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Eleven Local Bargaining Relationships and Urban Industrial Finance
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Local Bargaining Relationships and Urban Industrial Finance

Andrew G. Walder

I wish to thank Kenneth Lieberthal, David M. Lampton, Barry Naughton, Michel Oksenberg, and Ezra Vogel for their detailed comments on the original version of this chapter.

The term "bargaining" is used frequently to characterize bureaucratic behavior in socialist states. Political scientists have characterized policymaking and implementation as protracted processes of bargaining and accommodation among leaders of organizations.[1] Analysts of planned economies have come to see them as "infinitely flexible bargaining systems," in which production plans, material supply, prices, taxation, and credit are subject to protracted bargaining and renegotiation.[2] For the political scientist "bargaining" is an emblematic style of politics, said to be responsible for ambiguity and delays in decision making and for intractable problems of policy implementation. For the economist bargaining is a cause of soft enterprise-budget constraints, which in turn are said to explain the perennial inefficiency of traditional central planning and the protracted difficulties of industrial reform in Hungary, China, and elsewhere.

While these studies aptly characterize a style of bureaucratic decision


making and its consequences, there is a structural dimension to bargaining that has not received careful attention. With notable exceptions, political scientists have focused on the activity and strategy of bargaining, and economists on the consequences of bargaining, while neglecting the patterned relationships within which bargaining activities take place.[3] The bargaining that we see is a symptom, not a cause, of preexisting institutional structures. As Ellen Comisso observed, "Focusing on the bargaining process alone ignores the fact that the arenas within which bargaining occurs are strictly limited and the issues up for bureaucratic negotiation are tightly restricted. Further, the bargaining partners themselves (e.g., enterprises and ministries) do not determine these limits and restrictions; rather, the political leaders outside them do."[4] Bargaining is also constrained by peculiar kinds of resource dependencies and resource flows. It is accompanied by identifiable norms and is justified (or rationalized) by deducible values. The relationships in which bargaining activity is embedded are a neglected but vitally important subject. Here we focus, not on bargaining activity per se, but on bargaining relationships .

Nowhere are these relationships more evident, or more vital politically and economically, than in the government's fiscal and budgetary processes. In Chinese cities revenues come almost exclusively from taxes on enterprise profits. The proceeds are divided with the provincial or the central government, according to a negotiated formula. With its share, the city funds its social services, public works, and infrastructure development. Through its planning commissions and bureaus, the city government also redirects part of its revenues back into industry as credit and investment funds. Just as the retained share of its total annual revenues is renegotiated separately for every city, the city itself negotiates the proportionate annual flow of revenues between it and each enterprise.[5] These negotiations are especially important when the government approves a factory's investment project. Several local organizations are


involved continuously in these negotiations. Each of them plays a different role, and each has a different interest in the proceedings, but they must all work out a viable compromise on each case.[6]

In the summers of 1984, 1985, and 1986 I investigated these relationships in a study of industrial planning and financial reforms in Chinese cities.[7] I interviewed officials and executives from a total of sixty-one government agencies and industrial enterprises (see the appendix to this chapter) about production planning, supply and sales, and the present subject, taxation and finance. These interviews underpin the analysis I offer here.

Corporate Ties In Local Industry

One arresting image of China's huge bureaucratic policy is that of fragmentation. Lieberthal and Oksenberg specify the aspects of fragmentation that require such compensating integrative mechanisms as regular meetings, document-transmittal systems, and personal ties, to give it whatever cohesion it may possess.[8] But if one looks at only a part of the whole, in this case a city's industrial system, what strikes the researcher is not its fragmentation but its degree of integration. Here the problem is less to compensate for fragmentation than to allow enterprises significant autonomy in important business decisions. From the mayor's office to the enterprise, there is considerable integration in fiscal and budgetary matters within the municipality's own industrial system.[9] As I describe the relations among actors in the process of budgeting and finance, we shall see that a city's industrial system operates in ways that we associate with large, diversified corporations: carefully regulating financial flows to subsidiaries and blurring organizational boundaries by intervening extensively in important decisions.


Institutional Actors

There are six kinds of municipal institutions that participate in decisions on the extraction of revenues from enterprises, or the funding of their expansion or renovation. Some seek to support the development of enterprises under them; others seek overall balance in the growth of different industrial sectors—slowing it in some areas, speeding it in others. Some view investment in an enterprise purely from the financial angle; others must balance social utility and local advantage against narrow considerations of profit. Some seek to maximize tax revenues and maintain the city government's ability to guide local development. Others seek to keep resources in the enterprises and protect them against excessive demands from the government.


One of the most important tasks of factory directors and of department heads in charge of finance is to turn the flow of financial resources between their enterprise and the government increasingly in their favor. The greater the proportion of revenues they keep, the more prosperous will be their employees and the greater their ability to fund their own expansion. Such growth and prosperity will be viewed favorably by their superiors.[10] The nominal tax rate on enterprises in China is very high. Taxes on sales revenue or value added usually take from about 10 to 15 percent, and of the remaining "realized profit" (shixian lirun ) there is a standard income tax (shouru shui ) of 55 percent, an individually set adjustment tax (tiaojie shui ) that usually is between 5 and 30 percent, and a variety of smaller local taxes and levies.

