Rural development in china the rise of innovative institutions and markets (volume 1)

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Chinese original edition © 2013 China Renmin University Press
By Lu Yilong
English edition © 2015 by Enrich Professional Publishing, Inc.
With the title Rural Development in China: The Rise of Innovative Institutions and Markets Volume 1
Translated by Yu Lun
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Contents
Preface

..............................................................................................................vii

Chapter 1 Institutional Innovations and Rural Market Development ......1
Chapter 2 Institutional Supply, Demands on Institutions, ..........................21

and China’s Rural Development
Chapter 3 Reform of the Urban-Rural Dual Structure ..................................43



and China’s Rural Development

Chapter 4 Farmland Expropriation and the Reform .....................................91

of the Rural Land System

Notes

.............................................................................................................111

Bibliography .............................................................................................................115

Index

.............................................................................................................123



Preface
Looking at China’s implementation of the Reform and Opening Up policy over
the past 30 years, the following observations can be made: reform is the only
way to ensure steady and stable development. Reform, in essence, is institutional
innovation through which society and the economy embrace greater progress and
productivity as well as get rid of ineffective institutional arrangements. Therefore,
in a sense, institutional innovation can be counted as a productive force, for its
process encompasses achievements from various fields, including philosophy,
social sciences, as well as advanced economic and social management.
Originating in rural areas, the Reform and Opening Up policy made happen
the first leap in China’s economic and social development: China has got rid of
destitution and begun striding towards moderate prosperity. In the meantime,
however, sluggish rural development remains a big problem. The second leap
would require the development of China’s rural areas, for they are the bottleneck of
national development, or in marketing terms, the hole of the “leaky bucket,” while

at the same time being the solid foundation of all socioeconomic progress. Then,
how is it possible to realize the second leap in rural China? They key lies very likely
in institutional innovation: changing the impeding institutional arrangements and
establishing institutions that could stimulate development. This book will discuss
how rural China, in this new era, should develop in the respects of institutions and
market, specifically what institutional factors are constraining the development of
the rural market and the “three rurals” of agriculture, villages, and farmers, and
what kind of institutional innovations and institutional arrangements could bring
improvements.
The development of rural China has long been the concern of Chinese
sociologists: Yan Yangchu raised the idea of village construction movement, Wu
Wenzao initiated community studies, Fei Xiaotong proposed the developmental
model of “leaving the land but not the village,” the approach of constructing small
towns, and the theory of coordinated regional development, and Philip C. C. Huang
(Huang Zongzhi) developed the idea of “the third way” of rural development.
This book chooses to discuss China’s rural development from the perspectives
of institutions and market development mainly because of two reasons. First,
institutions are a comprehensive variable that shows clearly the relationships among
institutions, social activities, and development, for institutions combine factors of
all fields from the economic and political to the social and cultural. This suits the
research of rural development, which is a complex issue itself, perfectly. Second,
rural development depends on economic progress, whose key is the development
of the market against the backdrop of marketization and globalization. Effective

vii


Preface

leveraging of the market system would not only drive the development of the rural

economy but also help solve problems of the “three rurals.” Although not almighty,
the market has its effect in promoting development, and neglecting this “invisible
hand” would gravely discount the efficiency of socioeconomic development.
G. William Skinner has conducted research on the relationship between the
marketing system and social development in rural China, and Justin Yifu Lin makes
developing rural markets the key of his rural reconstruction theory. In the field of
institutional analysis, the neoinstitutional school has developed plenty of models.
Borrowing the achievements of these past studies, this book takes a sociological
perspective and uses empirical studies to discuss the interrelations and trends in
China’s institutional changes, market development, and rural development.
In terms of empirical studies, this book adopts the China General Social Survey
(CGSS) and uses its data for analyses of the household registration system, the
urban-rural structure, farmland expropriation, farmers’ actions of “braving the
market,” market awareness, and the use of rural land. Also included are analyses
of field surveys on rural market development in Xiaogang Village, Anhui Province;
Dingzhou, Hebei Province; and suburban Beijing. The above studies are used to
figure out the status quo and problems in rural China and its market development
as well as investigate how these problems are related to institutional arrangements.
This book is divided into three volumes:
• Volume 1 is tackles institutional issues in China’s rural development,
covering institutional innovation, rural reconstruction, the household
registration system, the urban-rural structure, and the rural land system.
• Volume 2 focuses on specific issues in rural market development, such as:
government-induced institutional innovations; emerging factor markets;
farmers’ “braving the market”; farmers’ market awareness; farmers’ uses of
rural land; rural fairs; and the cultivation of entrepreneurial talent in rural
areas.
• Volume 3 discusses the developmental issues of rural China from a historical
lens. This volume contains analyses of China’s 60 years of rural development;
changes in the Chinese rural class structure and hierarchy; dilemmas in

