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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
Decentralization, Growth and Unfairness
Qijing Yang
Abstract: In this paper, we stress one of basic questions in the process of industrialization and
urbanization is how to transfer resources from less efficient to high efficient sectors. In
comparative institutional analysis, we prove that although the economic decentralization and
inter-jurisdictional competition for mobile capital help to build a friendly business environment,
and to promote economic growth, but also cause the government to grab vulnerable groups. This
dilemma might become most seriously in tournament among local governments. However, growth
and some social injustice may be two sides of a coin in the process of development. Therefore, it
is necessary to adopt appropriate institutional and contractual arrangements to ensure the
appropriate balance between economic growth and unfairness.
Key words: decentralization, inter-jurisdictional competition, Growth, unfairness
JEL: H11
H77 O10
1. Introduction
Enlightened by the history of the development in Anglo-American countries,
Weingast (1995) and others systematically put forward the market-preserved
federalism, and emphasize that the decentralization and inter-jurisdictional
competition for mobile capital may prompt local governments to build a friendly
business environment, thereby to promote economic growth. Subsequently, huge
literature has been emerging, and attributed the success of China's reforms to
Chinese-style market-preserved federalism (Montinola et al, 1995), which places
special emphasis on GDP as the core to political performance evaluation and
promotion (Yang, 1998; Maskin et al, 2000; Li and Zhou, 2005; Wang et al, 2007;
Zhou, 2007). At the same time, many empirical studies also confirmed that there are
positive correlation between economic growth (reform) and fiscal decentralization
(Zhuravskaya, 2000; Jin et al, 2005; Lin Yifu, Liu Zhiqiang, 2000; Zhang and Gong,
2006). However, the scholars also realize that federalism would hurt social harmony
as by-products of economic growth, because it may not only lead to imbalance
between jurisdictions (Cai and Treisman, 2005), and local protectionism (Young, 2000;
Zhou, 2004), but also may produce some social inequality. First, local governments
strongly prefer to reduce the spending on education, health care and other public
goods in order to increase the constructive spending (Qian and Roland, 1998; Yong
and Zhang, 2007). Secondly, it always triggers vicious competition (race to bottom) to
cut tax rates and environmental regulatory standards (Oates and Schwab, 1988;
Qijing
Yang, Associate Professor in the Study Center for Firms and Organizations, the School of Economics,
Renmin University of China. This research is supported by National Excellent Author of Ph.D. Thesis and “Project
985” in RUC.
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
Rodden and Rose-Ackerman, 1997; Oates, 1999; Revesz, 2001). In a word, the
contradiction between growth and social harmony has been discussed to some extent.
However, there are still some seriously inadequate.
Firstly, although federalism focuses on the issues of development, the
governments in the existing models are not particularly concerned about the following
basic question in developing countries. How can government prompt resources (such
as land, labor, capital, etc.) to be transferred from the inefficient sectors (for example,
agriculture, traditional state-owned enterprises) to the more efficient sectors and areas,
while maintaining social harmony and stability?
Secondly, the federalism is always simply considered as fiscal federalism.
However, considering the transaction costs and information advantage, local
governments are always granted much actual discretion on many important resources
(for example, land, minerals, state-owned enterprises, environment, labor, etc.). It
means a lot of political and economic authorities are decentralized to local
governments. In a world, federalism is a multi-dimension institutional arrangement
between central and local governments (Treisman, 2000).
Thirdly, the federalism usually assumes that the friendly policies to investors and
enterprises will be supports by the residents because they will share the benefits of
economic growth. However, it is not always true because the friendly help hands must
base on some unfair transactions with vulnerable groups. In this situation, the
government can not be simply assumed as the representative of all (median) voters
(Oates and Schwab, 1988). Therefore, we can neither analyse the relationship between
economic growth and social harmony, nor comprehensively understand the content
and scope of decentralization and incentive contracts between central and local
governments.
Moreover, the political micro-environment is absent to be described carefully
(Rodden and Rose-Ackerman, 1997)｡ Given the decentralization and incentive
contract, the behaviors of local governments also depend on the environment of
political economy that they live in. For example, different voting institutions and
different structure of voters will induce governments to act in different way. In this
paper, the population proportion, voice of residents in the traditional sector, as well as
the power of the investors, will affect the behavior of local governments.
Finally, we get used to discussing this question only in the following specific
institutional environment, which is characterized with fiscal federalism, tournament
among local governments, and inter-jurisdictional competition for mobile capital. In
other words, since the absence of comparative institutional analysis, it is very difficult
not only to understand the relationships between growth and inequality in the process