The remainder is kept by the enterprise and put into several funds in proportions decided upon by the finance bureau, with participation of their "leading organ" (lingdao bumen or zhuguan bumen )—either an industrial bureau (gongye ju ) or a company (gongsi ). Commonly, a portion is for employee benefits and bonuses, another for development of production, and a third for reserves. Only one of these funds, for bonuses and benefits, comes close to meeting perceived factory needs (though managers commonly feel pressure to enlarge this fund even further).[11] China's reformers also encourage enterprises to pay for more of their own expansion out of retained funds. From 1977 to 1984 the percentage of national investment paid for by enterprises increased from 38 to 44


percent.[12] But retained profits themselves cover only a fraction of enterprise investment funds: as late as 1982, enterprise depreciation funds were still double the amount of retained profits.[13] In short, enterprises must still rely upon public investment and bank loans to cover their projects, and they must have tax breaks in order to repay these loans.

Therefore, negotiations over investment projects and marginal changes in revenue flows have assumed central importance to the manager; they determine the prosperity and future vitality of the firm. Managers seek to reduce the effective taxation rate on their enterprises in both the long and the short run. Their primary opportunity to do so is when they are given permission to engage in a major construction or renovation project that expands plant capacity or increases the technical efficiency of the firm. When this occurs, the flow of funds must be renegotiated in the short term, because enterprises otherwise will be unable to repay their loans, and in the long term, because plant improvements or expansion can greatly affect the firm's ability to generate revenues. Almost every investment project is accompanied by a corresponding set of tax breaks. The task of the manager, therefore, is to get investment projects approved and to negotiate the most favorable possible tax treatment, both during and after the project. He must draw up financial projections, submit applications to leading organs, and persuasively present the project, both formally and informally, to the members of the city's industrial circles.

Industrial Bureaus

Every industrial bureau manages a cluster of enterprises in similar lines of production. Their finance and planning departments are the ones most actively involved in decisions regarding investment projects and their tax treatments.[14] Whenever an enterprise manager wants to engage in an investment project, he must first get the approval of its industrial bureau. Every project must be approved and put into the city's construction or renovation plan. Small projects that are paid for entirely by an enterprise's own funds are routinely approved, but they must still be approved by the bureau and counted toward its city-delegated quota of industrial investment for the year. Anything


large enough to require a loan—all but the smallest projects—must be studied, approved by the bureau, and then taken to higher levels of government to arrange financing and put the project into the city's industrial-investment plans.[15]

For the enterprise, the bureau is the first and easiest step in a process that usually takes between three months and a year. Industrial bureaus generally support any project that will improve or expand the capacity of their enterprises. But they are limited by city investment plans, which ration investment projects to various lines of industry and cannot champion every proposal brought to them, at least not immediately. They therefore evaluate enterprise proposals and authorize full-scale feasibility studies for the ones approved, after which they go to other government agencies to get permission and funding. Enterprises whose initial proposals are rejected will work with the relevant officials in the bureau to come up with a better proposal in the immediate future.[16] The bureau's primary function in this area is to strengthen proposals that it forwards to higher levels, while keeping within the overall limits placed on investment.

Finance and Taxation Bureaus

These are the two "comprehensive bureaus" (zonghe ju ), responsible for coordinating the financial activities of industrial bureaus and enterprises.[17] Although their relations are not always harmonious, municipal bureaus of taxation and finance perform closely related functions and indeed have been separated organizationally only in recent years. The scope of responsibility, and power, of the finance bureau is greater than that of the taxation bureau. The finance bureau is responsible for managing both revenues and expenditures for the city. It budgets industrial investments from city revenues to bureaus and enterprises, and it sets tax quotas for collection in the city as a whole and divides them among industrial bureaus, which in turn divide them


among their enterprises. While it is under the nominal leadership of the Ministry of Finance and must conduct its business in accord with that ministry's regulations and documents, the bureau is in fact an organ of the city government that is directly under the city's planning and economic commissions and ultimately responsible to the mayor's office.[18] The finance bureau must agree to all investment expenditures by enterprises, whether they are made out of city funds, loans from bank deposits, or their own funds. Public finance funds to be loaned to enterprises must be placed in the city budget. The bureau must also approve any tax breaks that are included in financing packages given to enterprises, or any tax bailouts or subsidies of firms in financial trouble.

The taxation bureau was a department within the finance bureau before the tax reforms of the early 1980s. Now it is a separate organ responsible for fulfilling tax quotas set by the finance bureau. Although it conducts its work according to guidelines and regulations sent down from the General Bureau for Taxation in Beijing, the taxation bureau operates under the guidance of local authorities: the finance bureau, which sends down annual tax quotas that serve as targets both for enterprises and for tax collectors; the planning and economic commissions; and ultimately the mayor's office. Its relationship with the finance bureau is an ambiguous one: in many cities, the rank of the bureaus is the same, and their responsibilities overlap, whereas the scope of the finance bureau's responsibility and power are broader. The two organizations must agree to all tax breaks, but the responsibility is often blurred because of an overlap in functions. Many local tax bureaus have tried to assert their independence in recent years and have precipitated discord with finance departments over their mutual powers and responsibilities. These disputes must be ironed out by planning and economic commissions, or by the mayor's office.

Local Bank Branches

Local banks—primarily branches of the Construction Bank in the case of capital-construction (jiben jianshe ) projects that involve significant expansion of plant capacity, and the Industrial-Commercial Bank in the case of technical renovation (jishu gaizao ) and equipment purchases—have sharply defined and different interests in these matters than do the bureaus of taxation and finance. Banks study every loan application from an enterprise for its financial prospects. They want evidence that the firm's profitability will be significantly improved by the project (xiangmu ) and that the firm can repay the loan


within the specified period of time entirely from its increased profits . Banks reject proposals that do not meet these financial criteria, unless the bureaus of taxation and finance, with the permission of the planning commission, are willing to cut taxes to allow the firm to repay. Since that is usually what happens, banks rarely end up killing investment projects.

