Observers of the late developing states have long stressed the role of the government in the catch-up process. They often claim that the low market demand, capital shortages, and the high risk of business ventures call for the state activism, direct or indirect, in the economic development process. Although a few countries, such as Germany, Russia and Japan, achieved impressive spurts of industrialization in the late nineteenth century through strong state intervention, these few success stories are overshadowed by far more numerous post-war examples of developing countries with strong state intervention that failed to catch up. State activism, while overcoming market failure and mobilizing national resources under some circumstances, often degenerated into rent-seeking, corruption and favoritism that both handicapped and lowered the incentives of private investment. An intriguing question is why the role of the government has played out so differently in similar developing context.
The contrast between the responses to the West in late Qing China and Meiji Japan offers a classical example of how the role of the central government and bureaucrats can be quite different even under the same competitive and political pressures. In this article, my approach places weight on the incentives of the agents in the economic and political marketplaces, and treats the government and bureaucrats as strategic players. The focus of the article is on the relationship between the officials and the enterprises in the industrialization process which started in the 1860s and 1870s in the Qing China and Meiji Japan. My interpretation of the different responses centers on the different incentives of the government officials as constrained by the political, economic and social structures in each country.
Central Government Incentives
The Qing government had been plagued by the fiscal crisis since the Opium War. The huge war indemnity and the expense of suppressing rebellions drove the imperial court to look desperately for new sources of revenue. The means which it often resorted to was the creation of the new taxes and fees levied on modern business ventures established during the wave of “self-strengthening” programs sponsored by provincial leaders. These exactions were commonly called “baoxiao”(i.e., contributing to the nation), belying the fact that a budget deficit does not by itself justify predatory behavior towards modern industry and trade. Persistent government financial difficulties were also a feature of Meiji Japan. The land tax reform in the early Meiji period laid a sound fiscal foundation for the ambitious national policy of modernization, but did not enable the new government to avoid a large budget deficit. The new government inherited all debt obligations from the bakufu (the Shogunate government located in Edo, which was the present day Tokyo) and domains (lords), some 30 percent of revenue went to pay the samurai’s (warriors) stipends, and suppressing uprisings like the Satsuma Rebellion created another huge outflow of government resources. Faced with the burden of tremendous expenditures, the Meiji government’s response was to cut the samurai’s stipends dramatically and to issue successive bonds, rather than demand contributions from the newly established industries. The budget deficit did not change the government’s long-term policy of favoring modern enterprises by using subsidies and other promotions.
The interesting question, then, is why, in similarly difficult financial situations, were the targets of the government authorities so different in Qing China and Meiji Japan? The key difference lay in the ambivalent attitude of the imperial court in Peking towards the self-strengthening programs. On the one hand, Peking hoped to see an increase in military strength, since it would serve to keep peace with the aggressive western powers and suppress the mounting rebels at home. But on the other hand, one important consequence of the launching of modern industries (especially arsenals and shipyards) was the rise of regional power against Peking. This regionalization of power was definitely something the imperial court hated to see. Appropriating the surpluses of the enterprises sponsored by provincial leaders served not only to fill the state coffers but also to limit the growth of modern ventures outside Peking’s control. The weakening of the central power in late Qing China led to its inability to initiate and support industrialization efforts, and created distorted incentives for the central government to intervene in modernization efforts initiated at the local level.
By contrast, the Meiji government, which was dominated by a small oligarchy, did not have the same concerns as the Qing government. The crucial political event of the Meiji Restoration was the centralization of authority away from the 280-odd han (local governments) in Tokugawa period and into the hands of certain powerful ex-samurai leaders in the central government. The authoritarian nature of the Meiji regime enabled it to consolidate and maintain its policy of establishing military power and modern industry at the expense of the traditional samurai and landowners. The development-oriented mindset of these leading officials in the Meiji government was also crucial in sticking to a preferred long-term policy for industrial promotion under tremendous fiscal pressure.
The Incentives for Local Officials and Bureaucrats
Although both Qing China and Meiji Japan witnessed the attempts at industrialization, self-strengthening in China was less a rallying cry for genuine efforts at innovation and catch-up than a shibboleth that served to justify expenditures and vested bureaucratic interests. This was a distinctive yet unfortunate feature of modernization in late Qing China, and was shaped by the evolution of late Qing politics.
