As China’s economy soared to become the world’s second largest, with GDP increasing an average of 10 percent per year for almost two decades, it spurred envy as well as debate. Many economists pointed to gradual improvements to formal economic institutions—such as an increasing openness to foreign investments, centralization of the banking system, and membership in the World Trade Organization—as the reason for China’s success.
But that success may have been due to something less centralized, research suggests. Many Chinese companies enjoyed rapid growth because they received special deals from local government officials, find Tsinghua University’s Chong-en Bai, Chicago Booth’s Chang-Tai Hsieh, and Chinese University of Hong Kong’s Zheng Song. “Private firms succeed in China by obtaining a special deal from a local political leader, which allows them to either break the formal rules or obtain favorable access to resources. This practice is common in countries with poor formal institutions, and China is no different,” write Bai, Hsieh, and Song.
Companies made deals that at times involved local leaders granting them exemptions from regulations, among other perks. Leaders could lobby the central government on a business’s behalf or help block potential competitors. In return, local officials might receive tuition payments for children, equity in private companies, and added prestige in the Communist Party if they delivered economic growth in their municipality or province.
Surveys of the members of the Chinese National Association of Industry and Commerce indicate that from 1997 to 2012, 30–40 percent of private companies were owned by members of local political bodies—either a People’s Congress or Political Consultative Conference. These politically connected companies were larger than companies without the same political connections and had better access to bank loans and preferential access to capital.
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China’s 2014 crackdown on government corruption could explain why the country’s economic growth has since slowed, the researchers write. “While there is limited information on the crackdown, if local officials are motivated by private economic benefits, the crackdown on corruption will dampen their incentive to use their authority to grease the wheel for private firms,” they write.
Chong-en Bai, Chang-Tai Hsieh, and Zheng Song, “Special Deals with Chinese Characteristics,” NBER Macroeconomics Annual, forthcoming.
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