The bank's attitude toward a loan application depends on the proposed source of funding. The great majority of funds for capital-construction projects are made through the Construction Bank and come not from bank deposits but from public finance funds or credits (caizhengxing jinrong or xindai ) from the budget of the city or a higher level of government.[19] If the funding for the project is to come from the budget of the city or another level of government, it reaches the bank in the form of a grant earmarked for a specific enterprise. The bank manages the investment for the government, eventually returning all repaid principal to the public coffers while keeping the interest as a service fee. This practice is known as "loans from grants" (bo gai dai ). In these cases the role of the bank is largely to inform the finance bureau of the prospects for repayment of the loan. It is up to the finance and tax bureaus to come up with a package of tax breaks to allow the firm to repay if that is necessary.[20] But whether the firm can repay does not greatly affect the bank, since its own credit reserves (xindai jijin ) are not at risk.

In many cases, however, a firm's municipal sponsors would prefer to have the project funded with the bank's own funds. This is the case for the great majority of loans for technical-renovation projects made by the Industrial-Commercial Bank.[21] These loans, usually smaller than the


construction projects but much more numerous, are made from the substantial deposits that this bank keeps as manager of the accounts of local industrial enterprises. On loans of this type the bank involved will inspect the application more carefully and object more pointedly if there is too much risk. From the bank's perspective, the finance system can risk its own funds on marginal projects but has no right to force the bank to use its own funds to do so. The bank's protection of its own funds affects the funding process in two ways. First, bureaus and planning commissions will generally send only the better projects to apply for bank funds. Second, recalcitrant bank officers need to be "convinced" by local officials—usually from the planning commission or the vice-mayor's office—to "think over" their denial. In almost all cases, the city "convinces" the bank by tailoring a package of subsidies and tax breaks that will virtually guarantee that the firm can repay.

Planning and Economic Commissions

In the cities in which I conducted my interviews, these commissions are usually higher in rank than the local industrial bureaus, comprehensive bureaus, and banks, and their task is to coordinate the work of all of them to fit into an overall plan. Their exact division of responsibilities is often vague and varies from city to city. But in general, the planning commission is responsible for the long-term development of the local economy, which includes all aspects of industrial finance and planning, and it is directly responsible for coordinating the work of all of the comprehensive and industrial bureaus in the city. The economic commission, in contrast, is usually responsible for the immediate coordination necessary to iron out bottlenecks and delays that threaten the implementation of annual plans. The planning commission's departments for basic construction and industry (jijian chu, gongye chu ) are responsible for budgeting and arranging funding for major investment items and for fitting these items into its longer-term plans for the development of local industry. The commission deals primarily with the various comprehensive bureaus, especially the tax and finance bureaus, and the banks. The economic commission, on the other hand, approves the technical-renovation projects, which are smaller but more numerous, spending most of its time trying to resolve urgent problems of materials supply, transportation bottlenecks, shortages in operating capital, and energy shortages. Because of its problem-solving role, the economic commission deals much more frequently with industrial bureaus and factory directors.

However they divide their responsibilities, both of these commissions see their mission as "managing local industry on behalf of the city government." Their immediate superiors are the vice-mayor in charge of local


industry and, ultimately, the mayor himself.[22] The heads of the planning commission's finance and business department (caizheng jingying chu ) act as both coordinators and participants in negotiations over individual investment items and tax breaks. In some cities they have organized coordination groups (tiaojie xiaozu ) made up of representatives from each of the concerned comprehensive bureaus, to resolve disputes and come to decisions on contested items.[23]

The Mayor's Office

The mayor's office is the ultimate source of authority for all decisions on investment and taxation. To be sure, there are regulations and guidelines regarding taxation and industrial investment issued by the Finance Ministry, Central Bureau of Taxation, State Planning Commission, and other central-government agencies. But these guidelines leave broad discretionary powers to local authorities, who have wide latitude in granting tax breaks and who have an abiding interest in directing investment to those sectors high on their development plans.

Unless the enterprise involved is substantially funded by a province or a central ministry, the mayor's office is the appeal of last resort in disputes over these issues. Usually it is only the largest or most controversial cases that are sent to the top for resolution. But such cases are brought to the top with enough frequency that in Dalian a "policy coordination group" (zhengce xietiao xiaozu ) has been established by the mayor's office, headed by the vice-mayor in charge of industry, to foster the prompt resolution of all of these questions; its members include the heads of the


finance, taxation, price, and labor bureaus. When the mayor's office has spoken on such a matter, that is the end of the issue, at least for the current year.

Municipal Budgetary And Fiscal Processes

The most distinctive feature of China's local budgetary and fiscal process is how closely, and routinely, investment and taxation decisions are interwined. What economists have called the "soft budget constraint" does not mean simply that enterprises can expect to be bailed out if they run into financial difficulty. It means that the decision to invest in industry is paired with a decision about changes in the division of revenues between enterprise and government, such that conditions for repayment will be created. Each decision about an investment loan is accompanied by a decision about the flow of revenues.

