Macroeconomic Management and Intergovernmental Relations in China

January 1995
Decentralization in China has been crucial in stimulating regional economic growth and reform, but local governments have attained de facto control over many policy instruments, seriously weakening the central government's ability to achieve and sustain macroeconomic stability. And in areas where the division of regulatory power is vaguely defined, local governments' protectionist behavior has led to a malfunction in resource allocation.
Over the past 15 years, China has gradually moved from a highly centralized to a decentralized system in almost all aspects of economic management. Decentralization has changed the role of each level of government in economic management, and has greatly complicated the relations between levels of government.
Ma analyzes three aspects of intergovernmental relations and their impact on macroeconomic management and market development, and suggests the implications for future reform. He addresses three main questions:
° How do fiscal relations between the central and local governments affect the central government's ability to use fiscal policy to achieve stabilization and equalization?
Localities have controlled effective tax rates and tax bases in two ways: they controlled tax collection by offering tax concessions, and they found ways to shift budgetary funds to extrabudgetary funds, thus avoiding tax-sharing with the central government. As a result, the center has had to resort to ad hoc instruments to influence revenue remittances from local areas, which caused perverse reactions.
° How do monetary relations between the two levels of government affect the central bank's ability to control the money supply?
In the past 14 years, the economy has overheated several times because of an excessive money supply. Ma argues that blame for this should be assigned not to the central bank, but to the institutional structure of monetary relations between the central and local governments. The main source of trouble is the central government's inability to commit to a preannounced credit policy.
° How does the division of regulatory power between the central and local governments affect the functioning of the market system?
As the central government relaxed its control over the economy, local governments used the powers transferred to them to restrict market competition. What is needed is a legal framework (including a fair trade commission) that restricts local governments' ability to abuse power.
This paper -- a product of the Public Economics Division, Policy Research Department -- is part of a larger effort in the department to develop policies to reform fiscal systems in developing countries.