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Home >> Great Minds China Forum >>  2nd Great Minds China Forum >>  Mechanism Design Theory and Its Significance to China's Reform, Development and GovernanceMechanism Design Theory and Its Significance to China's Reform, Development and Governance
Yang Ruilong:Mechanism design theory is about dynamic

Yang Ruilong:


First of all, I would like to thank NEF for their work which should be done by universities. Thank you for doing such work with benefits beyond measure.


Secondly, I would like to congratulate Professor Qian and Professor Xu on winning the award.

My topic today echoes with Professor Tian’s. Mechanism design theory is about dynamic. We are anxious when we talk about reform. We know we need to reform, otherwise there is the dead end. There are many documents and scholars talking about it. Why there is no significant result? An important reason is that we lack of dynamic mechanisms in the reform. When talking about dynamic mechanism, we need to talk about the current China. The economic future downward trend of China is decided by the structural factors. Thus, we reached consensus on propelling supply-side structural reform. However, we found that structure can’t be adjusted without reform. Why? Because the current economic structure is the reflection of interest structure under existing system and development mode. If we do not change system mode and development mode, the interest structure will be rigid. Structural adjustment can only be done by the government. However, the results of adjusting by government are not desirable. Therefore, we have the consensus to reform but we fail to take actions. We used to conduct a research on the effectiveness of supply-side structural reform but we failed to grasp the key and only generated a series of documents. Why? We still need to talk about China’s reform in the past combining with the mechanism design theory.

Why could China’s past reform make achievement? Mainstream theory tells us that the reform could be faced with strong resistance if led and promoted by the government hand. However, China’s reform over the last 30 years has made great achievements. Why? Professor Qian and Professor Xu introduced research of such field on the international journals. I also began to research on this quite early. Between 1993 and 2000, I published four papers on Economic Research to discuss this issue. The research was quite simple at that time. I researched on Kunshan of Jiangsu Province. In Jiangsu, there is a very good national development zone which was not developed by the country but on its own. The government didn’t blame it and allowed it to become a development zone at the provincial level and later national level. I researched on this case and proposed three questions. Firstly, why local government officials dared to take political risks to establish this development zone in that political framework without leader’s permission? Secondly, why the government at a higher level didn’t stop them from establishing this zone when they disobeyed central government’s order? Thirdly, why cadres that didn’t listen to the central government were promoted while those so-called well-behaved ones were not? I consulted the secretary and he told me about decentralization. That’s when I began to research on decentralization. At that time, the Secretary of the Kunshan County Council could sit according to the arrival time when attending meetings in Suzhou as there was no decentralization. When we began to have decentralization, the seats arrangement was positively related to the economic power. Kunshan has the smallest economic power. Therefore, officials of Kunshan were sent to sit at the back and given no opportunity to speak. Then secretary said this was awful and he might not be promoted all his life if he didn’t take any actions. That’s why he thought about development. From this case, we can see that fiscal decentralization changes local government behaviors. This might be a simple research as I didn’t know about optimal mechanism theory. This is the difference between us and the scholars who used to study abroad. We began from a simple perspective. Fiscal decentralization connects local officials’ promotion with GDP. Therefore, GDP growth has become the most important weight for government officials to be promoted.


All in all, I have similar research results with the GDP Championship theory that researched by other scholars. A very good reform dynamic mechanism that satisfied the participatory constraint and incentive compatibility was introduced in this system. If officials want to be promoted, they need to enhance GPD and introduce more profits under the condition of decentralization. The most effective method is to invite investment which becomes officials’ favorite due to fiscal decentralization. To attract more investments, a good investment environment has to be built. The best environment for investment is to obtain priority in reform because behind every reform priority, there are special system and preferential policy. The special system and preferential policy will bring rent that creates by the reform priority. The rent will be used by investors to increase the return on investment. In the last 30 years, even though the powers of administrative reform were delegated in the administrative system, enterprises don’t have the power to reform even until now. Such power is controlled by the government. In this system, we introduced fiscal decentralization and incentive mechanism of local governments, local government officials are interested in and have enthusiasm to cooperate with enterprises and seek for reform priority, or in other words, pilot right from the central government. Local governments can earn benefits if they could win the pilot right because reform priority brings special system and preferential policy which could create a higher return on investment. Thus, a complicated relationship was built, which formed the incentive mechanism of China’s reform over the last three decades.


