Regulatory Reform and License Downsizing in PRC: Background

Carlile and Tilton (1998) identified two models of regulatory reform. One is an Anglo-American tradition and increasingly European trend of correcting market failure. Behind the model are mistrust of government and worship of market: Government should refrain from intervening in markets to reduce inefficiency. Government’s primary function is to ensure smooth operation of the market and to deal with such market failure as protection of public health and safety. A desirable regulatory reform is one seeking to reduce the regulatory costs on firms (such as the costs of adapting business processes to meet regulatory requirements, licensing fees, delays in obtaining regulatory approval, and time cost and bribery used for dealing with officials) to the level not higher than necessary for tackling market failure. The advocacy of antitrust, transparency, and competition is largely based on this model. The second model is a developmental state model represented by Japan, Korea, and Taipei,China. The advocates of this model have a high trust in government and believe that bureaucrats should actively foster technological development and designate particular industries and businesses for support. This model is characterized by government’s extensive use of licenses to influence economic development. No companies, including domestic and foreign, are allowed to enter particular industries, alter their mode of production, or import particular products without appropriate licenses for the sake of protecting these industries from excessive competition, accumulating a technological foundation for quick modernization, and facilitating “late developers” to catch up with early industrializing countries (Carlile and Tilton, 1998: pp.1-15).

The PRC’s regulatory reform exhibits both the similarities with the above two models and characteristics shared with many developing economies. The PRC’s regulatory reform is a mix of corporatization, privatization, deregulation, and reregulation. It is a response to the need for filling a regulatory vacuum left by the rolling back of the state in micro-managing the economy (Pearson, 2004: pp.567-583). The rolling back is characterized by a de-nationalization of public ownership (such as telecommunications), rise of new economic activities (such as insurance and stock exchange), emergence of market failures (such as coalmine accidents, shoddy product quality, and environmental pollution), and the perceived necessity of protecting domestic enterprises against foreign competition resulting from trade liberalization (such as banking). One aspect of the regulatory regime is a licensing system. Like their counterparts in many developing countries, bureaucrats in PRC often use various administrative and business licenses to extract rent. Removing officials’ licensing authority and the opportunities for extracting rent by downsizing regulations on the private sector has become a major strategy in the latest round of regulatory reform.

Regulatory reforms are widely used to resolve economic problems because of their potential in encouraging private investment and bolstering GDP without incurring government expenditure and debt. Recent studies in OECD economies show that both the private investment level and the productivity of that investment are higher in countries with lighter regulatory burden. Estimates for a group of developing countries suggest that reducing the cost of registration procedures to the level in the United States (0.6% of per capita income) could increase private sector investment by more than 20%. A growing number of countries reducing administrative licenses and simplifying licensing procedures have achieved positive results. For example, the World Bank reported that after the municipal government of La Paz, Bolivia reduced the procedures required in business registration, the number of registered businesses increased by 20%. Similar measures in Viet Nam increased new businesses from 6,000 in 1999 to more than 21,000 in 2002. In Uganda, the new businesses increased even by four times (The World Bank, 2005: pp.99-104; Asian Development Bank, 2003: p.97; International Finance Corporation, 2000).

In comparison to other developing countries, PRC’s licensing system for regulation of business on paper is not particularly burdensome (Table 2 [ PDF 99.3KB | 1 pages ]). However, the reality suggests a worse picture. The licensing system is arbitrary, cost inflating and inconsistent. Setting up a local retail business, for instance, needs 112 licenses from different departments. To get approval for importing certain types of foreign equipment may require six months or even longer (Meng, 2004). Bureaucrats’ arbitration in revoking licenses has made an unpredictable business environment. On a single day, the government of an unnamed city illegally revoked the business licenses of 100-odd joint ventures. Beijing city once revoked the permission granted to the fast food chain giant McDonald’s for establishing a restaurant in a prime location (Ambler and Witzel, 2004: p.84). In 2003, the public security bureau of Leqing city of Zhejiang province withdrew 150 business licenses of man-powered tricycles auctioned in 1999, and penalized the license holders who refused to return the licenses (Liu, 2006). Without giving compensation or grace period, an unnamed city withdrew the operation licenses of the schools below the benchmark that the government imposed arbitrarily (Zhao, 2006). The resultant unpredictable business environment, together with the inconsistency of regulations and policies of different levels of government, had put off many private investment projects involving more than one level of governments as the risk involved in these projects is either difficult to calculate or prohibitively high. Licensing barriers also precluded private sector from entering the market sectors dominated, but badly served, by state-owned enterprises. Many investors relied on personal relationships and bribery to transcend the red tape and get things done. The consequences were a lower level of infrastructure investment, lower degree of institutionalization of administration, rampant corruption, and business cost inflation (Asian Development Bank, 2003).