of industrialization and urbanization, but also to identify which are the outcomes of
developing, or the market power of mobile capital, or the specific decentralization, or
the measure of political performance and the relevant incentive contracts.
Considering the above, this paper focuses on those developing countries, where
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
the capital is very scarce, and the social-economic and institutional environment is
also poor. We hope to understand how their governments take part in land acquisition
and trading, and how they balance between growth and inequality in the
industrialization and urbanization under different decentralization arrangement,
political incentive contracts. Hence, we try to compare the strategic behaviours of
local governments in three models with different institutional environments. The first
is the benchmark model, where mobile capital can’t be moved among different
jurisdictions and the political performance of each local government is the economic
growth and social harmony in their own jurisdictions. Actually, it can be considered
as a closed country that hasn’t be disturbed by outside market and authority. It is
possible for us to discover some pure problems about development. The second is the
normal competition model, where the local governments are still measured
independently, but the mobile capital can be moved among different jurisdictions
before investment. The third is the tournament model, where mobile capital can be
moved among different jurisdictions and the performance of local governments are
mainly evaluated in relative-GDP growth. Comparing the second with first model, we
may find the influence of the market power on the local government. Moreover,
comparing the third with second model, we may identify the affects of incentive
contracts to the strategic behaviors of local governments.
Our research shows that at the early stage of economic development, in order to
prompt the resources transferred from low efficient sectors to high efficient sectors, it
is necessary for government to take part in some transactions which may be to some
extend unfair. Meanwhile, It is not only market power from inter-jurisdictional
competition for mobile capital, but also the contractual incentives from tournament
based on relative economic growth among local governments, which are likely to
speed up the transfer process and economic growth. However, they are also likely to
worsen the trade fairness and endanger social harmony. This means that federalism is
not so beautiful described by its advocates, because when local governments give
warmer “helping hand” to the enterprises and investors (Frye and Shleifer, 1997) and
thus promote economic growth, but they prefer to stretch out “grabbing hand” to the
vulnerable groups, thus jeopardizing the social harmony. These models suggest that
not only the content of decentralization but also incentive contracts should be
appropriately adjusted along the process of development in order to balance the
growth and social harmony. Nevertheless, owing to limited space, we can’t discuss
the issues of the optimal decentralization and political incentive contract in detail in
this paper.
Ⅱ. The Setup of the Models
1. The Production and Unfair Trade
We suppose an underdeveloped country with many identical localities. Each of
them has N units of land and population with Y0 of per capita GDP, and is
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
decentralized with Z0  Y0 t of fiscal revenue. At the beginning of the tenure, each
local government is granted with L units of land, which can be exploited for
industrialization or urbanization although it is now used in efficient industry such as
orthodoxy agriculture. Because the economy is underdeveloped and the capital is very
scarce, each local government tries to absorb mobile capital as much as possible.
However, the mobile capital per se is not the actual production capability unless it is
transformed into capital goods, such as constructions and equipments. In a given era,
the production technology defines the ratio of factors, although it is not absolute. We
assume each one unit of capital goods needs  units of land.
Without loss of the generality, the price of the capital goods is normalized as 1, and
p is the market price of the land. However, the local government provides the land to
investors at actual price aie p , where aie  [0, 1] . It is important part of friendly-business
policies. In our paper, p is exogenous. In the rough, the more developed the economy
is, the more important for the production the land is. Hence, to some extent, the scale
of p implies the scarce degree of the land and the level of economic development.
If the amount of potential mobile capital is Fi , it may be transformed into
K i  Fi  (1   aie p ) 1 of capital goods. It can not become realistic production
capability before the tenure is over, unless the necessary infrastructure ( I i ) is
provided. If all are right, there will be economic growth:
yi =vI i Ki  vI i Fi  (1   aie p ) 
Where v ,  ,  are positive parameters. For simplification, let     1 . The society
must enjoy some positive utility although the marginal effects would decrease at a
given period. Meanwhile, some reserved growth ( y ) is required by the society; or
else, the society must suffer great pains such as high level of unemployment. For
simplification, let y  0 , and let the social utility of growth as ln yi ①.
However, it can’t become true unless enough land can be confiscated in time. We
① We can also assume that there is an expected benchmark growth
than
yi . Only if the actual growth ( yi ) is larger
yi , the society can enjoy positive utility: (ln yi  ln yi ) .
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
assume each government prefers to confiscate all the L units of land in order to avoid
