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Regional Protectionism Weakening State Capacity
Regional competition within China is far more intense than on the international market. However, this is not the healthy competition of a free market. There are many factors contributing to the competition, which include unreasonable resource allocation, irrational investment, product duplication and regional protectionism.

Among all these problems is regional protectionism which should be regarded as the leading obstacle to improving China’s state capacity and developing national economy, as some well-known economists warned recently.

Moreover, given China’s expected WTO entry, local protectionism may even cause foreign sanctions as the WTO regards any local government actions violating its rules as the sole responsibility of the central government. Experts suggest the state to clean up local protectionism as soon as possible. The following are their analyses and suggestions.

Protectionism for local enterprises impairs economic development

“Localities usually conduct protectionism under the name of 'assistance to the local economy'. Cigarettes, autos, alcohol, products with high revenue, often top the list of items subject to local protectionism. In a short-term view, such actions shield local enterprises from fierce competition with other Chinese cities, but in the long-term the result is just the opposite,” said Lin Jiabin, vice-director of Society Department of the Development Research Center of State Council.

Local protectionism is apt to trigger retaliative actions from counterparts. China’s auto market is one of the best examples. To boost local economic growth, provincial and city officials naturally favor local car manufacturers. Last year, Shanghai announced it would levy an 80,000 yuan license fee for each Fukang auto in Shanghai to stop the increasing market share being gained by the mode produced by the Citroen joint venture in Hubei Province. But the license fee for Santana made by the Shanghai Volkswagen Co. is only 20,000 yuan. Hubei Province immediately issued a rule that all institutes and departments that received national financial appropriations either had to opt to buy the local-made Fukang auto or pay an additional 70,000 yuan “Enterprise Poverty Relief Fund” for other brands.

Though the central government made great efforts to halt similar practices, a lack of corresponding law gives localities immunity to impose extra fees and taxes on non-local cars, in some cases driving the price up by half.

Besides trade wars, local protectionism will definitely hurt the future development of local enterprises. In a socialist market economy, the survival of an enterprise depends on its competitive edge. Government departments at various levels should encourage local enterprises to surf and grow in the market instead of building a fragile fence by discriminatory policies. Without competitive pressures, without the drive to enhance efficiency and improve technique, enterprises cannot build up a competitive edge and win market share, and are eventually doomed to fail.

Lin specifically pointed out, “The relationship between cities is a competitive partnership." Productive resources can circulate where they are most needed and be used most efficiently in a free market, which is necessary for the promotion of national economic performance. If localities interfere in the restructuring or annexation among enterprises, they are hindering enterprises from faster and healthier development.

The result is that China is not really one market but rather a collection of markets, each with its own unique trade and investment barriers. Without being able to benefit from economies of scale or standardization, production costs are higher than normal and, certain enterprises cannot expand market share and accumulate enough strength because they have been effectively barred from competition in certain localities. This exacerbates their inefficiency as well as impairing the ability to make effective alternative financing choices.

Until now, this has primarily been a problem between Chinese and joint venture manufacturers. But foreign businessmen may likely encounter similar barriers for their imports even as China’s national tariff level drops according to WTO agreements. As non-Chinese companies move from the edge to the center of the domestic economy, the problem will be more prominent.

Lin stressed, “In developed countries, if a local government issues some measures favoring its local companies, consumers or competitors will definitely sue it for impairing consumers’ interests or for interference in the healthy competition among companies. The verdict will absolutely overturn the localities’ unfair policies.”

Under WTO principles, the central government would be held accountable for any protection actions of a province, county, or a city even with no advice or consent from the central government. There is not much time for China to clean up local protectionism.

Employment protection push product price up and result in shrinking market share

Discriminative employment policies are adopted in almost every big Chinese city.

As many rural populations who live in relatively backward areas, and who have been tied to the land up to now, are moving to the cities, the social and natural environment and employment circumstances of many of the latter have worsened. The state adopts a “residence system,” which is granted according to parents’ living and working place, to discriminate in favor of city people and against rural people.

For rural people, it is quite difficult to get a city ID and this affects their opportunity of finding a job because many vacancies require hiring people with a proper residential permit. Even if the rural people managed to get a job; their children’s education will also be a headache, because all schools will impose heavy additional fees due to their rural identification.

