Download The incentive role of creating “cities” in China

China Economic Review 22 (2011) 172–181
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China Economic Review
The incentive role of creating “cities” in China
Lixing LI ⁎
China Center for Economic Research, National School of Development, Peking University, Beijing 100871, China
a r t i c l e
i n f o
Article history:
Received 12 April 2010
Received in revised form 5 December 2010
Accepted 5 December 2010
Available online 24 December 2010
JEL classification:
H11
R11
P26
H77
O40
a b s t r a c t
China operated an urbanization policy by which counties could be given city status between
1983 and 1997. The policy had substantial impacts on the new administrative entities,
including more discretionary power and fiscal independence. Such “county-to-city upgrading”
provided the central government with an instrument to reward localities. Using a large dataset
covering all counties during 1993–1997, I show that upgrading is not an automatic procedure
that endorses the high urbanization levels in existing counties. Although official guidelines for
upgrading counties to cities were published, these requirements were largely ignored in
practice. Instead, economic growth rate was the key factor in determining which counties
obtained city status. This paper interprets the creation of county-level cities through upgrading
as part of the incentive structure of Chinese local officials. The importance of both fiscal and
political incentives facing the local government in promoting economic growth is highlighted.
© 2010 Elsevier Inc. All rights reserved.
Keywords:
Incentive mechanism
Economic growth
Regional competition
Urbanization
China
1. Introduction
In developing countries, local governments play a key role in economic growth. For example, in China, the local government
not only provides public goods and services to its residents but is also deeply involved in economic activities. In most regions,
building infrastructures, offering inexpensive land and preferential tax policies are the main jobs of the local officials, whose goal is
to attract investments. Although not allowed to directly engage in borrowing, local governments have established companies to
borrow from banks and invest in urban infrastructures. The effort of the local government and its attitudes toward the market can
easily become the binding constraint for regional development.
Thus, a major concern of the central government in developing countries is to give local governments the right incentive to
spur market development and economic growth (World Bank, 2008).1 Under a hierarchical political system in which local officials
do not face election pressure from citizens, the central government must rely on its administrative authority to create effective
incentive mechanisms (Zhuravskaya, 2007). For example, fiscal decentralization and the promotion of local officials are two
important institutions that provide market incentives to local governments in China (Huang, 2002; Jin, Qian, & Weingast, 2005; Li
& Zhou, 2005; Xu, in press).
⁎ Tel.: + 86 10 62759485; fax: + 86 10 62751474.
E-mail address: [email protected].
1
The Growth Report (page 4) by the World Bank states that “the administration must also attract and retain talented people, by offering better pay, promotions,
and recognition to officials.”
1043-951X/$ – see front matter © 2010 Elsevier Inc. All rights reserved.
doi:10.1016/j.chieco.2010.12.003
L. Li / China Economic Review 22 (2011) 172–181
173
The current paper examines a specific incentive mechanism that is related to urbanization policies in developing countries. In
China, awarding “city” status to existing counties is the dominant way to create new urban administrative units in the reform era.
The so-called county-to-city upgrading is not only an endorsement of high urbanization levels in existing counties but also
provides local governments many political and fiscal benefits, thus providing the center with an instrument to reward localities.
Furthermore, economic growth rate, which was not written in the formal requirements, plays an important role in determining
which counties can be upgraded to cities. Thus, county-to-city upgrading forms part of the incentive structure of Chinese local
officials in promoting economic growth.
Using data for all counties in China during 1993–1997, I show that the official minimum requirements for county-to-city
upgrading are not enforced in practice. Instead, economic performance is the key to obtaining city status. I provide evidence on the
relationship between a county's economic growth rate and its probability of obtaining city status after controlling for urbanization
levels and other requirements, such as industrial output and fiscal strength. This reflects a principal–agent relationship between
the center and the local governments in which the center uses incentives to induce high growth rate and the localities compete to
obtain rewards, including city status.
The current paper draws extensively on the growing literature on the relationship between urbanization and economic
development. In China, urbanization is featured with the emergence of a large number of new cities, which stands in contrast to
the typical urban growth process of other countries, for which the main channel is the expansion of existing cities (Anderson & Ge,
2005). Studies on China's urbanization and city creation are not rare (e.g., Au & Henderson, 2006a,b; Chung, 1999; Deng, Huang,
Rozelle, & Uchida, 2008), but the political economic driving forces have largely been ignored.2 The present paper makes the first
attempt to interpret city creation as an incentive mechanism to promote economic growth.
This paper also highlights the coexistence of fiscal decentralization and political centralization in China. This unique
institutional setting is attracting growing interest (Blanchard & Shleifer, 2001; Zhang, 2006; Zhuravskaya, 2007). While the
competition and commitment role of fiscal decentralization has been discussed extensively (e.g., Jin et al., 2005; Qian & Weingast,
1997), some recent studies argue that the centralized power structure is also crucial in creating yardstick competition among local
officials and constraining the practice of local protectionism (Bai, Tao, & Tong, 2008; Bo, 2002; Li & Zhou, 2005). In this paper,
upgrading is the result of centralized decision-making and, at the same time, gives local officials more discretion over revenue
collection. The current work provides a chance to learn political centralization and fiscal decentralization in the same setting.
