ECON 455 Lecture 11 Urban reforms

ECON 455 Lecture 11 Urban reforms - Econ 455: Chinese...

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1 1 Econ 455: Chinese Economics Lecture 11: February 14 Urban reforms Sandra Poncet Lorch Hall, room 207 Email: sponcet@umich.edu Office Hours: 2 Introduction Downsizing SOEs was the most politically risky thing the Chinese government has done in the transition process. -End of the period of “reform without losers.” -Little choice: driven by finances. Conversely, the restructuring was successful in the fundamental sense that it was thorough enough to return at least the large-scale sector to profitability Despite two waves of reform and enormous distance traveled, no creation of a broadly based system of private ownership
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2 3 4 Lecture Outline Introduction I-Legacies 1-Legacies of the socialist system 2-Why privatize? II-Reforms: why reform of SOEs has been so hard 1-Transition 1979-1993 2-Transition 1996- III-Consequences of reforms 1-Economic performance 2-Inequality 3-Managerial incentives and behavior Conclusion: challenges
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3 5 6 Source: Park (2005) Evolution of ownership
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4 7 I-Legacies 1-Legacies of the socialist system “Iron rice pot” and the work unit Pros: Equality and no poverty (safety nets) Cons: Low incentives to perform and to invest in human capital Low efficiency Soft budget constraint (Kornai): financing is guaranteed no liability of losses Consistent with the planned economy: Guaranteed financing of policy-led project (distorted prices) Cons: No incentives for financially prudent and profit maximizing investment (only expansion, prestige and promotion) Low efficiency 8 I-Legacies 2-Why privatize? A. What is ownership: 1-Right to (residual) income produced by assets 2-Right to (residual) control of assets Control of assets is typically in the hands of managers and employees Control of (residual) income (profits) lie in those of owners Potential conflict of interest between those with control and those with income rights. Main issue is the capacity to monitor (imperfect information) Illustration Managers and employees have an incentive to use their control to extract resources (or minimize their effort) to the detriment of the owner
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5 9 I-Legacies 2-Why privatize? B. Determinants of ownership choice 1. Political factors – revenue, employment, rent-seeking 2. Efficacy factors – government leader’s managerial ability, privileged access to loans, land, energy, inputs, marketing outlets 3. Monitoring ability of leaders – prevents moral hazard by managers If government monitoring ability is high (planning) and profitability is high: rational to keep state ownership (even if efficacy is low) If government monitoring ability is low (capacity of managers to extract resources) and efficacy and profitability is low: rational to privatize 10 II-Reform Early phase of reform: focus on incentives to correct low efficacy: -autonomy to managers -incentives devices to seek profits With greater autonomy, the potential conflict of interest between managers and the state increased due to lower monitoring capacity especially as aspirations increased
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ECON 455 Lecture 11 Urban reforms - Econ 455: Chinese...

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