Abstract
Capitalism from Below offers a highly original and compelling analysis of the growth of a thriving private manufacturing sector in China over the past three decades. From a marginal role limited to tiny family firms in the early 1980s, private enterprises grew rapidly in numbers and scale at the expense of state firms, and now comprise roughly 70 percent of national output and employment. Victor Nee and Sonja Opper find existing explanations for this evolution to be partial and one-sided, focusing too exclusively on the evolving role of the Chinese party-state. They contrast their perspective with what they call “state centered” views of the growth of capitalism offered by Douglas North and others, which emphasize the prior construction of institutions that clarify property rights, creating a “credible commitment” on the part of states not to expropriate assets or engage in arbitrary or unpredictable forms of revenue collection. They point out that a thriving private manufacturing sector has grown up in China despite the absence of clearly defined and legally enforceable property rights, and moreover that this is the way that economic history has unfolded as capitalism has developed elsewhere in the world. States respond to pressures created by entrepreneurs who create capitalism from below.
The alternative offered in this study is a micro-analytic perspective that focuses single-mindedly on endogenous grassroots processes of institution-building, as entrepreneurs build networks, develop trust, and create informal enforcement mechanisms in the context of relentless competition on product and labor markets. These in turn alter the choices and incentives for government, creating pressures for the design of supporting regulations and laws. Nee and Opper do not dispute the important role of the state, but they make a compelling case for their claim that any account of the emergence and growth of private enterprise in China that neglects these micro-level processes will be partial and ultimately incomplete.
It is beyond dispute that the literature on the evolution of China’s economy over the past three decades has been dominated by analyses of the state and its agents at various levels of the government hierarchy. This literature, however, is not founded on the premise that states must first create clear and enforceable property rights and regulatory institutions in order to permit a market economy to flourish. The focus on state actors, instead, was motivated by the very same puzzle that intrigues Nee and Opper: how is it that a thriving market-oriented economy was possible in the absence of the clear and enforceable property rights for private enterprise emphasized in some branches of economic theory? The most common approach, taken up primarily by political scientists, is perhaps more accurately characterized as “political economy” rather than “state-centered.”
The political economy literature is now quite extensive and has a history that goes back to the beginning of China’s market reforms. Like Nee and Opper, it has also emphasized the construction of market economies “from below,” although it has often emphasized the behavior of government officials at the grassroots—in villages, townships, cities—as opposed to the design of formal institutions by the central state. The political economy literature essentially strives to view grassroots officials as themselves important actors in local economies, and seeks to explain the incentives and constraints that drive their behavior, which in many ways was unanticipated beforehand. Why did local officials not effectively block small-scale private enterprise, and prevent it from growing in scale and scope, especially since they had the power to do so? Why did local officials shift from tolerating to actively promoting local private enterprise and investment? Why in the early years of market reform did local officials actively invest in and promote market-oriented small-scale enterprises that were owned and operated by village, township, and county governments (rural “township and village enterprise”)? Why, subsequently, did they proceed with extensive privatization of the sector they had built up? The explanations take a variety of forms: incentives provided by decentralized taxation systems in the form of budgetary and extra-budgetary revenue, the ability of officials and their relatives to reap much larger incomes in the market economy, and incentives embedded in a national hierarchy that explicitly ties promotion opportunities to local economic development. Whatever the preferred explanation, this literature has focused single-mindedly on the incentives that bear on the behavior of government officials, and it views these officials as important economic actors embedded in local economies.
A second well-established explanation, which is not directly addressed by the authors, is a macro-economic perspective on the impact of market competition on a centrally planned economy. State socialist economies systematically overinvested in producers’ rather than consumer goods, an imbalance that creates an enormous and underserved market niche at the outset of a market transition. Existing state enterprise could not respond adequately to this pent-up demand—consumer goods industries were underdeveloped, produced shoddy products, and could not retool quickly enough to respond to consumer demand for increased variety and improved design. In the manufacturing sector this demand was adopted initially by enterprises in small towns and rural areas close to cities that were established by local governments eager to increase fiscal revenues and employment. The output of local government enterprises expanded rapidly, undercutting the profits of state enterprises and, as new firms crowded into these markets, created downward pressures on the profits of the new market-oriented local government firms. Small government jurisdictions were unable to bail out these increasingly loss-making enterprises, leading to a systematic shakeout of the local government sector via a wave of privatization that began in the mid-1990s and accelerated over the next decade. This left a greatly downsized and consolidated sector of government-owned firms, as local officials abandoned their direct involvement of the early years and voluntarily turned over the bulk of manufacturing to a much larger sector of private enterprise.
Nee and Opper correctly point out that neither of these perspectives actually explains how it is that private entrepreneurs were able to build their enterprises in an environment that was initially hostile, in the absence of clear regulation and effective contract enforcement, despite the favoritism initially shown to government-founded firms in directly competing lines of production. This is the puzzle that they unravel in their book with remarkable clarity, theoretical precision, and disciplined empirical analysis.