The remainder of the paper is organized as follows. Section 2 introduces the background of county-to-city upgrading. Section 3
describes the data and presents evidence on the non-enforcement of formal upgrading requirements. Section 4 presents empirical
evidence on the incentive role of awarding city status. Section 5 concludes.
2. County-to-city upgrading in China
There are two main sub-provincial administrative levels in China, prefecture and county. County-level jurisdictions have
approximately three thousand individuals and include counties, county-level cities and urban districts.3 At the end of 2008, there
were approximately 1700 counties and 368 county-level cities. In the present paper, “upgrading” refers to the reclassification from
a county into a county-level city. During upgrading, the entire county is labeled a “city.” Thus, a city includes not only the relatively
urbanized section, but also large expanses of rural areas. The administrative units created through upgrading are different from the
typical understanding of the term “city” (Chan, 1997). The creation of cities through upgrading stands in contrast to the experience
of most countries, where “city” and “county” fall into different administrative categories. Cities typically only govern a small area
where urban population is concentrated. Rather than reclassifying an entire county, a new city is normally created inside a county.
Furthermore, the decision is often made through a vote. For example, in the U.S., a new city could be created by adopting a home
rule charter (Hennessey, 2008), while in Brazil, new municipalities are established through local voting (Naritomi, Soares, &
Assuncao, 2007).
At the beginning of China's economic reform in the early 1980s, restricting the size of large cities and promoting small cities and
towns was adopted as the major strategy for achieving urbanization (Saich, 2008). Because setting up a new city government
incurs great administrative costs, upgrading existing counties into cities became the major form of city creation in China (Liu &
Wang, 2000), constituting more than 90% of county-level cities established after 1982. By 1997, nearly 15% of counties had
obtained city status. The total number of cities grew quickly from less than 250 in 1982 to more than 650 in 1997 (See Fig. 1).
The official rule for regulating county-to-city upgrading first appeared in 1983, when cities had shown the advantage in
attracting investment and the demand for city status increased in the coastal provinces. Under some rough requirements proposed
by the Ministry of Personnel and Ministry of Civil Affairs, nearly 100 counties obtained city status during 1983–1986. The number
of cities continued to rise, and the central government raised the minimum requirements for city status in 1986 and 1993. The
1993 requirements set different standards for counties with different population densities. The three major requirements include
the industrialization level, urbanization level, and fiscal strength (see Table 1). Growth rate is not formally written into the
documents as a requirement. It is apparent from Table 1 that the standards vary by population density. The entry barriers for
counties with lower population density were set lower than those with higher population density. This seems to imply that,
according to the central government, setting up cities does not follow the typical notion of urban agglomeration.
2
3
For a general discussion on the political economy of city formation, see Henderson and Becker (2000).
Autonomous counties in the minority area are counted as counties. For a detailed description of the Chinese administrative system, see Chung (1999).
174
L. Li / China Economic Review 22 (2011) 172–181
800
700
number
600
500
400
300
200
100
19
1981
1982
1983
1984
19 85
1986
1987
1988
1989
1990
1991
1992
19 93
1994
1995
1996
19 97
1998
2099
2000
2001
20 02
2003
2004
05
0
year
county-level cities
prefecture-level cities
all cities
Fig. 1. Number of cities in China.
Table 1
Minimum requirements for county-to-city upgrading.
Source: “The Report on Adjusting the Criteria for the Designation of New Cities” by the Ministry of Civil Affairs in 1993 (Available in Zhang & Zhao, 1998).
Population density (person/km2)
N 400
100–400
b100
Percentage of counties in this category
25%
45%
30%
Industrialization level
1.5 billion
80%
150 k
30%
60 million
100
1.2 billion
70%
120 k
25%
50 million
80
0.8 billion
60%
100 k
20%
40 million
60
Urbanization level
Fiscal strength
Industrial output value (yuan)
Share of industrial output value in gross output value
Urban population (engaged in non-agricultural production)
Share of urban population
Fiscal revenue (yuan)
Per capita fiscal revenue (yuan)
As will be shown later in this paper, these formal minimum requirements for upgrading are not enforced in practice. Many
counties that do not meet these requirements gained city status nonetheless. These widespread upgrading cases have masked
China's true urbanization level (Zhang & Zhao, 1998; Zhou & Ma, 2003). In large part because of these problems, the central
government eventually stopped the policy of county-to-city upgrading in 1997, freezing all applications in hand. Since then, no
new cities have been established at the county level. Rather, the total number of cities has remained stable.4 County-to-city
upgrading has not been resumed until now. To discuss the incentive role of this upgrading policy, this paper will focus on the
period before 1997.
