A Screening Perspective on Experimental Zones

Abstract

Experimentation, or, setting experimental zones, is essential to many countries’ economic success, especially China. Traditional explanations suggest that setting experimental zones is for loss-control or resistance-minimization. In this paper, we provide an alternative rationale that emphasizes the “screening effect” of experimental zones: when proposals—whose qualities are unknown to the central government (principal)—are proposed by informed local officials (agents), providing support gradually over time rather than all at once reduces the local governments’ incentives to propose low-quality projects, resulting in a higher proportion of high-quality projects in equilibrium. The main tradeoff facing the central government is between better screening and delayed implementation of good projects. We show that when the central government is more patient, or good projects exhibit a larger positive externality, the reform speed, measured by the initial support level, decreases while the reform scale, measured by the number of approved projects, increases. As the negative consequence of bad projects becomes higher, however, both reform speed and scale decrease, implying a steady but stagnant reform. By contrast, in a benchmark case without information asymmetry between the central and local governments, the optimal initial support is either minimal or full and does not depend on the externality.

Keywords: Experimental zones, Gradual reform, Asymmetric information, Screening, Limited liability, Decentralization

JEL Classification: D72, D78, D80, P26