The evolving nature and implications of ambiguous property rights in the case of China and its non-state sector as a transitional economy; can they be efficient?

Index

Introduction I. Past to present People’s Republic of China, towards transition Property rights, defined

p. 3 p. 3-4

II. III.

p. 5-6

The Chinese Model p. 6-8 Evolution vs. Big Bang, and the employment of ambiguous property rights Current p. 8-11 China, mid-transition and the functionality of ambiguous property rights in transition Future China, post transition, and does one size fit all? p. 11-12

IV.

V.

Conclusion Bibliography

p. 13 p. 14-15

2

Introduction
China’s remarkable and unmatched growth of the past decades, regardless of it ambiguous property rights and a relatively weak legal framework, have puzzled governments and economists to date. The contrast between China’s transitional economy and those in Eastern Europe and the former Soviet Union could not be more striking. Whereas the transition of the latter two has been a struggle and have sparked recession, China’s transition has brought about an economic boom and its gradual reform path has challenged the belief that gradual reform and public ownership cannot work as a transitional strategy. This paper aims to analyse the Chinese Model of economic transition with a focus on the structure of property rights in the system, primarily in the rural sector. First, a brief historic background of China and its course towards transition is provided, after which property rights and the various approaches to them are examined. I will then explore what system China currently employs, whether or not this has been effective, if it is sustainable and if it is to set a precedent for other transitional economies.

I. Past to present: People’s Republic of China, towards transition
The aim of this chapter is to offer a brief chronological background on China’s (economic) history. A more specific outline of the structure and history of property rights in China will be discussed by the end of chapter three, ‘The Chinese Model’. The civilization of China is one of the oldest, most complex and most fascinating ones in the world. The line of imperial, medieval and early modern dynasties reaches from the Xia Dynasty of circa 2100 BC to the Qing Dynasty that lasted as until 1911. Currently, the People’s Republic of China is in place. After the Chinese Civil War, Mao Zedong proclaimed the People Republic of China (PRC) in 1949. This marked the arrival of communism and a dramatic change of the property system in society. With his fixation on socialism, Mao replaced the old system of landlord ownership of land with a distribution system in favour of the poor and landless peasants (Wong). Multiple stages of collectivization took place in rural 3

areas and deindustrialization moved the country backwards rather than forwards. Prior to Deng Xiaoping’s rule, state-owned enterprises (SOEs) accounted for 77% of China’s industrial output. The remaining 23% was claimed by collective enterprises, including the Township and Village Enterprises. The amount of private enterprises was 0% (Lee). Until the late 1970’s, with Mao’s death in 1976, Mao’s regime and the land reform during ‘The Great Leap Forward’ accounted for a period of death, famines, an extremely low birth rate, suppression and economic deterioration (Wong). China’s transition from a planned economy to a market economy started in 1978 under Xiaoping. The country, by then, was battling a distorted macro-policy, artificially low interest rates, low nominal wage rates, low prices for living necessities and a simply derelict economic and social environment (Wong). With no exact ‘blueprint’ to this transition, the approach has been incremental and often initially called experimental (Lin, Cai and Li). In his path to ‘Economic Reforms and Openness’, Deng started with the de-collectivization of the countryside, followed by decentralization to motivate local and regional governments to achieve economic prosperity (Wong). He also implemented the concept of Special Economic Zones (SEZs); areas where foreign investment was to be allowed to run on a practically capitalist system, without the strict control of government regulations. Privatization was still a sensitive subject, but the market was allowed a larger role and the establishment of private firms and quasi-private businesses grew. By 1986, the governments control over investment assets had decreased from 53% in 1978 to around 20% in 1986 (Lee). After the Tiananmen massacre of 1989, Jiang Zemin replaced Deng Xiaoping. He built upon Deng’s vision and continued macroeconomic reforms. The Chinese government recognized the urgency of property rights in China’s market transition (Lee). The growth of the private sector continued at an accelerated pace. In the decade of the 1990s, the amount of private enterprises grew from 98,000 to 1.5 million (Lee). Growth of the domestic economy and trade was bolstered by China’s reliance on foreign investment and demand. Still, a radical change in property rights was not a priority in the process of China’s transition.