Although obtaining city status does not change a county's rank in the administrative hierarchy, its government gains much
more political power, which is the reason for the term “upgrading.” For example, the party secretaries of many county-level cities
are able to enter the standing committee of the prefecture-level party committee and enjoy a deputy-prefecture political rank.5
The administrative authority is also expanded (e.g., in terms of governing local finance, trade, and transportation activities; see
Table 2 for details). In Hubei province, there were experiments to place the budget of county-level cities under the direct
supervision of the provincial government, thus bypassing the prefecture level.6 Table 2 also lists other benefits associated with city
status, among which the most prominent is that cities are granted more quotas to convert farm land into non-farm use. Through
land conversion, local governments can obtain a substantial amount of revenue (Lichtenberg & Ding, 2009).7 Moreover, these
benefits are not only for the local officials, such as larger government size and higher official rank, but for the entire county as
well.8 For example, additional revenues and favorable policies typically result in more urban infrastructures. In sum, localities
were eager to obtain city status in the 1990s (Ren & Wang, 1999).
At the same time, upgrading is costly to the central government. For example, the expanded government size increases salary
expenses that are paid out of the central budget (Wong & Bird, 2008). In many cases, the central government must provide
4
After 1997, some county-level cities were further upgraded into prefecture-level cities, and some counties were transformed into urban districts of
prefecture-level cities. The total number of cities did not change (Chan, Henderson, & Tsui, 2008).
5
The political privilege also brings the local government closer to higher-level governments, thus facilitating the supervision from above. If this is counted as
the cost of upgrading, such a small cost is overshadowed by the political and fiscal benefits. In fact, we have observed great enthusiasm for city status among
counties in the mid 1990s.
6
This is called "line item under province", or Shengji Jihua Danlie.
7
Land revenue belongs exclusively to the local government. In 2009, the total land revenue was 1424 billion RMB yuan, an amount that is equivalent to 1/5 of
the budgetary fiscal revenue.
8
For simplicity, this paper ignores the divergence of objectives among different local officials in a county and assumes that they have the common interest of
obtaining city status.
L. Li / China Economic Review 22 (2011) 172–181
175
Table 2
Benefits of being a city: an incomplete list.
Category
Benefits
Source
Tax and fee
Cities enjoy a higher urban construction tax (7% compared to 5% for counties); could collect
the surcharges levied on the issuing of motorcycle registration. In Liaoning province, cities
could get 1 to 2 million additional subsidies each year after upgrading.
Cities get more quotas to convert farm-land to non-farm use
After achieving the status of “line item under province” (Shengji Jihua Danlie), cities could
report directly to the provincial administration to ask for investment project.
Cities have more authority on foreign trade and exchange management; gains authority
over police recruitment and vehicle administration; could establish the branch of custom
and large State-Owned banks; could approve projects with higher cap of investment.
Cities could establish more branches of government and have a larger size of government employees.
At times, the bureaucratic rank and salary of officials are raised after upgrading.
Cities generally carry greater prestige and are more attractive to outside investors.
Chung and Lam (2004);
Zhang and Zhao (1998)
Land-related
Favorable policy
Administrative power
Government size
Rank and salary
Reputation
Zhang (2006); Ping (2006)
Liu (2004); Su (2000);
Zhang and Zhao (1998)
Chung and Lam (2004);
Du (1993)
Ren and Wang (1999)
Liu (2005)
Gu (1997); Chung and
Lam (2004); Wang, Ji,
and Lin (1998)
Note: Given the volatility of Chinese policies, the benefits are continuously changing overtime; benefits listed are not necessarily effective during the same period.
subsidies to new cities for their infrastructure construction. In addition to these fiscal burdens, inequality could also rise as a result
of the upgrading policy. Because counties that are upgraded are generally rich ones, the favorable policies and subsidies for new
cities are likely to enlarge regional disparity. Thus, as a way of rewarding local governments, the number of city titles is limited, and
the central government faces constraint when making upgrading decisions.
3. Data and descriptive evidence
3.1. Data
Systematic data on Chinese counties is rare, especially for the period before 1990. To the best of my knowledge, only one paper
has used county-level data to study the incentives of local governments (Guo, 2007). The data used in the current paper is from the
yearly series of Sub-Provincial Public Finance Statistics published by the Ministry of Finance. It covers all county-level jurisdictions
and includes detailed public finance and basic socio-economic information.
I use upgrading to capture the political rewards associated with county-to-city upgrading, which differ from the typical
measure of promotion. The specific benefits associated with city status make upgrading a reliable measure of rewards. In contrast,
the existing literature that examines political promotion often faces the problem of identifying when the mobility of an official is a
true promotion and when it is not.9 Compared to promotion, upgrading also suffers less from the omitted-variable problem caused
by unobserved personal relationships. Because the promotion decision of local officials is made by the government at only one
level higher, personal relationships surely play an important role. In contrast, because upgrading is costly, the decision is made in a
deliberate manner (Wu, 2000). In fact, applications for upgrading are submitted to the Ministry of Civil Affairs through each
provincial government, and the State Council is responsible for the approval decision. This strict process is normally beyond the
influence of county leaders.
