Microsoft Word EcRefChina Oct06. doc

particular, by Hayek, 1945). In fact, since the mid-1990s, market forces in China 
determine the prices of the vast majority of products.
10
There are, however, important 
exceptions. One is the market for natural resources. Moreover, while in the case of 
industry market forces are constrained by government interventions to mitigate 
unemployment, in agriculture they are constrained both by the absence of a market for 
land ownership and by government interventions in the marketing of grain. Therefore, it is 
an open question in which sector the shift to market prices has been most pronounced. 
It is also difficult to generalize about the relative importance of economic incentives in 
agriculture and industry (dimensions 5 and 6 in Figure 1). I would, however, argue that 
incentives play a greater role for firms in agriculture than in industry. While farmers make 
9
According to the Deputy Finance Minister of China, Jiwei Lou, only about six percent of the 
employees in public-sector administration work in the central administration (address to conference of 
China’s Economists Society, Shanghai, July 1, 2006). 
10
See, for instance, Iskander (1996) and Beijing Normal University (2003). 

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production and investment decisions based on the expected economic rewards to their 
family members, provincial and local political interventions limit the role of economic 
incentives for many firms. Indeed, these interventions by government officials and 
politicians in individual SOEs – in particular in the case of investment, export and 
employment – is the background for Gregory Chow’s characterization of China as “a 
bureaucratic market economy” (1997, 2002, Chapt. 19). As a result, there are tensions 
between market signals and political signals for the management of SOEs, with unclear 
responsibilities and principal agent problems as a consequence.
The important role of economic incentives for agriculture farms directly translates into 
strong economic incentives (economic rewards and punishment) for individuals working 
on the farms. By contrast, the role of economic incentives for individual employees in 
industry and services depends on the system of wage formation. Indeed, while state firms 
today are quite free to set wages for their employees, the latter still often enjoy higher 
wages than employees in other firms. This is the case, in particular, when state firms have 
monopoly positions in product markets (such as in the case of public utilities). 
It should be noted, however, that low marginal tax rates on work and saving contribute to 
maintaining economic incentives in all sectors, as compared to the situation in a number 
of high-tax developed countries today. Very few individuals are subject to marginal 
income tax rates above 20 percent, although a small group of high-income earners pay 45 
percent. An important explanation is, of course, that total government spending is less 
than 20 percent of GDP (18 percent in 2004 according to the 2005 revision of the national 
accounts). Another explanation might be that the authorities have been careful not to 
diminish economic incentives for entrepreneurship and investment in human and physical 
assets. 
Competition has certainly also increased dramatically during the reform period – for firms 
as well as for individuals. But it is difficult to determine whether the degree of 
competition among 
firms
(dimension 7 in Figure 1) is stronger in agriculture than in 
industry and services. The character of this competition obviously differs: atomistic in 
agriculture but strategic – reflecting “rivalry” – in most other sectors. It seems, however, 
reasonable to argue that