookof China (p. 129) reportedthatcollectiveand
privateenterprisesaccounted for56.3 and 26.7 percent,
respectively,of Wenzhou's industrialproduction.According
to Kikuchi(1988), who conducted fieldresearch in Wenzhou,
family-ownedbusinesses commonlyregistertheirfirmsas
collective; he claims this accounts forthe discrepancy
between the reportedstatisticsforregisteredownershipand
industrialproduction.
The collectiveand privateeconomies have undoubtedly
become loosely interwovenand interactin a mutually
beneficialmanner,more so than eitherdo withthe state
sector. The growthof the privateeconomy stimulatesthe
ruralcollectiveeconomy by providingthe collectivesector
withboth factorresources and marketdemand, and vice
versa.Sustainedinteractions
betweenthese organizational
formscan be expectedto induceinstitutional
isomorphism
17/ASQ,March1992
(DiMaggio and Powell, 1983). As privatefirmsmimicthe
organizationalritualsand practicesof collectivefirms,they
gain greaterlegitimacy(Meyer and Rowan, 1977), rendering
them less vulnerableto social hostility
and cadre
malfeasance. By contrast,state enterprisesview rural
enterprisesas rivalsthatcompete forscarce resources and,
especially,formarkets.Thus, whereas "blending" is
increasinglyevidentin interactionsbetween the collective
and privatefirms,"segregating"tendencies appear to be
strongerin boundarydynamicsbetween the state and
marketizedsectors (Hannan and Freeman, 1989).
Nonetheless, the rivalrybetween state-ownedand rural
enterprisesis muted somewhat by the factthat rural
enterprises,throughsubcontractingarrangements,now
providepartsand assembly formost industrialproducts
made by state enterprises.This may be analogous to the
Americancorporationthatcomplainsabout foreign
competitionwhile importing criticalcomponents and
products.
The incrementalshiftin the 1980s fromredistribution to
increasingrelianceon the marketmechanism is seen in
Table 3, which reportsthatby 1987, 65 percentof all farm
and sideline products,67 percentof consumer goods, and
40 percentof all industrialmaterialshad theirprices
determinedto some extentby the market.The post-reform
expansion of the price-fixing role of the marketis impressive
in lightof the factthat in 1978 the state determinedthe
prices of 92.6 percentof farmand sideline productsand 97
percentof consumer and industrialmaterials.Likewise,as
reportedin Table 4, the numberof industrialproducts
plannedand distributedby the state declined from120 to
60, and the numberof raw materialsdistributedby the state
fellfrom256 to 27. Whereas in 1980 the state allocated 70
percentof industrialproducts,this dropped rapidlyas
economic reformprogressed in the 1980s, so thatby 1987
only20 percentof industrialproductscame underthe state
plan.

Table3
Changein the Scope of State DeterminedPrices*
% State-determined
1978 1987
Pricesforagricultural
products 92.6 35.0
Pricesforall manufactured
products 97.0 47.0
a. Consumerproducts 83.0 33.0
b. Factorproducts 100.0 60.0
* Source:EconomicManagement (1988: 799).
Publisher

Figure3 chartsthedeclining economicperformance of state

enterprisesafter1978; when reform began.The ratioof
to capitalallocatedto stateenterprises
profit declines
progressively.
Thispattern declinein
ofaccelerating
economicperformance ofstateenterprises is also seen
whenprofit and taxare combined,whichprovidesa picture
ofthetotalincomegeneratedbystateenterprises. After
18/ASQ, March 1992
MarketTransition
Table4
Changein the IndustrialProductsRedistributed
by the State Plan*
1980 1987
No. ofindustrial
productsallocated
bythecentralplan 120 60
No. ofindustrial
materials
allocatedby
thecentralplan 256 27
No. ofcommodities distributedbystate
commercial departments 188 22
Percentofindustrial
materialallocated
bystateplan 70% 20%
* Source:EconomicManagement
Publisher
(1988: 798).