4

II. Property rights, defined
In order to identify and analyse the property rights structure in China, it is important to first outline what property rights exactly are. By itself, this setup of rights is one of the four dimensions, as defined by Gregory and Stuart (2004), that are used to determine the makeup of an economic system. Property rights are closely related to ownership. ‘Ownership’ refers to a mixture of rights that an individual may have over objects or claims on objects or services. These rights, in their turn, affect the manner in which the object is used. The above-mentioned ownership, or property rights can be divided into three broad types: 1. The disposition of the object (or asset), which refers to the right of transferring ownership rights to others. (eg privately owned/bought car) 2. The right to utilization of object, whereby the owner can use the asset in any legal way possible. Here the owner cannot pass on ownership rights to others, but make use of it as if it were in his ownership. (eg renting a car) 3. The right to use of the output produced by the product and/or service, where the property holder can only use whatever the output of the asset provides. (Gregory and Stuart) The three widely recognized forms of property ownership are private, public and collective. Under private ownership, each of the three forms of ownership rights belong to individuals. Here, the market values of property reflect the inclination and demands of the rest of society (Alchian). This shows a paradox, where ‘’private’’ property is founded on society’s assessment (Alchian). In contrast, the property rights under public ownership belong to the state. Most economic systems are in fact mixed systems, in terms of all of the four characteristics that determine an economic system, and therefore also with regards to property rights. Whereas more complete property rights are preferable to less complete rights, there is always a high level of complexity related to property rights theory (Alchian).

5

Differences in property rights affect the institutional structure of an economy in that they determine resource allocation by shaping incentives of individuals to carry out productive activities. Property rights also determine how income is accrued, the development of markets, the pattern of production, and thereby wealth distribution (Besley and Ghatak). Property rights exist to eliminate detrimental competition for power of economic resources (Alchian). Finally, it is crucial to define property rights in an economy, as not doing so will have destructive outcomes. Common ownership, for example, brings no strong incentive to preserve a resource and a complete abolishment of property rights is catastrophic; see the Tragedy of the Commons by Garrett Hardin (Alchian) (Hardin).

III. The Chinese Model: Evolution, but not a big bang
In its decision to depart from its original planned economy, China has employed an unprecedented approach. Rather than a rapid change to free prices, currency convertibility or policies, and immediate privatization of government enterprises, it has chosen a more gradual and flexible approach ( (Walder). Before I examine more carefully what approach China has pursued and whether or not this has been efficient, I would first like to outline the three broad perspectives regarding property rights in a transitional economy, as analysed by Putterman in his Cambridge research paper (1995). The first view argues that privatization is pivotal to economic reform and efficiency, and that a lack of immediate implementation of this decelerates economic growth (Putterman). According to this point of view, a free market cannot prevail or even be established without private ownership rights, for the absence of these obstructs efficient investment incentives and optimal response to price fluctuations (Sachs and Woo). This ‘privatization fundamentalism’ is countered by a less radical theory that in this argument could be named ‘evolutionism’. This second view is similar to the first in that it recognizes that private ownership must be an outcome of transition as it is the only way forward to a long-term healthy environment of competition and profit 6

seeking behaviour (Putterman). However, it differs from the fundamentalist perspective in that privatization is not necessary at the early stages of reform as the present institutions in the relevant economy need time to adjust and develop in a newly set environment (Yusuf) ( (Putterman). The third point of view is not a direct opposition of either of the two mentioned above, but rather a completely different approach. In this perspective, mere marketization without privatization is seen as sufficient, and even desirable, for an economy. This underpins the notion of market socialism, where the power of private institutions in managing wealth is limited, and the importance of equality and the improvement of poverty is the main focus (Putterman). Whereas the above three approaches, shock therapy, gradualism and market socialism, have been recognized as the three broad approaches to economic transition as a whole, the transition of property, or ownership, usually goes through a common process (Putterman). First, there is decentralization to allow governmental agencies, among which state-owned enterprises (SOEs) to have more autonomous powers in management of their properties (Lee). Second, privatization allows for the transfer of these powers to private control. Finally, after new regulations have been implemented, the state serves only as a regulatory organ for market equity in transactions and dispute settlements (Lee). It is undeniable and important to note that the state plays a critical role in economic transition to a market economy (ironically so) and that the transition of the property regime is arduous and costly. The conventional wisdom is that clearly defined property rights are key in economic transition and a precondition to economic prosperity (Li). In contrast to this wisdom and the above-mentioned common approach to property transition, China has taken a different course. Rather than a rapid change to free prices, currency convertibility or policies, and immediate privatization of government enterprises, it has chosen a more gradual and flexible approach (Walder). Ownership reform in markets, international trade and other economic aspects, has indeed been much less radical than privatization programs of other (former) planned economies, such as Soviet Union and other Eastern European countries. China has

