Reforming Intergovernmental Fiscal Relationships in China: A Political Economy Perspective

Abstract

This paper first explores some key principles central to a well-functioning, central/local fiscal relationship from a political economy perspective of federalism. It then applies these principles to an examination of reforming intergovernmental fiscal relationships in China from 1980s to the early 1990s. It is argued that the economic principle central to fiscal federalism is the determination of the optimal structure of the public sector in terms of the assignment of decision-making responsibility for specified functions to representatives of the interests of the proper geographical subsets of society. Fiscal decentralization, as evidenced in China, provides local government with incentives to build a hospitable environment of competition for people and capital and, therefore, prospers local economies. However, China's experience also suggests that fiscal decentralization without the relevant political institutional foundation will bring about negative effects. The political foundations of fiscal federalism are as essential as its economic principles in preserving and sustaining fiscal federalism.