Governance and Foreign Investment in China, India, and Taiwan: Credibility, Flexibility, and International Business

Chapter 4. Local Accountability under Authoritarianism: Evidence from Development Zones in China

77 Chapter 4 Local Accountability under Authoritarianism Evidence from Development Zones in China The previous chapter addressed China’s growth myth: in the absence of credible institutions, an authoritarian regime, through specific institutional arrangements , can credibly commit itself to attracting foreign investment and promoting growth. Indeed, the setup of development zones, initially as a flexible institutional innovation, created a certain degree of credibility that would otherwise be absent in an authoritarian government. More than two decades after these experiments were launched, development zones remain the primary destinations for FDI in China. In 2009, 54 national economic and technology development zones (ETDZs), a prominent group of development zones for which statistical information is available, received US$20 billion of FDI, 22 percent of the total in China (Ministry of Commerce 2010). Their land area, however, only accounts for 0.04 percent of the entire country. It is not surprising that development zones were more successful than the rest of the country in attracting FDI. Most of these national zones are located in big cities that have the best infrastructure and workforce. More important, they were granted political and fiscal privileges, including a simplified bureaucratic structure, tax benefits, and fiscal subsidies, all of which were desired by other regions but impossible to get. In other words, development zones were designed to promote, not to prevent, economic imbalance within China. Increasing disparity is not just salient between development zones and nonzones . The cross-­ zone distribution of FDI is more unbalanced than the cross-­ province distribution. There was tremendous variation in the amount of FDI 78 governance and foreign investment in china, india, and Taiwan inflows and the degree of export orientation in 2009. Tianjin, the largest zone on the northern coast, received 300 times as much FDI as the zone located in Zhanjiang, the southernmost zone in mainland China. Some zones (e.g., Caohejing , Fujian Rongqiao, and Kunshan) exported more than 70 percent of their industrial products, whereas others sold their products almost entirely on the domestic market. This finding appears puzzling because development zones, given their similar regulatory environment and pro-­ investment policy arrangement, were expected to overcome locational effects and have similar performances in attracting FDI and promoting exports. A compelling explanation would emphasize the incumbency advantages of the early zones. Location-­ specific factors (e.g., natural resources, quality of labor, infrastructure, industry composition , and access to international markets) have clearly played a major role in the successes of the early zones in coastal areas. Indeed, the latecomers in the hinterland are at a disadvantage. They are far removed from international markets, burdened with inefficient state-­ owned industry, and handicapped by an open-­ door policy that has discriminated against them for at least 15 years. Over time, the initial advantages created path dependencies that reinforced the attractiveness of coastal zones to foreign investors. Incumbency advantages in these zones persist even after their initial policy advantages diminished (Graham 2004). The huge disparity in economic performance might therefore have been affected by the interaction of the incumbency advantage and the forces of agglomeration. This explanation, although plausible, appears unable to explain the distinct performances of some early zones. Table 4.1 compares two zones—­ one in Ningbo city in Zhejiang Province and the other in Zhanjiang city in Guangdong Province—­ both of which were set up in rich coastal provinces with extensive diaspora connections in 1984. Although the Zhanjiang zone attracted twice as much FDI as the Ningbo zone did in 1989, the latter significantly outperformed the former two decades later. In 2009, the Ningbo zone received more than 50 times as much FDI as its counterpart in Zhanjiang. The incumbency advantage, if there was any, cannot explain the dramatically divergent performances of these two similarly endowed zones. Central to this chapter is the role played by local institutions in policy implementation. They are crucial for economic development in a country with strong features of fiscal federalism. The theory of market-­ preserving federalism , derived from the Tiebout Model (1956), suggests that fiscal decentraliza- Local Accountability under Authoritarianism 79 tion motivates local governments to implement policies that are perceived to be successful in other places and to compete to foster economic prosperity. Competition therefore gives local governments the incentive to limit their ability to abuse their policy authority by preying on investors (Weingast 1995; Montinola et al. 1995). The theory of market-­ preserving federalism is insufficient, however, to explain China’s persistent...