any opportunity of growth although some of the land may be not uses. The acquired
price is air p , where air  [0, 1] . Obviously, it is an unequal transaction and the
residents become victims unless air  1 . The marginal negative social effects would
increase with the degree of the inequality. And, the higher the land price is, more
negative effects the victim must suffer. Considering the proportion of the victim
is LN 1 , let the negative utility of the inequality as  N 1 Lp ln air ,② where  is a
nonnegative parameter.
2. The Utility Function
Any society is a political unit, where different interesting groups pay different
attention to growth and inequality. Through its political mechanism, the society
delegates a government to develop economy and preserve equality. Let h  [0, 1] and
(1  h) denote the weight assigned to growth and inequality by the society,
respectively. Meanwhile, each local government has preference to private benefits
( C )③. Thus, let the utility of each local government as the following.
U  h ln yi  (1  h) N 1Lair p ln air  c ln Ci
Note that c implies how efficient the central government or society monitors and
punishes the local government who pursue the private benefits.
3. The Budget
Because the new production capability is not the available source of fiscal revenue,
local government i can collect disposable revenue from two resources. One is T0 , the
other is to sale the land ( Li aie p ), where Li is the amount of sold land. We assume all
of the revenue is spent on the compensation to the victims, productive infrastructure,
and his private benefits.
Z0  Li aie p  Lair p+Ii  Ci
② Strictly speaking, the function of negative effects should be drawn as Ei (air )
  i ln(air   i ) , where
i  0 .
③
Bi can be also interpreted as the public goods and services, such as education, health, defense, and so on.
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
Table 1
To
commit
investors:
( aie p , I )
Mobile Capital:
Fi
Capital Goods:
K  Fi  (1  aie p )1
Growth: lnyi
Ineq.:N-1Lln air
To Confiscate land:
( ar p , L )
4. The participation Condition of Investors
Besides, only if the return rate is not less than the reserved rate ( r0 ), namely,
participation condition of investors is held, the investment would happen.
(1  t )
y
 (1  t )v I  F  1 (1  ae p )    r0
F
1
It is easy to know the maximum amount of capital is Fmax  I (v (1  t )r0 )  that can be
-1
absorbed at a given period, even if the land is provided freely. However, this condition is
neglected as most of relevant literature in order to simplify analysis.
Ⅲ. Institutional Comparative Analysis
1. The Benchmark Model
As a benchmark model, we assume each locality is independent to others. That is
the mobile capital can be moved among them. Meanwhile, the performance of the
local governments is also evaluated independently. Now, the strategy of local
government i can be drawn as below.
(2)
max
( air , aie , I i ,Ci )
U  h ln yi  (1  h) LN 1 p ln air  c ln Ci
s.t. (3) Z 0  aie p Fi  (1  aie p ) 1  Lair p  I i  Ci
(4) Fi  F
According to Lagrange multiplier procedure, the optimal solution is the following.
（1-1） air  (1  h) N
B*
 B1
1
（1-2） aie  [(  h)  B F  1]( p)
B*
B*
（1-3） I i
1
1
  h B1
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Decentralization, Growth and Social Harmony
B*
（1-4） Ci
Qijing Yang,RUC
 c B1
where  B1  ( Z 0  F )( N 1Lp(1  h)  h  c)1 . And the expected growth at the end of tenure
is Yi
B*
 v    h B1 .
Proposition 1 In a capital-scarce society, as long as the society prefers to high
economic growth (that is h is not small), the social first-best prices of some critical
resources paid by government and enterprises should be to some extent less than the
actual prices, namely, airB*  1 , aieB*  1 ,
even if c  0 .
Although it is a very disputable proposition and perhaps induces lots of people
unhappy, even very angry, it maybe stands a good chance to be true. In a society, not
only capital ( F ) is very scarce, the institutional environment and economic
conditions ( v ) are very poor, but also the government has not enough fiscal resource
to improve its infrastructure. It is not easy to satisfy the participation constraint
condition of investors. At the same time, there is huge land sunk in less-productive
sector, for example traditional agriculture. Only after the land is used by entrepreneurs
and combined with capital, can they become a part of actual production capability,
and realize its relative high economic value, and improve the economic growth.
Hence, how to resolve this paradox is very important for the society.
Unfortunately, Coasean bargaining (1960) is not a feasible resolution to this
problem in many situations because of the bargaining costs. Even if such bargaining
could be feasible, it would be only a static Pareto efficiency, because a lot of financial
capital is not converted into capital goods but non-capital income. As a result, the
society enjoys the equality but losses the chance of faster growth. It is only equality
with poverty! Hence, it may be necessary to allow government creating and taking
part in some unfair transaction in disfavor of the relevant agents (henceforth,
“victims”) but in favor of entrepreneurs. Note that, such transition is the social choice,
although the direct player is government and it is always companied with corruption.
Proposition 2: In the decentralization arrangement
( N , t , L) and incentive
contract ( h,1  h, c) , the characteristics of the strategic behavior of the local government are
the following.
（ⅰ）
aieB*
I iB*
CiB*
yiB*
airB*
，
，
，
，thus
>0
<0
>0
<0 ；
0
c
c
c
c
c
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Decentralization, Growth and Social Harmony
（ⅱ）
（ⅲ）
Qijing Yang,RUC
I B*
C B*
airB*
a B*
yiB*
<0 ， ie <0 ， i >0 ， i  0 ，thus
0；
h
h
h
h
h
airB*
a B*
I B*
C B*
yiB*
<0 ， ie <0 ， i <0 ， i <0 ，thus
0；
p
p
p
p
p
I iB*
aieB*
aieB*
（ⅳ）
0；
0，
0，