The burdensome regulatory framework has not a risen in a vacuum. It was established when the market system was budding and the private sector was insignificant. Many new regulations targeted big state-owned companies and reflected a higher emphasis on economic security than efficiency values. Investors were required to put down a large registered capital and undergo strict examinations before starting a business so that the risks of creditors – which were from state sector - could be minimized. Less resourceful investors from the private sector were then barred from entering markets. Therefore the minimum capital requirement in PRC as a percentage of GNI per capita is the second highest in the world, only after the 5,627 of Syria (Table 3 [ PDF 99KB | 1 pages ]). Besides that, regulators are highly interventionist in market regulation, and often oblige investors to prove their technical abilities measured against governmentimposed standards before they can enter markets. The dynamics of commerce and convenience for private businesses were not regulators’ main concern (Jiao, 2005; All- PRC Federation of Industry and Commerce, 2005: p.20).

The decentralized public finance system is another barrier to the formation of business-friendly regulatory regime. The PRC government has decentralized much of its economic authority to local governments to motivate them to achieve higher economic growth and enhance the regime’s legitimacy. The decentralization has turned the PRC economy into, using the terms of Qian and Weingast (1995), “market-preserving federalism”. However, local governments are not authorized to adjust the rate of local taxes or create new taxes. Without adequate tax revenue, local governments have to rely on extra-budgetary revenue – the part of government revenue not included from planned revenue. It encompasses both officially sanctioned and illegal levies beyond the narrowly defined formal budget (Lu, 2000: p.218; Wong, 1997: p.60; Breslin, 1996: p.129). Examples of extra-budgetary revenue include various fines and license fees. The amount of license fees is huge and therefore important to public coffers. The abolition of 78 business activities requiring licenses (or licensing items) in Zhejiang province engendered a loss of license fee revenue of 120 million yuan a year (Luo and Yu, 2005: p.21).³ The Heilongjiang provincial finance bureau predicted that the downsizing of 152 licensing items in 2006 would reduce its revenue by 300 million yuan. Between May and September 2003, the licensing fee that Yanggang city, a medium-sized city in western Guangdong province had to give up due to license downsizing amounted to 22.97 million yuan (Xiao, 2004).

The level of license revenue may impact the amount of subsidies (a rather regular monthly income usually in cash and sometimes in kind) that bureaucrats receive as well. In the late 1990s, subsidies accounted for around 70 to 85% of the total income of individual bureaucrats (Chou, 2004: p.230). In view of the impact of extra-budgetary revenue on their well being, local leaders are highly motivated to create and defend license revenue. They may assign a quota of extra-budgetary revenue that individual departments must generate. The levels of bonus (a more irregular cash income) and penalty are often linked to the amount of extra-budgetary revenue generated. In 1995, Yulin city in the Guangxi Autonomous Region imposed a fee collection target of RMB 12 million yuan on the city’s round-city highway management office. The subsidies of the office’s employees would be cut back if they could not reach the target. If they generated more than the target, they could retain 80% of the surplus portion for subsidies, although central government had decreed to rule out this practice (Qin, 1996). Quite often, licensing items were created purely for generating revenue but not regulating markets. An entrepreneur of Yanggang city complained that the city labor bureau required him to apply “appointment cards” (shang gang zhen) on behalf of all his employees. Each appointment card cost him over 100 yuan. The fee collected was supposed to finance government-sponsored training courses for new employees. In the end, no training was provided. Another agricultural entrepreneur complained that the traffic bureau of the city charged him some 1,000 yuan of vehicle maintenance fees every year without providing any meaningful maintenance service in return (Xiao, 2004).