There was a very interesting phenomenon. The major or secretary of a well-developed place has a common feature. What feature? They look like a major when making report, drinking like a boss when negotiating with foreign businessmen in the evening and making report like a scholar in the university. That was a typical image of a good major. If the major only talks about documents, there wouldn’t be any development; if the major works like a boss then there might be a chaos; if the major only works like a scholar, he might not be able to make actual achievement. That is the special incentive mechanism that formed in the last 30 years and also the topic of my research between 1993 and 2000.


After introducing incentive mechanism of fiscal decentralization in the reform of vertical distribution system, a 30 years’ growth was achieved like a new born baby because local government and enterprises were willing to stimulate property reform through cooperation. Such reform caused many issues such as misbehavior, corruption, conflicts between capital and labor. We create a baby in the last 30 years of reform, but the baby slept in the dirty water. In order to tackle the issue that brought by reform, the anti-corruption campaign that we unswervingly carry out is absolutely correct. Under those circumstances, reform has brought many problems like working on the edge of laws, unspoken rules, rational but illegal, legal but unreasonable. If we ignore these problems, they will damage China’s future growth. Thus, anti-corruption is right as it cuts the relationship between politics and business. By cutting down, the reform incentive mechanism, or in other words, dynamic mechanism of local government officials is lost. Sloth administration can be seen everywhere. In the past, government officials were hard to meet and being unfriendly to businessmen. Now, it is barely possible for businessmen to meet officials. Such issues are also very severe in state-owned enterprises. Central government published papers said state-owned enterprises need to have classified reform and mixed ownership. However, there was no action being taken in the state-owned enterprises. There are many reasons. One of the most important reasons is that sloth administration also exists among leaders of state-owned enterprises. They all have safety awareness in this environment. The benefit they could get from the reform is much less than the risk that brought by the reform. Based on rational thought, they want to be stable. There is a great amount of evidences can prove the results of sloth administration. After 2011, the effectiveness of microstimulation plans conducted by the central government has been decreasing. In terms of the quantity of money being invested since 2011, Professor Song mentioned about the relevance between investment and growth in last two years. There are many reasons. One of the most important reasons is local governments did not take positive actions which resulted in the decrease in the macro effectiveness. In the last few years, we had neutral monetary policy, positive fiscal policy but not positive fiscal. Why? Did we reduce taxation? No. Did we increase fiscal expenditure? The fiscal deposits of government at different level were constantly accumulated. These reflect the issue of sloth administration. The key for China now is to reform. The most significant reason for the difficulty in reform is the dynamic mechanism issue. If we don’t have a corresponding reform dynamic mechanism, it is difficult to make achievements in the so-called supply-side structural reform. The key for promoting the supply-side structural reform is to exploit and development dynamic mechanism. It is unreasonable to say that China can’t develop any more. The traditional growth factors like dividend brings by reform and demographic dividend as well as the new growth dynamics like innovation, urbanization, the increase of spending power and structural optimization provide opportunities for China to maintain mid and long term growth. The key is to reform. How to reform? We must arouse the enthusiasm of elite class, especially the local governments from the strategic level, which is also the core for future economic transition and upgradation. If we want to insist on the so-called progressive reform, we must arouse the enthusiasm of local governments. Local governments should be keen to reform and realize that excessive decline or even continuous depression could become the biggest political risk for China.


Therefore, after we make achievement on anti-corruption, we need to positively build a new round of dynamic mechanism of big reform and big adjustment on the basis of stable growth. Thus, we need to clean the boundaries between government and market again. The 3rd Plenary Session of 18th CPC Central Committee said that the market mechanism plays the decisive role. We are a little bit biased when reading this central government document. Government’s role is boundless if we ignore the decisive role of market mechanism and only talk about enabling the market to play a better role. It is important to talk about government’s role with the precondition of market mechanism playing the decisive role. At the same time, we need to prioritize the reform of top level design. If we review the last 30 years of reform, all the successful results were generated by the microeconomic entity, not by the cooperation between local governments and enterprises. This is why we have to arouse the enthusiasm for micro reform.


The reform in property institution will definitely be the core of future reform in China. The core of property institution reform is the reform of state-owned enterprises and land system. Last but not least, we have to promote the reform in the factor price system.


The success of the reform in the last 30 years is attributed to the dynamic mechanism. Just like Professor Qian said, this mechanism talks about the second-best rather than the first-best, but it did promote the marketization process of China. China’s future development still has to rely on the reform. Now, we have to reshape the dynamic mechanism for reform, which is very important. Thank you!




◆please indicate the source if authorized: National Economics Foundation

◆photo:National Economics Foundation