Data used in the current analysis range from 1993, the first year of the published data, to 1997, when upgrading stopped. Data
of Xizang (Tibet) were dropped because many variables had missing values. A total of 99 upgrading cases were identified through
official records from the Ministry of Civil Affairs. Table 3 shows the summary statistics for upgrading and non-upgrading cases.
Because GDP data are not available at the county level, Gross Value of Industrial and Agricultural Output (GVIAO) is the best
consistent measure of a county's total economic activity. The official requirements on upgrading include industrialization level,
urbanization level, and fiscal strength. Measures for these requirements include industrial output value, share of industrial output
value in GVIAO, urban population, share of urban population in total population, and per capita fiscal revenue. All of the output and
revenue measures were adjusted to 1993 constant prices using the yearly GDP deflator. Except for growth rate, all variables are
averaged from 1993 to 1997.
As summarized in Rawski and Xiao (2001), there are concerns about the accuracy of China's economic statistics in the
literature. Here I address the issue of data quality from three perspectives. First, price reforms in 1993–1994 led to evaluations of
economic statistics based on market prices and eliminated the double counting problem. As noted by Au and Henderson (2006b),
data at sub-provincial levels “at least up to 1997, are viewed as being extremely high quality” and “are less likely to be
manipulated, compared to manipulation at the level of the provinces and centre.” The data used in the current paper are at the
county level and mainly cover the period of 1993–1997; thus, data manipulation should be less of a problem. Second, the public
9
Part of the reason is that the actual power and political benefits enjoyed by an official may be hard to discern using only his or her job title under the Chinese
political system. For example, when a provincial governor is assigned to be the director of the provincial People's Congress, this seemingly lateral move typically
means a loss of power and marks the end of his or her political career. While Li and Zhou (2005) categorize this type of mobility into the same category as
demotion, Bo (2002) simply drops these observations from his study.
176
L. Li / China Economic Review 22 (2011) 172–181
Table 3
Summary statistics (by upgrading status, 1993–1997).
Non-upgrading
Gross value of industrial and agricultural output (GVIAO,10 K yuan)
Per capita GVIAO (yuan)
Growth rate of GVIAO (1994–1997)
Industrial output value
Share of industrial output value in GVIAO
Population (10 K)
Urban population (10 K)
Share of urban population
Budgetary fiscal revenue (10 K yuan)
Fiscal revenue per capita (yuan)
Upgrading
Obs
Mean
Obs
Mean
8,048
8,048
6,349
8,048
8,046
8,053
8,046
8,046
8,053
8,051
145,563
3,220
0.164
97,858
0.527
41.7
4.93
0.138
4255
92.0
99
99
99
99
99
99
99
99
99
99
651,154
8,896
0.246
558,708
0.732
65.2
11.04
0.198
6,980
122
Note: All of the output and revenue measures have been adjusted to 1993 constant prices using the yearly GDP deflator. Growth rate is calculated using adjusted
values.
Table 4
Number of counties that satisfied each upgrading requirement in 1993.
Requirement
Criterion for this requirement
Number of counties (total is 1,678)
Met one criterion
Industrialization level
Urbanization level
Fiscal strength
Industrial output
Share of industrial output
Urban population
Share of urban population
Fiscal revenue
Per capita revenue
329
290
212
212
444
976
(19.6%)
(17.3%)
(12.6%)
(12.6%)
(26.5%)
(58.2%)
Met both
158 (9.4%)
67 (4.0%)
352 (21.0%)
finance dataset used in this paper is compiled by the Ministry of Finance. It is difficult to manipulate statistics on local public
finance activities, such as fiscal revenue, because every statistic reflects actual money flow. In fact, Tsui (2005) and Zhang (2006)
used this dataset and did not find any significant problems. Third, if the local officials in a county attempted to inflate statistics to
obtain city status, they would first inflate industrial output, urban population and fiscal revenue to meet the official requirements,
which are explicitly announced. Thus, checking whether these requirements were satisfied could provide useful information on
local officials' behavior. If the majority of counties that received an upgrade did not meet these requirements, it would be hard to
believe that false reporting is widespread.
3.2. Non-enforcement of upgrading requirements
Because the central government created rules to regulate upgrading, a natural hypothesis is that the center aims to enforce
these rules. However, many scholars (e.g., Chung & Lam, 2004; Liu & Wang, 2000) have observed that the official minimum
requirements for upgrading are not enforced in practice. While eligible counties compete for upgrades, some ineligible counties
received city status due to special treatment. Thus, the conjecture is that the formal minimum requirements for upgrading were
not enforced in practice. The data allow me to directly determine whether counties that received an upgrade met those
requirements.