China's tax-for-profit reform (li gai shui ) and its budgetary reform (caizheng baogan ) have reinforced the tendency of local government to monitor closely the division of revenues between enterprise and government. The revenue share for the central or provincial budget, for local roads, hospitals, housing, and much of the funds for expansion of local industry (and thereby the further expansion of the local revenue base), all must come from locally collected taxes.

Since these reforms took effect in the early 1980s, local actors have had much more latitude in initiating industrial projects and have allocated greatly increased proportions of national investment.[24] Through the new tax system they have also become involved for the first time in continuous negotiation over the revenue flows between the city and industrial enterprises. This involves the development and evaluation of project proposals (xiangmu jianyi shu ) and feasibility studies (kexingxing baogao ); it requires successive rounds of meetings and approvals on each proposal; and it requires local actors to put together the funding from central, provincial, or local budgets, or from bank loans, to augment the funds provided by the enterprise.

In this short period of time a regular pattern of behavior and accompanying attitudes have already become evident. There is a marked tendency to appropriate and redistribute enterprise revenues when they are deemed inordinately high, to build consensus and thereby parcel responsibility among all local actors for specific investment decisions, and to reduce the risk of failed ventures beforehand by granting favorable terms to important projects. This behavior is accompanied by a clear set


of local attitudes toward the business environment and managerial responsibility, about welfare and employment, local development needs, and the legitimacy of claims to enterprise profit.

The Redistribution of Local Resources

Ironically, the same arguments that reformers use to argue for thorough price reform and greater enterprise autonomy are also used by local officials as the justification for their intervention in enterprise activities. Reformers argue that in today's half-reformed economy, unreformed prices do not yet send the proper signals to enterprises, and a number of objective conditions beyond the control of managers—transportation links, energy supply, state pricing decisions, existing state of capital stock—make the link between efficiency and profit tenuous and threaten to exacerbate existing distortions and imbalances. In the terminology of reform, these "objective conditions" (keguan tiaojian ), beyond the control of enterprise managers, make it impossible for such "subjective factors" (zhuguan yinsu ) as good management or hard work to be measured by factory profits. Local officials are highly conscious of this, and they take it as their right, indeed their duty, to protect enterprises under them from the consequences of unequal "objective conditions," ensure the balanced and stable growth of the local economy, and protect the welfare of local citizens.

The first consequence of this situation is a practice popularly referred to as "whipping the fast oxen" (bianda kuai niu )—in effect, tailoring effective taxation rates to rates of profit. As one factory director stated to me in a matter-of-fact fashion, "If our profits increase in future years, there will be supplementary taxes to adjust for changed performance."[25] This is often said, both in China and abroad, to reflect the desire of local officials to restrict enterprise autonomy and maintain their power. But even if local officials fully supported enterprise autonomy (and I encountered some very critical and outspoken advocates in various bureaus and banks), they would be compelled by circumstances to behave in this fashion.

Every city government will have a set of enterprises, typically producing raw or intermediate materials, whose products are in short supply and badly needed by other local enterprises, but whose price niche ensures that their profitability will be very low. These enterprises, typically producing steel or fabricated metal products, nonferrous metals, industrial chemicals, or simple components for engines or electrical equipment, will at best make profits that are quite small compared with their capitalization, and will frequently operate near the break-even point or below. They will be unable to cover more than a fraction of their badly


needed investments for plant renovation and expansion. Yet these are precisely the industries that need to develop most rapidly.[26]

At the same time, every local government will have a set of enterprises that are highly profitable and that succeed, not because their products are generally in short supply, but because the quality or specifications of their products are such that they find steady markets. These enterprises typically fabricate finished consumer or producer's goods; various kinds of machinery, electrical equipment, or consumer electronics are common examples. Their profit rates are much higher than those of older, inefficient plants and those producing raw or semifinished materials. Yet these high profits are arguably due to state pricing policies, which keep materials' prices relatively low and finished products' relatively high.

Unless it is to allow current bottleneck industries to stagnate, the city government has no choice but to favor the disadvantaged enterprises across a broad range of financial measures and administrative practices. The first measure it takes is to ration investment by setting its own priorities in local construction and renovation programs (guihua ), allocating investment projects to those enterprises the city wishes to develop fastest, regardless of prevailing profit rates.[27] Every city and every industrial bureau has five-year investment plans that allocate investment quotas down to each enterprise. Every construction or renovation project must be approved by the industrial bureau, the planning commission, or higher authorities, depending on its size, and put into this plan, even if it is relatively small and funded entirely by the enterprise. Enterprises with the financial wherewithal to substantially fund investment projects are allowed to do so, but only up to the limits established in the plan. Those who have been allocated a place in the plan, but who cannot substantially cover their needed investment, will receive tax cuts or subsidized loans to allow them to complete the construction or renovation plans decided upon by their leading organs.

Effective taxation rates are tailored to the profit rates of each enterprise. The adjustment tax (tiaojie shui ), designed to compensate for unequal competition due to price niches, different capital endowments,


and other "objective factors," was instituted with the shift to enterprise taxation and is the best known of these leveling mechanisms.[28] But in practice it was found that this tax was too small and too inflexible to allow local officials to guide industry effectively (tax regulations specified that this tax rate remain unchanged for a certain number of years).[29] In fact, on paper the entire tax structure looks quite inflexible, since localities, as it was explained repeatedly to me, do not have the power to change centrally determined rates of taxation.

Localities do, however, have a free hand in deciding how much of a factory's profits shall be exempted from taxation during any given year, and for most products they also have the right to exempt any amount of sales revenues from taxes on products. The only limit on these tax breaks, other than central regulations forbidding sales tax breaks on such products as alcohol and tobacco, is the finance bureau's calculation of the effect they will have on local revenues.