1984 profitis retainedby the enterprise,while the state's

share is paid as tax on profit.
Figure4, which traces the performanceof marketizedfirms,
reveals a perceptibledecline in economic performance.
Althoughthe ratioof gross income to capital increases
throughmost of the 1980s, there is a steady decline in the
ratioof profitto capital investedand profitto gross income.
This indicatesthatdespite the impressiveperformanceof
marketizedfirmsin the 1980s, thereare limitsto their
continuedgrowth.Managers of marketizedfirmsapparently
maximizeon gross income, but not profits.This is consistent
withthe view thatmanagers pass on profitsto workersand
staffthroughincreases in wages and bonuses. Expanding
markets,new economic institutions, and a changing
structureof propertyrightsare incrementally transforming
the institutional
environment, resultingin changes in the
comparativecost of governance. Figure5 shows the
explosive growthin the numberof privatefirmsin rural
industryafter1983, which includesjoint-stockcompanies,
privatecooperatives,and a multitudeof verysmall family
businesses. The numberof enterprisesowned by township
and villagegovernmentsremainslargelyconstantthrough

Figure 3. Economic performance of state enterprises.'

26
24 -
22 -
20-
18 -

14
12
16 -
Profit+ tax/100
yuancapital S i e 1
19/- Profit/lOyuancapital

6
4-

1978 1980 1982 1984 1986 1988 1990

Year
*Source: StateStatisticalBureau(1991: 416).

19/ASQ,March1992
 of marketizedfirms.*
Figure4. Economicperformance
300

260

220 -

180 -- - -
C

> 140 Profit/100

yuan capital
yuan gross income
Profit/100
100 ------- Gross income/100 yuan flow capital

60

20
0
1978 1980 1982 1984 1986 1988 1990
Year

* Source: State Statistical Bureau (1991: 379).

this period.Start-upcompanies are virtuallyall privatefirms.

Althoughmost of these are verysmall familyfirms,many
are genuine capitalistenterprises.Althoughthe numberof
privatefirmsfarexceeds thatof the township-and
village-ownedmarketizedfirms,as Figure6 indicates,the
value of privatefirms'outputvalue is less than thatof the
marketizedfirms.Yet the rate of growthof gross receiptsof
privateenterprisesis faster.
Figure7 shows a dramaticincrease in tax revenue and
decline in non-taxrevenue fromstate enterprisesafter1978.
Althoughoverall,tax revenues soar followingthe shiftto
markets,by the mid-1980s the decliningeconomic
performancesof state enterprisesand the increasing
demands of money-losingfirmsforsubsidies transformed

formsin ruralindustry.*
Figure5. Property

18 -

16 ~ --- Township
Village
14 Private

12
C
D 10
C
0

2
0 r---I
1978 1980 1982 1984 1986 1988 1990
Year
Bureau(1991: 377).
*Source: StateStatistical

20/ASQ,March1992
Market Transition

Figure 6. Value of economic transactions (industry,commerce,

construction, transport) of rural enterprises.*

320

280 --Township /
Village
240 --Private
2400
20
C

c 160 //
0

120

80 a

40- -

1979 1981 1983 1985 1987 1989 1990

Year
* Source: StateStatistical
Bureau(1991: 378).

state enterprisesprogressivelyfromrevenue-generating
assets to sources of financialliability.
Figure8 provides
anotherview of the decliningperformanceof state
enterprises.Profitability declines progressivelyafter1987,
while losses increase. Viewed as elements of a largerstory
in the transitionto a hybridmarketeconomy, figures3 to 8
convey the extentto which parameterchanges in the
institutionalenvironmentaffectedthe comparativecosts of
governance,resultingin changes in the relativeeconomic
performancesof the state, collective,and privatesectors.
They show thatstate enterprisesbecame a financialburden
to the state just as the thrivingprivateand hybridsectors
emerged as sources of sustained increases in revenue to
the state. Despite uncertaintiesrooted in weak market

Figure7. State revenuesand subsidiesto state enterprises.*

280
---Tax revenue
Revenue fromstate firms
-- Subsidies to state firms
220
C

c 160

120

80 ,

40 -
---I

1950 1955 1960 1965 1970 1975 1980 1985 1990

Year

* Source: State Statistical Bureau (1991: 212).

