Paper prepared for the conference ：The Rise of Local Governments in DevelopingCountries ，London School of Economics ，May 2003.
1.Introduction
In any discussion of China‘s decentralization and local governance ，thereare three aspects that deserve special attention.First ，China is a large countrywith five levels of government.Below the central government are 31provincial levelunits （42million population on average），331prefecture level units （3.7millionpeople on average ），2109counties（580，000people on average ），and 44，741townships （27，000people on average ）。Furthermore，there are about 730，000more or less self-governed villages in rural areas below the township level（World Bank，2002）。The multi-level nature of Chinese bureaucracy frequentlycauses confusion when people talk about decentralization and local governance inChina ，since the level can range from provincial to village level.
Second，the fact that China is still a transitional economy in a process ofmarketization makes the existing literature on China‘s decentralization somewhatdifferent from the general decentralization literature.Since China used to be aplanned economy and most of the economic activities were under center ’s controlin the plan period，the reforms initiated since the late 1970s can be viewed asa process of delegating more decision-making powers in investment approval，firmentry ，revenue mobilization and expenditure responsibilities to lower levels ofgovernment and granting more autonomy in production and marketing to state ownedenterprises.As a result，much of the literature on China‘s decentralization actuallydealt with China’s economic transition and liberalization（see Qian and Weingast1996as an example），compared to the general literature of decentralization thatfocuses on the transfer of public functions to lower level governments.
Third ，China is still a Party State with all levels of government officialsappointed from above by the ruling Communist Party.Unlike many industrializingcountries of Africa or Latin America that are often plagued by bureaucracies lackingexperiences or organizational capacity，the Chinese bureaucracy is an elaboratenetwork that extends to all levels of society ，down to the neighborhood and workingunit，exhibiting a high degree of discipline by international perspective（Parishand White ，1978，1984）。Within each level there exists an impressive organizationalapparatus that could effectively transmit the state policies down to lower levelgovernment agencies step-by-step through several layers of government bureaucracy（Oi，1995）。Only in the 1990s，grass-root elections took place extensivelyat village level，which is not formally a level of government.Therefore ，theconcepts of “constitutional decentralization ”and “political decentralization”do not quite fit in the case of China since neither are there institutionalizedrights of local governments in the central decision-making procedures nor are therewidely accepted genuine elections at and above the township level.
This paper focuses on a limited number of topics considered essential to understandChina ‘s decentralization and local governance by the authors.Considering themulti-level nature of Chinese bureaucracy ，we will focus on the decentralizationand governance issues at local level，i.e.county，township and village level ，while at the same time strive to illustrateing the structure and evolution of inter-governmentalarrangements at higher levels that constitute the institutional background.SinceChina is still a transitional economy ，the Chinese state was deeply ，and stillis，though to a lesser and lesser extent ，involved in some competitive sectorsand intervenes into the social and economic lives on many fronts.The decentralizationprocess in China has been accompanied by institutional changes such as grantingmore power of non-public functions（such as investment approval ，entry of non-statefirms ）to local governments.Given decentralization of non-public functions constitutesan important element in China ’s economic transition and in many cases took placesimultaneously with decentralization of public functions，both dimensions willbe explored.Furthermore，the centralized political system not only have largelyshaped the administrative and fiscal decentralization process ，but also constitutethe basis for understanding major local governance issues in China such as unfundedmandates and farmer ‘s tax burdens ，ineffectiveness in anti-poverty programsto be discussed in the paper.
The paper is structured as follows：in section 2，we review the centralization-decentralizationcycles in the plan period before 1978and the logic for such cycles.In section3，a discussion of administrative and fiscal decentralization in China‘s market-orientedreforms since the late 1970s and their impacts on economic growth ，spatial inequalityand poverty reduction are presented.In section 4，we describe the recentralizationsince 1994and analyze how it affected local public finance and public goods provision.Based on analyses of China’s inter-governmental fiscal and political arrangement，section 5further explores two major local governance issues in China ，i.e.，un-funded mandates and ineffectiveness in anti-poverty.Part VI concludes.
2 Centralization-Decentralization Cycle In the Plan Period
The founding of the People‘s Republic of China in 1949marked a new era ofthe Chinese history.The ambitious government leaders then believed that to defendthe new socialist system，and to keep pace and even overtake western industrialcountries ，rapid industrial development ，especially the establishment of a completeset of heavy industries was essential.Learning mainly from the Soviet experiences，the Chinese government began to formulate and implement the First Five-year Planthat gave priority to heavy industrial development since 1953.
However ，development of capital-intensive industries would have been extremelycostly if free market were allowed to operate in a capital-scarce economy.To mobilizeresources for such a heavy industrialization，a plan system was established，whichwas characterized by a trinity of a macro-policy environment of distorted pricesfor products and essential factors of production（e.g.trained personnel，funds，technologies，resources，etc.），highly centralized planned resource allocationand a micro-management mechanism in which firms and farmers had no decision-makingpower （Lin et al ，2003）。For instance，the People ‘s Commune system wasset up in the rural areas in the late 1950s to guarantee state monopoly of grainprocurement.Besides supplying grain at depressed prices，the communes and productionbrigades were also responsible for mobilizing financial and human resources forlocal public goods provisions ，such as water conservancy construction by organizingcompulsory labor services of farmers.
Under the plan system ，a heavily centralized fiscal system was established.Not only the accounting systems of SOEs were directly incorporated into governmentbudget，but also major resources were controlled by the center.The State PlanningCommission commanded the authority in determining local revenue and expenditureplans on an annual basis，known as \"unified revenue and unified expenditure\"（tongshou tongzhi）。Local governments（at province ，prefecture ，county leveland commune level ）did not have independent budgets.[ii]As to expenditure assignment，the central government was responsible for national defense ，economic development（capital spending，R&D，universities and research institutes ），industrialpolicy，and administration of national institutions such as the judicial system.Responsibilities for delivering day-to-day public administration and social servicessuch as education （except universities ），public safety，health care，socialsecurity，housing，and other local/urban services was delegated to local governments.