post-earthbound China; and the recent progress and future path of China’s
rural development.
The theoretical discussions and explanations in this book are based on empirical
studies. The following ideas may require further improvement, but they are
based on the author’s understanding of the macro- and micro-experience of rural
development in China: reforms towards a “unitary system” for urban and rural
institutions; induced institutional innovations; farmers’ “braving the market”;
“post-earthbound China”; and diverse paths towards urbanization and rural
development.

viii


1

Chapter

Institutional
Innovations and Rural
Market Development


RURAL DEVELOPMENT IN CHINA

Over the 30-year course of China’s rural reform, rural society and the rural economy
have leapt to the next stage of development characterized by the steady growth of
agricultural production, higher levels of household income, and an overall higher
quality of life. Such progress should be attributed to the adoption of the household
responsibility system which replaced the collective economic system and inspired
growth in economic efficiency in rural China. Under the collective economy, actual

household labor input was very limited due to complex influential factors. The
new practice provided strong incentives for farmers to increase labor input, and
thereby output. Under the reformed production structure, rural communities are
basically free from destitution. But new challenges have arisen, the biggest ones
being how to maintain the steady growth of household income and quality of life,
and how to make further social progress in rural areas. Institutional innovations,
rural market developments, and their connections may shed some light on the
solutions to those challenges.

Institutions and Rural Development
Institutions
An institution is a mechanism of social order governing individual choices and
behavior. Douglass C. North describes the role of institutions in human society as:
In a world of uncertainty they have been used by human beings in an
attempt to structure human interaction. They are the rules of the game of a
society and in consequence provide the framework of incentives that shape
economic, political, and social organization. Institutions are composed of
formal rules (laws, constitutions, rules), informal constraints (conventions,
codes of conduct, norms of behavior), and the effectiveness of their
enforcement.1
Formal and informal rules exist and impact each and every move of human
society, whether in the preindustrial or postindustrial age, and whether at the
economic, political, social, or cultural level.
Institutional economists were the first people to notice the role of institutions
in socioeconomic contexts. John R. Commons and Thorstein Veblen shared
insightful views on the institutions of economic operations. Commons noted that
an institution can be a framework of laws and regulations, as well as individual
behavior. As a universal principle, an institution means that collective actions can

2

Institutional Innovations and Rural Market Development

control individual actions.2 New institutional economists rediscovered the roles of
institutions and provided a deeper, broader, and more organized explanation of the
linkage between institutions and economic operations. North, along with Oliver
Williamson, discussed how institutional arrangements can impact transaction
costs, and thereby people’s choices and economic efficiency. When institutions
provide interactions and trade with value-bearing services, the enforcement of
institutional arrangements will incur costs which are known as transaction costs.
Some institutional arrangements are, in theory and reality, more cost-effective than
others. In other words, institutional arrangements can help reduce transaction
costs. And those that enable cost reductions are more efficient than others.
Armen Alchian, Harold€Demsetz, and Ronald Coase presented a new theoretical
explanation for services and transaction costs. By introducing property rights
into institutional analyses, Demsetz and Coase formed a new school of thought
in new institutionalism. Property rights are an individual’s or a group’s rights of
possessing, disposing, consuming, exchanging, and transferring property.
According to the property rights school, how an institutional arrangement
defines property rights makes a big difference in the resulting transaction costs. The
clarity and scope of a property right are the major factors that influence transaction
costs. Clearly defined individual property rights generate€less transaction costs than
ambiguous, collective ones. Take for example a transaction between a beekeeper
and an orchard owner. No matter who owns the honey, the transaction costs could
be lowered and productivity optimized if this ownership is defined.
Using game theory, Olson, and the advocates of Olson’s collective action theory,
provides a noncooperative solution to ineffective institutions. They argue that
when acting in a group, individuals are easily tempted to take free rides on the
efforts of others — meaning to loaf on the job or act noncooperatively. Common

ownership and collective ownership tend to give rise to this sort of loafing around,
and this may result in low, or even near-zero, collective efficiency.3
In classical Marxism, institutions are interpreted in multiple layers. Social
institutions, being the most general and abstract concept, are composed of a set of
institutions that emerged in human history, such as slavery, feudalism, capitalism,
socialism, and communism. In terms of analyzing social institutions, Marx
introduces the concepts of “relations of production” and “superstructure,” both
of which cover economic and noneconomic institutions. Economic institutions are
rules that shape human interactions. An economic institution is determined by
its current productivity level, and, at the same time, it has a counter-effect on the
productivity. Being a vital part of the superstructure, institutions are based on a
certain economic foundation. They exist to serve and also shape the economy.