Tax breaks are routinely considered in three kinds of situations. In the first, enterprises that have habitually operated at a loss, yet which continue to turn out badly needed materials or components for other local industries, will receive tax breaks to allow them to continue to operate. On occasion, such enterprises will receive even larger concessions to subsidize large investments if local officials deem it necessary to turn the situation around. In the second situation, a plant that normally operates with a profit may, because of "objective conditions," find itself in financial difficulties. The objective conditions may be any number of things: shortages of raw materials, energy blackouts, price rises for raw materials. A temporary tax break will be negotiated to permit the firm, which is in trouble through circumstances beyond its control, to keep operating. The third situation is when a sizable renovation or construction project is undertaken. Because nominal tax rates are so high, very few can afford to repay investment loans within the customary time period. Every such project has a variable tax subsidy in its "loan repayment contract" (huankuan hetong ).

Although we have no data on the prevalence or magnitude of such tax


breaks, one gains the impression from interviews—particularly in the detailed knowledge that people at all levels have of the subsidies and the conditions under which they may be secured—that favorable tax treatment is common. This means that the upper limit on taxation is the nominal tax rate, with widespread reductions in the effective tax rate through exemptions of varying magnitudes. The actual rate of profit retention appears to average between 20 and 25 percent.[30]

There is another important redistributive mechanism known as "the concentration of funds" (jizhong zijin , or jizi ). These are administrative levies, usually by industrial bureaus but sometimes by planning commissions, on the retained profits of enterprises. One bureau official explained, "This is like an additional adjustment tax. We take more from those with more money, and less from those with less. All sixteen industrial corporations (bureaus) in Beijing do this."[31] The administrative agency simply takes away part of the factory's retained profits. At the industrial bureaus that described the practice to me, these levies ranged from 7 to 15 percent.[32] The bureau deposits the funds in a local bank or an investment and trust corporation and loans or grants them to needy enterprises under its supervision at preferential rates. In other cases, in a practice called "apportionment" (tanpai ) in one city, the city government simply places a levy on the profits of a particularly large and profitable firm in its jurisdiction.[33] These practices were controversial in 1986, and since the press at that time carried articles critical of them, enterprise officials openly complained to me about such "arbitrary practices."[34]


Sharing Risk

One important consequence of the city government's mission to compensate for "objective conditions" is the provision of a kind of insurance against the risk of industrial undertakings. This is an ironic consequence of the new stress on having enterprises repay investment loans. The bank examines every feasibility study and loan application for the firm's ability to repay out of increased profits. Not uncommonly, an application will be flagged by the bank as having too much risk (fengxian ) and as unacceptable, without awarding the firm favorable conditions.

At this point, industrial decision-makers are faced with a conflict between two principles, which they refer to as "economic efficiency" (jingji xiaolu ) and "social utility" (shehui xiaolu or shehui xuyao ). The prevailing attitude among those I interviewed is that the former is a rather narrow, blind, and calculating criterion, whereas the latter takes into account the greater public good. By the time a project application is rejected or flagged by a bank as unprofitable, it has already been approved by the industrial bureau involved, placed in the plan, and if it is large, already approved by the planning commission. In other words, the planning apparatus of the city has already pronounced upon its social utility.[35] There follows a protracted negotiation among industrial bureau, bank, tax bureau, finance bureau, and planning commission. The usual result is a set of "favorable conditions" (youhui taiojian ) that will allow the venture to succeed.

The finance and tax bureaus have four mechanisms that, in combination, allow them to fashion "favorable conditions" of widely varying attractiveness. The first is to reduce or eliminate the interest rate on the loan. The financial system simply pays the interest directly to the bank, and the enterprise repays only the principal. This is an "interest free loan" (wuxi daikuan ) or a "subsidized interest loan" (tiexi daikuan ). The second mechanism allows the enterprise to deduct its annual debt repayment from the profit subject to taxation. But it is common practice on construction loans financed by budgetary funds ("special project loans," texiang daikuan ) to allow up to a 100 percent income tax deduction on the debt repayment, or as the Chinese put it, to repay loans before taxes (shuiqian huankuan ).[36] Since the various taxes on enterprises usually add up to a nominal tax rate of 70 to 85 percent, this can be a large subsidy,


equal to the percentage the factory is allowed to repay before taxes times the tax rate.[37]

The third mechanism is to allow the enterprise an exception from the principle that it repay a loan out of new profits generated by the investment project. Enterprises whose projects are judged to be economically unprofitable but socially necessary will be granted the right to repay their loans out of their "old" profit, in addition to the new. The fourth mechanism, usually used only in projects with urgent social justification but poor financial prospects, is simply to treat loan repayments as taxes (shitong shangjiao renwu ).[38] In this case, loan repayments are simply counted toward the factory's tax obligation, releasing them from their normal tax obligations until the loan is repaid. With so many mechanisms at their disposal, local officials can tailor tax breaks of any size. They can, and do, fine-tune loan and tax packages to create in advance the conditions for repayment.[39] One might reasonably ask, given this ability to fine-tune financial conditions, whether there is any criterion financial bureaus use to determine how much preferential treatment to give a firm, and if so, what.