The book’s empirical focus is on seven cities in the Yangzi River Delta, a region on China’s east central coast, including southern Jiangsu Province, Zhejiang Province, and the municipality of greater Shanghai. This is one of the two coastal regions with the highest per capita concentrations of private manufacturing—the other is Guangdong, further south, bordering Hong Kong. A carefully drawn probability sample of just over 700 private enterprises was taken from complete lists kept in local firm registers. The sampled firms reflect the structure of the private sector itself: primarily small enterprises in consumer-oriented manufacturing (textiles, auto parts, machinery, pharmaceutical, electronics). Just over 9 percent of the sampled firms are classified as “large” (more than 300 employees), and just over 50 percent are classified as “small” (fewer than 100 employees).
The first wave of interviews was conducted in 2006, with a follow-up wave in 2009 with participation by 75 percent of the original firms. Professional interviewers administered the questionnaires (included in the book’s appendix) to the enterprise’s CEOs and covered the firm’s size, structure, ownership, performance, competitive environment, taxation, and finance over the three previous years. Chief Financial Officers were invited independently to fill out a detailed questionnaire on the same subjects. In addition, the authors personally conducted semi-structured face-to-face interviews with 111 entrepreneurs during factory visits over a six-year period.
This carefully designed study serves as the foundation for a remarkably clear and compelling analysis of the origins and development of a thriving private business sector. Starting in the early 1980s as tiny private undertakings, sometimes disguised as “collective” firms, the businesses began as technically illegal undertakings with capital borrowed from friends and relatives, recruiting unskilled and skilled labor on informal labor markets. Developing in close-knit communities, frequently in small towns of rural regions, the entrepreneurs formed close-knit communities and created dense social networks. Repeated transactions in local communities produced reputational effects that bred trust and emergent business norms that stabilized expectations about trustworthy behavior and yielded confidence in contracts. In an unregulated but tightly knit community, loss of reputation entailed effective sanctions. Entrepreneurs in nominally competing lines of enterprise often found it in their interest to band together to ensure supplies of inputs at lower cost and export opportunities. Early success bred imitation and piling into markets, which intensified competition and spurred innovation and improvements in quality. Norms of cooperation fostered strategic alliances among firms and the exchange of information. Specialty industrial clusters grew up in localities, and private enterprises built independent supply and distribution networks and cooperated to enjoy economies of scale and competitive advantage. These alliances and networks served as conduits for the flow of information across markets, yielding access to novel ideas and technical innovations from the global economy. All of this activity grew without the benefit of clear legal regulations or effective contract law, and the reality of a growing private sector in turn created pressures for governments to clarify regulations and establish legal protections, albeit partial ones.
The core chapters of the book demonstrate the potential power of a certain variety of sociological institutionalism. The theory that drives the analysis draws deeply on insights from institutional economics, but insists on the crucial importance of social structure in the form of networks and the endogenous emergence and enforcement of norms that govern transactions and stabilize expectations. It is not possible to convey adequately the theoretical and empirical richness of the core chapters even in a long review. They begin with the origins and development of a novel institutional form, how initial resources and knowledge were converted to early enterprise, how these small start-ups were developed through mutual assistance and cooperation; how start-up finance was secured through relationship lending that bred mutual dependence between lender and borrower, and how reputation and community sanctions secured transactions (Chapter Four).
From this foundation there follows a creative chapter that describes how entrepreneurs, once they moved beyond the start-up phase, adopted formal structures sanctioned in early enterprise laws to secure legitimacy. Organizational sociologists will enjoy the rich account of how individual entrepreneur/owners fabricated formal structures of modern corporate governance that were essentially myths bearing little relationship to how the firm was actually managed (Chapter Five). The resulting industrial clusters formed dense networks of personalized exchange and mutual cooperation, providing information about market opportunities, supplies, and technology, and generating informal means of norm enforcement and conflict resolution. The cooperation that resulted served as a foundation for building supply and marketing networks far beyond the locality and even into the global economy (Chapter Six). Remarkably, sophisticated and stable labor markets expanded via chain migration from poorer rural regions, creating networks of labor supply not unlike the migration of unskilled labor from Mexico to the United States, and also made many of the more established companies serious competitors for high-end managerial and engineering staff. Competition for both skilled and unskilled labor drove up prices and led private firms to offer wages, longer-term contracts, and benefits that began to reduce the differences with large state enterprises (Chapter Seven). Finally, the intense competition on product markets, coupled with informal networks that conveyed information and ideas, spurred innovation in product type, quality, and design that moved the small firms in this sector to close the innovation gap with more established state firms (Chapter Eight).
