Bilateral Monopoly

By itself, the indeterminacy of so many economic parameters cannot explain the persistence of bargaining relations at the enterprise level. Indeed, given the rise of marketlike institutions in China during the past ten years, the question is why market forces do not in the long run eliminate the indeterminacy. Ultimately, the crucial factor is that state enterprises are in a relationship of bilateral monopoly with their superiors. The two-track reform strategy implies the retention of the administrative hierarchy, and because of the retention of the administrative hierarchy, enterprises cannot escape the influence of their superiors, while superiors cannot escape their ultimate reliance on the productive capacity of their enterprises. The importance of the retention of the hierarchy is thus not primarily that the enterprise remains subject to arbitrary commands from its superior (though this is sometimes a factor). Rather, the importance lies in the fact that the enterprise and its superior are forced to make a deal with each other. This is a special case of the general problem of small numbers exchange: one buyer confronts one seller and there are no competitive forces to drive the two into competitive equilibrium. The transaction takes place, given there are gains to be realized, but the benefits are divided between the two parties according to their relative bargaining power.

Within the state sector relations between the enterprise and its superior body are always situations of bilateral monopoly. Within any given urban area there is always a sector-specific bureaucracy that has responsibility for a certain type of production. For example, production of machine tools in Taiyuan will be subject to the Taiyuan machinery bureau, or to a similar provincial or national body. That bureau has the authority to permit or prevent production of machine tools by anybody in the city of Taiyuan, and this type of authority is universal and entirely formalized. It is impossible that "nobody" could be in charge of a certain kind of production in a certain locality; every locality and every type of production is automatically established as a monopoly.

Two particular aspects of the Chinese economic system affect the way these local-sectoral monopolies are managed, but they do not change the basic monopoly condition. First, it is a curiosity of the relatively decentralized Chinese system that industrial production in rural areas is controlled, not by sectoral bureaucracies of broad geographic scope, but by local bureaucracies with authority over a broad range of industrial sectors. Since there are so many local bureaucracies (more than 2,000 county-level governments), urban producers cannot be completely protected from competition arising in a nearby rural area. Indeed, markets

in which rural producers play a role are the most competitive markets that exist in China. In most cases, though, rural industries have limited technological capabilities and produce goods of poor quality. Although this is gradually changing, competition from rural factories does not yet significantly change the market position of most modern urban factories, particularly in an economic environment characterized by excess demand and inflationary pressures.^[28] Urban producers of a given product would be far more threatened by the threat that another urban factory would cross sectoral boundaries and produce a competing product, and it is precisely this danger from which they are protected by the monopoly power their superiors exercise over their own product lines.

Second, the enterprise may be subject to a number of different supervisory bodies that make its task more difficult. For instance, the municipal labor bureaus, tax offices, and banks may intrude from time to time on enterprise decision making. Even worse, during certain periods the enterprise may be subject to "dual leadership" in which authority is shared by local and national authorities. These peculiarities make the job of running a factory much more difficult, but they do not fundamentally alter the enterprise's position. Except for brief periods following on administrative reorganization, an enterprise always has an immediate superior (zhuguan bumen ), which is clearly identified. The fact that individual decisions must be made taking into consideration the opinions of various "related administrative agencies" (youguan bumen ) makes the deal-making process more complex and onerous. However, this does not change the basic situation, which is that the enterprise must procure the assent of its superior organ to every significant decision, while additional approvals may still be required for some of these decisions. Quite frequently the enterprise's superior organ negotiates with the related administrative agencies in place of the enterprise. In all cases the one permanent and inescapable relationship every enterprise has is the one with its superior organ.

Conversely, the enterprise possesses significant task-specific capital, which cannot be easily exploited by other parties. The superiors cannot simply dispense with the existing enterprise and its workers and hire somebody else to produce machine tools. Because of China's decentralized management system, most enterprises are subordinate to authorities in the city in which they are located; this means that superior authorities have under their control only a handful of enterprises, or

even a single enterprise, capable of producing a given product. Because their span of control is narrow, it is difficult for the superior to monitor enterprise performance by comparing it with other enterprises, and difficult to apply severe sanctions to the enterprise because there are few alternate sources of supply. Ultimately, bureaucratic superiors must deal with the existing enterprises, which are their only viable sources of money and output. Bureaucratic superiors in China worry constantly about the possibility that subordinates will restrict output, substituting perfunctory performance (or nonperformance) for hard work and frustrating the objectives of superiors by slowdown and egregiously sloppy work. The relationship between superiors and enterprises is thus the same as that between management and workers within the Chinese enterprise, and for the same reason: top and bottom are locked into a relationship that neither can escape. The ultimate bargaining power of those at the bottom derives from the fact that they can frustrate the deal-making process so that both sides lose. Because those at the top are aware of this power, they strive to keep those on the bottom mollified and part of the bargaining process. This one-on-one bargaining process is thus the inevitable outcome of a basic condition of bilateral monopoly, in which neither side can do without the other.