（ⅴ）
I B*
C B*
y B*
airB*
a B*
 0 ， ie  0 ， i  0 ， i  0 ，thus i  0 ；
F
F
F
F
F
airB*
aieB*
I iB*
CiB*
yiB*
（ⅵ）
0，
0，
0，
 0 ，thus
0。
Z 0
Z 0
Z 0
Z 0
Z 0
Proposition 2 is very easy to understand.
(1) If the local government strongly prefers to collect private benefits ( c  ), such
as corruption, luxurious officious conditions and so on, he must be less interested to
develop economy. As a result, he tries to claim high price from enterprises ( aie  ),
exploit much wealth from residents ( air  ), invest less productive infrastructure
( I i  ), in order to increase his private benefits ( Ci  ). Consequently, the society
suffers inequality and less growth.
(2) When the society is much eager for the growth ( h  ), and the infrastructure is
very important to facilitate investment and production (   ), it would support great
amount of productive infrastructure ( I i  ). Of course, the larger the financial capital
is ( F  ), the larger the available fiscal revenue ( Z 0  ), the more the government
should invest on infrastructure ( I i  ). Consequently, there are more capital goods,
more infrastructure, and faster growth. On the contrary, if the society emphasizes
equality ( (1  h)  ) and intensifies to prevent the local governments from pursuing
private benefits, not only the scale of capital goods but also the fiscal revenue which
can be allocated to infrastructure is relative small. As a result, the growth is relative
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
slow. Besides, if the land is very scarce and expensive ( p ), it is very difficult to
exploit the residents and decrease the supply price to enterprises, the growth would be
low.
According to the above two propositions, we can get a main conclusion: If a society
is eager for faster growth, it is necessary to suffer more serious inequality. Although
the previous research has realized the government should not be grabbing hand but
helping hand to enterprises (Frye and Shleifer, 1997), they haven’t recognized that
while society welcomes one helping hand to the enterprises from government, the
society would accept other grabbing hand to some weak groups in many poor
developing countries. However, it is almost a common principle of development for
every existing developed country (Chang, 2002). Perhaps, it is not a realistic good
choice for those societies that both of two governmental hands are warm helping hand.
In other word, what is the real important issue for those societies is how to avoid both
of governmental hand becoming grabbing hands, and how to distribute the results of
growth!
Moreover, we can further induce several important conclusions.
(1) In order to develop economy, it may be necessary for government to create and
involve to some extent unequal transaction in a country where the capital is very
scarce. Especially, when the scarce capital is dispersed in the individual hand and the
capital market is very less developed, such inequality may be more necessary.
(2) If the jurisdiction is extreme small, the government is too weak ( Z 0  ) to
compensate the residents or invest productive infrastructure. At the same time, if it is
a democratic society, such transition would be very difficult, because the relevant
victims perhaps are very important group in a small society ( (1  hi )  ). In this
situation, there would be less unfair transactions in a given period, but the poor
society might loss the chance to growth which would benefit most residents including
the former sacrificed. As a result, the poor residents might suffer more serious
inequality in long term.
(3) If the legal reward to politicians is poor, the quality of the government would
be poor. In the reality, when the political competition is too fierce and the government
is rather unstable, the incumbent governors would be engaged in collecting private
benefits. Consequently, their behaviors may not only exacerbate serious inequality,
but also induce none-friendly-business environment. The society might suffer
inequality and less growth.
Now, we induce further judgments.
Corollary 1 It is very important for economic growth and social inequality to control
the private benefits of the government.
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
In fact, the theory of incomplete contract has proved that controlling private
benefits of the insiders (here is local governments) would soften the participation
condition of the investors (Aghion and Bolton, 1992; Tirole, 2001).
Corollary 2 In many poor developing and transitional countries, at least at the initial
stage, to some extend authoritarian and economic centralization would promote
growth and development, although it would cost some inequality; On the contrary,
democracy and economic decentralization may hinder growth or development.
In a society, if the political and ownership institutions prevent such unequal
transaction; the society will be forced to develop such kind of industries which only
require relative small amount of the critical resources (   ), such as land, pollution.
This implies they are dense-capital and technological industries. Obviously, it is a
paradox for most of developing countries, which always suffer the severe absence of
capital and advanced technology. In turn, this further implies that their economic
take-off is perhaps delayed until the society accumulates capital and technology huge
enough. Unfortunately, only very few countries, for example India, can enjoy this luck
chance, especially in the time of global competition.
Although the most popular viewpoint is that democracy and decentralization is the
best way to control government, more and more scholars begin to recognize it is not a
panacea. Even if in the democracy, the larger the number of tiers of government, the
higher the corruption is (Shleifer and Vishny, 1993). In virtue of a formal model,
Bardhan and Moorherjee (2000) proved that the lower the level of government, the
greater is the extent of capture by vested interests, and the less protected minorities
and the poor tend to be. In an empirical research, Treisman (2000) further found that
in countries with a larger number of tiers of government, the quality of government is
poorer, because of higher perceived corruption, a worse job of providing public health
services, less effective at providing public health services, less successful at reducing
adult illiteracy.
As below, we will focus on the decentralization and intergovernmental competition
in authoritarian.
2. Normal Inter-governmental Competition for Mobile Capital
Although central governors might take advantage of authoritarian to mobilize
resources from less-productive sector to the higher-productive sector, they haven’t the
complete local information and knowledge (Hayek, 1939, 1945), or the ability to
develop the locality by them. Hence, it is necessary to delegate agents to administrate
local economy and society.
Now we suppose there are two identical local jurisdictions and the amount of
mobile capital is 2F  Fi  F j , which can be moved between them unless it becomes
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Decentralization, Growth and Social Harmony
Qijing Yang,RUC
specific investment. Meanwhile, the political performance of the local governments is
evaluated independently. Hence, the local government would like to take strategic
behavior as the following.
(2) max U iN  h ln yi  (1  h) N 1Lp ln air  c ln Ci
s.t. (3) Z 0 
(5)
aie p Fi
 Lair p  I i  Ci
1  aie p
yi y j

