One of the central themes of modern Chinese economic history is the puzzle of “China's premodern success and its downfall after the Opium War.”¹

,² In 1644 Manchu tribes from northeast China founded the Qing Dynasty upon the ruins of the civil war that ended the Ming Dynasty (1368–1644). Despite the initial popular resistance to its rule as an alien minority, the dynasty quickly recovered. For the next two centuries, the economy steadily expanded, China solidified her regional dominance by assuming suzerainty over neighboring states and regions, and the dynasty strengthened its imperial power. Equally well known, however, is the swift economic stagnation (and decline relative to the world economy) and political disintegration of China in the decades following the First Opium War (1840–1842).³ The Opium War, as the first open military conflict with the industrializing West, was the watershed of modern Chinese history. A new geopolitical reality, symbolized by the ensuing military defeats and the resulting treaties, brought about significant macroeconomic shocks and posed unprecedented challenges for the Qing government. In particular, fiscal stability and adequacy in the earlier periods gave way to modest revenue growth that fell short of the government expenditure levels that a modernizing economy required. Not only did overall economic growth stagnate, but sustainable, large-scale modern economic growth was also absent—mechanized industrial production, modern infrastructures (such as the railway and telegraph) and economic institutions (such as modern commercial banking) developed at a very slow pace.⁴ External crises and economic stagnation bred further internal political strife—domestic rebellions reached an unprecedented scale and corruption became widespread. In 1911 the dynasty collapsed under mounting fiscal and political pressures.

The relevant historical literature offers two divergent views on China's failure to keep up much less catch up in the global race of industrial development: the “foreign-intervention” approach that blames the West's gunboat diplomacy and colonial economic exploitations, and the “domestic-limitation” approach, which focuses on China's internal growth-inhibiting institutions.⁵

The criticism of the “foreign-intervention” approach lies in the mixed impact that the West's military and economic superiority had on China's society and economy.⁶ The domestic-limitation approach is inconsistent with the fact that the supposedly growth-inhibiting institutions did not prevent China from enjoying tremendous economic and political successes before the mid-nineteenth century. What, then, had impeded rapid, sustainable, and large-scale industrial development in China during the late nineteenth century, despite of its “premodern success”?

In this dissertation, I develop the hypothesis that the contrasting political and economic outcomes in pre- and post-1840 China reflect underlying institutions that both formed the foundation of the Qing's early success, and paradoxically, contributed to its eventual demise. To examine these institutions, I adopt a game-theoretical approach. My methodology differs from standard political economy analysis in that, instead of taking the political order of the pre-1840 China as given, I derive early-nineteenth-century China's political stability, economic prosperity, and fiscal adequacy as equilibrium outcomes that rested on the inflexibility of coordinating beliefs. When compounded with drastic exogenous shocks, the resulting institutional inflexibilities limited the regime's ability to adapt to the post-1840 world. I further articulate the impact of such institutional inflexibilities as manifested in the fiscal changes, guild development patterns, and the speed and scope of China's economic development during this period.

In chapter 1, I focus on the fiscal aspect of the aforementioned “puzzle” and pose the question: Why did China's system of public finance, which had previously enjoyed a long period of stability and sustainability, fail rather “unexpectedly” in the late nineteenth century? To address this question, I start by developing a context-specific model. One part of the model is a game of political pre-emption in which, at the equilibrium, the sovereign offers an attractive career option with a sufficiently high payoff and thus diverts local elites from leading political opposition. The other part of the model is a game of taxation in which a perfect equilibrium prevails where the threat of third-party enforcement triggered by taxpayers' collective rioting deters tax agents from overtaxing. By linking the two games together, I formulate the hypothesis that taxation during the Qing, especially land tax, functioned as a double-edged sword—it mobilized resources for the state as well as encouraged rent seeking by the local elite that pre-empted political opposition. By entering the bureaucracy, local elite became tax officials whose fiscal discretion allowed them to profit from retained extralegal tax proceeds. Through a highly meritocratic selection process that emphasized classical learning, the expected economic gains from becoming a bureaucrat acted as an important incentive that diverted the ex ante human capital investment by the local elite away from subversive activities. At the same time, despite the absence of formal institutions constraining the state, shared beliefs coordinated rural taxpayers, whose threat of collective action protected their property rights against potential fiscal predation by tax agents. Secure property rights in turn, provided the basis for long-term fiscal viability for the state and sustained economic growth.

