China's Evolving Managerial Labor Market TORIo Theodore Groves; Yongmiao Hong; John McMillan; Barry Naughton The Journal of political Economy, Vol. 103, No 4(Aug, 1995), 873-892 Stable url: http://links.jstor.org/sici?sici=0022-3808%28199508%29103%3a4%03c873%03acemlm%3e2.0.c0%03b2-h The Journal of political Economy is currently published by The University of Chicago Press. Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/ucpress.html Each copy of any part of a jSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor. org http://www.jstor.org Fri may2123:08:432004
China,s Evolving Managerial Labor Market Theodore groves University of California, San Di Yongmiao Hong John Mcmillan and Barry Naughton University of California, San diego Recent reforms of Chinese state-owned enterprises strengthened a nascent managerial labor market by incorporating incentives sugges- tive of competitive Western labor markets. Poorly performing firms were more likely to have a new manager selected by auction be required to post a higher security deposit, and to be subject to more requent review of the manager's contract. Managers could be, and were, fired for poor performance. Managerial pay was linked to the firm's sales and profits, and reform strengthened the profit link and weakened the sales link. Thus the economic reforms helped develop an improved system of managerial resource allocation responsive market forces I. Introduction In this paper we give evidence that the reforms of the 1980s in Chi- nese state-owned enterprises significantly strengthened a nascent e thank the Ford Foundation for research support and Masahiko Aoki, Takeo Hoshi, John Litwack, Mark Machina, Yingyi Qian, Valerie Rar minar participants resere ford onmivesits we athe ackiversie ot Calitornv Slaa Diego, and an anonymous sity and the Economics Research Institute at the Chinese Academy of Social Sciences for their participation in the larger project, of which this paper is but a small part
JOURNAL OF POLITICAL ECONOMY managerial labor market. We suggest that one important result of the economic reforms was the development of an improved system of managerial resource allocation that is responsive to market forces The overall objective of the reforms was to move from a system under which enterprises obeyed detailed centralized commands to a decen- tralized system that rewarded enterprises for improved productivity As a part of this effort, the reforms transformed the role of manag ers, requiring them to sign contracts outlining their responsibilities nd rewards, and enacting new incentives and punishments. We dem onstrate below that this new system was working surprisingly well by he late 1980s: managerial efforts were being rewarded and manage- rial resources being assigned in accordance with criteria established by market forces This is perhaps a controversial thesis. The conventional view of China seems to be that managerial assignments in state-owned enter- prises are still governed by bureaucratic and political considerations and managers are subject to rigid supervision and control. It is, how ever, widely appreciated that the reforms of the 1980s were directed the efficiency of enterprises by replacing direct control at improvin ith managerial incentives. New incentive systems such from above w as the"profit responsibility system" were introduced that linked re- wards to managers to improvements in firm performance. However, hile necessary, it is not sufficient to provide incentives alone. Al- though some managers who were appointed prior to the reforms could be expected to welcome and respond to the new incentives others might be expected to have trouble adapting or, worse, be resis tant to change. a thoroughgoing reform must not just change the incentive environment but also must provide a mechanism for select- ing managers who will be responsive to the new opportunities. Ap- propriate supervision and replacement of managers may be as impor tant as the provision of incentives In this paper we first examine the process of managerial turnover. 'e show that managers changed jobs sufficiently frequently to sup- port a functioning managerial labor market. We further study those markets by analyzing two types of events. First, we analyze the circum- stances around the most recent change of managers and show that both the fate of the prev ous man and the conditions of the new manager's appointment can be partially explained by the firm's performance immediately before the change of managers. Second, we analyze the circumstances around the most recent managerial contract, which need not coincide with replace ment of the incumbent manager. Managerial contracts were the cen- tral innovation of the managerial reforms of the 1980s. Nearly all the managers in our sample had signed multiyear managerial contracts