Fi Fj
(6) Fi  F j  2 F
Solving by backward induction, we firstly notice that the marginal return of
financial capital must be equal among different locality in equilibrium, namely,
(1  t )yi / Fi  (1  t )y j / Fj
Fi 

2FI i (1   aie p )   / 
I i (1   aie p)   /  +I j (1   a je p )   / 
Because locality i and j are identical, the optimal solution is the following.
（2-1） a =
N*
ir
(1  h) N 1

（2-3） I iN *   (
where
N
h

（2-2）
N

F
)
1 
（2-4）CiN* 
F
h
F
 ( 
)
N*
1  aie p
N 1 
c

N
T0   F /(1   )
1
. Therefore, the local government expects the growth is

 N (1  h) N 1Lp  h  c
h
F
yiN*  v    ( 
) in its jurisdiction.
N 1  
Comparing this model with the benchmark model that works under authoritarian,
we can get the following propositions.
Proposition 3 In the situation that local governments compete for mobile capital,
besides proposition 1-3 are still held, we can get further conclusions as below.
N*
(ⅰ) Ci
 CiB* , airN *  airB* ， aieN*  aieB* , I iN*  I iB* , thus yiN *  yiB* ;
11
Decentralization, Growth and Social Harmony
(ⅱ)
CiN *
airN *
0,
0 ;