21/ASQ,March1992
 of state enterprises.*
Figure8. Economicperformance

180 _----

160 - --- Totallosses

Total profits
140 Profits+ taxes

120
C

100

- 80

60

40

20?T--

0 r--n --r- ,-- __ ___ ___

I

1978 1980 1982 1984 1986 1988 1990

Year

* Source: State Statistical Bureau (1991:410).

structuresand propertyrights,theexplosiveincreasein
entryof privatefirmsand the rapidgrowthoftheiroutput
valuerelativeto marketizedfirmsand stateenterprise
the importance
highlight ofentrepreneurial The
incentive.
significanceofsharplyincreasingstaterevenuesthrough the
1980s shouldnotbe missed,as itexplainswhythe Chinese
stateacquireda compelling interestinsupportingmarket
during
transition thefirstdecade of marketreform. As
North's(1981) theoryofthestatemaintains, rulerswill
implement changesinthestructure rights
of property and
lowerthecost oftransacting whensuch changesincrease
theiroverallrevenue.
DISCUSSION AND CONCLUSION
Ratherthan conceivingof markettransitionsas a linear
progressionto capitalism,we may analyze the departures
fromstate socialism as likelyto produce hybridmarket
economies that reflectthe persistence of the institutional
centricityof theirparentorganizationalform.The deep
structuresof the reformregimeare likelyto reproduce
importantfeaturesof the state socialist redistributive
economy in emergentorganizationalforms.This is the
meaningof path dependence. The emergence of the
marketizedredistributive sector rests on a corporatist
alliance between local governmentand industry, which
represents,in transactioncost terms,a locallyefficient
solutionto the problemof weak marketstructuresand
incompleteinstitutional foundationsfora marketeconomy.
For the economy as a whole, however, local corporatism
may exacerbate problemsof inefficient allocationinasmuch
arrangementsof state socialism that
as the institutional
cause Kornai'sshortageeconomy persist,albeit in the guise
of paternalismon the partof local governmentratherthan
the centralministry. The relianceof flexiblespecializationon
local governmentsupport,forexample, in the "thirdItaly"
(Brusco, 1982; Piore and Sabel, 1984; Trigilia,1986),
suggests that local corporatismmay well be aroundfora
22/ASQ, March 1992
Market Transition