The only clear standard that I was able to discover was evident in all the cities I visited: the factory's bonus and welfare funds shall not be allowed to fall below the level of the year reforms began (1983 or 1984). Even if, in extreme cases, the factory must use all of its reserve funds to repay loans or cover losses, wages and benefits must not be allowed to fall.[40] This standard was usually justified by the argument that "objective conditions" necessitate tax breaks in the first place, so the work force should not suffer from circumstances beyond their control. Others stated the point more baldly and said that workers' incomes should not be allowed to suffer in the course of reforms.

These practices reduce significantly the element of risk in enterprise operations. Enterprises can depend on leading organs and other agencies to devise an investment package designed to secure success. If the enterprise still runs into difficulties repaying because the feasibility study


was too optimistic, or because of objective conditions, a firm can apply for a "hardship tax break" (kunnan jianmian ). The plea of "objective conditions" is ruled out in only three cases: if labor costs go up; if materials use rises; or if sales go down because of poor quality of product. The loan repayment contract is viewed as legitimately open to renegotiation. After confirming this, one enterprise manager said, "Usually this is no problem if you are a well-run factory and aren't a chronic money loser."[41]

If poor financial performance can be traced to "subjective factors," this is a blight on the manager's record. But tax breaks are still given, usually for one year but sometimes longer, to help turn the situation around: "Whether it is due to bad management or not, we still reduce taxes if we want to save the enterprises in a certain line of production. We are after all a socialist country, and we don't want enterprises to go bankrupt."[42] If the problems persist, local authorities may eventually decide, if the plant is important, to give the firm a large renovation project to increase its technical productivity and start with a clean slate.

The Shared Responsibility of Collective Decisions

Just as much of the risk of investment projects is absorbed by local industrial circles, so is the responsibility for investment decisions. Since government agencies have taken it upon themselves to intervene actively and compensate for "objective conditions," they take up much of the responsibility for investment decisions.

An enterprise's initial project proposal (xiangmu jianyi shu ) is submitted to its industrial bureau, but after that point various government agencies become involved. The industrial bureau commissions a feasibility study and may order revisions. Depending on its size, the project will then be taken to the planning commission, or to higher levels of government, for approval and to arrange a funding package. Finance bureaus and banks will examine the project proposal and arrange funding; when a tax break is required, the tax bureau must also be consulted. The loan repayment contract represents prolonged discussions by these agencies. Symbolically, it must be affixed with the seals of the enterprise itself, its industrial bureau, the finance bureau, bank, and tax bureau.[43]


In effect, the investment is not the enterprise's decision: it is a collective one of all of the local agencies that have discussed and approved it. "The responsibility is unclear, however, who it is that gives final approval, or who it is that has the right of final denial. If any one of these organs turns you down, you can't get it. So the responsibility is unclear. No one is entirely responsible."[44] In controversial cases, the decision follows from a long process of consensus building, which may in the end be settled by the planning commission or the mayor's office. The manager's plans have been scrutinized and approved by the entire local industrial circle. If something goes wrong that cannot be attributed directly to the manager's subsequent actions, all of the departments involved share responsibility for the initial decision to go ahead. This is one important reason, in addition to the more obvious economic ones, why local industrial circles are prone to save firms in financial difficulties. Not only can "objective conditions" be blamed, but they are themselves implicated, since they set the financial conditions under which firms operate.

Redistributive Politics: Bargains And Strategies

Bargaining closely follows the design of local fiscal and planning processes. Since these processes are essentially ones of revenue redistribution, bargaining is designed to affect marginal changes in redistributive decisions. Managers have an identifiable set of strategies, but their effectiveness is limited by the enterprise's bargaining position—something that cannot be changed by the manager.

Bargaining Positions

The enterprise that enjoys the best bargaining position is the one on which the city depends substantially for the supply of scarce inputs for local industry. Steel foundries and rolling and stamping mills, for example, enjoy an excellent bargaining position if they are not located in a major steel center, and if the city has a substantial heavy-manufacturing base. Here the city will be highly dependent upon the firm for the completion of local production plans, and the factory's arguments for favorable treatment and complaints about "objective conditions" carry considerable weight.[45] When profit rates are low because of a firm's price niche, as for steel mills, such pleas are even harder to resist. In one of the cities I studied, one large metal-fabricating plant, with only a fraction of


its annual production, could supply all the needs of local industry. When the local bureau of material supply needed an urgent shipment of its product for a local enterprise, that firm could use its assistance as leverage in financial negotiations with the city.

Size, however, is not an unalloyed advantage. In another city, a large metal-fabricating plant, relatively profitable and the largest of its kind in the country, turned out a product urgently needed throughout the nation. However, local demand for that firm's products was not high: the city had a small industrial base. In fact, this firm was so large that its taxes contributed 25 percent of the city's annual budget. Its size and profitability, however, were too tempting for the city: not only did the firm pay a high adjustment tax, it was also required to turn over 40 percent of its retained profits. The city justified this by arguing that support costs for such a large plant were a great burden for the relatively poor city. Whether this was true, I could not tell, but the manager of the firm complained at length.[46]

These cases illustrate the vagaries of size and dependence as an advantage for the firm. If the firm is large, is relatively unprofitable, and is a crucial supplier for local industry, it will consistently obtain the most favorable of financial conditions. If, however, it is large, is relatively profitable, and supplies national rather than local industry, it can be preyed upon as a cash cow for the local budget. The only recourse a firm in this situation will have is to appeal to the relevant ministry, and perhaps even to the state planning commission, to bring pressures upon local officials. I suspect that in this last example the matter could only be resolved if pressure from central agencies was accompanied by a concession in the revenue-sharing agreement between the finance ministry and the city.[47]

National priorities also appear to affect bargaining positions of enterprises, although to what degree I cannot measure. While objective conditions are often difficult to separate from subjective ones, the price niches of most sectors are relatively well known. Reform plans at the national level specify certain sectors as suffering from distorted prices, and others as having an unfair advantage. If you plead "objective conditions" to gain favorable treatment, your task is made easier if you are in a sector that does suffer from the price system. If you are not in such a position, you may be in a sector—such as most machine-building industries—that is experiencing rising materials costs but steady product prices. Central policy mandates that these firms "absorb" (xiaohua ) new costs through


increased efficiency. Officials will be less immediately attentive to pleas from these firms, unless there are additional objective conditions that affect them.

