The Chinese Economy in Crisis

State Capacity and Tax Reform

Xiaohu (Shawn) Wang, An'gang Hu

• Publisher: Routledge
• Year: 2015
• Topic: Economics
• eBook ISBN:
  9781317457961
• Subtopic: Business General
• Index: Economics

The authors of this work argue strongly that the decentralization that has taken place in China over the past two decades threatens to undermine the future of reform and perhaps even the state itself. They contend that reform has undermined state capacity in China, and that the state's fiscal revenues, as a percentage of GNP, have declined and will continue to decline into the foreseeable future, thereby weakening China's ability to mobilize resources for modernization.

Part I

The Decline of State Capacity

Abstract of Perspectives*

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The process of modernizing a country requires the mobilization of the human and material resources of the entire society. It is also a process of the continuous strengthening of the state’s capacity. In order to respond to the demands of modernization, to mobilize all sorts of society’s resources, to unite all forces in society to establish a stable social and economic order, to form a consensus regarding modernization among the entire population of citizens, and to maintain the solidarity of the nation as a whole and the unity of the country—in all these purposes, it is urgently required that there be a stronger and more authoritative central government, so as to continue to enhance the state’s fiscal extractive capacity and speed up the nation’s modernization process.

The state (represented by the central government) is the primary leader in the development and growth of the economy, in political change and reform, in the transformation of society, and in the conduct of international relations. To enhance the state’s capacity means to enhance the central government’s capacity to promote reform and the opening up of the country and society, and also its capacity to accelerate the pace of industrialization and modernization.

The purpose of this book is to explore the issues relating to the transformation and evolution of the state’s capacity in the People’s Republic of China, and to analyze the leadership role that the central government should play in the process of transition to a market economy. This book is the result of research analyzing national conditions in China; it comprises a topical research report that systematically studies China’s state capacity and the development of its national economy—research funded by the Chinese Academy of Sciences and completed by the authors in cooperation with Yale University in the United States of America.

China’s economic reform has transformed society politically and economically. Although the reform has been gradual, its impact on the transformation of Chinese society exceeds that of any reform in any other period of history, and its role in China’s economic development and growth also surpasses the role played by any revolution in the history of China.

The issues on which this book1 focuses are:

• What is the long-range impact of this reform on the changes and transformations in China’s state capacity?

• In the process of transition and transformation toward the market economy, should the role of the central government be weakened or strengthened?

• If the central government is to play a leadership role in China’s transition toward a market economy, then what are the specific roles that the central government should play and, at the same time, what should be the function of local governments?

• In such a large country, with its huge population, large territory, and extremely unbalanced economic development, how do we establish a stable and normal set of relationships between the center and the hinterland?

• How, in the process of transformation toward a market economy and of catching up and surpassing others in modernization, do we strengthen the leadership role of the central government?

The analysis of these issues and problems form the primary thematic content of this book. As is the case with other analytical reports on the state of the nation, the primary points of view and the basic conclusions in this book are based on the authors’ interpretation of certain Chinese statistical data, and on a comparative analysis of the state of affairs from an international perspective. Objectivity and fairness are fundamental principles of the authors’ approach to research. At the same time, the authors have sought to be clear and precise in articulating viewpoints and well-grounded in their analysis. It should be noted that this book also assimilates the results of international scholarly research on the topic of state capacity.

The State’s Financial Extractive Capacity Is the Most Important Aspect of State Capacity

State capacity refers to the the ability of the state (i.e., the central government) to transform its own will and purposes into reality. There are four categories of state capacity: financial extraction, regulatory and/or control capacity, the capacity of legitimation, and the capacity for coercion. Of these, the state’s financial extractive capacity is the most important aspect of state capacity, and it is also the foundation for the realization of the other aspects of state capacity.

State capacity has a profound impact on the country’s process of industrialization. The more backward a country’s economy is, and the later it begins to take its first steps toward industrialization, the larger the role the state plays in the industrialization process. For this reason, as far as such countries (in fact, all countries) are concerned, it is particularly important to enhance state capacity, and, in particular, the state’s financial extractive capacity, making this the most important aspect of state capacity, and making it the foundation for the realization of the other aspects of state capacity.

For less-developed nations, the enhancement of the state’s financial extractive capacity is one of the most crucial conditions for lifting themselves out of poverty and backwardness, bringing about an economic takeoff, and closing the gap between themselves and the developed nations.