3


RURAL DEVELOPMENT IN CHINA

Institutional transition
Increased attention has been given to the roles of institutions. Previous economic and
social theories consider institutions as comparatively inactive and unimportant. This
may be because institutions are subject to complex economic and social reality, or in
Marxist terms, social productive forces. Therefore, little attention and limited research
efforts have been devoted to an institution’s countereffect on productive forces.
Institutional economists (in the study of economic history) and property-right
economics (in the study of the modern economy) consider institutions very
crucial. North and Thomas, in their The Rise of the Western World, argue that
technological innovations contributed greatly to social progress. When studying
the driving forces of the European scientific revolution, they focus on institutions
and institutional innovations. Looking through European economic history, they

reveal that early Patent laws played a significant part in defining and protecting
intellectual property rights. This legal institution proved to be€a strong incentive
for European industries to make continuous technological innovations.4
Today, institutional transition and institutional innovation have been introduced
by developmental economics and agricultural economics to expand the theoretical
explanations of new institutional economics. Lin suggests that the effectiveness of
any institutional arrangement is determined not only by the arrangement itself,
but also by many relative institutional arrangements. In the 1950s, China suffered
a severe agricultural downturn. Its causes were in two aspects: first, collective
farming could not stop people from loafing, which occurred because it was difficult
to assess labor’s contribution in agricultural production; second, individuals were
forbidden from exiting collective communes.5
Not all institutions are effective. Even the most inefficient institutions can last
because of inertia. Also, less effective institutions would not naturally give way
to more effective ones. Institutional innovation can be introduced only when it
induces more benefits than costs. Such institutional innovation is called an induced
institutional transition. This suggests that it is possible to manipulate the costs and
benefits of an action through institutional arrangements.
In China’s rural reform, the collective farming system was replaced by the
household responsibility system. Thereafter, agricultural production bottomed
out and quickly sprang back to normal. In Xiaogang Village of Anhui, where the
reform started, household harvests increased and the 20-year-long destitution
was basically resolved in the first year after adopting the household responsibility
system. Under this system, enough food was produced to not only feed the
villagers but also to meet the government requisition and communal reserves.6

4


Institutional Innovations and Rural Market Development

This change proved that even just one institutional innovation is important for
social and economic development. Why was the household responsibility system
effective when factor markets, such as land factor markets and factor markets,
had not yet been formed? Experience and theories indicate that the problems
of cooperation and supervision within rural production units were solved not
only by this institutional arrangement but also by many other arrangements
within the new institutional framework. Lin mentions that farmer’s rights to exit
cooperative organizations, among other related institutions, played a critical role.7
As was shown in the case€ of Xiaogang Village, institutional changes — such as
the weakened embedded€ politics and farmers’ improved autonomy — were
fundamental in increasing economic efficiency.8
Since the mid-1980s, the emerging rural markets have become a strong driving
force behind China’s rural development. Soon, township enterprises emerged and
expanded rapidly, providing evidence of the rapid development of rural product
markets and the booming of the rural economy. Meanwhile, land markets and
labor markets started joining product markets to appear in rural areas. Rural factor
markets have played an integral role in facilitating fairer income distribution and
improving the quality of life, while regional growth has been achieved through the
proper use of land. More importantly, rural laborers have widely entered limited
labor markets. So far, the 150 million (approximately) rural migrant workers have
made up a vital portion of the entire labor force. Most rural residents rely on the
urban labor market to top up their income. Therefore, rural migration has been
growing, regardless of their jobs being highly uncertain. Judged in light of the
above facts, the emergence and expansion of rural markets have been the driving
forces behind the success of reforms.
Now, rural China needs a new driving force to step forward and climb to the
next stage. But what is that driving force? Perhaps previous successful reforms can
provide some insight.