However ，in a country of the size like China，the working loads to formulate，administrate，coordinate ，and monitor the central plans were extremely heavyand became more and more so as the economic system became larger and more complicated.For example ，the number of state owned enterprises（SOEs）subordinated to thecentral government increased from 2，800in 1953to 9，300in 1957，and the numberof items in material allocation under central planning increased from 55in 1952to 231in 1957（Qian and Weingast 1996）。The classical problem of control andmonitoring under information asymmetry emerged soon after the planned system wasset up.As the economy grew larger with more projects initiated and enterprisesstarted ，the plan system became increasingly unmanageable.To make things worse，a highly centralized planned system inevitably undermined the incentives of localgovernments when local coordination in industrial development was essential.
Under this background ，China initiated its first decentralization within theplanned framework by delegating more powers to local governments in 1957.The policiesthen included ：（1）delegating nearly all SOEs to local governments，such thatthe share of industrial output by the enterprises subordinated to the central governmentshrank from 40percent to 14percent of the national total；（2）central planningwas to change from a national to a provincial basis ，with decisions about fixedinvestment to be made by local governments rather than the central government ；（3）revenue sharing schemes were fixed for five years and local governments weregranted some authority over taxes.The share of central revenue decreased from 75percent to around 50percent within 2years.
Indeed，local incentives responded quickly to decentralization.Local smallindustries such as backyard steel mills and coal mines boomed in this period.Thisprogram ，however，did not succeed because of serious coordination failures causedby the radical decentralization.The soft budget constraint faced by local governmentsand SOEs soon led to excessive investment expansion and inefficient interregionalduplication of production.Recentralization had to begin in 1959in which all largeand medium-sized industrial enterprises were again subordinated to the center.However，the centralization again brought about the incentive problem and economic stagnationin the 1960s，thus a second wave of decentralization followed in the early 1970swhen local governments gained more authority over fixed investment and local revenue.Afterwards，a similar，but less serious investment boom led to yet another roundof recentralization in the mid-1970s.
In retrospect ，it is easy to see that the decentralization under a plan systemwas not able to alleviate the inefficiency problem since it could neither improvemicro-efficiency through market discipline，not could it change the heavy industrydevelopment strategy inconsistent with China‘s comparative advantage.Under thesoft-budget constraints faced by local government and SOEs，a cycle of “decentralizationleads to disorder ；disorder leads to centralization ；centralization leads tostagnation；stagnation leads to decentralization ”was inevitable.
3 Decentralization under Market-Oriented Reforms：1978-1993
Low efficiency in the plan system was considered as a serious problem as earlyas the 1950s before the first round decentralization was initiated（Mao ，1956）。However ，it was not until 1978that some fundamental reforms were undertaken.What was evident to the policy makers in the late 1970s was the correlation betweenproduction inefficiency of enterprises and People ‘s Communes and lack of stimulusfor workers and farmers.That explains why the reforms began with the micro-managementsystem in the late 1970s in an attempt to improve work incentives.In rural areas，the Household Responsibility System （HRS ）emerged in 1978.In just a few years，the system became a dominant form of microeconomic organizations in rural areas.In cities ，reforms on SOEs were initiated in the early 1980s，centering on powerdelegation and profit sharing.Such reforms rendered rural households and SOEs defacto residual claimers of their production and thus greatly promoted work incentives.
3.1 Administrative and Fiscal Decentralization
Accompanying the micro-reforms in rural areas and SOEs was a process of administrativeand fiscal decentralization ，which was deemed necessary in a large country likeChina to induce local coordination in market-oriented reforms.
Administrative Decentralization.
From the administrative perspective ，the reform period witnessed a significantstrengthening of local governments‘role in local economic management ，such asinvestment approval ，entry regulation and resource allocation.A particularlystriking example is the opening up policy initiated in coastal regions.Startingfrom 1979，many provinces were allowed to set up their own foreign trade corporations.From then on，regional experimentation of opening up began ，which includes the“one step ahead”policies implemented in Guangdong and Fujian in 1978，the establishmentof four special economic zones（Shenzhen，Zhuhai ，and Shantou，and Xiamen ）in 1980，declaring 14coastal cities as \"coastal open cities“in 1984.Not onlydid these areas enjoy lower tax rates and higher share of revenues，but also ，and perhaps more important，they enjoyed special institutional and policy environmentsand gained more authority over local economic development and the establishmentof special economic zones and economic development zones.
Another dimension of administrative decentralization was delegating more state-ownedenterprises to local governments at the provincial，municipality and county levelssince the early 1980s.By 1985，the state-owned industrial enterprises controlledby the center accounted for only 20percent of the total industrial output at orabove the township level，while provincial and municipality governments controlled45percent and county governments 35percent（Qian and Xu ，1993）。With ownershipshift from central to local ，local governments were provided with incentives intaxes and profits to step up their effort in revenue collection.At the same time，the spending of the fixed investment for local-government-owned-enterprises naturallyfell on the shoulders of local government.Since SOEs had provided a wide rangerof social services like education ，health care，pension services to their employees，more local ownership implied local governments‘primary and final responsibilitiesfor these expenditures.
Fiscal Decentralization.