Strengthening state capacity is to strengthen the state’s ability to mobilize the resources of society. The most important indicator reflecting the state’s financial extractive capacity is the ratio between the state’s fiscal revenue and gross national income; the second most important indicator is the relative weight of central government revenues and gross national income. The former reflects the portion of the overall aggregate social resources represented by the social resources mobilized by the government in general, and the latter reflects the portion of the overall aggregate social resources represented by the social resources mobilized and extracted by the central government in particular.

The factors that affect the state’s financial extractive capacity include developmental factors, systematic factors, and policy factors. When the nation’s level of economic development, economic structure, and the degree of internationalization of its economy have reached a certain standard, the fiscal system of the state becomes the most critical factor that determines the state’s financial extractive capacity. A fiscal system that is rich in developmental flexibility enhances the state’s financial extractive capacity; a fiscal system that is poor in developmental flexibility will severely weaken the state’s financial extractive capacity.

An industrialized (or industrializing) nation operating under a market economy will always continue to strengthen its state capacity. In the long run, through the processes of development, in an industrialized nation operating under a market economic system, the percentage [of the gross national income] represented by the fiscal revenues of the state in general and the percentage represented by the revenues and expenses of the central government in particular will always be rising. Proof of this lies in the tendency of developed and advanced countries that are based on market economies to turn gradually from small government to big government, from weak government to strong government, and to enhance continuously the capacity of the government—and in particular, of the central government—to intervene in the economy, and to play an increasingly strong leadership role in such areas as economic stabilization, income distribution, social security, provision of public goods and basic facilities, and so on.

State Capacity Has the Most Critical Impact on Propelling Industrialization in China

State capacity is one of the most critical conditions for the realization of industrialization and modernization in any country. In the two hundred years between 1750 and 1950, during the period of global industrialization and modernization, China’s economy deteriorated, as the country went from being one of the world’s greatest economic powers to becoming one of the weakest nations economically. Throughout this period, China was unable to bring about meaningful modern economic growth in any sense, and was unable to launch and develop formal industrialization. One of the most important reasons is that throughout that period China had consistently lacked a powerful central government that possessed a clear sense of purpose and will toward achieving the goals of modernization, and also lacked a powerful state financial extractive capacity. Up to 1949, the fiscal revenues of the Guomindang (GMD) government had never, [in any given year,] exceeded 7 percent of the gross national product (GNP); in other words, its state capacity was extremely poor.

Starting in the 1950s, a large, powerful central government was established in China. In an extremely short time, it strengthened state capacity very rapidly, developed and played the functions and the roles of a modern state in the areas of fiscal management and taxation. In such a short time, the state’s fiscal revenues expanded to become one third of national income. In comparison with the government of the Guomindang, the new central government possessed four to five times the magnitude of state financial extractive capacity. The rate of economic growth reached the levels of high-speed growth during the First Five-Year Plan period [of the People’s Republic of China,] signalling the entrance of China into a critical period of high-speed growth of a modern economy. This created the preconditions for China’s successful first steps in industrialization and the rapid construction of an industrial system. The change from a small state extractive capacity to a large one, and the change on the part of the central government from weakness to strength was a major reason for the realization of high-speed economic growth in China.

Nevertheless, an excessively centralized central government is not conducive to modernization. China’s fiscal system did not remain entirely unchanged or unchangeable after the 1950s, [but] throughout this period it remained unable to form a set of stable financial relationships between the center and the hinterland, and it continued to fluctuate between “centralization of power” and the “sharing of power,” and between “delegating power” and “taking power back [into the hands of the central government].” The 1950s were basically characterized by a highly centralized model; with the exception of the years of the Great Leap Forward, this system continued to be extended to the late 1960s. The 1970s, subsequently, were characterized by a model the primary feature of which was centralization, but with an appropriate degree of delegation of financial authority to lower levels. The state’s financial extractive capacity remained rather strong, with the state’s fiscal revenues comprising about one third of national income; the central government possessed a very high degree of authority. Although the traditional socialist system, which was characterized chiefly by the centralization of power and authority, had indeed achieved considerable success in the areas of mobilizing and centralizing all sorts of resources in society, and had created advantageous conditions for China to take its first strides toward industrialization, it had, nevertheless, one fatal weakness: in utilizing and allocating these resources, it was low in efficiency and poor in effectiveness. Therefore, the chief purpose of the reform that ensued was precisely to resolve the problems of resource deployment and allocation and of ineffectiveness in utilizing resources.

Since the Inception of Reform, the State’s Financial Extractive Capacity Has Declined Rapidly

Since the implementation of the “eating in separate kitchens” fiscal contracting system in 1980, the most important changes have been that the state’s financial extractive capacity has declined rapidly, the go...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Tables and Figures
• Part I. The Decline of State Capacity
• Part II. Tax Reform
• Index