The Incentive Role of Creating 'Cities' in China

Abstract

This paper examines a distinctive mechanism of providing incentives to local governments - upgrading counties to cities. In China, awarding city status to existing counties is the dominant way of creating new urban administrative units, during which the local government gets many benefits. Using a large panel data set covering all counties in China during 1993-2004, I investigate the determinants of upgrading. I find that the official minimum requirements for upgrading are not enforced in practice. Instead, economic growth rate plays a key role in obtaining city status. An empirical test is then conducted to distinguish between a principal-agent incentive mechanism and political bargaining. The findings are consistent with the hypothesis that the central government uses upgrading to reward local officials for high growth, as well as aligning local interests with those of the center. This paper highlights the importance of both fiscal and political incentives facing the local government. The comparison between incentive mechanism and bargaining sheds light on an important question about China's politics of governance: where does power lie in China?

Keywords: economic growth, incentive mechanism, bargaining, political centralization, fiscal decentralization, county-to-city upgrading, central-local relationship

JEL Classification: P26, H77, H11, O40, R11