The three major requirements include industrialization level, urbanization level, and fiscal strength. Each requirement has an
absolute criterion and a relative (or per capita) criterion. For counties with different population densities, these upgrading
requirements differ. Based on the 1993 data, I summarized the number and percentage of counties that met each criterion as well
as those that met both criteria of a specific requirement (Table 4).10 This table shows that the requirement on the urbanization
level is quite stringent, while the fiscal strength requirement is less binding.
I then assigned all county-year observations of 1994–1997 into different groups according to whether the three requirements
were satisfied. For example, for a county with a population density above 400 people per square kilometers to satisfy the fiscal
requirement in a particular year, its fiscal revenue must have exceeded 60 million RMB yuan, and the per capita revenue must have
been higher than 100 RMB yuan. Table 5 lists the number of observations in each of these groups according to whether upgrading
10
In the official requirements shown in Table 1, “urban population” refers to those who are engaged in non-agricultural production. There is no direct report of
this variable in the current dataset. Instead, I have data on the population with urban registration status for each county. For each population density group, I also
know the average ratio of the population engaged in non-agricultural production to the population with urban registration status. I multiplied these two
numbers to obtain an estimate of the population engaged in non-agricultural production for each county and used this number to determine whether a county
met the requirement on the urbanization level.
L. Li / China Economic Review 22 (2011) 172–181
177
Table 5
Number of county-year observations by upgrading status and specific requirements satisfied (1994–1997).
Urbanization requirement
Not satisfied
Industrialization requirement
Non-upgrading cases
Upgrading cases
Fiscal
Fiscal
Fiscal
Fiscal
requirement
requirement
requirement
requirement
not satisfied
satisfied
not satisfied
satisfied
Satisfied
Not satisfied
Satisfied
Not satisfied
Satisfied
4583
1005
24
14
212
375
14
31
96
83
2
8
5
36
0
6
Table 6
Number of county-year observations by upgrading status and number of requirements satisfied (1994–1997).
Number of requirements satisfied
0
1
2
3
Total
Non-upgrading cases
Upgrading cases
4583
24
1313
30
463
39
36
6
6395
99
occurred. To ease the reading of the results, I further combined cells with an equal number of satisfied requirements and
summarized them in Table 6. Among the 99 cases of upgrading, only 6 met all three requirements, 39 met two, 30 met only one,
and 24 met none. On the other hand, there were 36 cases for which all three requirements were met but the counties were not
upgraded. This table clearly demonstrates that the official requirements were not enforced in practice.
4. Importance of growth rate in obtaining city status
Because the formal rules were not enforced in practice, upgrading should not be an instrument for urbanization. The central
government must have had other considerations when making decisions. That is, informal rules existed that were not explicitly
written in the official documents but nonetheless played an important role in the upgrading decision. Although unusual, this has
been a normal practice in the Chinese political system. In this section, I investigate the incentive role of county-to-city upgrading in
terms of promoting economic growth under the principal–agent relationship between the center and localities.
4.1. Empirical strategy
Awarding city status is a way to promote urbanization. More importantly, because city status provides many benefits to local
governments, it could be used to provide incentives to local governments to achieve certain goals. Growth has been widely
regarded as a critical component in the central government's preference set. As stated in Section 2, upgrading is costly to the
central government. Thus, the central government faces a problem of promoting growth with limited resources; therefore, it must
select appropriate counties to receive city status. With knowledge of the center's true preference, local governments compete to
obtain the lucrative benefits associated with city status. In the following, I directly examine how the upgrading prospects related to
each county's growth rate.
To show the importance of growth rate, Fig. 2 displays the number of upgrading cases from 1981 to 1997 as well as the
corresponding yearly GDP growth rate. We can clearly observe several waves of upgrading around 1983, 1988, and 1993, which
roughly correspond to the periods when China experienced high economic growth. This figure suggests that high growth may
generate high demand for upgrading at the national level. To test the positive effect of growth rate on upgrading, I conducted the
analysis at the county level and controlled for other confounding factors that affect upgrading. It is evident that industrialization
level, urbanization level and fiscal strength are important factors because they were listed in the official documents. Thus, the main
hypothesis of this paper is that, conditional on industrialization level, urbanization level, and fiscal strength, the higher the growth
rate, the more likely upgrading occurred.
I modeled upgrading as a discrete choice problem faced by the central government.11 For county i at year t, the upgrading
decision Yit depends on the county's growth rate Git and a vector of other county-specific control variables Zit, such as industrial
output, urban population, and fiscal revenue. I used a logit model to estimate the impact of these variables on the probability of
upgrading:
PrðYit = 1Þ = Φðβ0 + Git β1 + Zit β2 Þ = expðβ0 + Git β1 + Zit β2 Þ = ð1 + expðβ0 + Git β1 + Zit β2 ÞÞ:
11
If we assume that 1) all counties started to have a chance to upgrade in 1983, the beginning year of the policy, and 2) upgrading to city status is an ultimate
outcome for most counties with sufficient time, then upgrading could be alternatively treated as a duration problem. Obtaining city status means the ending of
spells, and the probability of upgrading is the corresponding hazard. However, because I can only follow the subjects for 5 periods, it is difficult to extract any
meaningful information on the shape of the hazard of ending the spell. Thus, a duration model is not adopted in this paper. In fact, a linear model could be used to
approximate a duration model. Currie and Neidell (2005) adopted a similar method to estimate the determinants of infant death.