The implication of licenses is furthered complicated by the narrow focus of local leaders’ performance appraisal on local economic development and the opportunistic behaviour of local leaders resulting from a job rotation system. On the basis of a Soviet practice of industrial management in which factory managers were appraised according to sets of specific production quotas, the CCP introduced a cadre responsibility system in the early 1980s to hold local leaders responsible for specific performance indicators. The performance indicators were characterized by a heavy emphasis on economic growth, and to a lesser extent social stability and development (Figure 1 [ PDF 1.3MB | 1 pages ]). The current performance appraisal of local leaders is largely modeled on this system. The exact performance targets vary across the country, depending on the economic structure of the regions that local leaders oversee. Many of these performance targets are related to economic development, such as the growth of industrial production, the growth of GDP, and the amount of tax and non-tax revenue generated. The achievement of these targets is linked to cadres’ future advancement, the level of their bonus, and punishment.⁴

In the meantime, central leaders are often worried that local leaders may establish their own patronages – major sources of corruption and localism (or a tendency of defying central directives for safeguarding local interests). Thus local leaders are rotated to different localities at regular intervals, usually three years for county magistrates and five years for governors at provincial and prefectural-level governments but not uncommon within a shorter period of time. The performance appraisal and job rotation systems shape local leaders’ incentive in the way that local leaders tend to promote the economic development in their jurisdictions, regardless of the policies’ impacts on neighboring regions and the country as a whole. Because of their short terms of office, they tend to work for immediate work achievement at the expense of the localities’ long-term benefits, such as improvement of business environment and product quality. Therefore, many local leaders pursue regional protectionist measures: Through licensing systems, they can raise the barriers of market entry for outside entrepreneurs, or impose a ban on the import of certain types of products to protect local business interests. A bus company in an unnamed city of Anhui province, for example, had got approval from city government before it purchased new buses. On discovering the new buses were not manufactured in Anhui province, the city government banned the buses from being used (Zhao, 2006). Shanghai and Beijing cities supported their own car industry by instructing the taxi companies in their respective cities to use locally produced sedan cars. Shanghai even charged the non-Shanghai-made sedan cars higher license fees to affect their competitiveness (Lardy, 2002: pp.29-62). As a result of a high degree of financial autonomy and local leaders’ peculiar incentive systems, local governments (especially those with small tax bases) have much motive to safeguard and expand their licensing authority.

Regulatory barriers have not stopped the PRC economy from growing. Private sector development remains robust. Foreign investment is huge. From the perspective of economic growth, downsizing administrative licenses is non-urgent if not unnecessary. Nevertheless, the accession to the WTO has made the matter different. The PRC’s regulatory framework fails to live up to PRC’s three major commitments which seek to expand the opportunities for foreign investors to enter PRC markets:

1. Transparency: Local governments’ use of secretive hongtou wenjian to create new regulations is incompatible with the paragraph 332 of the Report of the Working Party of the Accession of China (hereafter "the Report of the Working Party"), stating that PRC would:

"...publish in the official journal, by appropriate classification and by service where relevant, a list of all organizations, including those organizations delegated such authority from the national authorities, that were responsible for authorizing, approving or regulating services activities whether through grant of license or other approval. Procedures and the conditions for obtaining such licenses or approval would also be published."
2. Uniform administration of trade regime: Inconsistency of regulations among different levels of government contradicts paragraphs 73, 75 and 68. Paragraph 73 reads:

"...the provisions of the WTO Agreement … would be applied uniformly throughout its customs territory, including in SEZs (Special Economic Zones, added by the author) and other areas where special regimes for tariffs, taxes and regulations were established and at all levels of government."

Paragraph 75 reads:

"All individuals and entities could bring to the attention of central government authorities cases of non-uniform application of China's trade regime… . Such cases would be referred promptly to the responsible government agency, and when non-uniform application was established, the authorities would act promptly to address the situation utilizing the remedies available under China's laws, taking into consideration China's international obligations and the need to provide a meaningful remedy... ."

Paragraph 68 reads:

"...the central government would undertake in a timely manner to revise or annul administrative regulations or departmental rules if they were inconsistent with China's obligations under the WTO Agreement and Draft Protocol."
3. Licensing issues: Blocking market access through licenses and charging exorbitant license fees conflict with paragraphs 308 and 308(d) respectively. Paragraph 308 reads:

"...China would ensure that China's licensing procedures and conditions would not act as barriers to market access and would not be more trade restrictive than necessary."

Paragraph 308(d) states:

"Any fees charged … would be commensurate with the administrative cost of processing an application” (World Trade Organization, 2004)."

The impacts of these commitments are profound: the PRC government is obliged to reform its business regulatory framework as soon as possible. All levels of governments in PRC can no longer use hidden documents to create licensing authority. Their licensing authority should be based on national legislations which, in turn, has to be kept in line with the WTO requirements. Business licenses should not cost more than necessary for processing license application. Creation of regional trade blocs through licensing is prohibited. If successfully implemented, these measures have the potential of fueling the growth of private sector.

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