All of these core chapters draw deeply on systematic survey data and anecdotal interview accounts to weave a compelling, theoretically-driven description of a remarkable process of social and economic change. However compelling, this reader was left with the nagging suspicion that the analysis does not directly address the puzzle posed at the outset: how a thriving private economy grows up without secure private property rights and a credible commitment on the part of the state not to expropriate assets or engage in arbitrary and confiscatory taxation. The core of this book’s analysis in fact addresses a different question: how do autonomous entrepreneurs find it possible to cooperate and generate the trust and informal enforcement mechanisms essential for the stable expectations that are the foundation for investment and entrepreneurship? The informal institutions described in these chapters are ones that stabilize and enforce contracts and secure property rights from opportunism by untrustworthy business partners, customers, and suppliers. This is, admittedly, a very important question, and one that has not yet been systematically addressed in the literature on China. But the state and its agents are largely absent from this account, and it is their potential arbitrariness and predation that is the primary concern of “state centered” analysts who have heretofore dominated the analysis of the political economy of China’s reforms.
The reader therefore turns to the penultimate chapter on the “Political Economy of Capitalism” with great anticipation. Here, Nee and Opper finally turn to the question of the relationship between the state and private entrepreneurship: how important are ties to the party-state and local officials for success in the private economy? This has long been the subject of controversy, and the authors attack this question with clarity and empirical precision, mining their enterprise survey data to develop a nuanced and convincing set of answers. They begin, essentially, by asking “important for what?” And they find that various measures of “political capital” (party membership of CEO at firm’s founding, former cadres, current cadre relative, regular party donations, network intensity with government and party) actually have very little positive impact on a firm’s sales growth or expansion after founding. However, various measures of political capital do appear to have a positive impact on the likelihood of getting a bank loan at the time of the firm’s founding, and political ties are very important in garnering government contracts, obtaining land use rights, and obtaining ownership over government-owned firms as they are being privatized.
The authors’ interpretation of these results is straightforward: political capital has conferred real benefits in the past and into the present within those dimensions of economic activity where government officials still exercise control over assets and key decisions. This, they point out, is in general not unlike political influence in heavily regulated market sectors in any economy, including that of the United States. This may give the politically connected an initial advantage, but once they enter this highly competitive and crowded sector of private firms, ongoing political ties are of little direct help. The authors are mindful of the possibility that these findings about the limits to political capital might be specific to the lower Yangzi region, and they guard against criticism in this connection by analyzing data from a nationwide World Bank Investment Climate Survey conducted in 2003. Although that survey does not contain the same kind of retrospective data on firms, it largely confirms their findings.
This is a superb piece of scholarship, equally satisfying as a theoretically informed example of economic sociology and as a coherent and memorable empirical description of China’s remarkable transformation. It will be widely cited, and admired, by China specialists and other social scientists, two audiences that are difficult to fully satisfy at the same time.
While there are limits to analyses that the authors label “state centered,” there are also limits to analyses of endogenous “bottom up” processes of institutional change. What are the scope conditions for this analysis, and how far will the understanding of change that we gain from the growth and maturation of a largely small-scale manufacturing sector take us to understand the further evolution of Chinese capitalism? The counterpoint to the process of “bottom up” endogenous change examined in this book is the unambiguously top down, state-directed process through which the initially dominant, large-scale state sector was downsized and restructured after the mid-1990s, precisely the period covered in this study. After a decade of trying to prop up underperforming state firms while tinkering with incentives for managers, the central state shifted to a more radical strategy of selling off or closing the smaller backward state firms and consolidating the larger ones into even larger state-controlled corporations, restructuring their assets, downsizing their labor forces, and raising capital through public listings on stock markets. This has created a dominant sector of corporate giants, many of which are now among the largest in the world, and their share of employment and output appears to have stabilized at around 25 to 30 percent. More capital intensive, their share of total assets is much higher than their share of employment. They are fully under government control, their top management is part of the civil service system and are frequently transferred between party-state and business posts. These firms are given preferential treatment in obtaining loans on favorable terms from state banks, receive regulatory protection, hidden subsidies, and tax breaks, and frequently enjoy monopolistic or oligopolistic positions in the domestic economy. These firms do not compete with firms in the sectors examined by Nee and Opper. They are in civil aviation, telecommunications, heavy industry, shipbuilding, overseas shipping, banking, mining, energy production, and a range of other strategic sectors where entry barriers to private competition are still almost prohibitive. Many of the largest corporations are in fact former industrial ministries that have been restructured and converted into a modern corporate form. This bureaucratic capitalism is a novel creation, and the Chinese communist party defends this empire as the foundation for national strength and its continued rule. It is not immediately clear how the endogenous processes examined in this book will apply to this radically different context. Have Nee and Opper provided a backward-looking analysis that tells us how a stable equilibrium between a competitive private sector and a monopolistic large-scale state corporate sector has been created? Or have they identified processes that portend a further transformation of the state monopoly sector? I suspect that the answer to this question will require renewed attention to the political economy of China’s reforms, which reminds us that endogenous processes of change occur also within the structures of the party-state itself.