178
L. Li / China Economic Review 22 (2011) 172–181
60
18%
16%
50
14%
12%
10%
30
%
number
40
8%
6%
20
4%
10
2%
0%
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
82
83
19
19
19
8
1
0
year
number of upgrading (left axis)
growth rate of GDP (right axis)
Data source: GDP is from the 2006 China Statistical Year book published by the
National Bureau of Statistics; number of upgrading is from Liu and Wang (2000).
Fig. 2. Number of county-to-city upgrading cases and yearly GDP growth rate.
To estimate this model using data from different years, I treated a county that was upgraded in year t as if it contributed t-1993
county-year observations to the sample. The dependent variable was coded as 1 in the year that the county was upgraded and 0 in
all other years. All county-year observations after upgrading were dropped.12 This sample construction approach is similar to that
used by Currie and Neidell (2005).
4.2. Baseline results
I closely followed the official requirements for upgrading and controlled for industrial output value, share of industrial output
in gross output, urban population, share of urban population in total population, and per capita fiscal revenue. This specification
allows me to estimate the effect of growth rate conditional on industrialization level, urbanization level, and fiscal strength. All of
these control variables were lagged by one year to reflect the timing of upgrading decision, which should be based on realized local
performance. Because counties vary greatly in size, I applied a log transformation to those level variables to reduce the effect of
outliers.
Table 7 Column 1 reports the estimation results, listing coefficients and robust standard errors clustered at the prefecture level.
The key independent variable, growth rate of GVIAO, had a positive and significant coefficient. This finding is consistent with the
hypothesis that, conditional on industrialization level, urbanization level and fiscal strength, a higher growth rate increased the
probability of achieving city status.
Among the five control variables that measure the official requirements, urban population and fiscal revenue per capita had
positive and significant coefficients. While industrial output and its share in total output had positive and insignificant coefficients,
share of urban population had a negative and insignificant coefficient. To further control for the variation of upgrading policy
across years, which is common for all counties, I added year dummies (Column 2). The only change to the estimates was that the
coefficient on share of urban population became positive but remained insignificant. In Column 3, I added province dummies. This
is equivalent to asking the following question: what makes a county stand out from its peers in the same province in competing for
city status? The results were similar to Column 1, suggesting that growth was important in the within-province competition. Then
I controlled for both year and province fixed effects (Column 4). There was little change to the estimates of control variables,
except that industrial output became significant. In all of these models, growth rate remained positive and significant.
Because several provinces do not govern any county that was upgraded during the sample period, adding province dummies
resulted in dropping counties in these provinces from the estimation. To compare the coefficient size between the baseline
model and the model with year and province dummies, Column 5 reports the estimation results using the same sample as in
Column 4 without controlling for year and province dummies. Overall, adding province and year dummies generated a larger
coefficient on growth rate, which suggests that they may capture the effect of omitted variables. For example, if the upgrading
policy is in favor of provinces with low growth potential, such a bias in policy would have a negative correlation with growth
and a positive correlation with upgrading. Therefore, including province dummies eliminated the effect of this omitted variable
and increased the coefficient on growth rate. In the following alternative specifications, I will report results with province and
year dummies.
12
Because no city was downgraded to a county, we do not include cities into this discrete choice problem.
L. Li / China Economic Review 22 (2011) 172–181
179
Table 7
Positive effect of growth rate on upgrading—logit model.
Growth rate of GVIAO
Log(industrial output)
Share of industrial output
Log(urban population)
Share of urban population
Log(fiscal revenue per capita)
Year Dummies
Province Dummies
Sample size
(1)
(2)
(3)
(4)
(5)
0.473**
(0.211)
0.033
(0.257)
1.934
(1.267)
1.949***
(0.369)
− 1.304
(1.864)
1.097***
(0.272)
0.519**
(0.261)
0.367
(0.301)
1.322
(1.375)
1.584***
(0.396)
0.976
(2.002)
0.650*
(0.352)
Yes
0.546**
(0.224)
0.456
(0.282)
2.028
(1.345)
2.189***
(0.404)
− 1.374
(2.334)
1.390***
(0.276)
0.426*
(0.219)
0.103
(0.267)
1.903
(1.788)
1.978***
(0.367)
− 1.341
(1.317)
1.360***
(0.244)
6,436
6,436
0.749***
(0.275)
1.130***
(0.323)
0.950
(1.454)
1.600***
(0.395)
2.251
(2.313)
0.684**
(0.332)
Yes
Yes
5,649
Yes
5,649
5,649
Note: Coefficients and robust standard errors clustered at the prefecture level are listed. Significance levels of 10%, 5% and 1% are represented by *, ** and ***,
respectively. Except for growth rate and year dummies, other control variables are lagged by one year.
