The amount of debt borrowed by local governments in China has skyrocketed in recent years. What are the effects of the continued accumulation of debt at the local level in China?

It is unclear to me what is going to be the ultimate consequence; part of it depends on the period when localities are accumulating debt. Debt has been accumulating in the localities since the 1990s, particularly at the village level. On the one hand, there are situations where the debt seems to just stay there, and in other cases the debt was incurred by local village officials personally to pay for the debt of the village of the whole. Sometimes, the debt was incurred at the township level, because local officials were the ones who had the ability to take out individual loans even though in fact the debt that needed to be repaid was the debt owed by the local government. But local governments aren’t allowed to borrow, so individuals had to go out and borrow. As a result, they incur such debt. At the township level and above, often officials get transferred. The debt incurred by those officials that have been transferred is still on the books of the township government. There are a lot questions I am not able to answer.  For example, we do not know in the earlier period who came around to call in repayment. In that sense, I do not have an answer. But the impact of this at the lowest level means that all of the households in the village are party to this debt and so this is another debt burden. As you go on over time, particularly in the second half of the 90s and the 2000s, as the debt keeps increasing there were legitimate concerns because ultimately the higher levels of the state would be responsible for the debt. The other thing that is so interesting is that it is unclear what obligations local governments have to repay various types of debt. There is debt that the local government clearly has responsibility for and there is other debt where it seems that they actually do not have a clear-cut responsibility for. The situation is quite murky.

So is that debt still there?

Yes, this is what makes it so interesting. It just keeps building up; it has been accumulating over time since the fiscal reform in 1994 when more and more revenues were taken from localities by the central government. Localities have had to find ways of funding these unfunded mandates from the upper levels. They have had to find ways of securing the matching funds needed to receive and use the funds provided by the upper levels. So in that sense, the debt is still there.

What has the administration of Xi Jinping done to manage central-local relations in regards to fiscal concerns and what is the role of the center today?

After Xi Jinping came into power, he shortly issued a reform plan in late 2013. One of the reforms that was called for explicitly was the need for fiscal reform. Among other things, the issue of matching funds was explicitly identified as something that should be reformed and essentially abolished. It was seen as the cause of local government debt. Unfortunately, as far as I know very little has been done. The issue has been sitting around for quite a few years now and it seems that there has been very little progress.

In your 2012 article “Shifting Fiscal Control to Limit Cadre Power in China’s Townships and Villages,” you studied the fiscal and political consequences of recentralization starting in the mid-1990s. It is now 2016, did the increased fiscal reach of the state lead to more problems? What has been the long term-effect on local cadre-citizen relations?

In today’s talk, I didn’t really have time to go into great detail, but the situation between center and locality with regard to centralization and decentralization is very complex. On the one hand, in that article, I was writing about the recentralization of power by the upper levels of government. And here, it actually was recentralization by county governments, not necessarily Beijing. Although the policy was initiated in Beijing, the recentralization was only carried out through the county level. Resources were taken out of village and kept at the township to monitor village use of funds; the county also took some of the power away from the townships. It is not Beijing coming down and taking away power. In that sense, I think that it is the county trying to figure out how to promote more stability. They gave up on trying to control the lower level cadres because there were a lot of peasant protests against extortion and excessive collection of taxes and fees. So instead of trying more of the same, county-level governments decided they were just going to take control and solve the problem by abolishing the problem altogether. Instead of making villages raise get enough money, for example, to pay salaries of village officials, the county took over the responsibility of paying for the local levels, particularly the village level, officials.

Did that lead to an increase of bureaucracy on the county level?

I would say yes. On one hand, one of the things they did at the township level was taking the management of village funds out of the village and giving it to the township government. This money clearly belonged to the villages, but in an effort to reduce corruption and the mismanagement of funds, if a village head wanted to use the money for something, he had to requisition the money from the township even though the money belonged to the village. They had to go through a bureaucratic process and that was an attempt to try to cut back on the illegal or wasteful use of funds by village cadres because such abuse caused a lot of discontent among villagers. To increase transparency, the county also created committees of villagers who were charged with auditing the accounts. In the end, I still have a concern about the relationship between village officials and peasants and about what it does to the incentives of people who might want to be cadres. It may reduce the incentive for entrepreneurial activity at the village level.

You have also written a lot about corporate restructuring for SOEs. How do you view the recent merges of SOEs, such as that of the China National Travel Service Group and China International Travel Services Group, train makers CNR and CSR, shipping behemoths Cosco and China Shipping, or Wuhan Iron and Steel and Shanghai-based Baosteel? Are these merges the right way to make SOEs more efficient?