(ⅲ) 0 
(ⅳ)
Qijing Yang,RUC
CiN* CiB*
a N* a B*
a N* a B*
I B* I N*
y B* y N*
, 0  ir  ir , 0  ie  ie , 0  i  i , thus 0  i  i ;

F
F
F
F
F
F
F
F
F
F
xiN* xiB*
，where xi  ci , air , aie , I i , yi

Z 0
Z 0
(ⅴ) |
x N * x B*
||
| ，where x  Ci , air , aie , I i , yi ， g  h, c 。
g
g
The above proposition is not surprising but very interesting. There is an essential
difference between this model and benchmark model that the local governments now
must compete for mobile capital among them. In order to improve their own
competitive advantage, they try to provide more attractive business policies and
environment than others, namely, cheaper land and better infrastructure. However, the
critical question is how to support such strategy. The result ⅳ implies that the local
governors haven’t changed their way to allocate previous fiscal revenue ( Z 0 ).
Especially, they still enjoy same share of private benefits from Ti . In other word, the
more friendly-business policy and environment come from more serious exploitation
from relevant residents, although the local governors reduce to capture private
benefits from this revenue.
Anyway, the competition for mobile capital shows its power. Just because of
competition, the local governors pay more attention to the roles of capital goods (  )
and infrastructure (  ) than before. The more important the capital goods are in the
production (   ), the more the local governors want to cut down the cost of
nationalizing land ( air  ) and reduce to share private benefits ( Ci  ) from the land
revenue, because the local governments have more strong preference to give more
friendly price to enterprises. As a result, the government sells more land to enterprises,
but collects less land revenue than before. This implies that there would be
aieN * /   aieg * /   0 . Of course, if the infrastructure becomes more important in
the production, they not only would like to invest more on it, but also would like to
more than before.
Besides, even if the market supplies more mobile capital ( F  ), the local
12
Decentralization, Growth and Social Harmony
Qijing Yang,RUC
governments under normal competition become more reluctant to increase the
compensation to the victims, although they also become more prudent in private
benefits. On the contrary, compared with no competition, they become more generous
to enterprises: cheaper land and more productive infrastructures. All they wan to do is
attract more mobile capital in order to increase political performance.
This proposition also provides additional but important information. Comparing
with the benchmark model, all the marginal effects of central policies become weaker,
because the intergovernmental competition has made the variable room very small.
For example, central government pays more attention to the inequality in locality
( (1  h)  , c  ). Although the local governors would give more compensation to the
victims, but such increase is relative smaller than in the benchmark model. Even if the
central government wants to control the local infrastructure investment ( I i  ) and the
intension of competition ( aie  ) in order to control the growth speed, the local
governments always try to avoid decreasing their own local infrastructure investment
or increasing the land price.
This proposition makes us recognize the positive and negative effects of
intergovernmental
Corollary3 Intergovernmental competition helps central government to save efforts
and costs to mobilize local governors to develop local economy and control their
private benefits.
Corollary4 Intergovernmental competition produces more friendly-business policy
and environment ( CiN *  CiB* , aieN*  aieB* , I iN *  I iB* ), and faster growth. However, it
simultaneously induces more serious inequality ( airN *  airB* ).In a word, while the
helping hand becomes warmer, the grabbing hand also becomes colder.
3. Tournament
As we know, the growth is decided by not only the efforts of governors and his
government, but also the initial bestow endowments and exogenous states of nature.
However, the normal incentive mechanism can not distinguish them. Yardstick
competition is considered as a good way to overcome this problem (Lazear and Rosen,
1981; Nalebuff and Stiglitz, 1983； Shleifer, 1985), and is introduced into the
intergovernmental competition (Salmon, 1987; Besley and Case, 1995; Maskin, Qian
and Xu, 2000). Yardstick competition means the one governor’s actual political
performance depends on that others do.
Now, the winner will enjoy all the glory and bonus that is previously shared by
13
Decentralization, Growth and Social Harmony
Qijing Yang,RUC
everyone who achieves same political performance, although the possibility to win the
game decreases simultaneously. For simplification, we still assume that there only are
two identical localities i and j . Each of them has the equal chance to win the gain
with the possibility of 1/2. The winner will be rewarded 2R , while the loser will gain
nothing. Hence, one local governor’s behavior can be drawn as below.
(2) max U iT  h ln
aie p Fi
 Lair p  I i  Ci
1+aie p
s.t. (3) Z 0 
(5)
yi
 (1  h) N 1 Lp ln air  c ln Ci
yj
Yi Y j
=
Fi Fj
(6) 2 F  Fi  F j
The optimal resolution is the following.
(3  1) a =
T*
ir
(3  2)
(1  h) N 1