long time to come. Whetherin Eastern Europe or the

republicsof the formerSoviet Unionor China,the transitions
fromstate socialism to marketeconomies are likelyto take
place over a protractedperiodduringwhich a hybrid
marketizedsector mediates interactionsbetween the
and risingprivateeconomies. Rather
decliningredistributive
than a single path,there are multiplepaths fromstate
socialism to a marketeconomy in which the trajectoriesof
transitionare shaped by previousinstitutionalformsand the
politicsof markets,as demonstratedin this paper, observed
in Eastern Europe (Stark,1990), and evidentin the former
republicsof the Soviet Union.
The emergence of the hybridmarketizedsector reflectsa
fundamentalstructuralchange thatis stillin progress. In
China,the marketizedsector is gaininggroundrelativeto the
nonmarketizedsector, and the marketizedcoastal regions
are progressingmore rapidlythan inlandregionsin levels of
economic developmentand growthof per capita income. In
1981, the ratiobetween the industrialand agricultural output
value of coastal and inlandregionswas 55.7 to 44.3. This
gap in outputwidened to a ratioof 58.5 to 41.5 by 1988. In
monetaryterms,the marginincreased from85.8 billionyuan
($18.2 billion)in favorof the coastal provincesto 408.3
billionyuan ($86.7 billion)(ChinaDaily,September 28, 1990:
4). The social outcome of this change has just begun to be
played out.
The marketizedfirmspose the problemof propertyrights
and ownershipform.The partnershipbetween local
governmentand marketizedfirmsentails hightransaction
costs. Economizingon transactioncosts would require
reducingbureaucraticinterferencein economic decisions of
the enterprise.Yet the structureof propertyrightsof
collectiveownershipinvolvesgovernmentin
microinterventions in the firm.Althoughthe
board-of-directors analogypermitsa more positiveevaluation
of the role of local government,there remainsa crucial
distinction.The board of directorsof a capitalistfirmdoes
not includegovernmentofficialscommittedto redistributing
income, and intervention by directorsintothe enterprise's
operationis constrainedby custom and corporaterule.The
collectiveownershipform,in contrast,at best places only
informalconstraintson continuedbureaucratic
microinterventions, and more importantly, it exposes the
firmto politicalinfluencein investmentdecisions. Although
marketizedfirmsoperate with hardened budget constraints,
the third-party involvementof governmentinstitutesa
persistentsofteningeffectby weakening the disciplineof
marketcompetitionon the firm'sinvestmentdecisions.
These negativeeffectsmay be compensated forby the
positiveaspects of cooperationwithgovernment.But as the
economy evolves toward increased relianceon the market
mechanismand as privatepropertyformsare backed by law
and the state, the highertransactioncosts of interventions
by local governmentmay act increasinglyas a drag on
economic performance.The cost to the firmof redistributive
claims imposed by local governmentwillsurelyoutweigh the
supportwhenthe institutional
benefitsof political
foundations of a marketeconomyare morefullyinplace.
23/ASQ,March1992
To overcome currentstructuralimbalances in the Chinese
industrialeconomy,furtherprogresstoward institutinga
marketeconomy is needed. Fundamentallythis entails
puttingprivatepropertyrightson an equal basis withother
ownershipforms,creatinglegal normsand regulations-and
means to enforcethem-that protectprivatepropertyrights,
and makingfurther progress in instituting
a market-clearing
pricestructure.
One problemis providingadequate incentivesformanagers
to assume responsibility forthe growthof the capital assets
of the industrialfirm.As an economist observed, "In a
countryoperatingwitha privateownershipsystem,the
owners of capital property(assets) willdo theirbest to
suppress wages and increase accumulationin orderto attain
the goal of maximumgrowthin value of the assets. Without
this role of asset owners, therewill not be a motivating
forceforthe growthof the value of capitalassets" (Wang,
1988: 44). At present,managers have littleincentiveto
resistthe politicalpressure of workersto seek higher
salaries, bonuses, and fringebenefits.The power of the
partyapparatus entrenchedin the firmand the influenceof
socialist ideologyfarexceed the willof managers to
overcome laborcosts thatoutrungains in productivity. As a
result,a disproportionate share of extrabudgetary investment
capital has been spent in the past decade in social
investments,such as constructingnew housingforworkers,
ratherthan in modernizingtechnologicallybackwardplant
facilities.At the same time,local governmentshave become
dependent on revenues fromthe marketizedfirmto provide
fundingfora wide range of activities.Despite the impressive
performanceof the hybridmarketizedeconomy in the
1980s, it bears the markingsof its origin.The structureof
propertyrightsof the collectiveenterpriseis such thatthe
social benefitsof a profitablefirmexceed by farprivate
returns.The fatalflaw of the marketizedfirmmay be that its
innatetendencies are definedby the conflicting institutional
and market.There is stillthe tendency
logic of redistribution
for"rush growth"and inefficient allocationof resources.
Despite a substantialincrease in capital investmentsin the
early1990s, productivity and profitsin state enterprises
continueto plunge. Despite decliningreturnson investment,
the state must pump in more capitalto bail out money-losing
state enterprises.As a result,the centralgovernmentfaces
a classic budget squeeze. Insofaras the state seeks to
maximizetax revenues, itfavorsinstitutional arrangements
thatdeliverthe highestreturns(North,1981). The
state-ownedsector has responded poorlyto the central
government'seffortto sustain economic growthand
increase revenues. By contrast,privateenterprises,which
were the hardesthitby the recession, recoveredquicklyand
constitutethe fastest-growing sector of the Chinese
industrialeconomy. The organizationaldynamicsgrowingout
of disparitiesin economic performanceand access to
resources among the state, collective,and privatesectors is
what drives markettransitionin China.
The East Asian developmentmodel-Japan, South Korea,
and Taiwan-rested on continuousbut selective state
interventions
(e.g.,Amsden,1985; Hamilton
and Biggart,
24/ASQ,March1992
 Market Transition

1988). There, authoritarian

states intervenedin marketsand
firmsto shape the course of development,which enabled
these late-industrializing
economies to mountand sustain
highlevels of economic growth.China's markettransition
bears familyresemblance to the East Asian model, and
economic developmentthere may in time take a similar
course (Perkins,1986). As Biggart(1991) argued, the East
Asian culturaltraditionencompasses the deep structures
thatproduce the distinctiveinstitutional environmentsof
East Asian marketeconomies, which cannot be readily
accounted forby neoclassical assumptions. The markethas
penetratedthe state socialist redistributiveeconomy and is
in the process of transforming it intoa hybridmarket
economy characterizedby stronggovernmentinvolvement.

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