Incremental Reform and Distortions in Product and Factor Markets in China

The purpose of reform is to reduce distortions in the economic system and enhance growth. However, along with the incremental partial reforms, local governments or individuals often have the chance to capture rent inherent in the process. Young (2000) warned that rent-seeking behavior might lead to increasing market fragmentation. Empirical studies have shown the opposite in the product market. In this paper we argue that as the rent from the product market has been squeezed out due to deepening reforms, rent-seeking behavior may have shifted to other sectors, in particular to the capital market. The key is to conduct further reforms to squeeze out additional rent collection opportunities after those from product and labor markets have been squeezed out.