CHINA S MANAGERIAL LABOR MARKET hat committed them to meet specified performance indicators, in- cluding profitability. We find that firm performance is again related to managerial incumbency and replacement in predictable ways Of the results of au an experimental reform that was carried out in about 14 percent of es. We also examine the relatio rial compensation and enterprise profits and sales. We show that Chi nese managers'total compensation is positively related to both firm profits and sales and that, after a reform contract, the correlation etween total compensation and profits increased, whereas that be- tween total compensation and sales decreased. Finally, we examine the relationship between the new financial incentives given managers and the productivity of firms. We find that the direct monetary incen tives given managers improved firm productivity and that this im- provement was strengthened by the reforms. In short, we argue that managers were hired, fired, and paid increasingly over the decade of the 1980s in accordance with market-dominated criteria In assessing the managerial reforms, we are examining conse- quences of decisions made by two different sets of agents. One set of decisions is those made by bureaucratic superiors of the firm: (i)deci sions to promote, demote, or transfer a current manager;() the choice of selection method when a new manager is appointed; and (iii)the form of contract to offer the firm that governs the remunera- tion of managers. The other set of decisions is those made by manag ers in response to the incentives provided by the decision rules of eriors The decade of the 1980s in China was a period of remarkable innovation and experimentation in alternative methods of economic reform(see Naughton 1995). Thus our evidence is not that the whole state-owned sector was converted at once or even over the decade from bureaucratic to market-driven managerial appointment meth ods. But by the latter part of the decade, reforms emphasizing market solutions were quite widespread Managerial contracts and auctioning of firms were both broadly implemented for the first time during the latter part of the 1980s. The nature of our evidence does not permit direct comparison between the situation in the late 1980s and the prereform"period before such institutions existed. But we can say that the real allocation of managerial resources displays patterns that we would expect if the reforms were successful. It is reasonable to attribute those patterns to the reform innovations that were intended to produce such an outcome. Overall, the gains from the partial reform of China's state firms are demonstrable. Output per worker rose 67 percent (in constant prices) between 1980 and 1989 for the enterprises in our sample, and
876 JOURNAL OF POLITICAL ECONOMY total factor productivity rose 36 percent(Groves et al. 1994). Not all of this improvement in productivity is attributable to the particular reforms that we investigate here. Firms also faced increased product market discipline because of greater competition from other state firms and from new, nonstate firms, and this was an important source of productivity gains(McMillan and Naughton 1992). Gains also came from granting firms autonomy in their output decisions and increas- ing the share of profits firms were allowed to retain(Groves et al 1994). Managerial reforms would probably not have been effective had they not been made in conjunction with increased autonomy and increased product market competition Section II describes the selection of managers and the changes the overall environment within which Chinese managers operate since the reforms of the 1980s. Section Ill presents and interprets the main empirical results Section IV summarizes the findings and presents further speculations on the process of change in China. The Appendix provides details of our data set and the basic model speci- II. Selection of Managers and reforms of the 1980s In the prereform Chinese command economy, enterprises are best thought of as branch plants of a single giant firm. Enterprise manag ers were hired and fired by officials in the industrial bureaus, which vere in turn organized into sectoral and geographical divisions. The entire industrial system was accountable to a national or regional planning commission, which steered the entire system through a com- plex system of highly specific commands that extended all the way down the hierarchy to managers at the plant level. Authority relations were complicated by the intrusive role of the Communist Party, which functioned more or less as the personnel department of this enor mous corporation, maintaining dossiers and tracking managerial ca- reers. Managers were rewarded for following orders and for subservi- ence to political dogma. The inefficiency of which this system wa able is well know During the 1980s, China sought to improve industrial efficiency I Production function estimates from several other data sets also show increases in state firms' productivity. Gordon and Li(1989), using a sample of 400 state er by 4.6 percent Dollar(1990), using a sample of 20 state ent data, estimated that productivity rose between 1. 9 over the period 1978-88. See also Perkins(1988), Hay and Liu(1991), and jeffers Rawski, and Zheng (1992)