BARRIERS TO EFFICIENCY AND THE PRIVATIZATION OF TOWNSHIP-VILLAGE ENTERPRISES

institutional environment. More specifically, beginning in the mid-1990s, banking reforms
were initiated that provided banks incentives to allocate scarce financial resources to the
most productive uses: in essence, the reforms made banks independent, profit-driven units.
The impetus for such a move was likely engendered by the TVEs’ increased debt levels and
poor debt servicing behavior. Local governments began regarding TVEs with high levels of
debt as burdensome, and began to see the problem with not using market forces to discipline
TVE performance (Smyth, Wang, Kiang, 2001).

Another institutional detail of note relates to tax and fiscal reforms. With the local
government objectives noted above (labor and output goals, tax revenues), during the 1980s
TVEs were easier to tax and control than private enterprises, and hence, were the governance
structure of choice for the local governments. However, in 1994 China introduced major tax
and fiscal reforms. These reforms were more closely aligned with international practices and
strengthened the tax collection power of local governments (Qian, 1999). The reforms also
gave local governments more autonomy, but at the expense of increased fiscal responsibility
— as central government transfers to locals began to fall. The cut-back in central government
transfers forced the locals to become more self-sufficient, and the primary source of local
government funding became the tax revenues raised from TVEs and private enterprises. As
noted above, TVE revenues began to fall relative to private enterprises, and TVEs were much
worse at repaying debts than private enterprises. The combination of falling TVE profits/tax
revenues and poor TVE debt servicing led to a shift in bank and local government lending
preferences, with and private enterprises becoming the preferable institution (Smyth, Wang
and Kiang, 2001; Naughton, 1994).

Along with the improvement of governmental and market institutions, TVEs also lost
their relative advantage over private enterprises in getting scarce inputs, while retaining the
burden of meeting labor hiring and output targets.

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