The fiscal dimension of decentralization was no less dramatic.In 1980，inter-governmentalfiscal system shifted from a \"unified revenue and unified expenditure\"into a \"cookingin separate kitchens“（fenzhao chifan）that divided revenue and expenditure responsibilitiesbetween the centerl and the provincial governments.[iii]After that ，the central-provincialfiscal arrangement experienced some further changes ，i.e.，the proportionalsharing system in 1982and the fiscal contracting system in 1988.In the 1988fiscalcontracting system，the center negotiated different contracts with each provinceon revenue remittances to the center，and permitted most provincial governmentsto retain the bulk of new revenues.There were six basic types of sharing schemesin 1988and they continued through 1993（Bahl and Wallich，1992）。Besides afixed subsidies from the center （in 14provinces ），fixed quota delivery to thecenter（in 3provinces），fixed sharing with the center（in 3provinces），quotadelivery with a pre-specified growth（in 2provinces），other provinces adoptedeither an incremental sharing （a certain share is retained locally up to a quotaand then a higher share is retained in excess of the quota in 3provinces ），orsharing up to a limit with growth adjustment（10provinces retained a share withina specific percentage of revenue from the previous year and then retain all revenuesabove that quota）。
At lower level，the provinces had substantial flexibility in setting the rulesfor subordinate levels；each province specifies the sharing system with its prefectures，and the prefecture for its counties ，and so on.Expenditure assignments were structuredin a similar way：the central government sets the division of expenditure responsibilitiesbetween the center and the provinces，and the intermediate layers decide how theywould share responsibilities with subordinate levels.
3.2 Decentralization and Economic Performance ：1978-1993
In general，with the decentralization from 1978to 1993，though politicalpowers were still heavily centralized ，local governments not only began to enjoymore autonomy in local economic management such as enterprise production and materialmarketing ，but also began to control a larger share of fiscal resources and atthe same time assume primary responsibilities for local public goods provision.This implies a very decentralized fiscal expenditure arrangement in which localgovernment assumed greater responsibility for providing education ，health ，housing，social security ，local infrastructure ，and so forth.In the context of marketizationreforms （deregulation），the decentralization in this period was associated withsignificant economic growth as well as mixed performances in spatial inequalityand poverty reduction.
Economic Growth and TVE Development
Decentralization in this period played an important role in promoting nationalas well as local economic growth.From 1978to 1993，China's per capita GNP increasedin real terms by around 280percent.National absolute poverty was reduced by morethan 50percent in the first half of the 1980s，dropping from 17.9percent of thepopulation in 1982to 6.1percent in 1984（World Bank，2001）。This downwardtrend corresponds to the growth of real income and real GNP.China also witnessedan across-board growth both in coastal and inland regions.Indeed ，if each China‘s province were taken as an economy ，about 20out of top 30growth regions inthe world in the period would be provinces in China.
Much of the economic growth in the period could be attributed to a spectacularentry and expansion of non-state enterprises，especially the township and villageenterprises （TVEs），which actually has been one of the most distinctive featuresin China‘s economic development and transition （Qian and Xu ，1993）。Nationally，the output of TVEs grew more than six-fold in real terms between 1985and 1997，leading China ’s rapid industrial and overall growth.By 1993，TVEs already accountedfor 36%of the national industrial output ，up from 9%in 1978.Within the ruralsector，the TVEs accounted for three-quarters of rural industrial output ，ormore than one-quarter of the national total （Che and Qian 1998）。
The rise of TVEs was closely related to the administrative and fiscal decentralizationfrom the late 1970s to the mid-1990s.Local governments actively supported marketoriented，non-state enterprises to expand their revenue base under competitionbetween jurisdictions for getting rich first.With the de-collectivization of agriculturalproduction，local governments had to seek further revenue sources，and the fiscalreform that gave higher shares of revenue （TVE tax or profits）to local governmentsand granted them the rights to use the fiscal surplus paved the way for local governmentsto support the TVE developments under a better incentive system.The decentralizationpolicies granted local government officials great autonomy over their economies ，including the autonomy to set prices，to make investment with self-raised funds，and ，more importantly ，the autonomy to restructure their firms and issue licensesto newly established firms.[iv]By delimiting better the property rights betweengovernments at different levels ，decentralization rendered governments at eachlevel the residual claimant and controller of its own public enterprises.[v]
In the transitional process ，local governments at county，township leveland village organizations played unique roles in fostering local economic development，especially in supporting the TVEs.In the early to mid-1980s when the TVEs startedits golden period of growth ，the perspective private entrepreneurs were stilluncertain of the directions of central policy regarding private enterprises.Localgovernments stepped in and assumed the entrepreneurial role and started rural industrialdevelopment.
According to empirical investigations carried out by the Byrd and Gelb（1990）and Oi（1994），although most TVEs enjoyed a considerable degree of enterpriseautonomy，the community government made strategic decisions in investment and finance，manager selection ，and the use of after-tax profits for public expenditure.Thecommunity governments usually initiated internal fund raising ，either from collectiveaccumulation or from individual contributions to start up the community owned enterprises.The community governments were also pivotal in securing loans from either the AgricultureBank of China （ABC ）or Rural Credit Cooperatives （RCCs），two major externalsources of financing，using the community assets as collateral and provided loanguarantee for TVEs.Using information and contacts that they developed beyond thelocality through government network ，local government officials could usuallyprovide many essential services to local enterprises，such as raw materials，andinformation about new products，technology and market for TVE products.[vi]Localofficials also often tried their best to circumvent government regulations to allowTVEs to receive the maximum tax advantages and exemptions ，so that more revenuescould be kept within the locality to further the competitive advantages of TVEsand enabled local government with more funding for local public goods and serviceprovision.