Whether they are profitable or not, some sectors are designated in each city as "key points" for local development. Sometimes these are determined by long-standing local needs; in other cases, they may represent a response to the priorities of the national five-year plan. It was evident in some cities that certain sectors—especially electronics and the computer industry—were receiving preferential treatment as a matter of both local and national policy, relatively independently of their profitability. As new growing sectors, they were being given favorable conditions for rapid growth.

On the other hand, unneeded industries perennially operating in the red will be gradually phased out. In Beijing in 1986 such a sector comprised the small, antiquated, and unprofitable chemical-fertilizer plants that could not sell their poor-quality products. The city had for several years been phasing out this sector. Heavy-industry plants in the city center were receiving the same treatment that year because the city had a beautification plan that sought to relocate polluting firms in the suburbs.

Bargaining Strategies

When an enterprise manager seeks to improve his firm's position, his bargaining strategies are constrained by the objective bargaining position of the firm. An effective bargainer might be able to compensate somewhat for such disavantages, or might be able to capitalize on a firm's inherent advantages better than a poor bargainer. But the general odds of success are limited by one's objective position.

Nonetheless, every manager appears to follow a standard set of strategies. The first is not to let obvious indicators of poor management appear. Make sure that labor-productivity figures do not drop, or that costs of production do not rise. Keep the labor force happy by making sure that their bonus income does not fall, and show them that you are making sincere efforts to build housing and improve other factory benefits. If necessary, let the word out that you are bending state regulations to help out the workers.[48]

As insurance against the possibility that, despite your best efforts, indicators of "subjective factors" will appear, begin to lay the groundwork for the plea of objective conditions. If there are any delays in the deliveries of materials or components, or if there are any other problems that constitute an objective condition that might explain lower productivity or higher costs, be sure to complain early and repeatedly to your


industrial bureau, the materials-management bureau, and even the economic commission, to make sure that it registers firmly that you are besieged by myriad urgent problems beyond your control. If it turns out that your costs stay down and your labor productivity goes up after all, you may convince your superiors of your skill.

Another strategy is an adaptation of traditional "hoarding" behavior: make sure that you do not do so well that you overfulfill your tax quota by a substantial amount. That will provoke an upward revision of your quota in the next period, making your life more difficult. Moreover, under the principle of "whipping the fast oxen," city authorities will be less amenable to your pleas for tax breaks or subsidized credit. Managers commonly work operating surpluses back into costs by engaging in small-scale renovation and construction, purchase materials, and "prepare for next year's production."[49] Managers commonly admit to this practice and do not view it as illegitimate, and industrial bureaus fully understand that this is going on and acquiesce in it. Tax and finance bureaus view this as a violation of state regulations, but do not have the capacity to monitor the bookkeeping techniques managers use to pad costs. It is also not clear whether, as representatives of local interests, they have a clear motivation to do so.[50] One tax official explained, "State enterprises are usually guilty of tax evasion. They generally hide funds, enter too many items into costs. We mainly use propaganda to control it, make sure everyone knows the regulations. We can only do spot checks of factory accounts, and rely on reports from the masses."[51]

Managers can also use the state plan to bargain for favorable financial treatment. Getting into mandatory state plans or "guidance plans" (really


mandatory plans imposed by local authorities) can be a real advantage.[52] If in the October planning work conference the planning commission wants you to increase your output of a certain product, or to produce a different one, a manager can use this request to bargain for a subsidized loan or a break on sales taxes for new products. One of the explicit rules of the game is that enterprise-government relations are in a state of moving equilibrium, or as one manager put it, "The standard is not what everyone else gets; its what you got last year. ... If you must accept a higher target, try to get something in return. Ask for approval of a renovation project using imported equipment, and a loan in foreign exchange. Then the (industrial) bureau runs to the economic commission to argue for the loan."[53] If a request or a demand from the government upsets that equilibrium in one area, it is only fair that in compensation, negotiations proceed in other areas to allow the enterprise to meet that request.

Finally, if city authorities find that "subjective factors" have caused declining performance, try to turn defeat into victory. Are profits down because you cannot sell your poor-quality products? Argue that the root of the problem is poor and antiquated capital equipment; what you really need is a large loan to import advanced Western technology and build a modern new workshop capable of producing the best quality items. Are your costs of production rising in the absence of higher costs for raw materials? Argue that the problem is dilapidated equipment that continually breaks down, requiring expensive repairs and causing delays; what you really need is a large renovation loan to replace your outdated machinery. Managers in this position, if unwilling to accept defeat, can use their situation as an opportunity to display managerial talent. Aggressive advocacy of a project proposal to turn the situation around will often meet a receptive response from local officials, who are also interested in turning a liability into an asset.

