Why Do Entrepreneurs Enter Politics? Evidence from China

Beginning of article

I. INTRODUCTION

There is a growing interest among economists in studying the implications of political connections, particularly in the business world of developing and transition countries. It has been found that political connections help firms secure favorable regulatory or tax conditions (Faccio forthcoming) and obtain access to resources such as bank loans (Mian and Khwaja forthcoming), which ultimately increase the value of firms (Shleifer and Vishny 1994; Fisman 2001). Despite a vast accumulation of evidence on the relationship between political connections and economic benefits, most works in this literature assume that entrepreneurs have political connections, and researchers have largely overlooked another important question: Why do entrepreneurs enter politics? Our purpose in this article is to answer this question.

There has also been a voluminous literature that examines the underdevelopment of markets and market-supporting institutions in developing and transition economies. Governments in these countries normally possess considerable control over the allocation of resources either through their power of planning or through their control of state-owned enterprises, including banks (Nee 1992; McMillan 1997). Because of the high degree of control exercised by these governments and the imperfections in the product and credit markets, private businesses cannot fully rely on the markets to secure resources. The same governments may also intervene in private business by frequently imposing unnecessary regulations (red tape) and/or very high tax rates (Johnson et al. 2000; Hellman et al. 2003; Guriev 2004). According to De Soto (1989) and Brunetti et al. (1997), these regulations and taxes have come to impose considerable costs on private firms in transition economies. Apart from the weaknesses in state and market institutions, the legal systems in these countries are also very weak (Hay and Shleifer 1998). Because laws are either nonexistent or are not enforceable, entrepreneurs cannot rely on the legal system to secure property rights and enforce contracts (McMillan and Woodruff 1999a; Frye and Zhuravskaia 2000).

Because of the lack of market-supporting institutions, private entrepreneurs in these countries either are passive victims or have to rely on other institutions to do business. Entrepreneurs in Eastern Europe and Russia have been observed to go underground to escape overregulation and high taxes (Johnson et al. 1997, 1998; Friedman et al. 2000). In Vietnam, the courts are incompetent, and entrepreneurs there depend heavily on relational contracting to lower their contract enforcement costs (McMillan and Woodruff 1999a, 1999b). In China, to overcome these institutional difficulties, local governments themselves became involved in business operations, and in the 1980s this led to the creation of an exceptionally innovative government ownership form known as the township-village enterprises (TVEs). (1) A recent study by Djankov et al. (2005) finds that entrepreneurs are less likely to expand their businesses if local institutions are weak.

Another response to state and market failures, one that has been much overlooked in the literature, occurs where entrepreneurs actively participate in politics to overcome the lack of well-functioning markets and market-supporting institutions. Or, to put it the other way, entrepreneurs' motivation to participate in politics is shaped by the institutional environment in which they operate (Bartels and Brady 2003). Many entrepreneurs in Russia, to defend themselves against "legislation that could raise their taxes, tie them to red tape, or threaten their property rights," are vying to secure a seat in the Duma, the popularly elected lower house of Russia's legislature. Dmitry Orlov, a political scientist at the Independent Center for Political Technologies in Moscow, estimates that one-fifth of the Duma's 450 seats are going to be directly occupied by businesspeople and twice as many as that (about 180 positions) could go to business lobbyists representing their clients' interests (Business Week, December 8, 2003). Likewise, an increasing number of businessmen in Vietnam are running for the National Assembly, the country's highest legislative body (Far Eastern Economic Review, May 9, 2002). The issues commonly taken up by these entrepreneurs include cutting the heavy tax burden and making it easier to start private businesses. Recently, more members of China's business elite have begun actively participating in politics. Many of them have attained membership of the People's Congress (PC) or the Chinese People's Political Consultative Conference (CPPCC). Membership in the PC or CPPCC is advantageous to private entrepreneurs because it not only gives them some measure of political power but also makes it easier for them to cultivate formal and informal ties with important government bureaucrats who are also members of the two organizations. Chinese private entrepreneurs who are PC or CPPCC members can obtain resources that are not accessible through markets; they can circumvent government regulations; they can secure tax deductions and obtain legal or non-legal protection for their businesses. (2)