This state of affairs is perpetuated by the financial and pricing policies that the central government carries out. By maintaining low prices on energy and basic foods; by subsidizing capital (interest rates) and social security and health benefits; and by protecting factories from import competition, the government ensures that the great majority of state factories turn a paper profit regardless of their economic efficiency. The large stream of accounting profits generated in industry—industry accounts for over 80 percent of budgetary revenues—ensures that there will always be a deal to be struck over enterprise revenues. Both superiors and subordinates have a major incentive to stay in the bargaining process so that they can reap a share of these accounting profits. The bilateral monopoly persists because neither party would be likely to gain by breaking up the relationship, even if that were possible. We might say that the monopoly power exists, not to keep the two sides in the bargaining relation, but rather to keep other parties out. Having between them the disposition of the surplus generated in industry, the two sides then bargain over the precise distribution of benefits.

Market forces cannot yet dissolve this monopoly relationship, because there is always some combination of concessions and benefits the superiors can grant that will enable the enterprises to survive even the fiercest competition. State enterprises have large buildings and extensive arrays of equipment for which they pay little; and they have access to substantial financial resources at very low cost. It is not difficult for even a very

inefficient enterprise to "out-compete" his potential rivals from rural industry. No superior will acquiesce in the collapse of a sector under his control, because that will shut him out of the stream of benefits generated by that sector. Thus, both parties remain locked into the hierarchical structure and the bilateral monopoly bargain that goes with it. One consequence is the maintenance of the monomorphic organizational form from the command economy. The internal organization of the enterprise is standardized to match that of its superior organs: functional departments within the enterprise report to—and bargain with—parallel departments in their superior organs, as well as management in their own enterprise. According to a survey of 170 managers of large factories in Liaoning province, the two greatest sources of discontent were the lack of control managers had over personnel decisions, and their inability to alter the organizational structure of their enterprises.^[29] Given this state of affairs, Chinese industry is unable to reap the efficiency gains that come from idiosyncratically specialized organizational forms, or those that come from diversified multiproduct corporations with significant economies of scale.

Finally, the maintenance of the administrative hierarchy and the underdevelopment of outside-of-plan markets has meant that the monolithic character of the state economy has not been fundamentally changed. In the discussion of the central-government role in investment, it was argued that the information available to central planners had been greatly increased. Planners had better technical information for project design and long-range projections, and more timely and complete information about the behavior of the economy as a whole. These generally can be understood as improvements and rationalizations of the information-gathering facilities that normally characterize command-bureaucratic systems. That is, even for a command-bureaucratic system, China had an exceptionally weak information-coordinating capability before reforms, and this weakness has been partially rectified. However, if market-oriented reforms are to work, whole new channels for the circulation of information must be created. These channels operate through the market mechanism itself to provide information to decentralized agents (not just to central planners) about economic opportunities. In this respect, the Chinese reform has not

really transformed the state-owned sector. Indeed, the two-track system has in some respects impeded the circulation of information in the economic system. Since enterprises do not regularly sell above-plan output at market prices, it is difficult to tell what market prices are. This—combined with rapidly changing market prices in an inflationary environment—has meant that market prices cannot really serve as readily available "shadow prices" that could be used to assess state enterprise performance. At the same time, each enterprise's capital stock and inputs are purchased at widely varying prices. As a result, an enterprise that purchased its fixed capital at low state-set prices will show a much higher profit rate than one that purchased machinery outside the plan; enterprises dependent on high-priced inputs may show losses while less well run factories in the same sector generate profits because of access to subsidized inputs. These factors are too complex to allow systematic calculations at the higher level to correct for them. For instance, who can say whether textile production is more efficiently carried out in small-scale rural factories or in state urban factories? Certainly the central government has no information at its disposal that would permit a ready answer to such a question.

Because of the weakness of markets, both central planners and local agents continue to base much of their decision making on pseudoinformation. Nominally profitable enterprises are propped up or expanded, without accurate information about the actual comparative productivity of those enterprises. Local monopolies are perpetuated because it is impossible for governments or enterprises to devise alternative strategies based on mutually beneficial specialization and trade. While technical information available to the Center has been enhanced, local information on economic choices has not been qualitatively improved. The two-track system has thus not been able to change the fundamentally hierarchical nature of the system, and this has perpetuated the basic bargaining relations of that system.