Institutional innovations
In reality, changes do not come easily to inefficient institutions. Path dependence
often develops once an institution starts operating. It does not mean that an
institution then assumes an irreplaceable role in people’s lives, but that most
people would become used to its ways and would not want a change if they have
to bear the adaptation costs of the institutional reform.
Ideology also impedes institutional changes. Ideology could have the core
values of an institution turned into common beliefs and habits. Moreover, it

5


RURAL DEVELOPMENT IN CHINA

can force the implementation of an institution, as well as prevent it from being
directly opposed or overthrown. For instance, in the late 1950s, ideology played
a critical role in implementing the people’s commune system, which proved to be
inefficient. This same ideology also constituted grave resistance to the replacement
of this system. Therefore, China started its Reform and Opening Up by calling for
“emancipating people’s minds” in order to get rid of the ideology associated with
the old institution.
Interest groups also hold sway over institutional changes. The rules and
choices, established by an institution, determine the allocation of interests among
interest groups. Therefore, replacing an institution would change the present
balance of power. That is to say, the new institution may be beneficial to some
groups while damaging to others. Institutional changes shall face grave resistance
if vested interest groups hold great power in interest expression and decisionmaking. Changes can happen rather smoothly when reinforced by strong potential
beneficiaries whose power matches or surpasses that of the old vested interest
groups. For example, in the early 1950s, the Chinese government introduced a state
monopoly on grain trade. This institution did not motivate farmers to work harder,

but it lasted until the late 1990s before being officially abolished. In this case, the
old vested groups were cadres and workers, whose power was so great that the
new beneficiaries — farmers — could not compete with them.
The complete transition from one institution to another can be regarded as a
qualitative change. Like customs and social habits, established institutions are
difficult, but not impossible, to change. In fact, institutions go through quantitate
changes constantly, meaning that they subtly adapt to social reality. For an
institutional innovation to take place, however, a new set of rules and arrangements
shall displace the old, and the fundamentals of the old institution be completely
transformed.
Some ineffective institutions in society have never been fundamentally
changed. Innovation can only happen in a right institutional environment. An
institutional innovation opens a window of opportunity amidst the institutional
disequilibrium. And from this innovation, society can benefit as a whole. But the
happening of innovation depends on the innovator’s expected costs and benefits,
the distribution and externality of these benefits, and the possibility of having freeriders.9
Game theory considers institutional innovation the result of repeated games.
Historically, institutional innovations have happened with or without an effective
nature. For example, in the 1950s, the institutions of collective farming and people’s
communes were established in rural China. These damagingly problematic
institutions could not have been implemented without a game between various

6


Institutional Innovations and Rural Market Development

interest groups. In the same way, the downfall of such institutions involved
another gaming between the farmers and the holders of the vested interests. In
1978, farmers of Xiaogang Village broke the system of the people’s communes by

dividing their common farmland into individual plots. Farmers were definitely
motivated by the potential benefits this new institutional innovation might bring,
but still, they took the risk of breaking the rules. Theoretically, all farmers could
have initiated such a change, but it was the farmers of Xiaogang Village who made
up their mind to make the first move. And fortunately, they were rewarded with
approval. In a sense, this constitutes an equilibrium of games. At one end of the
equilibrium, the farmers acted in a game of survival — destitution versus survival
— by secretly and illegally dividing common lands. They were endorsed, because
at the other end of the equilibrium, policy-makers desired solutions to the problems
of agricultural and rural development, and policy-makers considered Xiaogang
Village’s innovation a successful example.
Considering that not all innovations would lead to better effective institutional
arrangements, an effective reform suggests great difficulties and efforts. To make
an innovation effective, the initiators should propose effectiveness-appraising
criteria, on top of new institutional rules. Neoclassical economists apply a
seemingly straightforward standard — rational choices. The free market theory
has it that a rational economic man has the freedom to choose. A rational man
tends to make “rational” choices that are the most beneficial to themselves. By
that logic, commonly recognized actions are beneficial to the majority of people
in a community, and decisions are the most reasonable when made according
to the majority rule. However, some scholars of new institutionalism argue that
rational choices can only lead to the best decision for specific people. In reality, no
institution can make life better for everybody.10
Historically and realistically, when it comes to innovations in rural institutions,
farmers€often have little say in institutional design. As a result, in most cases
they either follow conventions and established practices, or join forces to resist or
even overthrow the existing hostile institution. It is indeed a challenge to develop
effective institutions for rural communities.