F
2h
F
 (

)
T*
1+aie p
T (1+ ) 1+
2h
F

)
T (1+ ) 1+
(3  3) I iT *   (
(3  4) CiT* 
where
1
T
growth is Yi
c
T
=
Z 0   F /(1+ )
。Therefore, the local government expects the
(1  h) N 1 Lp  2h /(1+ )  b
T*
 v    (
2h
F

) in its jurisdiction. Comparing this model with the
T (1+ ) 1+
normal competition model, we can get the following propositions.
Proposition4 Besides proposition 1-3 are still held, yardstick competition among local
governments further produces the following effects at least.
(ⅰ) Ci  Ci ， air  air ， aie  aie ， I i
T*
N*
T*
N*
T*
N*
T*
 I iN * ， yiT *  yiN * ；
14
Decentralization, Growth and Social Harmony
0
( ⅱ )
0
Qijing Yang,RUC
aT* a N *
I N * I T*
CiT* CiN *
aT* a N *
， 0  ie  ie ， 0  ir  ir ， 0  i  i ， hence

F
F
F F
F
F
F
F
yiN * yiT*
；

F
F
(ⅲ) 0 
(ⅳ) |
CiT * CiN * aieT * aieN *
aT * a N* I T * I N *
yT * y N *
,


 0 , 0  ir  ir , i > i >0 , thus i > i >0 ;
Z0 Z0 Z 0 Z 0
Z 0 Z 0 Z 0 Z 0
Z 0 Z 0
xT * x N *
||
| ，where x  Ci , air , aie , I i , yi ， g  h, c 。
g
g
Under normal competition, each local governor’s the political performance is
relative independent of others, although he needs to compete for the mobile capital.
However, as long as the central government measures the political performance of the
local governments by yardstick competition, every local governor has to not only
compete for the mobile capital, but also directly compete for political performance. As
a result, the local governors further reduce their private benefits and try their best to
further reduce the compensation to the victims, in order to provide investors land as
cheap as possible, and productive infrastructure as much as possible. As a result, the
government sells more land, but collects less revenue than in normal competition.
Moreover, even if the mobile capital in the market becomes larger, the bargaining
power of the local governors only increases a little smaller, but induce much more
infrastructure investment than in normal competition. At the same time, when the
local governments get huger fiscal resources, they would be very reluctant to increase
the compensation to the victims, and the degree is smaller than that in normal
competition. On the contrary, they would like to be much more generous to the
investors.
From this proposition we can get the following results.
Firstly, among the three kinds of decentralization, Intergovernmental yardstick
competition forces local governments to enjoy lest private benefits, provide the most
friendly business policy and environment, and promote the fastest growth, but society
suffers
the
worst
inequality.
Namely, CiT*  CiN *  CiB* ,
aieY*  aieN*  aieg * ,
I iY *  I iN *  I ig * , yiY *  yiN *  yig * , but airY *  airN *  airg * . In other world, while the
helping hand becomes warmest, the grabbing hand also becomes coldest.
Besides, if Bi is interpreted as public goods, such as education, healthy, rural
infrastructure, intergovernmental competition means less supply of them. The more
15
Decentralization, Growth and Social Harmony
Qijing Yang,RUC
attention the government pays to the growth ( hi  ,R  ), the less the supply of them is,
because the government tries to allocate fiscal resources to subsidize the enterprises
and invest infrastructure as much as possible. Especially, when the yardstick
competition is adopted, those public goods are supplies least.
Secondly, although yardstick competition helps central government most
successfully to resolve the problems of incentive and private benefits of local
governors, it is unprecedented difficult for central government to control the
inequality and hot economy.
The last but most important point is that in the developing countries, the growth
and economic take-off is not only the achievement of entrepreneurship of
entrepreneurs and government, but also the result of great sacrifice of relevant
residents. As the above models, just because of cheap land, the entrepreneurs can
transform a given amount of capital into relative huge capital goods; just because of
good infrastructure, the capital goods have relative huge production capability. When
the society and government are very poor, the cheap land and good infrastructure are
to great extent based on the exploitation from the relevant residents. In other word, if
there was not such inequality transaction, the government hasn’t ability to do that. In
this course, the role of government is to transfer some private and public wealth into
the hand of entrepreneurs, who can combine them into actual highly-productive
capital. Hence, we should deeply thank the latter and remember them, even if they are
always forgotten by history, even are discriminated by the society.
Ⅴ. Conclusions
In a poor society, there is a basic dilemma: on the one hand, there is a huge
amount of resources locked in less productive sector; on the other hand, the capital is
very scarce and much dispersed. Growth generally means the former is absorbed or
