As discussed in Chapter 2, the relative bargaining power at the time of entry favors private investors vis-à-vis local officials because, first, local officials are trying to attract investment under the pressure of the performance-based evaluation, and second, investors may have other options even for resource-intensive firms. However, once an investor has made firm-specific investment in a locality, the relative bargaining power may shift to local officials. In the post-entry situation, his/her investment may be held hostage by an opportunistic local official. The local government would then take advantage of it so as to impose new requirements on the firm, which might more than offset the initial incentives. Moreover, in the context of China, private entrepreneurs risk
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not only outright expropriation but also a host of other predatory actions taken by the local government in the guise of fines, taxes, and/or “charitable contributions” to government-sponsored projects (Nee and Opper 2012).
However, a firm’s specific characteristics can greatly empower its bargaining power, and if a private investor’s post-entry bargaining power is strong, he/she will be able to protect his/her bargains. The degree to which the investor will be able to resist local officials’ predatory actions depends on the level of Firm Specific Assets (FSAs) and the degree he/she will need from the local government for, say, licensing, permissions, resources, and public-goods provisions.
As discussed in previous section, private firms with an exit option will enjoy sufficient protection because they possess high levels of FSAs. The outright
expropriation of this type of firm will hurt the government or affect the local political leaders negatively in terms of performance based evaluation measured by real figures like tax revenue, employment creation, and GDP growth rate. Political and social
considerations at both central and local governments with the incentive structure embedded in the CES have thus created relatively stable conditions for these types of investment, which appears to facilitate a self-enforcing solution to the commitment problem. In this situation, everyone benefits and no one has the incentive to deviate.
Governments, both central and local, have strong incentives to keep their promises since these firms can generate higher GDP growth, tax revenue, and
employment. Although private firms in general may have an incentive to conceal real profits and hence decrease the taxes they pay to the government, it is more difficult for
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high level FSAs firms, such as labor-intensive, export-oriented manufacturing firms and high technology firms to do so.
For local officials, due to relatively short tenure in office (e.g., less than three years, on average, for local mayors), they are under enormous pressure to show their ability to produce economic growth quickly (Pei 2012). Thus, local political leaders have strong incentives to maintain a collaborative relationship with these firms because it is an easy way to demonstrate their job performance. Also, knowing that this type of firm has an exit option even if it isexpensive for them to do so, and that the worst scenario of resistance to predatory actions will severely damage their reputation, local political actors will restrain their predatory behaviors.
However, there is no self-enforcing commitment for investors with rapidly obsolescing post-entry bargaining power. Private firms without an exit option, such as resource-intensive and local market seeking firms, are in a disadvantageous position to overcome the commitment problem. This type of firm’s FSAs is low as its firm-specific assets are common, easy to be imitated and substituted, and hard to transfer. They need more government-related resources for their projects. Investors may prefer a better legal environment to constrain the predatory activities or rely on personal networks (guanxi) or bribing local officials to protect their investments.
More importantly, for local officials, the political risk of direct expropriation of
private firms without an exit option may be lowdue to the moral hazard problem.For
instance, the predatory actions may not be seen as personal responsibility. It may be done in the name of the local government. In addition, a local official could assign his/her protégé to take over the firm and to run the business as usual. After the outright
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expropriation, the local government still retains GDP growth, tax revenue and
employment opportunities. Moreover, the local official receives private benefits from the outright expropriation as well. No matter who is going to take over the firm, the new owner will owe a favor to the official, and will pay back in some form of revenue. Therefore, private investors who engage in low-level FSA investments without an exit option will, from time to time, rely on their personal networks (guanxi) or bribery to protect their property rights.
If the local official chooses not to expropriate directly but to be engaged in indirect expropriation, such as collecting fees, fines, forced apportionment of funds (tanpai), or forced contribution of government sponsored projects, the firm with no exit option has little bargaining power and has no choice but to give in with either direct payments or bribes. In this case, the local official receives both higher merit and private benefits with no risk of the exit of the firm.
Given the above discussion, I come up with two hypotheses:
Hypothesis 1: All else being equal, private firms with an exit option and high level of FSAs enjoy sufficient property rights protection.
Hypothesis 2: All else being equal, private firms with no exit option and low level of FSAs are vulnerable to local officials’ predatory activities.