Market and Rural Development

Market
Markets are generated by exchanges between parties. In a narrow sense, a market
is where people meet for transactions and exchanges. But market also has a broad
and abstract sense of meaning. Weber linkes markets to society. He writes:

7


RURAL DEVELOPMENT IN CHINA

The market community as such is the most impersonal relationship of
practical life into which humans can enter with one another…. The reason
for the impersonality of the market is its matter-of-factness, its orientation to
the commodity and only on that … there are no obligations of brotherliness
or reverence, and none of those spontaneous human relations that are
sustained by personal unions.€ Market behavior is influenced by rational,
purposeful pursuit of interests.11
In situations where there are perfect competition, no externality, and sufficient
information, a competitive equilibrium can realize Pareto efficiency. That is,
individuals can improve their situation without sacrificing any other€individual.
This concept of market efficiency was what Adam Smith describes as the market
being an “invisible hand.” Smith’s theory states that an open market is like an
“invisible hand” that regulates people to seek private interests while also
optimizing the public interest. Traditional institutionalism criticizes markets for
creating inequalities of income, wealth, and economic opportunities; giving rise to
monopolies and other forms of economic privilege; causing low productivity, and a
slow pace of technology and tool development; and “wasting” various resources by
applying competitive marketing and other methods.12 But neoclassical economics
also rediscovered the efficiency of markets, which is quite effective in reducing
transaction costs and scarcity.

A market is established for conducting transactions, and its development helps
bring about added transactions. More goods and services mean better satisfied
demands, and this will attract even more people to engage in the exchange, thereby
forming a virtuous cycle. Also, the development of a market will promote labor
divisions, specialization, and the expansion of production scales. This is because
some people would be able to build a fulltime career in market exchanges, and
the producers and service providers could work to expand their business for new
opportunities. The more a market develops — meaning that it can offer more
options — the stronger influence it has on the social structure and the economy.
In rural China, traditional markets exist in various forms. In southeast China,
central markets usually exist in towns, to which a round trip requires less than one
day’s time from nearby villages.13 In Sichuan, standard market communities and
regional markets constitute a rural market system. Geographically speaking, one
regional market usually supports its surrounding six standard market communities,
which are in a hexagonal manner. Standard market communities, consisting of
village fairs and intermediate markets, serve to satisfy the daily needs of rural
households. Regional markets, usually located in the geographical center, hold lots
of itinerant vendors. But the demand for goods and services is not so great there.14

8


Institutional Innovations and Rural Market Development

In North China, village fairs and temple fairs are the typical market forms. They
developed rather quickly after the Ming and Qing dynasties. In modern Dingzhou,
Hebei Province, village fairs grew rapidly during the Qing emperor Daoguang’s
reign (1821–1850), at which time an average village fair catered to 39.4 villages
in an area of 110 km2 with a population of 18,912. And by the early 1930s, the
corresponding numbers had changed to 5.5 villages in an area of 14.6 km2, with a

population of 4,819.15 Villages were no more than 10 km — in most cases, within 5
km — from the nearest marketplace.16 This indicated an approximate seventh-fold
increase in the number and density of marketplaces in this region. Temple fairs
are also a special and important traditional market form. Other than trading, they
also satisfy multiple needs such as religious needs, entertaining, and socializing. Li
once conducted a survey in Dingzhou, and found that there existed over 50 temple
fairs, the largest of which occupied approximately 150 mu and attracted around
10,000 people daily.17
Discussions on the history of China’s rural development have centered on
traditional rural markets. Why has China’s traditional rural market not rocketed
up? What has kept it to its basic form?
In reality, traditional markets and modern markets coexist in rural China, and
they are each distinguished with fundamental characteristics. Traditional markets,
in the forms of fairs and various kinds of exchange, have long been irreplaceable
to rural communities. Modern markets, compared to the traditional ones, focus
on specialized commodity transactions and professional trading. Based on highly
developed labor divisions and specialization, modern markets require certain
farmers to quit farming and enter marketing.
Since the start of the Reform and Opening Up era, rural markets in Eastern
China and especially along the southeastern coast — particularly in Jiangsu,
Zhejiang, Guangdong, and Fujian — have been rapidly stepping up, evolving
from traditional markets and into modern ones; whereas in Central and Western
China, the transformation was relatively slow. In North China, where the tendency
of market-oriented production became obvious since the late Qing Dynasty,18 the
transformation of the traditional markets has not been a quick process. Huan states
two possible causes: first, income and consumption fail to step up from the longterm low level; and second, labor force migration remains slow.19 However, it is
complicated to deal with the transformation of rural markets. It is, in fact, connected
to the sluggish rural development. Fundamentally, this sluggishness results from
improper structural factors in the economy, society, and culture. Specialized
production, for example, can be severely hampered by the self-sufficient peasant

economy, undiversified agricultural economy, as well as closed and immobile
society.