Before the Opium War, Qing China was characterized by a highly centralized dynasty. The provincial governors had little independent authority over the military forces stationed in their respective jurisdictions. Peking also tightly controlled and monitored local fiscal revenues and expenditures. In addition, the imperial court controlled appointment and promotion of provincial governors in the central bureaucracy. The frequent rotation and relocation of provincial leaders, designed to eliminate the growth of local connections and regionalism easily nurtured by a stationary governor, made their positions more vulnerable. The Taiping Rebellion and western invasions shifted much of the bargaining power away from the Center at Peking to provincial leaders in the treaty-ports. With independent military forces and tax-collecting authority, the provincial leaders were able to entrench themselves through empire building in the form of establishing modern ventures with connections to the military. In this regard, it’s worth emphasizing that the provincial governors’ successful self-aggrandizement at the expense of the central authority resulted from the relation-specific nature of the military hierarchy and enterprises they led and sponsored. Provincial leaders were clearly aware that to keep their posts for a long period of time, they somehow had to make their positions irreplaceable. Some provincial leaders, Zeng Guo-fan and Li Hong-zhang , achieved this irreplaceability through patronage and highly personalized sponsorship of their military forces and enterprises.
The most prominent example of this phenomenon is the rise of regional armies during the suppression of the Taiping Rebellion. In the late 1860s, the most powerful regional armies included the Hunan Army founded by Zeng Guo-fan, and the Anhui Army coordinated by Li Hong-zhang. These regional forces distinguished themselves from their imperial counterparts by their greater use of Western weapons and higher costs of maintenance. More fundamentally, the regional armies were designed on the Confucian model, with its characteristic loyalties. Their relative strength lay in the close personal bonds that were formed between higher and lower officers and between officers and soldiers. For instance, in the typical organization of Hunan Army, which was founded in Zeng’s native district, the battalion officer chose his company officers and the company officer his platoon officers, while as a rule a platoon officers personally recruited the 10 soldiers who were to serve under him. The battalion officer was also attached to a particular commander. All the commanders were Zeng’s trusted associates. Zeng provided that each time a new battalion was appointed, all the lower officers as well as the soldiers of the battalion were to be chosen anew. The personal links thus formed supplied the cohesiveness which the imperial army and its mercenary adjuncts so conspicuously lacked. The political influence and power of Zeng rose with the expansion of Hunan Army that was loyal to him alone.
During the self-strengthening period, many of the pioneer firms were established on the initiative of the important provincial officials, with the aid of official funds, or with official support in such forms as partial tax exemptions or the monopoly of certain markets. Most of the new programs — arsenals, shipyards, even merchant steamships and mines — were administrated at the provincial level through newly created bureaus. The operations of these concerns followed the so-called “official supervision and merchant management”(hereinafter OSMM). This system in varying degrees underlay all efforts towards economic modernization throughout the late nineteenth-century. Under this system, the managing personnel were typically chosen by a commissioner of trade or a governor-general. These mangers usually had the titles of bureau director or “commissioned official”. In general, merchant management was to be guided by official supervision, although the degree of supervision might vary depending on the governor-general involved.
The OSMM enterprises shared with the regional armies the organizational characteristics of highly personalized patronage and sponsorship. Under this system, chief managers of the OSMM enterprises were appointed by the governor-generals, with whom they usually had close personal connections. Although these enterprises were nominally owned by the government, they were de facto personal properties owned and controlled by their prime political patrons. This is why the provincial leaders had the incentive to initiate and support the self-strengthening programs that helped to consolidate their own military strength and create new fiscal revenue, or served as an excuse for competing for funds otherwise under the control of Peking. It is worth noting that de facto control of the new enterprises does not mean that a provincial governor had correct incentive to manage them as a private owner. The governor’s control rights were very contingent and uncertain. If the governor stepped down, his economic empire also disappeared. The enterprises under his control were also subject to the confiscation or taxation by the imperial court in Peking. These uncertainties pushed the promoters and managers of the enterprises to act myopically. As a result, they demanded a handsome return on their investment and efforts at the expense of the company’s financial capability and long-term growth potential. They were eager to transfer the company funds — the bulk of which came from official funds — to their private business or to new ventures under their control. The other factor unfavorable to the company’s financial health was that the company’s best interest often had to yield to the governor-general’s political aspirations or an interest in expanding his power. Thus the profit principle was often compromised. A good example of this was when Zhang Zhi-tong was reassigned as the governor-general of Hu-guang. He moved the funds and the iron factory site from Canton, in which he originally served as the governor-general, to his new post, Wuchang, which enjoyed fewer advantages in the supply of cheap raw material.
