Choi, Jiang, and Shenkar (2015) offer an interesting and new perspective on the relationship between local governance and firm performance in China. This commentary focuses first on how we conceive of the nature of China's capitalism and then examines what that suggests about their metrics and findings.
China clearly still has a system of state capitalism (Huang, Reference Huang2008). As such, the institutions that matter for the functioning of state capitalism are different than those in a market economy. Under state capitalism, where the vast majority of financial assets are still under state control (Walter & Howie, Reference Walter and Howie2011), relationships between firms, banks, and the government, rather than property rights protection, matter most. The playing field is not level and firms that are prized by the state experience a different institutional environment than those that are not. This uneven institutional terrain holds true even within the same local jurisdiction. Thus, a mix of initial conditions and the position of a firm in the administrative and political hierarchy of the state will drive variation in firm performance.
Ironically, while Choi et al. (2015) investigate variations in market institutionalization in China, they only examine listed companies, which are predominantly state controlled or state share holding companies (Huang, Reference Huang2008). De-facto, this study is essentially an examination of state capitalism. As such, why do Choi et al. (Reference Choi, Jiang and Shenkar2015) use the same theory and metrics used for market economies?
In China, the most important set of market institutions, those related to property rights, has little de jure regional variation in China. Institutions have many different aspects, from the Weberian sense of carrying out bureaucratic tasks uniformly to property rights protection. According to a substantial body of literature, property rights protection is a key institution encouraging economic growth (Acemoglu, Johnson, & Robinson, Reference Acemoglu, Johnson and Robinson2000; Banerjee & Iyer, Reference Banerjee and Iyer2005; Tanzi, Reference Tanzi1997). In China, the Constitution states clearly that ‘the state can in the interest of public interest, confiscate or use the private property of citizens in accordance to the law’ (National People's Congress, 2004). Given that the courts and legislatures are both controlled by the Communist Party and the state's right to confiscate is enshrined in the constitution, citizens have no independent recourse to fight expropriation by the state (Hsing, Reference Hsing2010). No region in China is immune to the threat of expropriation. Most likely, investors and entrepreneurs prefer to invest in some regions over others due to other advantages, rather than variation in this core institution. This lack of variation suggests that the variation observed by the authors is driven by some other mechanism besides ‘institutions’ or ‘quality of provincial government’.
In reality, the interaction between government performance as measured by the authors and firm performance is likely to be very complicated. All of the government performance measures developed by the authors are related directly or indirectly to the level of development in a region. To make the results convincing, the authors would also need to control for the level of development in 1978, GDP per capita in the region, as well as fiscal expenditure per capita because these variables likely impact both the independent and dependent variables. Methodologically, we wonder why the authors didn't just include provincial dummy variables and rely on over time variation of within province governance changes to predict firm performance. This approach would have been more convincing.
Another issue is that the role of the state vis-à-vis firms suggests that much important action is at sub-provincial levels. Most of the work on how local governance ranges on a spectrum from predation on to cooperation with local firms has emphasized variation across sub-provincial jurisdictions from the city/county-levels on down to the township level. It is generally recognized that there is a wide variation within each province (Oi, Reference Oi1999; Ong, Reference Ong2012). We would argue much of that variation goes back to initial conditions at the start of reforms.
Turning to the results on firm performance, stronger performance by certain firms may well be a product of the monopolistic positions of some firms, which actually enrich certain local governments. Also, some local governments relocated core SOEs into SEZ in order to take advantage of preferential tax policies (Zweig, Reference Zweig2002). Thus, the firms selected into the SEZ were stronger from the beginning of reforms. Furthermore, showing that local SOEs outperform central government ones is probably due to the relatively greater role of market forces and lesser role of bureaucratic missions in local SOEs since many local SOEs have been effectively privatized since the late 1990s (Teng, Reference Teng2010).
A number of the metrics of governance are also questionable in terms of whether or not they represent what they are reported to purport. Equating autonomous region as ‘political freedom’ is a gross simplification, if not an inaccuracy, as ‘autonomous regions’ are some of the most repressive places in China. However, they also happen to have some of the most lucrative monopolies in China. Environmental governance at first glance appears to be both an adequate metric of governance and one that cannot be easily gamed as the authors claim. However, research has shown that in fact this measure can and has been manipulated by local officials (Wang, Reference Wang2013) and again probably tracks well with the initial conditions and current GDP per capita of the respective provinces.
Finally, there is the implication in the article's account of the SEZs and provincial governance that the trend of China's economy is towards ever increasing market-strengthening reforms. In fact, the SEZs stand out not just because of their earlier start at reform with the exception of the perennial exception, Shanghai, but also their relatively great command of resources. The whole motivation in gaining SEZ and other national development zone status was to use such zones as a vehicle to gain greater resources for the regional/local government through the preferential policies the zone status bestowed. Instead of the goal of building better markets, the local officials had the goal of gaining a policy edge to accrue further resources. Since the political and economic incentives for officials were about crude growth metrics and the maintenance of order, the incentives have in many cases driven local governments in the diametric opposite direction of fostering efficient markets leading instead to inefficient land-grabbing and irrational glory projects. Thus, governments that appear to rank high on market governance often are actually dominated by a mix of foreign and state-owned firms (Shanghai in Huang's Reference Huang2008 account) or have turned progressively away from their initial pro-private business orientation as the local state has accrued more resources (Wenzhou as documented by Chen, Reference Chen2015).