No matter how skillfully managers bargain for favorable treatment, successful bargaining further undercuts managerial autonomy. For the notion that drives these bargaining strategies is that of "objective conditions"—a term that justifies the city's responsibility to intervene extensively in enterprise affairs and to redistribute resources among them. No matter how much managers complain that they retain too little profit and have insufficient business autonomy, as soon as they run into difficulty or seek investment they turn to their superiors as supplicants


seeking relief from objective conditions. In China's budgetary and fiscal processes, bargaining strategies reinforce the dependence of enterprises on their superiors.

Conclusion: Bargaining In Perspective

If we view bargaining as a symptom of an institutional setting, it appears less consequential than if we focused exclusively on bargaining strategy and activity. For the rules of the game are given by a new system of revenue sharing that has given localities enhanced fiscal powers and a heightened incentive to regulate carefully the financial flows between the city budget and each enterprise. They are given by a system of unreformed prices and unequal capital endowments for which managers have no responsibility. They are also given, finally, by the city's quite legitimate task of managing local development, protecting fiscal stability, and safeguarding the income and employment of local citizens.

From this perspective, it makes little sense to account for soft budget constraints, or interminable delays in policy implementation, by invoking the phenomenon of bargaining. For bargaining is but a symptom of institutional realities that are themselves responsible for delays and soft budgets. The state's budgetary process and mechanisms for revenue generation are not premised on firm rules about property, responsibility, or entitlement. There are as yet no clear standards about what is legitimately the central government's or the city's or the enterprise's share of industrial profits. There are only customary practices and situational standards, which must be revised case by case. It is only out of the bargaining process that a "fair" determination of these matters can be reached.

The same is true of fiscal responsibility. Just as there are at best situational standards regarding shares of factory revenues, local industrial circles rarely assign final responsibility for investment decisions. Many agencies and officials are involved, and the responsibility is shared collectively. As a group they strive to create conditions that reduce risk, but they do not always succeed. Sometimes this failure can be laid to the manager's actions, but often it cannot. No matter how much managers may want autonomy in other areas of their jobs, in striving for these favorable conditions they willingly surrender their autonomy to city planners in return for insurance against financial risk and responsibility.

It is commonly said that China's industrial system, formerly a centralized bureaucracy, is becoming one in which autonomous firms face market situations. This is at best a half-truth, misleading because enterprises are not yet financially independent entities. They are more accurately seen, not as independent business entities, but as quasi-auton-


omous divisions within a corporate structure.[54] China's local industrial systems are becoming decentralized bureaucracies with expanded elements of market calculation. But they are still relatively coherent corporate structures. How these socialist corporations and socialist markets differ from their counterparts in market economies is beyond the scope of this chapter. Yet it is surely in the comparative study of corporate settings that we shall find answers to the most perplexing questions about China's industrial economy.

Appendix: Classified List Of Interviews

Government Commissions

1. Beijing Economic Commission

2. Beijing Planning Commission

3. Chongqing Planning Commission

4. Dalian Economic Commission

5. Shenyang Planning and Economic Commission

6. Tianjin Economic Commission

7. Tianjin Planning Commission

Functional Bureaus

1. Beijing Taxation Bureau

2. Beijing Materials Management Bureau

3. Beijing Finance Bureau

4. Chongqing Finance Bureau

5. Chongqing Taxation Bureau

6. Shanghai Taxation Bureau

7. Shenyang Finance Bureau

8. Shenyang Taxation Bureau

9. Shenyang Price Bureau

10. Shenyang Materials Management Bureau

11. Sichuan Province Finance Bureau

12. Tianjin Material Supply Bureau

13. Tianjin Taxation Bureau

14. Tianjin Finance Bureau


1. Beijing Branch, Construction Bank

2. Chongqing Branch, People's Bank

3. Chongqing Branch, Industrial-Commercial Bank

4. Tianjin Branch, Construction Bank

5. Tianjin Branch, Industrial-Commercial Bank

6. Shenyang Branch, Construction Bank


Industrial Bureaus (Corporations) and Companies

1. Beijing Machine Building Corporation

2. Beijing Computer Corporation

3. Beijing Woolen Knitwear Company

4. (Beijing) Capital Iron and Steel Corporation

5. Chongqing Machine Building Bureau

6. Dalian Metallurgy Corporation

7. Dalian Machine Building Corporation

8. Shenyang Machine Building Bureau

9. Shenyang Second Light Industrial Bureau

10. Shenyang Auto Industry Company

11. Shenyang Materials Trading Center


1. Beijing Electric Motor

2. Beijing Internal Combustion Engine

3. Beijing No. 2 Chemical

4. Beijing No. 2 Textile

5. (Beijing) Yili Foodstuffs

6. (Beijing) Guanghua Wood Products

7. Beijing No. 3 Semiconductor

8. Chengdu Seamless Tubing

9. Chengdu Internal Combustion Engine Parts

10. Chengdu Scientific Instruments

11. (Chongqing) Jialing Machinery

12. Chongqing Woolen Textiles

13. Dalian Steel Rolling Mill

14. Dalian Heavy Machinery

15. Shanghai No. 7 Radio

16. Shanghai Machine Tools

17. Shanghai No. X Clothing (pseud.)

18. Shenyang Cable

19. Shenyang Signal

20. (Shenyang) Dongbei Pharmaceuticals

21. Shenyang Transformer (1985 and 1986)

22. Shenyang Metal Furniture

23. Zhejiang Machine Building (pseud.)


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