Fiscal Decline and Impacts on Spatial Inequality and Poverty Reduction
Though decentralization was correlated to high economic growth in the 1980s ，it also led to significant fiscal decline of the state.The total budget revenuesfell from 35percent of GDP in 1978to below 12percent in the mid-1990s.This wasbecause the old revenue mechanism became unsustainable as central planning was dismantled.Profitability fell in industry as prices adjusted to market forces，sharply cuttingthe government revenue intake through state-owned enterprises （SOEs）。The emergenceof non-state enterprises competing for profits also contributed to revenue decline.Since the enterprise reforms required profit-sharing schemes to provide incentives，it reduced revenue flows to the budget，while creating extra-budgetary funds thatwere managed independently by enterprises.
The decentralization also led to fiscal decline of the center.In most instances，the revenue sharing contracts between the center and provinces were regressive，since they allowed richer localities to keep a larger portion of collected revenue.The contracting system tended to favor richer localities with more local enterprisessince local firms were the richest sources of extra-budgetary or off-budgetary revenue.Taking extra-budgetary revenue into account ，poor regions with few local enterpriseshad to share an even larger proportion of total collected revenue with the center.As similar contracts were made between the provinces and sub-provincial units ，the bias against poor localities extended to the grass-roots levels （World Bank，2002）。As a result，local shares of budget revenue rose steadily from 54%ofthe total government revenue in 1978to 61%in 1988，and further rose to 78%in1993.
With fiscal declines of the state as a whole and the central government ，thecenter‘s redistributive power was seriously damaged.Fiscal stress and decliningcentral revenues had already led to dwindling inter-governmental transfers and ade facto devolution of responsibilities to local governments.With the introductionof fiscal contracts in 1988，the central government formally ended its responsibilityfor financing local expenditures.The role of local governments was thereby shiftedfrom providing services to financing them ，a decentralization of responsibilities.[vii]While these levels of government had always provided such services，they had previouslyprovided them as agents of the central government ，i.e.，the center always subsidizedthe financial gap when necessary.By the end of the 1980s ，fiscal decentralization，which tied budgetary expenditures more closely to local revenues，had created abudgetary crisis in nearly all poor counties that they experienced difficultieseven in paying basic salaries （Park et al.，1996）。In these regions ，highnondiscretionary outlays for personnel on the government payroll，including localofficials ，teachers ，health workers ，and other social services personnel generallyaccount for well over half of local budgetary revenues；educational spending alone，most of which goes for teachers'salaries ，often accounts for 40percent to 50percent of local budgetary revenues in poor counties.Poor county governments hadto employ a range of creative mechanisms to cope with their persistent and accumulatingfiscal deficits.These mechanisms include deferring wages ，borrowing from thebudgets of various local government bureaus ，and borrowing against the next year'sbudgeted fiscal transfers from higher levels of government（Park，et al，1996）。Local governments in less developed regions had to cut spending on social developmentand let individuals share more healthcare and education expenses（West and Wong ，1995）。
Partly because of the limited redistributive power of the state ，especiallythat of the center，China witnessed an increasing spatial inequality and stagnationin poverty reduction.Spatial inequality began to rise after an initial declineof urban-rural as well as inter-provincial inequality from 1978to the mid-1980s（Chen and Wang 2001，Kanbur &Zhang ，1999）。Such initial decline can be largelyaccounted for by increased agricultural prices as well as rapid rural growth inthis period.However，when China further decentralized ，opened up and experiencedan explosion of trade and foreign direct investment in the mid-1980s，spatial inequalitybegan to rise steadily.The Gini index of provincial per capita income declinedfrom 29.3percent in 1978to 25.6percent in 1984，but then rose to a 32.2percentin 1993（Kanbur and Zhang，1999）。At the same time ，the urban-rural averageincome ratio declined from 2.87in 1978to 1.86in 1985，then increased to 2.5by 1993（SSB ，2004）。After the mid-1980s，the poverty rates even increased—reaching 14.7percent in 1989—and then stagnated，hovering around 10percentin the early 1990s.This was despite continuous growth in national income and GNP，indicating that in these years the poor did not share the benefits of overall economicgrowth.
4 Recentralization since 1994.
4.1 Fiscal Reform in 1994
As a response to the fiscal decline ，the center in 1994initiated a drasticfiscal reform to raise the central revenue share from around 35per cent of generalrevenue to 60percent along with a substantial increase in fiscal transfer.Amonga comprehensive package of measures ，the centerpiece of 1994fiscal reform wasto introduce the Tax Sharing System （fenshuizhi），which fundamentally changedthe way revenues are shared between the center and the provincial governments.Underthe Tax Sharing System，taxes were assigned either to the central or local governments，with the center having the bulk of the tax revenue，especially the 75%of newlycreated Value Added Tax （VAT ）。Local taxes mainly consist of business taxes ，personal and enterprises income taxes ，and other small taxes such as urban construction，land use and real estate taxes，and agricultural taxes.
The expenditure responsibilities were nominally unchanged with the sub-provinciallevels（prefecture，county ，and township ）still facing the expenditure responsibilitiesthat were delegated to them through the decentralization in the 1980s.While inmost other countries social security and welfare are almost always provided by thecentral government and education and health are often shared responsibilities withthe provincial and central governments，in China the county and township levelstogether provide the bulk of vital public services，including 70percent of budgetaryexpenditures for education，and 55-60percent of those for health.Cities at theprefecture and county levels account for all local expenditures on unemploymentinsurance ，social security，and welfare（World Bank，2002）。A critical difficultyhas arisen in maintaining the social safety net due to large-scale restructuringof China‘s state owned sectors since the mid-1990swhich is .sector since middle1990s.Generally speaking ，the basic central-local responsibility division hasnot been changed since 1980s，but Many much of the responsibilities in social servicesand social security responsibilities that used to be taken care of by SOEs havenow been passed to local governments without corresponding resources，being setaside to meet these responsibilities.Many local governments，now insolvent，arein urgent need either of effectively adding to their need for additional transfersor of a further rationalization of the intergovernmental fiscal system.
