Embedded State-Building: Economic Openness and Fiscal Capacity in China

• In Event: Comparative Historical Perspectives on the State and Policy Reform

Abstract

Economic openness is typically associated with the loss of tax revenue in developing economies. In contrast, this paper illustrates that China’s thirty years of economic openness led to growth in fiscal capacity and unification of subnational taxing efforts, characterized by the centralization of taxing rights and the expansion of tax bureaucracy. Theoretically, we contend that this aligns with the compensatory explanation for public sector expansion: the trade-induced relative decline of the privileged state sector necessitates compensation funded by raising taxes from the rising private sector. Empirically, we collected original and rich data on the universe of bureaucratic recruits, firm registration, and industry-level FDI. With Bartik export and FDI shock measures resulting from China’s WTO entry, we show that economic openness leads to the expansion of the nonstate sector, centralized tax bureaucracy, government budget, and central-local transfer scheme to disburse wages for local public jobs, strengthening the state’s control over the new subnational tax sources and ultimately a transitioning society.

Author

• Yajie Wang, Yale University