“Cities seem to have some reason to do this because they cannot assimilate so much labor,” said famous economist Mao Yushi, “but this practice confronts the economic principle and will finally hinder the city’s development.”

Shenzhen is one of the best examples for this discriminative employment policy though it does not do it on purpose. As a special region neighboring Hong Kong, a British colony before 1997, people to Shenzhen are required to get a special passport besides an identity card. This passport blocked many people from entering Shenzhen to find a job, which is reflected in a sharp markup in salary--50 or 100 percent higher than nearby Shunde and Dongguan cities. Many factories substantially opted to move out of Shenzhen Special Economic Zone, blunting its competitive edge.

In Mao’s mind, Beijing municipality adopts a much smarter way compared to Shenzhen. The floating labor under restriction is usually of low technical or intellectual level, while Beijing already has a big pool of reserves in urban citizens.

“WTO entry means a reallocation and optimization of productive resources and demands free trade in the global market. Local protectionism has meddled with efficient free circulation, and merely pushes up wage levels due to irrational resource allocation,” Mao said.

However, restrictions on low technical or intellectual workers still exist to have negative influences.

Mao said, “Those from rural areas have lower wage expectation than Beijing citizens. Thus, Beijing companies have to pay more to hire a Beijing citizen who is of the same level with one from the rural area. Driven by higher labor costs, Beijing products or services will inevitably soar and further affect its market share and economic growth.”

Local protectionism, a product of transition from planning economy to social economy

In the period of the planned economy, local governments at various levels were just appendages of the central government. They were economically dependent on national financial appropriations and had no independent interests of their own.

With the coming of political and economic reform since the late 1970s, the central government allowed more management decisions to be made at lower levels, with a redistribution of resources and greater attention to profitability. The decentralization process has given cities and counties significant decision-making power. Many state-owned enterprises are mandated to localities.

“Unfortunately, local authorities are obsessed with economic growth and local GDP growth rates--the leading criteria for evaluating cadre performance--and has made full use of their administrative rights to assist and protect local enterprises,” Lin Jiabin pointed out.

Especially in lawsuits between local and non-local enterprises, a local litigant usually enjoys a two-to-one advantage in courts. Prosecutors and judges overwhelmingly favor companies in their district. Even when the court scarcely holds local ones guilty, local authorities often tolerate or even protect local parties that refused or delay to comply with court verdicts on debt payment.

“For the same reason, and also out of fear of public exposure that would reflect badly on themselves and give a bad impression to leaders, local officials may also endure or shield local companies that engage in illegal activities, including smuggling, corruption, and the manufacture of fake, shoddy or illegal products,” said Lin.

All these discriminatory measures seriously worsen the investment environment and reciprocally impair their reliability and reputation. China’s national market has been broken into small pieces of “local-centric” entities. The integrity of legislative, administrative and judiciary rights are seriously damaged.

Transformation of government function, a key to eliminate local protectionism

The eradication of local protectionism will be impossible if we cannot weaken the locality’s role as an entity of the vested interests. Until enterprises are separated from governments’ direct control, local protectionism will still have its say to interfere in the fair competition among enterprises. The local governments should be transformed into a provider of public products and public services only.

“Local governments should neither be unconcerned nor go too far in assisting local parties. As more protectionism has revealed their malfeasance, they have begun to adopt new ambiguous measures and do it stealthily, especially when local companies are engaged in making fake, shoddy merchandise,” Lin warned.

Economist Mao Yushi suggests another way of economic principle to eliminate local protection.

“First the relationship between government and enterprise must be rationalized to make enterprise the main body of market behavior. The government should focus on how to build a sound business environment,” he suggested. “Secondly, I would like to suggest a revision to the ongoing taxation system, which levy taxes according to companies’ administrative subordination. Namely, the state-owned enterprises pay taxes to the state, provincial enterprises to province and municipal to city, which is, in some extent, a major cause for local protectionism because localities would exhaust every effort to protect their local parties in order to ensure higher revenue and discriminate against those pay no taxes to them.”

If taxes by companies in localities can be divided into two parts, one to central government and the other rebated to local governments, localities will enjoy relatively stable revenue and do not have to undergo protection actions, Mao suggested.

(CIIC 03/27/2001)

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