Not only there is an expenditure structure out of line with international practice，but also there is a serious lack of a clear assignment of responsibilities amongdifferent levels of governments below the province.This leads to a high degreeof concurrent and overlapping expenditures among the sub-national levels in China.In practice ，concurrent responsibilities has made it more difficult to identifywhat level of government should be accountable for the delivery of particular services.Due to the weak bargaining position of lower level governments under the centralizedpolitical system，there has been a tendency of concentration of revenue to upperlevel governments and delegation of expenditure responsibilities to lower levelgovernments.The tendency became increasingly apparent after the 1994fiscal reform.Provincial governments has tended to squeeze larger shares of revenues from lowerlevel governments and at the same time assigned more responsibilities to the latter.[viii]
The center had originally planned to mobilize fiscal resources so as to channelmore transfers from richer areas to poorer ones ，but the promised transfers havenot materialized.In order to satisfy the needs of coastal provinces that generatemuch of the revenues，a lump-sum tax rebates to guarantee them their pre-1994incomewas agreed.In addition ，to permit each province to share in the growth of itslost tax base over time ，the center committed to giving back 30percent of itsincreased revenue from the newly created value added tax as well as consumptiontax each year.The tax rebates，the largest item in overall transfers，are highlycorrelated with incomes and dis-equalizing in nature.The earmarked grants，thesecond largest item of transfer ，have been found to be mildly dis-equalizing becausethey were dominated by food and other consumer subsidies that favored urban areas（Wong 1997）。To offset this regressive effect ，the government introduced anequalizing（general purpose ）transfer to aid poor regions in 1996.They are rulebased and rely on variables such as provincial GDP，student-teacher ratios ，numberof civil servants ，and population density.However，these transfers have beenunder-funded since their inception，accounting for just 2%of total transfers.For example ，in 1998the central government allocated Y2.2billion to equalizationtransfers ，compared to the estimated fiscal gap of Y63billion produced by theformula.What each eligible province received was its estimated fiscal need multipliedby a coefficient of 0.035，which was derived from 2.2divided by 63.
4.2 Impacts of Revenue Centralization
The revenue centralization without corresponding equalizing transfers sincethe mid-1990s is partially responsible for enlarging inequality in both income andpublic spending across regions.The Gini index of provincial per capita income furtherrose from 32.2percent in 1993to a historical high of 37.2percent in 2000.Urban-ruralaverage income ratio increased from 2.5in 1993to 3by 2003.The combination ofheavy responsibilities and inadequate transfers means that the levels of serviceprovision vary across localities according to levels of local economic development.Among provincial level units，the ratio of the highest to lowest in per capitabudgetary expenditures（net of all transfers）has risen from 6.1in 1990to 19.1in 1999.The coefficient of variation has grown from 0.55to 0.86，indicating growingdispersion among the provinces（Kanbur and Zhang，2003）。
The current fiscal system leads to highly differentiated local disposable revenuesacross regions，and also highly heterogeneous level of local public good provision.In richer regions ，local governments，especially those at the county and townshiplevel ，are generally able to provide decent public goods and services to localresidents and businesses since they not only enjoy higher tax revenues coming fromthe developments of non-agricultural sectors，but also can draw on additional incomesfrom the sale of rights to develop local land ，and frompriced state land userright sales and non-tax certain profit remittances they receive from TVEs.On thecontraryBy contrast ，in less developed areas，that mostly in inland China，localrevenues must comeare mainly from agriculturale sources ，and are much more limited.In the absence of Without sufficient and dependable equalizing transfers from higher-levelss，local governments in these regions frequently find themselves in unable to pay theirbillsvery difficult fiscal conditions.In some cases，even basic wages paymentsare delayed for a long period （one year or more），or government employees canonly get half of their wages.[ix]The so-called “hidden deficits ”also emergedwhere the budget funds officially recorded as having been allocated to designatedspending categories ，but in fact diverted （or borrowed ）to pay for more pressingneeds （wages ）。
As the higher level governments shift more expenditure responsibilities to lowerlevels，local governments，lacking formal taxing autonomy and often finding transfersfrom higher levels increasingly unreliable，tend to energetically pursue extra-budgetrevenue expansion to meet expenditure needs （Wong 1998）。Besides local SOE profitsand user chargers of living infrastructure，much of the extra-budget revenues cameeither from various quasi-fiscal fees levied on local enterprises or direct illegitimatefee charges on farmers by local governments who have almost all the autonomy oflevying and spending the fees and facing virtually no oversight.According to Ahmadet al （2002），the ratio of local off-budget revenues to total local revenueswas as high as 40percent throughout the 1990s.
Heightened pressure on the revenue-starved local governments usually lead toover-investment in revenue-generating industrial enterprises，encourage bureaucraticpredation of enterprise resources and regional protectionism，and divert governments‘attention away from long-term development projects.In many cases ，townshipgovernment or village organization are highly indebted due to unsuccessful industrializationefforts.Lack of resources，poor leadership，misuse of funds by local officials，corruption accounted for most of such failures，which further turned out to increasefee charges on farmers，enlarge income disparity and become a further cause ofrural unrests.For example，in mid-1990s ，many local governments in inland China，driven by budget incentives and TVE development mandates set by upper level governments（usually the provincial governments），borrowed huge amount of funds from localbanks （especially the local branches of Agricultural Bank and Rural Credit Unions）and initiated a wave of TVE investment frenzy ，which turned out to be huge amountof debts at township and village level（Chen 2003）。An estimation is that theaverage township level debt is 4million across the country （Zhu 2002）。To ensurelocal tax revenue ，some less-developed regions took administrative measures toerect barriers for industrial products of other regions ，and in some extreme cases，local government employees were forced to buy locally produced cigarettes beforetheir wage payment.