These measures are not new at all; this has been a pattern that China has used for a long time. The whole idea is that China realizes that there are some companies that have been doing pretty well and there are a lot of companies that are having problems. Their solution is to ask the SOEs that are doing well to help the companies that are not doing well, so China puts the weaker companies under the wing of the stronger companies. China started during this in the 1990s and 2000s, this is when the creation of the jituan (集团), holding companies or corporate groups, started. If you go back and look at the number of SOEs, there is an impressive reduction, but one way they did it was by taking a lot of smaller, less well-performing SOEs and just putting them under stronger ones to create large SOEs. China then merged them. This pattern is not new and is very problematic. One of the reasons why some of the SOEs are not able to turnaround is because they have been burdened by having to take care of all of these companies that have had a lot of problems. They are sitting there and they cannot get rid of them. For a while they tried to sell them, which seems like an obvious solution. But there was the problem of asset stripping. If you sell a struggling SOE at a price where somebody would want to buy it, the price may seem pretty low. Then charges of giving the company away would pop up. China finds it difficult to sell these SOEs and satisfy all of the political requirements. It is very hard; I am not surprised that they are doing what they are doing because the problems they face are precisely the same problems China faced starting in the 1990s. They feel that they cannot just lay off and close factories, even the ones that have stopped producing because of the problem with firing workers. There would be huge numbers of layoffs and unless there is some way to figure out how to take care of them it is politically risky to close the SOEs. It is better now because there is a social security system in place, but it is still being built up and standardized across the country. It is still a very difficult decision. What are you going to do with all of these people and close the SOEs down in a quick way? It is politically risky and I don’t expect them to do anything soon.

In “Will Demographic Change Slow China’s Rise?” you and your fellow authors argue that demographic change “probably will slow China’s rise, but its long-run impact almost surely will be manifest as a consequence rather than a cause of slower growth.” In light of your article and China’s current economic slowdown, how do you see demographic change affecting the likelihood that China will be stuck in the middle income trap?

Based on the work of my colleagues on education, such as Scott Rozelle, there are two parts that are worrying. In China there is still a lot of inequality, particularly poor areas in the countryside. There is the question of whether the young people – the children – are getting the education to prepare them properly so that China can move up the value ladder. Based on the evidence of colleagues working in this sector the answer is a very clear no. Problems in terms of the health of these students that prevent them from learning, from everything like worms to anemia, make it difficult for them to concentration on their work. There is also a problem in terms of the poor quality of the education that these young poor children are getting. The other part of it, the demographic change, is the worry that the population is getting increasingly to the point where the one child families are going to have a much greater burden in terms of taking care of the parents. I think that it was not surprising that they have abandoned the one child policy, but abandoning it may not solve the problem. There is also the problem of decreasing birthrates. You find this in many more developed countries, such as Taiwan, Japan, France. As countries develop families hesitate having more than one child. This is where India has a greater advantage, their population is much younger. Japan has it big time, but are in a better situation in that the country got rich before it got old. In China, the question is whether they are going to be able to get rich before getting old. But then there are things that can be changed, for example changing the retirement age and not making them retire at 50 or 55. There are policy changes available, but the thing I worry about more is the education and the preparation of that portion of the people who are young and whether they are getting the proper training.

What was the status of the central state, particularly state capacity, after the Cultural Revolution? What kind of impact might that have had on decentralization?

Here, I was drawing from part of what Andrew Walder was talking about last night and the damage the Cultural Revolution did to the state, the institutions and organizations of the state. As I said this morning, even the Maoist period, which we think of much stronger than the current period, was very vulnerable to these same problems, such as information symmetry, since localities controlled the information. The planning system was very much dependent on the information that was sent up. On the one hand, one could see that the authorities, Deng Xiaoping and others, thought that they did not do too well with the collective system and they were willing to take some risks and willing to decentralize. A key point that I did not have time to make this morning was that although they decided to decentralize, this does not mean that they decided to give up power. They pushed the work and responsibilities down to the localities rather than give it to non-state actors. One question they faced was whether to decentralize to the market, i.e. privatize, or decentralize to the local state. What they did in the post-Mao period was to move away from central planning, but it still was not that risky because they only decentralized down to their agents. As long as they had control over the agents, i.e. local officials, by evaluating and appointing them and giving them incentives to carry out state policies, it was not that risky. When they did this, as Deng Xiaoping said in one of his interviews later, they had no idea that the reforms, in particularly the fiscal reforms, would have the very positive impact that they did. He was really surprised by how successful TVEs were. That’s why they then had to readjust because they basically gave away too much in the 1980 reforms. They had given localities the rights to a number of taxes, but, at that time, these taxes were nothing. But when reform took off, this was where all of the money was, and they gave that all to the localities and could not take it back. They let it go for a while, but in 1994 they wanted it back and instituted reform, rewriting the tax system.

What are the principal manifestations and causes of dysfunction in China’s central-local relations today?

There are many problems, but I think the one that is the most important is the fiscal system. The fiscal system needs to be reformed, in fact this has been identified by Xi Jinping and the state. It is in the latest party documents, but they just have not done it. It is the question of money, who is going to pay for everything? The center wants the localities to do things, but it is not providing the money. The center puts pressure on localities--if they are not going to do anything they are going to be punished. The officials in the localities may get demoted or not get promoted. So what do the officials in the localities do? They go out and find ways to generate money, which includes things such as taking away land from peasants. This of course generates a lot of discontent and protests, like those recently in Wukan. There are also more political problems, but it is the fiscal system that I think is the root cause of these other things. Xi Jinping is going out and trying to fight corruption, but a lot of these things that have been labeled corrupt practices could be traced to these fiscal problems.