In this article we examine the determinants of the entrepreneurs' political participation by employing a unique matched firm-institution data set from China. We hypothesize that a private entrepreneur is more likely to participate in politics if his or her firm is situated in a province where market-supporting institutions are weaker. Employing the multinomial logit model, we find that a private entrepreneur is more likely to participate in politics where the market is less developed, where the local government has more regulations, where the informal tax burden is heavier, and where the legal system is weaker. According to our estimates, the probability of entering PC (or CPPCC) decreases by 8-20% from the mean when the institutional indices improve by one standard deviation. This empirical finding supports our conjecture that the institutional background shapes the entrepreneurs' motivation to participate in politics. We also find that both the human and political capital of entrepreneurs contribute positively to the likelihood of their political participation.

To the best of our knowledge, this is the first empirical study of the political participatory behavior of private entrepreneurs in transition and developing countries. (3) Unlike other institutional responses, such as going underground and government ownership, political participation is an aggressive response of entrepreneurs to state, market, and legal failures in transition countries.

The structure of the article is as follows. Section II introduces the institutional background in China. Section III proposes several hypotheses pertaining to the determinants of political participation. Section IV describes the data and variables. Section V outlines the econometric specification. Section VI empirically tests the hypotheses and reports results. Section VII concludes.

II. INSTITUTIONAL BACKGROUND

In this section, we first describe the history of private business in China since its rebirth in 1978 when the far-reaching economic reform started. In particular, we focus on the institutional environments in which firms have grown in the past two and a half decades. We then outline the basic characteristics of the two political bodies in which private entrepreneurs have been actively participating, that is, the PC and the CPPCC.

Private Businesses in China since 1978

Private business regained its legitimacy in 1978, when the state endorsed the reemergence of individual household business during the Third Plenum of the Communist Party's Eleventh Central Committee. (4) Despite ideological and other obstacles, from 1978 to 2001, China's private businesses grew from 0 to over 38 million firms employing 160 million people and producing more than one-third of China's industrial output. The growth rate of the private sector has far outpaced that of the public sector since its revival.

In spite of the speed with which the private sector developed after 1978, the path was by no means free of obstructions. (5) Although private businesses were accorded a measure of political recognition when they resurfaced in 1978, (6) they were not allowed to hire more than eight employees. This rule remained in place until 10 years later, when the National People's Congress authorized the establishment of private enterprises with more than eight employees. (7) In the 15 years following the beginning of the reform, private firms were considered an inferior ownership form for ideological reasons. Despite the existence of formal legislation permitting it, the overall political environment was antagonistic toward private business in the early years of reform (Young 1989). Private entrepreneurs had to deal with hostility and social prejudice on the part of cadres and people in general who regarded them as dubious, ignoble, or even despicable. Challenges to the legitimacy of private business also came in the form of various political movements, for example, periodic campaigns against spiritual pollution in 1983-1984, against bourgeois liberalization in 1987, and other movements cracking down on private businesses on the plea of "rectifying the market" and "attacking speculation," to name a few. Until the early 1990s, private entrepreneurs were carefully controlled and denied entrance into the political establishment.

Ideology has become less important since the early 1990s. At the Fourteenth Party Congress held in 1992, the government attempted to raise the image of the private sector by discarding ownership discrimination and acknowledging the important role played by the private sector in China's social and economic development. This was followed by the lifting of various restrictions on private business (Sabin 1994). Indeed, even before this formal endorsement of the private economy, four private business owners from Shenzhen, the city from which most of China's reforms started, became members of the CPPCC at the national and local levels, and another two became members of the local PC in 1991, (8) symbolizing the loosening of the ideological concerns that had dogged private sector development throughout the 1980s.