9


RURAL DEVELOPMENT IN CHINA

Rural industrialization is the key to activating the rural markets in the
southeastern coastal areas. There, township enterprises sprang up, leading to a
change of economic and social structure, and thereby rapid improvements in the
factor markets of products, labor, land, and capital.

Market system
Neoinstitutionalism further connects markets with institutions by portraying
the market as highly economical and efficient. A market system is made up of
cooperating organizations, an ethical system, and contract-enforcement-relating
laws. In an institutional sense, markets serve to regulate and guide socioeconomic
operation. Smith regards the market as an “invisible hand” which guides people
to make economic choices that benefit others while pursuing their own profits.20
The power of markets is generated by the interactions and mutual influences
between individuals. The market is an intangible force, similar to “social cohesion”
in classical Marxist terms. When there is a huge demand for a certain commodity,
the market will drive producers to produce that commodity. And when a certain
technology is in need, the market can turn this demand into a strong motivation for
technological innovations. In this respect, the market is much more effective than
any academic research. In short, market demand stands for common needs.
Neoinstitutionalism emphasizes that market systems are cost-saving, and
therefore economical. Cutting costs means raising profits. Then how does a market
system work to save costs? Free markets allocate economic and social resources,

and in this process, the changes of demand and supply would be immediately
reflected in prices. Prices impact consumer choices greatly. Prices rise when supply
is tight and demand exceeds supply. And a high price, in turn, would dampen
consumption, thereby saving resources. In the same way, when producers scramble
to offer similar products, supply would be pushed over demand and results in
prices dropping and profits shrinking. Lessened profits may force some producers
out of business, and thus conserve resources.
How can the market boost efficiency? The market mechanism acts through
perfect competition, selected priority of efficiency, and natural selection. Unlike
the planned economy or the redistribution economy, the market economy affords
its participants and resource users constantly improved competition mechanisms,
by which they can openly and fairly compete for the access and share of resources.
Highly efficient competitors get a larger share of resources, while inefficient ones
get eliminated in the competition. The market is like a coliseum, where only
the strong ones survive. To win a coliseum fight, one must sharpen one’s skills;
likewise, to survive the stiff market competition, businesses must improve their

10


Institutional Innovations and Rural Market Development

efficiency. In the water rights market, water is considered a dedicated resource
instead of a public good. When the right to use water becomes tradable, naturally,
the more efficient users would be favored, for they can pay higher rates. In a
market economy, efficiency has the vital say on the survival of all businesses. To
survive the competition, every business owner must put boosting efficiency as a
top priority.
In fact, it is debatable whether the market system is superior. In the real world,
“market failures” — where a market fails to achieve economic goals and become

efficient — happen every now and then. If the market system is so superior, why
have farmers not chosen it? What has hampered the transformation of the rural
market? In a sense, China’s sluggish rural development in this era of marketization
and urbanization is an example of a market failure.
The market system in rural China is not evenly developed. In agriculture-based
rural communities, rural markets are relatively inactive. Agricultural production is
still a household activity, and farmers remain quite unaffected by the market. With
natural inputs — such as soil, water, weather, and climate conditions — being the
dominant influential factors, farmers hold very little control over their agricultural
production. Therefore, they can do little in response to the ever-changing market
demands. Farming is largely determined by nature, technology, and habits. Thus,
it is unlikely for farmers to change what they produce, even when the demand for
and the price of a particular product is soaring. Seen from the above perspective, a
traditional rural economy could not benefit from the market system, which helps
save costs and boost efficiency. For the market to be able to exercise its efficiency,
the participants must have the freedom to make their own production choices,
which the farmers do not have.

Institutional Innovations and Rural Market
Development
Market transition
As was shown by China’s rural reform, improvements in market institutions could
promote the development of rural and urban areas. Based on empirical research,
new institutional sociologists point out that market transition is an important factor
that pushes social differentiation, rural development, and farmers’ income. Based
on a research study of rural Fujian, Nee tests his “market dynamics” and “market
opportunity” propositions. He believes that, compared with a planned economy, a
market economy better motivates direct producers by allowing them to keep more

