Local Governments as Industrial Firms: An Organizational Analysis of China's Transitional Economy

Despite widespread skepticism about government ownership in transitional economies, China's rapid industrial growth has been led by public enterprises. Kornai's theory of soft budbet constraints, born of the failure of earlier Hungarian reforms, fosters such skepticism-but it assumes as fixed organizational characteristics that in fact vary widely across government jurisdictions. Local governments with smaller industrial bases have clearer financial incentives and constraints, fewer nonfinancial interests in enterprises, and a greater capacity to monitor them. In China's vast public sector, the fastest growth in output and productivity has occurred where government ownership rights are clearest and most easily enforced, which enables officials to manage public industry as a diversified market-oriented firm.