However, the economic environment in China remains far from perfect for private businesses. The official document from the same party congress also stated that the government should create fair market conditions, under which firms characterized by different types of ownership structures can compete fairly with each other. However, there is still a long way to go before the market environment in China becomes truly fair for private firms. The government still controls much of the resources; the state-owned enterprises enjoy preferential status in obtaining bank loans and in other key inputs (Che 2002; Brandt and Li 2003); private businesses are subject to arbitrary harassment by government officials (Pearson 1997); and commercial and property laws are either nonexistent or are not enforceable (McMillan 1995).

Given the adverse political and economic environment and the discrimination suffered by the private sector, private entrepreneurs have been finding new ways to make their operation easier. In the early 1990s, many private businesses chose the somewhat expedient strategy of "wearing a red hat," that it, they registered themselves as "collective enterprises" (Pearson 1997; Che and Qian 1998; Gore 1998). (9) The disguise of "collective ownership" not only made these firms ideologically acceptable but also won them material advantages like favorable tax treatment and better access to credit and other resources (Nee 1992; Naughton 1994). Since the loosening of ideological and political constraints in the 1990s, many of these private entrepreneurs have sought a new and even more powerful "red hat," that is, they have been choosing to actively participate in politics. In particular, more and more entrepreneurs are becoming members of the two powerful political bodies, the PC and the CPPCC. We introduce these next.

PC and CPPCC

The PC is China's legislature, which, as stipulated by the Chinese constitution, is the highest organ of state power in China. Following the party and government hierarchies, there is a PC at each administrative level, including the central, provincial, municipal, county, and township levels. Local PCs have the power to elect chief officials at their own administrative levels, to draft and approve local laws and policies, and to impeach government officials when necessary. The PC at the central level, or the National People's Congress (NPC), is considered the highest organ of state power of the People's Republic of China. Its main functions and powers include making laws and policies and electing top government officials in the central government. Theoretically, the PCs at all levels are instituted through elections, but the party and government officials still control the process of candidate nomination. Thus, it is not surprising that all major party and government officials are deputies of the PC at the local/central level.

The CPPCC is an advisory body to the party/government in China, somewhat analogous to an advisory legislative upper house. The main functions of the CPPCC are to hold political consultations and to exercise democratic supervision of the party and governments. Political consultation is held on major political, economic, cultural, and social policies, both before decisions are made and in the process of their implementation. By making proposals and criticisms at regular meetings with the party and government officials, the CPPCC exercises its function of democratic supervision over the enforcement of China's constitution, laws, and regulations; the implementation of the major policies; and the performance of government departments and their employees. When a CPPCC member makes a proposal, the government is committed to responding to it within a certain time. (10)

Although the party/government still has tight control over the CPPCC, it is more independent from the party/government than is the PC. Although CPPCC nominees on the preliminary list need to survive the screening process by the party to get on the final slate, all social and economic organizations are allowed to nominate their own candidates. Because of the special mechanism for selecting CPPCC members, it has a much smaller party representation than the PC, and its members come from more diversified backgrounds, many of them being members of the social, cultural, and business elite. The average education level of CPPCC members is much higher than that of PC members.

III. HYPOTHESES

Before discussing hypotheses, we first define private entrepreneurs and political participation. In this article we refer to owners of private firms as private entrepreneurs. We refer to the securing of membership in the PC/CPPCC as political participation.

In this section, we begin by describing four major institutional difficulties faced by private businesses in transition countries. We then summarize several responses with which private businesses seek to deal with these difficulties. These responses have been well studied in the literature. Finally, and more importantly, we argue that political participation of private entrepreneurs can serve as an institutional response that overcomes these difficulties. Based on these arguments, we develop hypotheses regarding the determinants of political participation of private entrepreneurs in China.

Transition countries are characterized by posing several institutional difficulties for private …