Posted February 1998

Food and Agriculture Organization of the United Nations

United Nations Capital Development Fund

International Fund for Agricultural Development

German Agency for Technical Cooperation

Swiss Agency for Development and Cooperation

World Bank

Rome
16-18 December 1997
Technical Consultation on Decentralization
Documentation

Fiscal Decentralization and Rural Development in China - Summary

DECENTRALIZATION has become a trend in many areas in the world. All previously centrally-planned economies, and many other developing countries are decentralizing political powers, fiscal resources and economic decision-making authority to local governments. China is no exception. In 1979 the government initiated a series of reforms. Major programs included the "household responsibility system," which replaced the collective farming system; price reforms, which increased or liberalized agricultural procurement prices; enterprise reforms, which delegated partial autonomy to the state-owned enterprises; and fiscal decentralization, which introduced a tax-sharing system between central and local governments and increased local governments' autonomy in determining their expenditure structure.

Since 1979 China has been one of the fastest growing economies in the world. Many scholars have studied the impact of the household responsibility reform, price reform and enterprise reform on China's economic growth. This study attempts to assess the impacts of fiscal decentralization and other reform measures on rural development, including economic growth, consumption, and general social and living standards.

It is often argued that fiscal decentralization will contribute to rural development because fiscal decentralization encourages local governments to use existing resources more effectively and allocate resources more efficiently than before. However, local governments in China directly invest in and operate profit-making enterprises which provide them with revenues, and China's pricing structure still favors industrial output over agricultural products. Therefore local governments may use its resources to invest in industrial projects rather than for rural development programs which have much longer-term pay-offs. Whether fiscal decentralization in China have had a positive impact on China's rural development is an empirical issue.

We use two panel data sets in this study. The first is a province-level panel, covering 28 provinces for the period from 1970 to 1993, and the second is a county-level panel, including 10 counties each from three provinces for the period from 1970 to 1995. The major findings are:

• Fiscal decentralization reduces real budget revenues of county governments, but increases those of provincial governments. Thus decentralization has benefited mainly provincial governments. Political decentralization and the adoption of the household responsibility system have impeded the abilities of both the provincial and the county governments to collect taxes.

• Fiscal decentralization contributes to economic growth at the county level, but not at the provincial level. With county data, the estimates for fiscal decentralization in the national income regression is positive, but not significant, while that in the agricultural income regression is positive and significant. This suggests that, to have a positive effect on economic growth, fiscal resources and decision-making powers should be decentralized to the county government rather than to the provincial government. Many provinces in China are much larger than most countries. Provincial governments may therefore not be particularly knowledgeable about or responsive to conditions and needs at the local level. Moreover, because of price distortions and the government's role as investor in the Chinese economy, more autonomy may encourage provincial governments to invest in industries which duplicate others, protect provincial industries, and under-invest in agricultural projects.

• Political decentralization and the household responsibility system positively affect economic growth at the county level. Political decentralization and the household responsibility system both provide private actors with more scope for initiative, which stimulates economic growth.

• Except for senior high school enrollment at the provincial level, fiscal decentralization has insignificant effects on various indicators of development and rural development at the provincial and county levels.

• The household responsibility system has positive effects on the numbers of doctors and nurses at the provincial level. No other decentralization measures have positive and significant effects on indicators of development at the provincial or county levels.

These results suggest that, while decentralization has a positive effect on economic growth, overall it has a detrimental impact on many aspects of economic development.

There is a lesson to be learned from China's experience with decentralization. To ensure that decentralization has desirable effects on rural development in China, reforms of government's role in the economy are required. The government should withdraw from owning and operating profit-oriented economic activities, and instead concentrate on providing public goods. Finally, to be truly effective, decentralization should be carried out to the lowest level of government feasible - the county in China.