Principal Agent Theory and Private Property Rights in China's Economic Reform

By Yung, Ping | China: An International Journal, March 2009 | Go to article overview

Principal Agent Theory and Private Property Rights in China's Economic Reform


Yung, Ping, China: An International Journal


China's economic reforms over the past 30 years have been very successful. Gross domestic product has been growing at roughly ten per cent per year. The centrally planned economy has been transformed into a market economy. Although government intervention is still widespread, some industries in China are part of the most intensive competition in the world.

The miracle of China's success, in contrast with the relatively mediocre performance in Eastern Europe, has attracted scholarly attention. In the past, scholars observed forms rather than the essence. For example, in China the reforms were gradual rather than "big-bang"; agricultural reform preceded industrial reform, etc. Later, scholars investigated the institutional arrangements and proposed theories to explain China's success. For instance, the "local state corporatism" thesis, (1) "local governments as industrial firms" thesis, (2) "state entrepreneurialism" thesis where local governments constituted and coordinated the corporations, (3) "federalism" thesis, (4) "semi-federalist government" thesis (5) or "federalism, Chinese style" thesis, (6) "privatisation from below" thesis (7) or "privatisation and Chinese style" thesis (8) or "insider privatisation" thesis. (9)

Some scholars focussed on the reform of the state-owned enterprises (SOEs). They measured the changes in the performance of the SOEs after different reform measures such as the increase in managerial autonomy, (10) performance contracts, (11) modern enterprise system, (12) privatisation, etc. (13) The results were mixed. (14) Many theories or models were used to explain this. Examples were the multi-task theory, (15) competition, (16) policy burden (17) and soft budget constraint. (18) However, the most popular approach was the principal agent (PA) theory. This article demonstrates that the PA theory is not suitable for analysing China's public enterprises due to the enigmatic identity of the principals and the inability of deducing refutable hypotheses.

A noticeable difference between China and other transition economies was the growth of the non-state sector, notably the township and village enterprises (TVEs) in the 1980s. It is generally agreed that the growth of TVEs not only increased the size of the economy but also increased competition which substantiated and induced further reforms. Scholars diverge on the nature of TVEs. Numerous theories or models were adopted or proposed to explain the success and governance of TVEs. Examples included the "hybrid form" thesis, i.e., a form that falls between market and hierarchy, (19) the "vaguely defined cooperatives" thesis, (20) the "ambiguous property right" thesis, (21) the "insecure property right" thesis, (22) as well as the "double-sided moral hazard" model. (23) One primary reason for the divergent views on the identity of principals of the public economy and the nature of TVEs was the widespread misconceptions about the private property rights. This article reveals that the nature of TVEs is perfectly understandable if one has a correct concept of private property rights.

The main purpose here is to demonstrate that misconceptions in private property rights could lead to misleading views about enterprise reform in China. Given that China's transition experience is arguably the most important one in human history, a correct understanding of China's enterprise reform is vital to the understanding and development of institutional economics. The focus here is identification of the mistakes which could possibly bewilder future readers. Three interrelated areas are examined in detail: the merits of principal agent theory in explaining China's enterprise reform, the concept of private property rights and the nature of TVEs.

Applicability of PA Theory in China's Enterprise Reform

It has been popular to approach the issues of corporate governance in China's SOEs and TVEs with PA theory. PA theory has been widely used to analyse corporate governance in advanced capitalist economies. …

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