combined by the latter. However, poor institution and environment always prevent
entrepreneurs from converting financial capital into capital goods and actual
production capability; namely, there would be very less growth unless some specially
favorable policies are adopted and necessary infrastructure is invested. A cruel but
likely true result is that it would be necessary for the government to create and
involve some kinds of unfair transaction, which is in favor of the enterprises and
beneficial growth and social welfare in long term. In other word, considering the
reality of most of developing countries, the second-best government is “one hand is
grabbing hand, other hand is helpful hand”, although the ideal is both are helping
hands. It implies society would experience a stage of worsening social inequality in
the course of development.
Democracy and private property rights would make such transaction very difficult,
and extreme economic decentralization would make local governments too weak to
invest enough infrastructures or give the victims enough compensation. Besides,
16
Decentralization, Growth and Social Harmony
Qijing Yang,RUC
democracy couldn’t monitor and control the local governments efficiently in many
situations. Hence, democracy and extreme decentralization would be a hinder of
development in many developing and transitional countries. In other word, to some
extent authoritarian and economic centralization is beneficial to growth.
In authoritarian, decentralization and intergovernmental competition, especially
yardstick competition among local governments possibly induces less local
governors’ private benefits, much more productive infrastructures, and much faster
growth, while produces much more serious inequality. When the society is very poor
and there are huge amount of spare resources, it would be a good choice for the
central government to assigns more weight to local economic growth in the local
governors’ political performance, even induce yardstick competition among them.
Contrariwise, we should pay more attention to inequality, such as unfair land
transaction, income redistribution, pollution, labor security, the protection of
intellectual property rights.
However, in authoritarian economic decentralization couldn’t be efficient unless
central authority is powerful strong enough. After huge fiscal authority is
decentralized, the central government losses his previous fiscal levy to influence the
local governments. If the central government also loses political authority, he couldn’t
stimulate, monitor or punish the local government. Consequently, the latter may be
indulged in collecting private benefits. Both of their hands become predatory, and the
society suffers very less growth with serious inequality. We argue that “the
competitive benefits of ‘market preserving federalism emphasized by China scholars
depends very much on political centralization” (Blanchard and Shleifer, 2001, p.176).
In China, central government always holds the political authority while decentralizing
economic authority to local governments.
Just as Coase (1960) taught us, if the transaction cost is not small enough, it is very
important to define the initial rights which could affect the social efficiency and
welfare in long term. In given technologic and historic conditions, some degree of
pollution and inequality may be the necessaries for production, while the relevant
residents want to enjoy the rights of healthy environment and equality. Hence, we
should carefully trade off between the two sides. China is lucky, because she doesn’t
adopt big-bang reform sharply to privatize all the previous collective property rights,
while non collective property rights are respected well. Although corruption is very
popular, we don’t waste inequality in the mass.
In a word, we argue that the critical question is not whether there is inequality in
the course of development, but how to transfer inequality to growth, how to control
the degree of inequality, how to allocate the result of growth. Good institutions should
guarantee most of people especially the former sacrifice can share the outcomes of
growth, and finally improve the whole equality and social welfare. It needs a great
wisdom to design some kinds of appropriate match between decentralization and
authoritarian in economy and politics, which is helpful for growth and control the
scale and scope of inequality. Those questions need us to do further research.
17
Decentralization, Growth and Social Harmony
Qijing Yang,RUC
We should notice that there are several latent assumptions in our model. One is
that different locality enjoy identical initial endowment; another is that the local
governments have capability to adopt and implement the appropriate strategy and
policies to develop local economy. Lastly, we should point out that our models can be
very easily interpreted as the institutions and schedule of compensation in the firm.
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