Regulation of Local Governments and Enterprise Formation in Rural China

Given the rapid rise of the private sector in rural China, power, control over resources, has been shifting from local governments to the hands of entrepreneurs. In light of the two opposing theories in the literature on how local governments would react to the attrition of power (the "helping hand" hypothesis versus the "economic losers" hypothesis), in this paper we examine whether regulation formulated and implemented by township governments has different effects on the formation of village enterprises, private enterprises and self-employment in villages. Using a data set designed and collected by the authors, we find that regulation affects different types of enterprises in different degrees. Specifically, holding other things constant, higher entry costs and stricter general regulation tend to discourage the formation of private enterprises in villages (firms with 8 or more employees) while they do not seem to adversely affect village enterprises. In addition, when compared to private enterprises, self-employed firms (micro-enterprises with at most 7 employees) do not seem to be discouraged by regulation. Consequently, this paper provides evidence that is less consistent with the helping hand argument and more consistent with the economic losers hypothesis; according to our study, local governments in China appear to be resisting competition that emerges with the rise of private firms. To protect their interests embedded in village enterprises when facing the rise of the private sector that may be threatening village firms, township governments implement regulation discriminatorily, coddling village enterprises while being relatively harsh with private enterprises.