11

RURAL DEVELOPMENT IN CHINA

products and profits for themselves. Meanwhile, market transitions create marketcentered opportunity structures, meaning individuals can find opportunities in
markets, instead of having no choice other than counting on redistribution.21
Markets can, as proved by theories and experience, effectively promote rural
development. Lin suggests that building and perfecting rural markets should be
the core content of developing a new socialist countryside.22 There exists huge
potential hidden in rural China. The upgrade of rural markets could boost domestic
demand and accelerate economic growth. However, the status quo of rural China is
that the market system remains rather defective and underdeveloped. Specifically,
obstacles to achieving market transitions and the development of rural markets are
as follows.
First, the market structure is asymmetric. Currently, the rural markets are
mostly supply markets of primary commodities and of low-end labor. Consumer
markets and markets of higher levels of demand, however, are not that developed.
This situation demonstrates an unbalanced market structure.
Second, market stability fluctuates. Massive labor migration splits production
and consumption, thereby making both of them unstable. Rural migrant workers
live seasonably between the city and their hometown village, and this kind of
lifestyle would spoil the stability of rural markets, especially rural consumption
markets. As a result, some seasonal rural markets may face recession, since their
only customers are children and the elderly left in the villages.
Third, the rural market system is underdeveloped. Product markets and factor
markets are not desirable. Rural consumer markets’ slow development results from
the low level and slow growth of farmers’ income. The level of farmers’ income
depends on their income sources — the opportunities that the market offers —
which are ultimately determined by the factor markets. Unfortunately, factor
markets are not favorable or open enough, even after the rural reform. Take for

example the rural labor market. Rural workers are able to find jobs in a rural labor
market, but only low-paying ones. This is because the rural labor market is not on a
par with the urban labor market, and rural workers have only little human capital.
In addition, rural land markets are limited and not open. Land can only provide
farmers with production income, but not property income or development income.
Fourth, assisting systems are inadequate. Realizing a market’s efficiency requires
overcoming externalities, and this brings up the issue of whether transaction
costs are allocated to a third party or shared by all parties. Externalities affect the
maintenance of the normal market order. Without adequate assisting systems,
it is difficult to form a sound external environment. In rural markets, operating
organizations and management organizations remain underdeveloped, and this
has caused transaction costs to increase and impeded market development.

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Institutional Innovations and Rural Market Development

The above problems can be grouped into two categories: the lack of internal
drives for market development; and the lack of market openness. The former is
internally induced and the latter external.
The lack of internal drives is a fundamental cause of the slow rural market
transition. This is a structural problem, for internal drives exist within the traditional
three-rural structures. The address of this issue calls for the modernization of all of
the aforementioned traditional structures, which is a difficult and time-consuming
task. It also takes external supplementary reforms to boost the motivation-lacking
rural market. But these reforms should never be simple and homogeneous. China’s
history of rural development has shown that pushing idealistic changes externally
will, on the whole, do more harm than good.
Market transition is also constrained by the unsatisfactory level of market

openness, which relates to institutional and policy arrangements. China’s rural
economic performance has improved, whose credit should be given to the opening
of rural markets, as well as the adoption of the household responsibility system.23
By offering more opportunities, free markets could motivate farmers and thereby
boost the rural economy. First, adopting the household responsibility system means
allowing rural workers to flow and choose freely, instead of being confined within
the communes. Second, the gradual opening of agricultural markets allowed
farmers to arrange their own agricultural production, and this approach boosted
farming efficiency. Experience tells that policies and institutional arrangements
hold sway in whether a market can open and how wide it opens. That is to say,
institutional reforms and innovations are the start of the further opening of rural
markets. Then, it is worth figuring out: Which institutions or policies are holding
back the development of China’s rural markets? Which markets can boost economic
efficiency when further opened? What kind of institutional arrangements can
further open rural markets?

Institutional innovations
Realistically, institutional reforms and innovations are the most effective and
operative ways of promoting the rural market. Innovations could be made in the
following aspects:

Labor market system
Ensuring the steady growth of rural household income is the key to saving rural
consumer markets from shrinking. At present, rural migrant workers, despite

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RURAL DEVELOPMENT IN CHINA

their large numbers, still work temporarily and without contracts. As China’s
labor markets are not unified and are unsteady, it is difficult to increase wages
and effectively motivate people to invest in human capital. Innovations in the
employment system and the market opening mechanism will motivate farmers to
invest in their own human capital and, in turn, raise their personal income.

Rural land system
As part of the collective economy, collective land ownership has become outdated
in the market economy and may dampen future rural development. Reforming the
rural land institution does not mean adopting a system of private ownership. The
property structure of rural land is much more complicated than choosing between
private ownership and collective ownership. In fact, property rights include
not only ownership but also occupancy rights, use rights, and disposal rights
(including exchange, circulation, leasing, and mortgage). Rural land covers capital
farmland, mountains, forests, barren land, house sites, and other nonagrarian land.
Rural land institutions can become more economical and efficient by adjusting the
institutional structure, refining the collective ownership system, and activating land
markets, which will help farmers to use their land more effectively and efficiently.