7

prioritized the issues in macroeconomic control and barriers in strategic sectors such as energy and transportation (Yusuf) over privatization. The period of 1993 to 2007 saw the implementation of various civil and commercial administration laws, which eventually amounted in the passing of the Real Property Rights Law (RPRL) on October 1, 2007 (Lee). In 1981, for example, the Household Responsibility System (HRS) was introduced in rural China (Benjamin and Brandt). This system marked a radical change in property rights and organization in agriculture. Agriculture shifted from collective to family-based management. The HRS did not lead to decentralized decisions regarding land allocation: land ownership remained vested in the village (Benjamin and Brandt). With the vision of a ‘socialist market economy with Chinese characteristics’, the government continued to use the ‘land lease system’. The RPRL of 2007 covers the creation, transfer and ownership in the mainland of the People’s Republic of China (PRC) and is part of an ongoing effort by the PRC to gradually develop a civil code. Again, the system of land tenure whereby all land is mainly in the hands of the Chinese state remained unchanged (Ho). Whereas this law may seem to bring absolute clarity to the issue of property rights in China, this is not entirely true. The truth is that the exact perimeters of this land tenancy system are somewhat vague. We therefore speak of an unclear, or ambiguous property rights structure with regards to land property in China. Three main ambiguities in the law can be identified. First, the definition of public interest is quite vague. Second, the law does not specify in detail how to compensate those being deprived of land. Third, the law does not stipulate the relationship between collectives and peasants for rural land (Zhang). The effects of China’s policy will be carefully discussed in the next chapter.

IV. Current: China, mid-transition and the functionality of ambiguous property rights in transition.
This paper has now discussed what the common approach is to property right structure in economic transition, and what approach China instead has chosen to 8

pursue. The question is: Has this approach been effective? Has gradualism been beneficial to China’s economy? China’s growth over the past decades is undeniable. Its rate of growth of GDP per capita rose from around 4% during 1952-1978 to over 7% during 1978-1992 (IMF) (see Tabel 1). The effects of the (small) changes in China’s post-collective institutional framework for land rights are most clearly visible in the agricultural sector and the growth of Town Village Enterprises (TVEs). Although the TVEs did not have clearly defined property rights, the sector has achieved remarkable growth. In fact, it is because of the lack of clear formal property rights that this sector prospered, as the uncertainty within doing business is higher, which decreases the transaction cost related to it. In other words, high transaction costs provide an environment where ambiguous property rights can be more efficient under certain conditions than well-defined property rights (Ho). In addition to strong economic performance that resulted from it, the current rural ownership regime under ambiguous property rights has received support from farmers living on the land. China also ranks the highest in term of firms’ confidence and satisfaction with regulatory interpretations and confidence in the judicial system (see Tabel 2 below) (Zhang). It can therefore be stated that in China, land policy-making is ‘’an alternation of restraining practices that exceed legal boundaries and give space to experimentation by formulating unintentionally unclear policies and laws’’ (Ho). In China’s current state, it is precisely this ‘deliberate institutional ambiguity’ that makes the system ‘’tick’’ (Ho). The view that China’s growth has been caused by factors other than privatization has, however, been challenged on multiple grounds. According to this ‘counterperspective’, privatization has played a primary role. The rural economy, as is argued, is a form of private family farming and in industry nearly half of industrial output was

9

produced outside the state sector by early 1990s (Walder).

These arguments can however be invalidated by more evidence. First, even though the ‘private family farms, aka Township Village Enterprises, have been referred to as quasi-private, there is a general agreement that they are largely government owned. Furthermore, the greatest development and growth has in fact taken place in China’s rural sector (Walder). To sum up, the impressive economic growth that began and continues to be rooted in China’s rural sector, together with the support from the people, supports the idea that the privatization of land is actually not an essential ingredient during the process of transition in China. Under certain business environment, ambiguous property rights are more efficient than clearly defined private ownership rights. In particular, if legal disputes are likely to arise for an entrepreneur, local government is likely to be the more productive agent, causing the owner of a firm to invite the agent to share ambiguous property rights. In addition, there are some tax advantages as both local firms and local agencies share information about the firm’s taxable income (Le). Nonetheless, it is important to note that this current structure of deliberate institutional ambiguity (Ho) functions now, but cannot be maintained in the future, which will be discussed in the next chapter.

Table 1: Growth of China’s GDP per capita.

