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Regional Decentralization and Fiscal Incentives: Federalism Chinese Style

Jul 2004
Stanford King Center on Global Development Working Paper
By  Hehui Jin, Yingyi Qian, Barry R. Weingast

Aligning the interests of local governments with market development is an important issue for developing and transition economies. Using a panel data set from China, we investigate the relationship between a provincial government’s fiscal incentives and provincial market development. We report two major empirical findings. First, we find a much higher correlation, about four times, between the provincial government’s budgetary revenue and its expenditure after the reform as compared to that before the reform, demonstrating that provincial governments faced much stronger ex post fiscal incentives. Second, we also find that stronger ex ante fiscal incentives, measured by the contractual marginal retention rate of the provincial government in its budgetary revenue, is associated with faster development of the non-state sector as well as more reforms in the state sector in the provincial economy, even controlling for the conventional measure of fiscal decentralization. We compare federalism, Chinese style, to federalism, Russian style.