[MUSIC] Another key component of the political economy of any state, but here particularly in China, is the financial relations between the central and the local governments. Political economists often debate which level of government best promotes national development. Should there be more money at the national level? Should there be more money at the local level? And what are the responsibilities of the various levels of government for overall national public goods for the good of the society? Now, national governments often have to invest in public goods and services. They may have to roads, railroads, things like that, welfare. They often will make transfer payments from richer provinces or richer locations or richer states to poorer regions within the country. In some places education may be a provincial expenditure, rather than a national expenditure as it is in my home country of Canada. In some Western countries, the federal system gives both central and local governments their own taxes, and they sit down and negotiate and make deals about the taxes at the different level. And as I said in Canada the provinces control a significant amount of taxes. In particular, they control the taxes on the extraction of resources within the province. And by within the province, I mean if it's on the land of the province. If the province is a coastal province and maybe there's resources being extracted from the water. The central government may take that, that's actually the way it is in Canada. And there could be provincial sales taxes, in the United States we have states sales taxes, but not in all states. And cities often control property taxes, which is a way for them to get their resources. Now China in 1984, set up a unique, what we call the financial responsibility system, where each level of government was given a fixed amount of taxes to remit to the level, immediately above in the administrative hierarchy. So what I mean by that would be, let's say a city would have a fixed amount of taxation that it needed to give to the province. The provinces had a level that it had to give to the central government, and that amount was the amount that had to be remitted was set for three years. It was fixed three years based on the average tax revenue of the previous three years. And so, the surplus would remain with the government that collected it. Now, that often meant that you would be able to keep the amount of taxes that, a local government would be able to keep the amount of taxes that it raised in years two and three. Because it would have to give the level. The first year was kind of fixed, and that was the fixed level that it would have to remit. So they were really fantastic opportunities for local governments to make money. And the local governments still at various levels, province, city as we were talking about even down to the township, right, and the village. They had enterprises, and so they had a strong incentive to promote economic development and entrepreneurship, because they would get the taxes, the tax base, from these firms. And so what we see is between 1978 and 1995, the central governments share of the revenue dropped dramatically from 33.8% to 10.8%. Now overall the central government was still getting more money, because the economy continued to grow. But if you look at the share of GDP that went to the central government and the amount that went to the local government, the local governments were getting a lot more money, and they were hiding that money. The way they hid it was through what we called extra-budgetary funds. So these local governments would report a certain amount within their budget, and then hide the surplus in extra budgetary funds. And I recall going down to visit when I was doing my field research once. I went down and I was talking to some local officials, and they told me that in fact the amount of money in the extra-budgetary fund that the central government didn't get its hands on, was larger than the amount of their budgetary funds, which the central government could tax. Now this situation became somewhat intolerable with so much money being in the hands of the local government. And the central government really starting to, to feel that it was losing control. And so in 1994, the then Vice Premier, I think the slide says Prime Minister, but at that point he was a Vice Premier, Zhu Rongji. He introduced a new system, where he sat down with the Provinces and renegotiated their tax level, and so he increased the taxes paid by the Province to the central government. And then the Province looked at the level below them to municipality, the municipality looked down. And everybody started to put greater pressure on governments at the local level. Furthered the one level below them to start to cough up the money that was in their extra-budgetary funds. And in this way the money started to move up the system. And so what in fact followed, was that many local governments actually became impoverished. And we know that many of them could not even pay teachers salaries. And, unfortunately, at the same time the central government decided to impose new tasks on local officials, running schools, they wanted to re-establish a healthcare program that had ended during the reform period. They wanted new roads, so they put pressure on local governments, gave them these responsibilities without giving them a chance to raise more money. And in fact was taking money away from them. And so local officials had no real choice but to start to impose what were called arbitrary taxes. And the peasants saw as illegal fees on the peasants, for activities such as slaughtering pigs or chickens, or the local government was told to build a new road, where they want to build a new road they have no money, what did they do? They went around to all the villagers and they said a-ha. You know, everybody has to give us a certain amount of money so that we can afford to build the road. And these financial burdens, and the improper behavior carried out by the officials really led to an upsurge in rural protests. And so we see this very much in the 1990s. And it really becomes a problem. And a degree of instability started to emerge in the countryside, because of this policy. Nevertheless, from the overall national perspective it didn't work out to badly for Beijing, because the re-centuralization of taxes put a lot more money in their hands, and they were able to invest in infrastructure. Railroads, harbors, and other public facilities that are really important for a modern economy. And if you look at China today, in the last 10 years everybody talks about high-speed railway, and harbors, and all this stuff. And as we'll see later on, it really was beneficial for China as they tried to move into the export sector as well. So the Hu Wen, Hu Jintao and Wen Jiabao during their period when they were running China from about 2002 to 2012. They were able to spend more money in a way a kind of redistribution of wealth, putting more money back in the countryside. And particularly spending more money up in Northeast China, which had become a kind of rust belt. The enterprises up there had become old. The workers had been laid off, right, and they needed to reinvigorate this area. And all of a sudden, the central government had the money to do it, because previously, they didn't have it. Even more fortuitous, even more beneficial for Beijing and for the central government, was when 2008 came along and there was the global financial crisis. The central government had all kinds of money. And they had in fact invested $4 trillion RMB, the equivalent of just about the same as the United States spent in it's a stimulus package, $585 billion. But they could do it really quickly because they had the money. They didn't have to get the money from Congress like President Obama did. They had the money and they just pushed that money out, and started to develop more and more of the economy. Some of the money went into the rural areas, and overall they were able to avoid falling into this huge financial crisis.
