Decentralization, Growth and Social Harmony Qijing Yang,RUC
Decentralization, Growth and Unfairness
Qijing Yang[(]
Abstract: In this paper, we stress one of basic questions in the process of industrialization and urbanization is how to transfer resources from less efficient to high efficient sectors. In comparative institutional analysis, we prove that although the economic decentralization and inter-jurisdictional competition for mobile capital help to build a friendly business environment, and to promote economic growth, but also cause the government to grab vulnerable groups. This dilemma might become most seriously in tournament among local governments. However, growth and some social injustice may be two sides of a coin in the process of development. Therefore, it is necessary to adopt appropriate institutional and contractual arrangements to ensure the appropriate balance between economic growth and unfairness.
Key words: decentralization, inter-jurisdictional competition, Growth, unfairness
JEL: H11 H77 O10
1. Introduction
Enlightened by the history of the development in Anglo-American countries, Weingast (1995) and others systematically put forward the market-preserved federalism, and emphasize that the decentralization and inter-jurisdictional competition for mobile capital may prompt local governments to build a friendly business environment, thereby to promote economic growth. Subsequently, huge literature has been emerging, and attributed the success of China's reforms to Chinese-style market-preserved federalism (Montinola et al, 1995), which places special emphasis on GDP as the core to political performance evaluation and promotion (Yang, 1998; Maskin et al, 2000; Li and Zhou, 2005; Wang et al, 2007; Zhou, 2007). At the same time, many empirical studies also confirmed that there are positive correlation between economic growth (reform) and fiscal decentralization (Zhuravskaya, 2000; Jin et al, 2005; Lin Yifu, Liu Zhiqiang, 2000; Zhang and Gong, 2006). However, the scholars also realize that federalism would hurt social harmony as by-products of economic growth, because it may not only lead to imbalance between jurisdictions (Cai and Treisman, 2005), and local protectionism (Young, 2000; Zhou, 2004), but also may produce some social inequality. First, local governments strongly prefer to reduce the spending on education, health care and other public goods in order to increase the constructive spending (Qian and Roland, 1998; Yong and Zhang, 2007). Secondly, it always triggers vicious competition (race to bottom) to cut tax rates and environmental regulatory standards (Oates and Schwab, 1988; Rodden and Rose-Ackerman, 1997; Oates, 1999; Revesz, 2001). In a word, the contradiction between growth and social harmony has been discussed to some extent. However, there are still some seriously inadequate.
Firstly, although federalism focuses on the issues of development, the governments in the existing models are not particularly concerned about the following basic question in developing countries. How can government prompt resources (such as land, labor, capital, etc.) to be transferred from the inefficient sectors (for example, agriculture, traditional state-owned enterprises) to the more efficient sectors and areas, while maintaining social harmony and stability?
Secondly, the federalism is always simply considered as fiscal federalism. However, considering the transaction costs and information advantage, local governments are always granted much actual discretion on many important resources (for example, land, minerals, state-owned enterprises, environment, labor, etc.). It means a lot of political and economic authorities are decentralized to local governments. In a world, federalism is a multi-dimension institutional arrangement between central and local governments (Treisman, 2000).
Thirdly, the federalism usually assumes that the friendly policies to investors and enterprises will be supports by the residents because they will share the benefits of economic growth. However, it is not always true because the friendly help hands must base on some unfair transactions with vulnerable groups. In this situation, the government can not be simply assumed as the representative of all (median) voters (Oates and Schwab, 1988). Therefore, we can neither analyse the relationship between economic growth and social harmony, nor comprehensively understand the content and scope of decentralization and incentive contracts between central and local governments.
Moreover, the political micro-environment is absent to be described carefully (Rodden and Rose-Ackerman, 1997)｡ Given the decentralization and incentive contract, the behaviors of local governments also depend on the environment of political economy that they live in. For example, different voting institutions and different structure of voters will induce governments to act in different way. In this paper, the population proportion, voice of residents in the traditional sector, as well as the power of the investors, will affect the behavior of local governments.
Finally, we get used to discussing this question only in the following specific institutional environment, which is characterized with fiscal federalism, tournament among local governments, and inter-jurisdictional competition for mobile capital. In other words, since the absence of comparative institutional analysis, it is very difficult not only to understand the relationships between growth and inequality in the process of industrialization and urbanization, but also to identify which are the outcomes of developing, or the market power of mobile capital, or the specific decentralization, or the measure of political performance and the relevant incentive contracts.
Considering the above, this paper focuses on those developing countries, where the capital is very scarce, and the social-economic and institutional environment is also poor. We hope to understand how their governments take part in land acquisition and trading, and how they balance between growth and inequality in the industrialization and urbanization under different decentralization arrangement, political incentive contracts. Hence, we try to compare the strategic behaviours of local governments in three models with different institutional environments. The first is the benchmark model, where mobile capital can’t be moved among different jurisdictions and the political performance of each local government is the economic growth and social harmony in their own jurisdictions. Actually, it can be considered as a closed country that hasn’t be disturbed by outside market and authority. It is possible for us to discover some pure problems about development. The second is the normal competition model, where the local governments are still measured independently, but the mobile capital can be moved among different jurisdictions before investment. The third is the tournament model, where mobile capital can be moved among different jurisdictions and the performance of local governments are mainly evaluated in relative-GDP growth. Comparing the second with first model, we may find the influence of the market power on the local government. Moreover, comparing the third with second model, we may identify the affects of incentive contracts to the strategic behaviors of local governments.