The political uncertainty and resulting myopia of the provincial leaders also contributed to the prevailing predatory policy towards local industry and trade. Since the provinces gained increasing autonomy in creating and collecting local taxes, the excessiveness and arbitrariness of the provincial and local taxes began to constitute a crippling burden plaguing industrial or trading ventures.
Among the new sources of local revenues, the most important was the ‘lijin,’ which was first imposed in Jiangsu in 1853 as an internal transit tax on grain passing through the Grand Canal, and meant to raise money for suppressing the Taiping Rebellion. Lijin did not disappear after the Taipings were suppressed. Instead, by 1862 it had been applied to nearly all commodities and was copied by almost every province. In some cases lijin had come to be charged not only along the route of transit but also as a production tax at the point of origin and as one type of sales tax at the destination of the commodity. The rate varied widely, from 1% to 20% ad valorem. More than that, checkpoints were located almost everywhere, and the same commodity could be levied more than once while passing different checkpoints. Not only the major trading goods but also minor consumption goods such as a rooster or a piece of cloth intended for personal consumption were subject to taxation. Besides various kinds of taxes, there were numerous unpredictable extortions imposed on private business and trading companies that influential officials did not patronize, seriously weakening the incentives for private-sector economic activities.
Now let us look at the bureaucracy in Meiji Japan. We know that the Meiji statesmen were hard-headed in promoting modernization, however, a development-oriented central government did not guarantee that there would be incentives for lower-level bureaucrats to follow the central government’s development policy. There is substantial evidence showing how a desirable central policy can be manipulated, distorted, or ignored by the corrupt bureaucrats due to monitoring problems. Thus, in order to understand the effective implementation of industrial promotion policy in Japan, we need to examine the incentives on bureaucrats and constraints they faced.
According to the Meiji Constitution, the bureaucracy was protected by its provision for “independent responsibility to the throne”, that is, ministers and their ministries were not accountable to the prime minister, the cabinet, or the Diet, but only to the Emperor — and hence to no one but themselves. The drafters of the constitution intended to prevent rivals to the oligarchs from coming to power and using the government against them. Another crucial feature of the Japanese bureaucracy was the relative independence of the bureaucrats in one ministry from the authority of the director of the ministry. Their appointment and promotion followed certain merit-based procedure not readily manipulated in by the director or outside politicians. This formal recognition of the dominance of economic bureaucracy guaranteed that the bureaucratically directed economic development be protected from all but the most powerful interest groups so that bureaucracies can set and achieve long-range industrial goals. There was no myopia problem in the Japanese bureaucracy similar to the one that plagued the provincial governors of late Qing China.
Throughout the Meiji era the government remained an authoritarian, bureaucratic regime, presiding over a nation displaying marked cohesion and discipline, and with a Parliament (after 1890) capable of little but small and insignificant obstructionist tactics. Within the limits of its resources, therefore, the Japanese government was comparatively free to move the country towards the goals of national development as conceived by its leaders.
An industrial promotion policy implies rent creation, usually in the form of subsidy or tax incentives, which is necessary for the encouragement of private investment in the face of intense foreign competition and imperfect domestic economic environments. However, rent creation often invites rent-seeking activities, such as collusion and corruption between some particular officials in charge and businessmen. Japan’s state intervention in Meiji era was not free from rent-seeking problems. This was especially so in the early years of Meiji regime. At that time, a new type of businessmen emerged in the private sector: the seisho (political merchants), who rode a wave of government favors and used every opportunity to amass fortunes for themselves, glorying meanwhile in official titles and patriotic slogans. But they did not survive as a viable constituent of a thriving private sector of Japan’s modern economy. The importance of political merchants gradually dimmed as a new generation of progressive businessmen with fewer government connections rose to prominence. The factors driving this shift were many — intense international and domestic competition was one — but state intervention in the form of “contingent rent” policy was also responsible (Aoki, et al, 1996). Under this policy, the government chose which enterprise to favor based on its superior performance instead of personal connections between the officials and the company. The emergence of Mitsubishi and its takeover of the formerly government-favored company called YJK is an example in point. YJK lost the government’s favor not only because it refused to serve its military mission, but also because compared to the rapidly-growing Mitsubishi, it suffered from uncoordinated management and outdated shipping technology.
