Incentives, allocation and labour-market reforms during transition: the case of urban China, 1986-1990

Has the reform process in China resulted in the introduction of incentives directed at a more efficient allocation of resources? Using data on individual earnings in urban Liaoning province for the period 1986-1990 and a wage-equation approach, we address this issue in the context of labour-market reforms, focusing specifically on returns to education. Our results indicate that failure to address the issue of endogenous selection of more 'able' individuals into state-owned enterprises (SOEs) can severely bias returns downwards. Unlike in SOEs, returns in collective-owned enterprises (COEs) increased, the latter having been allowed to 'grow out of the plan' more quickly and subject to more competition in factor and product markets. We conclude that decentralization without competition is unlikely to result in the introduction of an efficient incentive mechanism. The more administratively determined regular wages are one avenue for increased returns. We find evidence of 'differentiated bonuses' in COEs, but we cannot reject the hypothesis of 'bonus sharing' in SOEs. Reforms which face SOEs with more competitive markets (e.g. reform of in-kind benefits such as housing) should have substantial benefits in terms of a more efficient allocation of labour both within and across enterprises.