To assess the economic magnitude of the effect of growth rate, I also calculated the marginal effect. In the estimation of Column 4,
the mean marginal effect of growth rate on upgrading probability equals 0.01. This implies that when the annual growth rate
increased by ten percentage points (e.g., from the average growth rate of 16% to 26%), the probability of upgrading increased by
0.001, which is approximately 7% of the average upgrading probability of 0.015.13 The change in probability of upgrading if
industrial output moved from the 25th percentile to the 75th percentile was 0.022, which is approximately 1.4 times the average
upgrading probability. For urban population and fiscal revenue per capita, this value was 0.026 and 0.007, respectively. These
values are in reasonable ranges.
4.3. Robustness checks
To check the sensitivity of the baseline results, I adopted alternative definitions of growth rate as well as various specifications
and techniques to estimate the model. The results are reported in Table 8.
Because upgrading decisions are made throughout a year, it is likely that the center refers to the previous year's performance
when making decisions. To determine whether the results are sensitive to different timing, I lagged growth rate by one year and
lagged all other independent variables by two years. The use of lagged values could also partially deal with the potential reverse
causality problem. The results (Column 1) are generally similar to the baseline results, with an even larger coefficient on growth
rate, suggesting that the results are robust to the different timing of variables.
By including all counties in the estimation, I implicitly assume that every county has a chance of upgrading and thus faces
incentives. In fact, some counties have little chance of obtaining city status; therefore, the upgrading policy does not provide any
incentive for them to increase growth rates.14 One group of these counties is the nationally designated poor counties, which
receive special subsidies from the center every year. The official document in 1993 (which also set the requirements on upgrading)
explicitly states that these counties generally should not be considered for an upgrade. Thus, I dropped these counties and reestimated the baseline model (Column 2). The results were similar.
Furthermore, I adopted alternative measures for growth rate. Chen, Li, and Zhou (2005) showed that relative performance
matters more than absolute performance in evaluating provincial officials. Following their method, I subtracted the average
growth rate of counties in the same prefecture from each county's growth rate and generated an alternative growth measure −
relative growth rate (Column 3). The relative growth rate had a positive and significant coefficient, and the size was even larger
than the previous measure of growth rate. This suggests that relative growth rate is also used as a reference in the evaluation of
counties' economic performance.
Following Li and Zhou (2005), I used average growth rate as another alternative growth measure, where the averaging is from
the beginning of the sample to the current year. This measure corresponds to an evaluation process that is based on both the
current and past growth rates. The results (Column 4) show that, although not statistically significant, the coefficient on average
growth rate had a magnitude similar to the baseline results. These exercises show that the baseline results were not driven by a
particular definition of growth rate.
The current sample covers several years, and the upgrading policy may vary across time. Additionally, growth rates in different
years may not be comparable to each other. For example, a growth rate of 14% was below average in 1994, but was above average
13
This magnitude is comparable to that estimated in Li and Zhou (2005). They showed that if the GDP growth rate of a province increased by the same amount
(10 percentage points from mean), the probability of provincial leaders obtaining a promotion increased by an amount that is 24% of the average probability.
14
Ideally, I should only look at those counties that joined the competition for city status. Unfortunately, the list of counties that submitted an application or did
any preparation is not available.
180
L. Li / China Economic Review 22 (2011) 172–181
Table 8
Positive effect of growth rate on upgrading—robustness checks.
Growth rate of GVIAO
Log(industrial output)
Share of industrial output
Log(urban population)
Share of urban population
Log(fiscal revenue per capita)
Year dummies
Province dummies
Sample size
Lagged
timing
Exclude poor
counties
Relative
growth rate
Average
growth rate
Split sample:
1994–1995
Split sample:
1996–1997
One crosssection
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1.107**
(0.470)
1.191**
(0.482)
1.514
(2.158)
1.679**
(0.664)
− 0.468
(2.741)
1.574***
(0.444)
Yes
Yes
3,904
0.739***
(0.282)
1.011***
(0.337)
1.169
(1.488)
1.618***
(0.400)
1.579
(2.390)
0.625*
(0.335)
Yes
Yes
3885
0.814**
(0.392)
1.06***
(0.315)
1.903
(2.259)
1.66***
(0.395)
1.121
(1.429)
0.732**
(0.331)
Yes
Yes
5,649
0.663
(0.438)
0.98***
(0.317)
1.617
(1.421)
1.73***
(0.400)
1.332
(2.314)
0.752**
(0.335)
Yes
Yes
5,654
0.592*
(0.345)
1.128***
(0.382)
1.451
(1.770)
1.648***
(0.481)
1.518
(3.209)
0.340
(0.444)
Yes
Yes
2,699
0.686*
(0.401)
1.272**
(0.591)
− 0.704
(2.524)
1.739**
(0.722)
6.517*
(3.470)
1.348**
(0.575)
Yes
Yes
2,511
0.967
(0.884)
− 0.276
(0.474)
2.50
(2.03)
3.58***
(0.598)
− 8.01***
(3.57)
3.65***
(0.487)
Yes
1,486
Note: Coefficients and robust standard errors clustered at the prefecture level are listed. Significance levels of 10%, 5% and 1% are represented by *, ** and ***,
respectively. In column 1, growth rate is lagged by one year; other control variables are lagged by two years.