10

Table 2: Firm’s responses

V. Future: China, post-transition, and does one size fit all?

11

The final question that is then raised is: Is China’s model a sustainable one and is it one to be imitated by future transitional economies? The answer to this question, as argued by this paper, is no on both accounts. Judged by the analysis of the economy and the interaction of economic and political change, continued partial reform without strong privatization will eventually bring about inflation, fear of unemployment, liquidity crises and drops in state revenues. This can already be seen in the acceleration of China’s home price inflation that is taking place today and its relative slowdown in growth compared to previous years. The material and information provided in this paper thus far gives rise to an alternative view on the role of property rights in the process of transition, not the outcome. Instead of propagating privatization as a precondition for development, it seems that the structure of property rights can in fact be the outcome of societal evolution, or societal and economic transition. Nonetheless, duplicating China’s model to be applied to other transitional economies would not be the solution. Gradual reform and a lack of privatization is not superior to shock therapy, as undertaken in Eastern Europe and the former Soviet Union. On the hand, these economies had multiple problem in common prior to their transition: poor export performance, lack of competition and product markets, prices that did not reflect relative scarcities, and so on (Walder). However, the reason that China performs well under its current policy is because of the differences in the economic structure prior to its reform. Whereas the USSR, for example, was already an urbanized industrial society, with 75% of employment in industry, employment in China was 75% agricultural. China’s success is not merely explained by its state enterprises, but also by the large agricultural sector, which contained a vast labour surplus, and did not enjoy subsidies. Once constraints on migration across regions and jobs were removed, this labour was available to fuel expansion in new industries (Walder) (Wong). Unlike the distributional conflict in EEFSU, reallocation of labour in China allowed all groups to gain. In both, partial liberalization also unleashed macroeconomic pressures, manageable in China because of rapid growth and adequate monetary policy, but explosive in much of EEFSU because of deeper structural problems and gross monetary mismanagement (Walder).

12

To quote a recent IMF report: ‘’the Chinese economy, unlike those of other former centrally planned economies in transition, was not in a deep crisis of macroeconomic instability just before reforms were implemented’’ (Putterman).

Conclusion
This paper has aimed to examine the nature of property rights in China as a transitional economy; its nature, effects, sustainability and possible imitation. It has brought to light the fact that China works with ambiguous property rights in its rural sector, and proved that growth can still take place, and can even be stronger, under ambiguous property rights in an environment where transaction costs are high. The creation and structure of property rights are unique to every country or state, and can therefore be called heterogeneous in nature and impact. The mantra of ‘one size fits all’ and the possible exact imitation of China’s approach to a transition should therefore not be pursued.

13

Bibliography
Alchian, Armen A. The Library of Economics and Liberty. 2008. 10 November 2013 . Benjamin, Dwayne and Loren Brandt. "Property Rights, Labour Markets, and Efficiency in a Transition Economy: The Case of Rural China." Working Paper. University of Toronto, 2002. Besley, Timothy and Maitreesh Ghatak. Property Rights and Economic Development. London School of Economic and Political Science. London: London School of Economics, 2001. Gregory, Paul R. and Robert C. Stuart. Comparative Economic Systems. 6th edition. Boston: Houghton Mifflin Company, 1999. Hardin, Garrett. "The Tragedy of the Commons." Science 162.3859 (1968): 12431248. Heller, Michael. "The tragedy of the anticommons: Property in the transition from Marx to markets." Harvard Law Review 111.3 (1988): 621-688.

14

Ho, Peter. "Who owns China's Land? Policies, Property Rights and Deliberate Institutional Ambiguity." The China Quarterly 2001: 395-421. Huang, Yasheng. Private ownership: The real source of China's economic miracle. 1 November 2013. Le, Nhat. "Contingent Delegation and Ambiguous Property Rights: The Case of China's Reform." The Australian National University, 2003. Lee, Wei-chin. "Yours, Mine, or Everyone's Property? China's Property Law in 2007." Journal of Chinese Political Science (2009): 47. Li, David. "A Theory of Ambiguous Property Rights in Transition Economics: The Case of the Chinese Non-State Sector." Electronic. 2012. Lin, Justin Yifu, Fang Cai and Zhou Li. "The Lessons of China's Transition to a Market Economy." Cato Journal (1996). Putterman, Louis. "The Role of Ownership and Property Rights in China's Economic Transition." The China Quarterly December 1995: 1047=1064. Rodrik, Dani and Mark Rosenzweig. Handbook of Development Economics. Vol. 5. Amsterdam: Elsevier BV, 2010. Sachs, Jeffrey and Wing Thye Woo. "Structural factors in the economic reforms of China, Eastern Europe, and the former Soviet Union." Economic Policy 9.18 (1994): 101-145. Walder, Andrew G. "China's Transitional Economy: Interpreting its Significance." The China Quarterly December 1995: 963-979. Wong, Jan. Red China Blues: My Long March from Mao to Now. New York: Anchor Books, 1997.

15

Yusuf, Shahid. "China's macroeconomic performance and management during transition." Journal of Economic Perspectives 8.2 (1994): 71-91. Zhang, Xiabo. "Asymmetric Property Rights in China's Economic Growth." Land Rights and Social Security in China. Washington: International Food Policy Research Institute, 2006. 28.

16