The centrality of entrenched cultural beliefs that sustained such an equilibrium also implies institutionalized inflexibilities that limited the Qing's fiscal discretion. To evaluate this thesis, I use insights from the model to suggest how these beliefs would affect the formulation of government fiscal policies in response to exogenous shocks, and what their economic repercussions would be. The set of hypothesized fiscal policy reactions and their impact correspond to some of the major fiscal changes occurring in the late Qing period, namely, the Qing's reluctance to increase land tax despite the apparent administrative ease of doing so, its puzzling preference for taxing commerce for additional revenue, and the egregious violations of property rights that resulted. By empirically substantiating these hypotheses, I am able to explicitly capture the source of the institutional inflexibilities that restricted China's fiscal adaptability, and in particular, the ability to raise substantially more tax revenues.

In chapter 2, I further study the pattern of guild growth in the late Qing, which include the acceleration of guild formation, the strengthening of internal guild power, and the expansion of guilds' external influence, in light of the above theses. The analysis developed in chapter 1 adds a crucial fiscal dimension that much of the prior work on Chinese guilds has failed to capture. Building on earlier sociological and historical studies on Chinese guilds, I embed this pattern of guild development in the fiscal context of the late Qing, where the initial lack of coordinating beliefs made commerce a preferred source of government revenue, and consequently, merchants an easier target of property-rights abuse by tax officials.⁷

From this basis, I demonstrate how guilds came to farm the collection of the particularly egregious likin tax (a domestic transit tax instituted in mid-nineteenth century) by resorting to their ability to coordinate and enforce the tax-farming agreement and restrain likin officials' fiscal predation. Effective internal monitoring, professional guild management, and the ability to enforce intraguild compliance via multilateral reputation mechanisms allowed member merchants to overcome their organizational deficiencies. Consequently, tax farming by guilds effectively protected merchants' property rights on the one hand and enabled a viable commercial taxation for the state and local officials on the other. In turn, the success and wide adoption of tax farming by guilds enhanced the value of guild membership, strengthened guilds' internal cohesion, and fueled their growth in size, number, and stature. Interpreting the prominence of late Qing guilds as a result of the self-enforcing nature of this tax-farming arrangement helps us appreciate some peculiar aspects of guild growth in the late Qing that have not been successfully addressed in the literature—open, universal membership; tendency for guilds to merge and form supraguild organizations; and provision of public goods to communities beyond their membership. The consistency between these empirical observations and the guilds' ability to leverage their organizational capabilities to sustain tax farming brings additional support to my hypothesis.

Finally, in chapter 3, I investigate the implications of late Qing's fiscal stagnation on China's economic development during this period. I begin by proposing that the lack of fiscal means was a major impediment to China's industrialization. I then explore its national security implications and, hence, the public-good nature of industrial development in this historical context and establish the causal relationship between the fiscal means and the success of industrial development in the late Qing. In addition, I study how such exogenous geopolitical events as the Opium War created systemic macroeconomic risks, which, compounded with capital market imperfections, severely constrained the amount of financial intermediation towards China's nascent industrial sector. Furthermore, I examine how the anemic government support in infrastructure and technology transfer limited China's ability to capitalize on the dynamic possibilities unleashed by new technologies and cross-sector linkages. By juxtaposing nineteenth-century China with contemporary Japan, I further suggest that if the Qing had been given sufficient fiscal resources, the paths of the two economies might have been much more similar.