Because there were discrete long-term policy target for the bureaucrats in the Ministry of Industry, continuing support for an inefficient and uncompetitive firm would invite criticism and pressure from the government, the industry and even the general public. Under the contingent rent principle, personal connection might still count given the first-mover advantage (e.g., learning-by-doing effect), and there was no perfect selection mechanism, but personal connections alone would not suffice in a highly competitive market. Those enterprises that had political connections to the government and were at the same time highly competitive would likely be the government favorites. This is the crucial difference between the rent-creating process of Qing China and that of Meiji Japan. In Qing China, the central government had no long-term industrial policy, and the operation of the OSMM enterprises was free from evaluation and monitoring by any outsiders (e.g. shareholders). If an enterprise ran a huge loss, it would be shuttered or rendered bankrupt. But no one would be held accountable, and minor shareholders or debtors would suffer the loss. Without constraints on their behavior, official-patrons created room for pure rent-seeking and corruption.
The Incentive of the Chief Managers or Private Owners
The relationship between the government and business in Meiji Japan was marked by two significant changes: one was state disengagement from direct ownership and management of the enterprises after 1882; the other was the eclipse of the political merchants and the rise of professional and independent businessmen in the private sector. In Qing China, what we observe is the persistence of official-merchant collusion and related rent-seeking behavior. This intriguing phenomenon can be explained by the two interrelated elements set out below.
First, successful treaty-port merchants or chief managers of the OSMM enterprises tended to be assimilated into the official bureaucracy (Chan, 1976). They often used their money to purchase official titles. Holding traded official titles brought the merchants a sense of legitimacy in a social order that had traditionally downplayed the role of the merchants and business-related activities. In addition, the position of the merchant was never felt to be secure. Like the salt merchants in the early Qing dynasty, who also depended on government favor and support, they were always vulnerable to official appropriation of their personal wealth or the assets of their enterprises. Therefore, in a society with a predatory state and official bureaucracy, seeking political patronage or assimilating into official bureaucracy were the typical ways of protecting and expanding business investments. At the same time, the officials also sought every chance to regulate mercantile activities in hope of profiting personally from the regulation and resulted rent-seeking. In fact, they usually went too far in “squeezing” commercial activities under the cover of regulation. Thus, predation created a demand for official protection and direct involvement, while officials found themselves in good position to seek private gains in the name of regulating commerce and industry. The official supervision and merchant management thus emerged as an equilibrium outcome in a predatory institutional environment.
Second, the serious problems related to the governance structure of the OSMM enterprises gave rise to a growing disenchantment among private investors, which in turn strengthened the need for official participation as a substitute for the shortage of capital supply in the market. As described above, chief managers transferred large amounts of a company’s funds to whatever uses they saw fit, without consulting general shareholders. The hiring of idle employees based upon personal connections, the wasting of money in the purchase of materials, and doctored accounts were commonplace in the OSMM companies. When any of these companies failed, the official leaders usually made official loans the priority claim on the company’s assets in bankruptcy, leaving very little for the merchant shareholders. The growing dissatisfaction of the private investors with the governance structure of officials-sponsored companies caused those companies to experience mounting difficulties to raise capital in the market. This resulted in more official support in the form of government investment in the business. The government intervention invited its further involvement in the business.
By comparing the divergent responses of Qing China and Meiji Japan to the West in late nineteenth century, we see that the in late Qing China, self-strengthening in a traditional society, which was not systematically reformed, evolved into a stable collusive equilibrium between the provincial leaders and merchants featuring rent-seeking and entrenchment of regional power. This equilibrium resulted from the strategic interaction between the imperial court, provincial officials and merchants in a predatory institutional environment. Meiji Japan presented another type of collusive equilibrium between the state and big businesses, featuring efficiency-enhancing rent-creation and private entrepreneurship. With a progressive and systematic transformation of the Japanese society, the central government, dominated by a small modernization-minded oligarchy, provided an enabling environment in which the private sector could thrive. A relatively stable and independent economic bureaucracy laid the institutional foundation for a long-term industrial promotion policy that encouraged productive collaboration between the state and the private sector, particularly the big businesses.
(The author is a Ph.D. candidate in the Department of Economics at Stanford University.)
- Aoki, Masahiko, Hyung-Ki Kim, and M. Okuno-Fujiwara. The Role of Government in East Asian Economic Development. Oxford: Clarendon Press, 1996.
- Chan, Wellington K. Merchants, Mandarins and Modern Enterprises in Late Ching China. Cambridge: East Asia Research Center, Harvard University, 1976.