5 Local Governance，Unfunded Mandates and Poverty Alleviation
Under a centralized political system with extensiveand expenditure decentralizationbut with little without revenue decentralization，local government officialss havetended to be more responsive to the Party and to the higher-level government policiesthan they are to local needs.LThese ocal government officials are，after all，controlled from above both by tight hierarchical personnel arrangements and by fiscaltransfer arrangements.The problem is further complicated and aggravated by thefact that all levels of governments in China are growth-driven and“overtaking”in nature.The performances of individual government officials at every level areevaluated by a series of indicators imposed from above.These indicators usuallyinclude a number of economic targets such as the annual growth achieved in localconsistof GDP，[OI1]growththe growth of fiscal revenue collected andand the revenue contributionsmade to higher levels of the state，and the quantityies of foreign investment attracted，as well as and various‘social’targets such as those for in birth control，maintainingpublic security ，raising school enrollments and so on.Successfully Rreachingor exceeding the targets set by higher-level governments is decisive for local officialsseeking political promotion.[x]
5.1 Unfunded Mandates ，Local Governance and Recentralization
When local governments lacks autonomy in formal taxation and effective transfermechanism are not in place，much of the development mandates imposed from aboveare un（der ）-funded ，and local governments have to find their own ways to meetthe targets set up by the upper level government，which leads to serious localgovernance issues in China.
In less developed regions where agriculture dominates ，farmers are directlytaxed in the form of various illegal fees.In our field surveys in some agriculturaltownships in Jiangsu and Hunan，we find control（such as regional protectionalismby limiting products from other regions to promote local enterprise developmentand raise tax revenue ）。However，after the rapid liberalization of product marketsand market integration process since after mid-1990s，local government bureaucraciesybegan to expand their staffs quickly so as to carry outsince the important but demandingwork of collecting explicit taxes from individuals and households throughout theirjurisdictions.became an very important ，if not the only，way to raise revenue.Since tax collection from individual rural households was such a burdensome taskthat more staffs and resources had to be mobilized.In such regions ，a viciouscycle clearly emerged ：local governments had to recruit more staff，s （bothformal（bianzhi nei ）within Bianzhi and informal （bianzhi wai ），outside Bianzhi）to ensure tax collection；，higher tax revenues then had to be used to supportfeedthe enlarging local bureaucracy ；，which lead ，in turn，to even higher taxcollections and even larger governments.
In more developed regions where where land value in urbanization and industrializationcontributed to raising land values，was high，grabbing land from farmers becameomespervasive.Revenue-hungry city governments have every incentive to expropriate moreagricultural land for urban expansion and commercial leases and make a profit sincesuch land revenues fall into the locally controlled extra-budgets.With faster urbanizationand stronger regional competition for outside investments in this period，localgovernments initiated a wave and another land requisition and established a lotof industrial parks and urban new development zones.
In response to farmers‘complaints and social unrest caused by excessive taxburdens and abusive land requisition，the center in recent years began to furthercentralize the fiscal and administrative system.On fiscal front，the center hasbegun to claim a share ofpartake in the personal and enterprise income taxes thatused to belong exclusively to local governments.Since 2000，the central governmenthas also initiated a rural tax reform that aimintended to remove all local informalfee charges and make up the shortfalls with fiscal transfers from the the center.Facing protests by farmers about the inadequacy of the compensation they receivein land requisition for urban development ，the center has begun to centralizethe decision-making power whereof converting agricultural land to urban and industrialconstruction is concerned ，with thean intention of to limiting transgressionsin granting arable land use rights，illicit expropriations of arable land and actionsdamaging to arable land management.Starting in 2005this year ，lots ofnumerousdevelopment zones are required by the center to been removed[OI2]and national inspectionteams are sent out to ensure progress.A It is stated in the nnewly-promulgatedParty Ddocument has declared that China intends towill establish and implement themost rigorousid arable land protection system in the world to ensure farmers’rightsand national food security（State Council ，2004）。
[OI3]
Broadly speaking then ，In general，instead of decentralizing controls further，the center has lately sought seems to centralize fiscal and administrative power.If we cConsidering the social unrests caused by such serious problems in rural taxationand land requisition，it is understandable that why the center has chosen to implementssuch policies.[OI4]But will these new measures bring the desired results ？Aswe argued before，local governments after the 1993liberalization and the 1994fiscal reform had lost a lot of channels to collect implicit taxes from productpricing and regional protectionalism and also surrendered much of their revenueto central control，they had to opt to more explicit taxes on individual ruralhouseholds and the very limited ，if not the only，channel of implicit taxation，i.e.，farmers‘land，since the latter became the last few production factors yetto be marketized.However ，directly taxing rural households and grabbing farmers’land without sufficient compensation easily led to bitter complaints and socialunrests.The center ，in defending its political legitimacy，had to carry outrural tax reform and centralize administrative power in land requisition.If localgovernments are stripped of power in collecting revenue through explicit taxes fromfarmers and implicit taxes from land requisition，they had to depend on centraltransfers to function and implement upper level government policies.This explainswhy the center had to carry out administrative centralization （limiting local governmenttax and fee charging powers and centralize land management）and revenue centralization（to create revenues for more transfers ）at the same time since late 1990s.
In the absence of without free elections and geneuine local participation ，local governments inevitably lack accountability and，thus the center has to stepin to heavily regulate local government behavior，by directly promulgating dictatingwhat shall be done and what cannot be done.However ，when the local governmentsare deprived of most of their fiscal and administrative autonomy，the only choicefor the center must be tois to centralize resources and keep control in its ownhands and provide transfers.While these transfers embody central policy intentions，they not only entail significant costs in dampening local initiativess to in resourcemobilize resourcesation and to catering to local needs，theybut also may also easilylead back to the further expansion of local bureaucracy expansion and to rent-seekingunder the soft budget constraints created by such transfer mechanism.