Our research shows that at the early stage of economic development, in order to prompt the resources transferred from low efficient sectors to high efficient sectors, it is necessary for government to take part in some transactions which may be to some extend unfair. Meanwhile, It is not only market power from inter-jurisdictional competition for mobile capital, but also the contractual incentives from tournament based on relative economic growth among local governments, which are likely to speed up the transfer process and economic growth. However, they are also likely to worsen the trade fairness and endanger social harmony. This means that federalism is not so beautiful described by its advocates, because when local governments give warmer “helping hand” to the enterprises and investors (Frye and Shleifer, 1997) and thus promote economic growth, but they prefer to stretch out “grabbing hand” to the vulnerable groups, thus jeopardizing the social harmony. These models suggest that not only the content of decentralization but also incentive contracts should be appropriately adjusted along the process of development in order to balance the growth and social harmony. Nevertheless, owing to limited space, we can’t discuss the issues of the optimal decentralization and political incentive contract in detail in this paper.
Ⅱ. The Setup of the Models
1. The Production and Unfair Trade
We suppose an underdeveloped country with many identical localities. Each of them has units of land and population with of per capita GDP, and is decentralized with of fiscal revenue. At the beginning of the tenure, each local government is granted with units of land, which can be exploited for industrialization or urbanization although it is now used in efficient industry such as orthodoxy agriculture. Because the economy is underdeveloped and the capital is very scarce, each local government tries to absorb mobile capital as much as possible. However, the mobile capital per se is not the actual production capability unless it is transformed into capital goods, such as constructions and equipments. In a given era, the production technology defines the ratio of factors, although it is not absolute. We assume each one unit of capital goods needsunits of land.
Without loss of the generality, the price of the capital goods is normalized as 1, and is the market price of the land. However, the local government provides the land to investors at actual price, where. It is important part of friendly-business policies. In our paper,is exogenous. In the rough, the more developed the economy is, the more important for the production the land is. Hence, to some extent, the scale ofimplies the scarce degree of the land and the level of economic development.
If the amount of potential mobile capital is, it may be transformed into of capital goods. It can not become realistic production capability before the tenure is over, unless the necessary infrastructure () is provided. If all are right, there will be economic growth:
Where,,are positive parameters. For simplification, let. The society must enjoy some positive utility although the marginal effects would decrease at a given period. Meanwhile, some reserved growth () is required by the society; or else, the society must suffer great pains such as high level of unemployment. For simplification, let, and let the social utility of growth as [1].
However, it can’t become true unless enough land can be confiscated in time. We assume each government prefers to confiscate all the units of land in order to avoid any opportunity of growth although some of the land may be not uses. The acquired price is , where. Obviously, it is an unequal transaction and the residents become victims unless. The marginal negative social effects would increase with the degree of the inequality. And, the higher the land price is, more negative effects the victim must suffer. Considering the proportion of the victim is, let the negative utility of the inequality as ,[2] where is a nonnegative parameter.
2. The Utility Function
Any society is a political unit, where different interesting groups pay different attention to growth and inequality. Through its political mechanism, the society delegates a government to develop economy and preserve equality. Let and denote the weight assigned to growth and inequality by the society, respectively. Meanwhile, each local government has preference to private benefits ()[3]. Thus, let the utility of each local government as the following.
Note that implies how efficient the central government or society monitors and punishes the local government who pursue the private benefits.
3. The Budget
Because the new production capability is not the available source of fiscal revenue, local government can collect disposable revenue from two resources. One is, the other is to sale the land (), where is the amount of sold land. We assume all of the revenue is spent on the compensation to the victims, productive infrastructure, and his private benefits.
4. The participation Condition of Investors
Besides, only if the return rate is not less than the reserved rate (), namely, participation condition of investors is held, the investment would happen.
It is easy to know the maximum amount of capital is that can be absorbed at a given period, even if the land is provided freely. However, this condition is neglected as most of relevant literature in order to simplify analysis.
Ⅲ. Institutional Comparative Analysis
1. The Benchmark Model
As a benchmark model, we assume each locality is independent to others. That is the mobile capital can be moved among them. Meanwhile, the performance of the local governments is also evaluated independently. Now, the strategy of local government can be drawn as below.
According to Lagrange multiplier procedure, the optimal solution is the following.
（1-1）
（1-2）
（1-3）
（1-4）
where . And the expected growth at the end of tenure is .
Proposition 1 In a capital-scarce society, as long as the society prefers to high economic growth (that is is not small), the social first-best prices of some critical resources paid by government and enterprises should be to some extent less than the actual prices, namely, ,, even if .
Although it is a very disputable proposition and perhaps induces lots of people unhappy, even very angry, it maybe stands a good chance to be true. In a society, not only capital () is very scarce, the institutional environment and economic conditions () are very poor, but also the government has not enough fiscal resource to improve its infrastructure. It is not easy to satisfy the participation constraint condition of investors. At the same time, there is huge land sunk in less-productive sector, for example traditional agriculture. Only after the land is used by entrepreneurs and combined with capital, can they become a part of actual production capability, and realize its relative high economic value, and improve the economic growth. Hence, how to resolve this paradox is very important for the society.
Unfortunately, Coasean bargaining (1960) is not a feasible resolution to this problem in many situations because of the bargaining costs. Even if such bargaining could be feasible, it would be only a static Pareto efficiency, because a lot of financial capital is not converted into capital goods but non-capital income. As a result, the society enjoys the equality but losses the chance of faster growth. It is only equality with poverty! Hence, it may be necessary to allow government creating and taking part in some unfair transaction in disfavor of the relevant agents (henceforth, “victims”) but in favor of entrepreneurs. Note that, such transition is the social choice, although the direct player is government and it is always companied with corruption.