Social systems
The urban-rural dual economic structure is a big hindrance for rural development.
For example, the defective social security system and insurance system have
hindered the rise of farmers’ income and living standards, as well as dampened
the upgrading of farmers’ consumption patterns and rural consumer markets. For
instance, farmers tend to save money for retirement by reducing consumption
since they do not enjoy pension insurance. It also calls for reforms to merge the
rural and urban public management systems. In this way, more public goods can
flow to rural areas to increase social capital, and thereby help refine the market
environment.

Cooperative organizations and management organizations
Markets operate through the cooperation of various organizations, which serve
as major market participants and a strong driving force behind market efficiency.
Therefore, organizational innovation is crucial in rural areas. Cooperative
organizations, intermediate organizations, supervision organizations, and

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Institutional Innovations and Rural Market Development

management organizations, as a whole, can work as the basis and safeguard of
a stable market order, once they are formed and developed. To introduce these

organizations into rural areas requires an incentive mechanism, which means that

the state should give institutional supports and encouragements to rural market
organizations.

In short, the level of rural market development is entwined with institutional

arrangements and structures. Innovation is required to push rural market

development to the next stage. Written or unwritten, outdated and unfit systems
should be replaced by new institutions.

Road to Rural Market Institutional Innovation
Driving forces behind innovation
Innovation of the market system has become the new driving force behind rural
development. Then, how can innovation be fostered? What are the driving forces

behind innovation?

North considers the state an important driving force behind institutional

innovation. According to him, state laws not only generate both incentive and
nonincentive systems but also decide the base for social welfare and income
distribution.24 In the theory of induced institutional transitions, whether an

institutional transition or innovation can happen depends on its cost-benefit

structure. When benefits exceed costs, a transition (or innovation) happens.25 It

is worth mentioning that, in important institutional transitions, the evaluation of
a cost-benefit structure is closely connected to the state and its ideology. In other
words, the state plays an indispensable role in promoting innovative institutions.

Thus, macroscopic systems and policies are decisive in opening society and

markets. Policy and institutional reforms determine the upgrading of rural labor

markets, land transfer markets, urban-rural relationships, and rural organizations.
In a reform, public ideas can serve as both a restraining force and a promotion

force. Habits and conventions are supported by corresponding ideas. Therefore,
the change of ideas should be the starting point of any reform. Common views
stand as a restraining force and reforms stand as a promoting force.

The prerequisite for institutional innovations is to change conventional thought.

In Deng’s words: “We must continue to emancipate our minds and accelerate the

reform.” Deng elaborated on the same occasion:

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RURAL DEVELOPMENT IN CHINA

To expand the productive forces we must carry out reform and open to
the outside world; there is no other way. We cannot continue to keep our
doors closed as we did for more than twenty years…. The differences are
not over whether we should carry it out but over how far it should go,
how it should be conducted and how we should go about opening to the
outside.26
Since the household responsibility system was adopted, rural economic
efficiency has risen and many famers have gotten away from destitution. However,
the present rural economy is stuck at a bottleneck, to break away from which
requires further reform and opening up. The rural areas must be open to society
and the market and vice versa. The opening of rural markets requires land reform,
and the opening of rural society demands social reforms.
Deng’s advocacy of emancipating people’s minds, on a deeper level, is about
emancipating their political ideas. This is because political ideas impact institutional
arrangements and policies in a most direct way. Historically, fundamental reforms
tend to take place in the midst of heated political turmoil, which may be a fight
between diverse paths or one between different political ideologies. The political
conflicts may be less of an argument of interests, but more of a disagreement
of values and political stances. It is safe to say that institutional reforms and
innovations depend on the openness and flexibility of people’s political ideas, that
is, whether their political ideas match the changes of society. Giddens’ work on
London demonstrates:
The conditions which influenced the rise of the City, and which have

subsequently sustained its privileges, are in some substantial degree
political. The City is probably best not regarded as a “part” of the state,
but both internally and externally its economic power has depended in a
profound way upon political factors.27
On the other hand, on the microeconomic level, institutional innovations
depend relatively little on political power. Within certain economic entities and
organizations, a reform in operational mechanism or in management mechanism
can take place even without a revolution in the macro-background. Take for
example the “induced institutional transitions” in new institutional economics.
The driving force behind institutional innovations is the microeconomic change
of costs, benefits, and their interrelations. When benefits outweigh costs, an
institutional transition is induced.

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