5.2 Poverty Reduction and Local Governance
The political and fiscal arrangements In China also lead to a fairly top-downapproach in anti-poverty policy formation and implementation.The major anti-povertyprograms in China are all planned from above and reflect political priorities andresource availability rather than locally defined needs or opportunities.Usuallythey are not designed or implemented on the basis of consultation with intendedlocal beneficiaries.One of the most prevalent complaints heard by farmers in poorareas that have received poverty alleviation investment funds is that they werenot allowed the choice of what activities to do ，and often are forced in participatingeven when they did not have the time，resources，or know-how to undertake theproject.It is found that when households are given funds ，provided with extensionassistance，subjected to tight monitoring on their repayment ，and offered participationin a sympathetic，supportive group ，there is a very rapid increase in the householdeconomic status and increased empowerment of farmers（Rozelle et al ，1998）。
Under such a system ，the centre is more willing to use earmarked transfersinstead of general-purpose transfers.Given that the centre knows that increaseof general purpose transfers may easily result in local bureaucracy expansion andincreasing staff wages other than the public goods provision that reach to the poor，earmarking the transfer and directing its use to designated purposes become theonly alternative.This also helps to explain why the centre ，after the 1994fiscalreform when it began to have more and more flexibility and control over fiscal resources，has not increased its equalizing general purpose transfer but instead significantlyutilized the earmarked transfers.However ，dependence on earmarked transfer usuallytranslates into highly political negotiations in transfer allocation.Lack of rule-basedformula and transparency in transfer tends to systematically distort local incentivesand draw local governments in poor regions into unhealthy competition for more transfersand political performance that caters to higher level.In China ‘s case，suchearmarked transfers has easily degenerated into poorly targeted patronage-type programsin many regions （Park et al，2002）。
When the evaluation on poverty is conducted from above，local governments havea natural tendency to focus more on projects that can reduce poverty headcountsquickly but ignore the poorest people most in need.Since local officials are evaluatedin no small part on the basis of concrete target such as the number of poor thathave been lifted out of poverty ，officials have an incentive to direct the fundsto the better off poor households or areas with better location ，better naturalresources so that project costs can be lower and the expected success rate higher.Zhu and Jiang （1996）found that poor county governments usually omit some of thepoorest villages in the public works construction projects based on evaluation ofeconomic returns.Villages with more favorable economic conditions were more likelyto receive support.In the subsidized loan program，local officials have strongincentives to direct funds toward industrial projects ，not only because they mightgenerate more fiscal resources，but also because local officials faceundergo professionalcareer evaluations in which TVE output and profit count as major successful performancesuccessindicators even if those may not make much contribution to poverty alleviation（Murdoch 2000）。All such practices result in significant leakage of benefitsaway from the poor and consist of a major constraint on the effectiveness of China'santi-poverty programs.
Under the current system，there has also been an excessive focus on physicalcapital development such as agricultural production and infrastructure constructionin anti-poverty programs，while investment in human capital（education ，labortraining and health ），capacity building in agricultural extension and socialassistance lags far behind.This is not only because the“software”type of investmentscannot show an immediate success by raising short-term income growth，but alsobecause physical capital and infrastructure investment are more visible and easilyregarded as concrete progresses in poverty alleviation.The result is that farmersin poor regions have to pay high education charges and ill-health has emerged asa major cause of poverty among vulnerable populations either due to excessive healthexpenditures or through the loss of labor as a result of illness.According to theWorld Bank（2002），lack of investment has led to a clear decline in access tohealth and education-and growing gender disparities in access to basic educationin poor regions.
6 Conclusion
In this paper ，we selectively review some of the key issues of decentralizationand local governance in the context of China‘s transition.We argue that centralization-decentralizationcycle is endogenous to the traditional plan system featured by heavy industrializationdevelopment strategy.Although decentralization in market-oriented reforms had helpedto promote economic growth by hardening local budget constraints and promoting localincentives to foster economic growth，it has led to lower central redistributivepower and enlarging spatial inequality.Without clear and appropriate intergovernmentalexpenditure responsibility division and equalizing transfer arrangements，the recentralizationin 1994has significantly impaired local capacity to provide decent public goodsand services in less developed regions and brought about serious local governanceissues and social unrests in China.
After the new rural tax reforms are enacted in recent years ，，local governmentsin agricultural regionshave los lose most of theirits local tax basis and becomeincreasingly dependent on higher-level government transfers.The problem lies notso much in whether the center can provide sufficient transfers，but in whetherratherthat such gap-filling transfers will discourage local resource mobilization andgive perverse signals of a“soft budget constraint”to local governments.If thelocal fiscal authority are de-linked from local government‘s to its service provisionresponsibilities and functions，are de-linked，then local governmentofficialswill have scant incentive to effectivelytheir decisions and provide the neededepublic goods and services since higher share of fiscal resources is coming fromtransfer that reflects more upper level policy intentions rather than local needs.to match the local needs.[OI5]On the one hand，a centralized one-party politicalsystem has inevitably led to lack of local government accountability to local populationand widespread corruption ；on the other hand，various un-funded development mandatesand policies from the center，and the current cadre supervision and monitoringsystem endogenous to the political system have resulted in distorted local governmentbehavior such as excessive rural taxes and abusive land requisition.If such policyburdens cannot be removed ，the alternative can only be it will necessarily leadto further administrative and fiscal centralization that that may bring yet moredistortions in local government behavior.In the long run ，good governance iswill be the outcome of an more decentralized administrative and fiscal system thatincludes，a sound inter-governmental transfer arrangement，of wider local politicalparticipation and competition under free elections，and，ultimately ，of ，strongerfactor mobility across regions.