in 1997. Controlling for year fixed effects could partially lessen this problem by allowing different intercepts for different years, but
the marginal effect of growth rate may also change. Ideally, I should estimate the model year-by-year to check the robustness of
the effect of the growth rate in different years. Due to the limited sample size and few upgraded cases in some years, I split the
sample into two periods: 1994–1995 and 1996–1997. The estimation of these two sub-samples (Columns 5 and 6) was consistent
with the baseline model. In addition, I estimated the model in a cross-section setting where each county served as one observation.
In this specification, the dependent variable equals one if the county obtained an upgrade during the sampling years, and the
independent variables are the average values across these years. Although the small sample size generates larger standard errors,
the results provide evidence on the positive effect of growth rate (Column 7). These tests demonstrate that, even though the
upgrading policy may vary across time, growth rate plays a crucial role.
In sum, the regression results show that the effect of growth rate on the chance of obtaining city status is robust. Whether in an
absolute or relative sense, growth rate plays the key role in upgrading. While the requirements included in the official guidelines
are not enforced in practice, the central government tends to upgrade counties with faster growth rates into cities.
5. Conclusion
Based on the example of creating cities in China, this paper relates urbanization policy with a fundamental question faced by
the central government in developing countries of how to provide incentives to local governments. The current work found that
economic growth plays an important role in determining whether a county obtains city status. The policy of “county-to-city
upgrading” serves as an incentive mechanism to promote economic growth, forming part of the incentive structure of motivating
local officials, Chinese style. However, it should be noted that upgrading only provides a one-time incentive to localities. This
incentive mechanism is backward-looking in the sense that the rewards are for past economic performances only and may lack
long-term effects.
It has been argued in the literature that China is underurbanized, both from the perspective of international comparison and
judged by the efficiency standard.15 Au and Henderson (2006a,b) proposed that various explicit and implicit restrictions on
migration are the main reason for China's underurbanization. Lin, Cai, & Li (1996) regarded these restrictions as being endogenous
to the development strategy that favors capital-intensive heavy industry over light industry and agriculture. The current study
provides another possible reason. Instead of being the natural outcome of agglomeration, city creation has been used as an
incentive instrument to serve political purposes, but likely at the cost of promoting real urbanization.
Providing incentives through upgrading has not only affected the urbanization level in China but has also fundamentally
changed China's administrative and governance structure. Such changes were made by the central government, likely under
pressure from localities, and are different from the political coalition or government decentralization in developed countries
(Alesina, Baqir, & Hoxby, 2004; Hennessey, 2008; Weese, 2009). Many county-level cities are now governed by prefecture-level
cities. The Constitution of the People's Republic of China does not provide for the administration of one city (county-level) by
another (prefecture-level) (Chan, 1997). Recently, promoting urbanization has been listed high on the policy agenda. The
15
By international standards, China's urban population ratio seems to be significantly lower than many other countries at the same development level (World
Bank, 2008; Zhou & Ma, 2003). From the efficiency point of view, Au and Henderson (2006a,b) shows that Chinese cities are far from optimal, suggesting that
further city expansion will bring about income growth. It is also commonly believed that China's urbanization lags behind its industrialization process. Sridhar
and Wan (2007) find that China's urbanization rate is 10 percentage points lower than its industrialization level. The presence of a large number of dependents
not being able to unite with the migrant workers in cities indicates that urbanization lags behind industrialization in a real sense (Lu, Huang, Lu, & Zhou, 2007).
L. Li / China Economic Review 22 (2011) 172–181
181
urbanization policy has been shifted toward a balanced development of large, medium, and small cities, as well as towns.
Understanding the political economy of city formation in the 1990s would provide an important reference for future city
development.
Acknowledgements
I want to thank Peter Murrell, Roger Betancourt, Alan Drazen, Shenggen Fan, Athar Hussain, Ginger Jin, Melissa Kearney, James
Kung, Yi-Min Lin, Wallace Oates, Xinqiao Ping, John Wallis, Chenggang Xu, Li-An Zhou, two anonymous referees, and seminar
participants at Fudan, HKUST, IFPRI, University of Maryland, SHUFE, SWUFE, Zhejiang University, CES 2006 Shanghai meeting, AEA
2007 Chicago meeting, and the 2009 Seoul National University WCU-Hong Kong University Conference for helpful comments.
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