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The logic of the plan system is the following ：（i ）a macro-policy environmentwith depressed interest rate，exchange rate and prices of much demanded goods wasthe prerequisite for the prioritized development of the heavy industries；（ii）the planned resource allocation system was the demand torequired for solveing thecontradiction that grossaggregated demand exceeded grossaggregated supply underthe distorted macro-policy environment and to guarantee resources for heavy industries；（3）the micro-management institution without any autonomy was implemented inorder to prevent enterprises from corroding profits and state assets by taking advantageof their operation rights （Lin et al ，2003）。
[ii]In this system ，the center set spending priorities and approved localbudgets.Local governments acted as agents of the Central Government.Policy wasset by the central government ，including civil service wage scales，pension andunemployment benefit levels ，educational standards，health care standards，andjust any other relevant aspect of local budgets.Inter-governmental transfers wereset at a level equal to the gap between locally collected revenues and permittedlocal expenditures.This revenue sharing system was based on extensive negotiation：since neither revenues nor expenditure needs could be perfectly known，centraltransfers were deliberately set at levels below expenditure needs in an effort toflush out local reserves.In addition ，it was also highly redistributive，withsharing rates that varied greatly across regions（World Bank 2002）。
[iii]Under this system ，（i ）some fiscal sources were clearly specifiedas the central government ‘s revenue ，among these were custom duties and revenueremitted by central-government-owned-enterprises；（ii）other sources such as salttax ，agricultural taxes ，and the revenue of local-government-owned-enterpriseswere defined as the local governments ’revenues.（iii ）for the profits of large-scaleSOEs under dual leadership by central and local governments ，the industrial andcommercial taxes（turnover taxes），central government and local government sharedthem with some fixed proportion.It is obvious that the sprit of the rearrangementsin 1980is to preserve the incentives for the local governments ，constraint tothe guarantee of the central government ‘s revenue.
[iv]While in the planning period ，the state planning seriously limited theautonomy of local governments to generate and retain revenues.Localities were requiredto turn over all or most of their revenues to upper level governments.The surplusretained was also subject to higher-level approval before any use.It is also interestingto mention that the upsurge of TVEs in post-reform period is also closely relatedto the two waves of decentralization before the reform，which led to the rise ofsome collective enterprises （such as Commune and Brigade Enterprises in rural areasto emerge outside the state plan before the advent of reform.
[v]All this said ，it must be mentioned that the deregulatory policies fromthe center to support TVE development was also essential：since the 1980s，theTVEs were no longer restricted to the industries that served agriculture，suchas producing chemical fertilizer and farm tools ，and they were allowed to entersectors where previously only SOEs had access to.They also no longer used onlylocal resources and could sell beyond local markets.In this period ，TVEs in themore labor-intensive light and consumer goods industries had huge profit marginsand short supply due to the depression of these sectors in the planned system prioritizingcapital-intensive sectors.In addition，much of the TVE production ，particularlyat earlier stages ，required relatively little expertise and start-up costs.However，as competition in both product and financial markets hardened with market deepeningsince the mid-1990s ，local governments began to privatize TVEs and returned tothe more“normal”functions of local public goods provision.
[vi]According to Oi（1995），the roles played by local governments in productdevelopment ，market research and technology acquisition went beyond the usualprovision of bureaucratic service ，but the activity of an entrepreneurial developmentstate.Officials from local Science and Technology Commission or Enterprise ManagementBureau spent much time and energy to represent local TVEs at higher revel agenciesto acquire technology ，materials and funding，and sometimes even accompany TVEmanagers to higher-level bureaus to facilitate access to inputs and services.
[vii]As a result ，local expenditures grew much faster than central expenditures，especially social security expenditures ，unemployment insurance ，increased pensionspending，increased subsidies for housing and fuel ，etc.The share of local expendituregrew from 54%in 1978to 66%in 1993and 64%in 1999.
[viii]According to the World Bank（2002），there was a trend toward an increasingshares of expenditures at the provincial level，and a declining share for the countyand township levels combined during the period of 1994to 1999.
[ix]An example is the middle-income coastal province of Hebei.In 1998，wagearrears to school teachers alone reached 155million RMB Yuan ，and an additional186million emerged in 1999.Although provincial governments raised 740millionin recent years to solve the widespread wage arrear problem in the past severalyears ，the total provincial wage arrears still reached 1.29billion by the endof 2000（Chen 2003）。
[x]Some scholars have vividly described the current arrangementsystem as a“pPressure iImposing sSystem ”（Rong et al 1998），under which all local governmentand Pparty agencies and cadres，from county to village level ，face constant pressuresfrom above to perform according to higher-level policy.As a result ，local cadresare enmeshed in meetings，documents，reports，receiving visitors and passingvarious inspections from above.To meet all their targets ，set up by upper levelgovernment，local officials have a natural tendency to fabricate statistics oineconomic growth and government revenues ，exaggerate farmers ‘income growth andunderreport rural tax burdens.Either showcase projects （such as the more visibleroads or expensive education and health care facilities ）top the local governmentagenda，or alreadyvarious excessive local fee charges on farmers are increasedyet again to meet the financial ends.needs
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[OI1]A query：Do you know if these performance targets are set in terms ofabsolute levels of GDP or in terms of rates of growth ？Or both？
[OI2]It is not clear what you mean by “relinquished”。
[OI3]Insert a footnote citing the Party document here please.
[OI4]A lengthy but very repetitive passage has been deleted here.
[OI5]Why should they need either financial or other “incentives”to do so？Would service provision then not simply become the nature of their jobs ？Thisstep in the argument is not as clear as could be.
发表于 2007-4-27 20:28:36
aper prepared for the conference.Socialism with Chinese Characteristics ：Chinain Transition.Logan：Utah.