Transcript Lecture 6. Meritocracy and Yardstick competition.

Lecture 6. Meritocracy and
Yardstick competition.
Introduction.
• While fiscal decentralization gives instruments to
pursue growth, the incentives work well if local
authorities can get rents from higher growth via
expanded revenues.
• However, better growth performance may also
lead to faster promotion within the government
bureaucracy.
• Meritocracy has always been an important
component of Chinese administration (with
fluctuations).
Yardstick competition
• Meritocracy makes use of yardstick competition (Lazear
and Rosen, 1981; Holmström, 1982; Nalebuff and
Stiglitz, 1983)
• Yardstick competititon used a lot in China. Different
provincial governments were ranked according to
different measures of performance and this played a role
for promotion of bureaucrats. Similar principle used for
airline companies and divisions of different agencies.
• Maskin et al. (1999) show that yardstick competition
works well in a M-form organizational structure (regional
organization) compared to U-form (functional
organization).
Yardstick competition
• Assume two regions A and B and two
industries 1 and 2. The performance of
region r has the following form:
• Rr = er + er
• er denotes unobservable effort by
bureaucrat in region r
• er denotes shock. eA and eB are jointly
normally distributed with E(er)=0, variances
s2A, s2B and covariance sAB.
Yardstick competition
• Similarly, define for industry:
• Ri = ei + ei
• e1 and e2 are jointly normally distributed with
E(ei)=0, variances s21, s22 and covariance s12.
• The utility of a regional bureaucrat is
U[w(RA,RB)]-g(er), g’ > 0, g” > 0, g’” > 0
• Define similarly the utility of a bureaucrat
heading a functional ministry
U[w(R1,R2)]-g(ei)
Yardstick competition
• If Var(eA r eB) < Var(e1 r e2) , then manager
A can be given better incentives than manager 1.
• Managers A and B can be given better incentives than 1
and 2 if the following hold:
min{ Var(eA r eB), Var(eB r eA) } < min {Var(e1 r e2),
Var(e2 r e1)}
max{ Var(eA r eB), Var(eB r eA) } < max {Var(e1 r
e2), Var(e2 r e1)}
• Intuition is the same as moral hazard. Better incentives
can be given if less noise (here conditional noise) since
insurance motive less important.
Yardstick competition.
• Proposition more easily derived with
specific functional form.
• Assume U[wr(RA,RB)]= -e exp{- rwr(RA,RB)}
• Assume linear incentive schemes in
regions and industries:
• wA(RA,RB)=aA + bARA + cARB
• wB(RA,RB)=aB + bBRA + cBRB
• w1(R1,R2)=a1 + b1R1 + c1R2
• w2(R1,R2)=a2 + b2R1 + c2R2
Using certainty equivalent expression for U(wr) :
E(wr)-1/2 rvar(wr) where r is constant absolute risk aversion
derived from functional form of U:
U[wr(RA,RB)]-g(er)=
breA+creB-g(er)-1/2 r(br2sA2+cr2sB2+2brcrsAB)
We can derive similar expression for i.
Assume the principal is risk neutral and maximizes payoff of
Managers A and B net of incentive payments:
E(RA)+ E(RB)-wA(RA,RB)-wB(RA,RB)=
(1-bA-bB)eA +(1-cA-cB)eB-aA-aB
• An efficient contract maximizes the joint payoff of
principal and managers:
• (er,br,cr)chosen to
Max eA-g(eA)-1/2r(bA2sA2+cA2sB2+2bAcAsAB)
+ eB-g(eB)-1/2r(bB2sA2+cB2sB2+2bBcBsAB)
• If effort were observable, first best would be g’(er)= 1 but
it is not observable.
• Managers will maximize their utility, yielding bA=g’(eA),
cB=g’(eB)
• Replacing bA in the objective function, we get the
following f.o.c. for eA and cA :
• 1-g’(eA)=r[g’(eA)sA2 + cA2sAB] g”(eA)
• cA = -g’(eA) sAB/sB2
• Plugging the expression for cA in the f.o.c. for eA, we get
• 1-g’(eA)=r[g’(eA) g”(eA)[sA2 -sAB/sB2]
• =r[g’(eA) g”(eA)Var(eA / eB) (since eA and eB are jointly
normally distributed)
• Denoting VarAB = Var(eA / eB) and differenciating
expression for f.o.c. w.r.t. eA, we get
deA
 2 g ' g"

0
2
dVAB g"rVAB ( g"  g ' g" )
A higher conditional variance will thus lower incentives for effort.
Yardstick competition works better when
lower conditional variance.
Yardstick competition
• Maskin et al. (1999) give evidence that conditional
variances of regional shocks are smaller than conditional
variances of industrial shocks. Moreover, yardstick
competition is effective for promotion.
• Sample of 520 SOE’s from 1986 to 1991. Industrial and
regional partition.
• Estimate industry-specific and region-specific shocks
based on log-linear Cobb-Douglas production function.
• Compare conditional variance under regional and under
industrial partition. Find on the basis of pairwise
comparison that means of conditional variances higher
on basis of industry rather than on basis of region.
Yardstick competition
• Look at provincial representation in CCP Central
Committee normalized by provincial population in 1987
compared to 1977 (before reforms started).
• Find that there was a positive correlation between
growth ranking and political representation.
Yardstick competition
• Hongbin Li and Li-An Zhou (2005) look at better
measure: effect of individual growth performance of
provincial leader on speed of promotion but also
demotion.
• Promotion within the government administration seen as
very desirable and also government career highly
desirable among elite.
• China has 31 provincial units in Central Committee
representation : 22 provinces, 4 cities (Beijing, Shanghai,
Tianjing, Chongqing and 5 autonomous units.
• Since 1978, evaluation of provincial cadres not only
based on political loyalty but also on expertise, education
and youth.
• Since 1983, retirement of provincial leaders at 65 if not
promoted, but not strictly enforced.
Yardstick competition.
• Provincial party secretaries can become
members of the State Council, vice-premier or
premier, member of Politburo or its standing
committee.
• Provincial governor one step below provincial
party secretary.
• People can also be “promoted” to honorary
positions without power.
• At that level, positions in private sector not as
attractive.
Yardstick competition
• Ordered probit model.
• Turnover variable y takes values 0 (retirement), 1
(same), 2 promotion. Assume evaluation y* unobserved,
y* =xb+e where b are coefficients, x economic
performance measure and a1, a2 are cutoff points for
evaluation. Call F cdf of normal distribution.
Yardstick competition
• Data on 254 provincial leaders between 1979 and
1995. Information on career moves, age, education,
past work experience. More than 70% of leaders had
turnover during that period.
• Average annual turnover rate of 20% (like in US
corporations).
• Estimates show that when annual growth rate increases
by one standard deviation (0.06) from the mean (.10),
the probability of promotion increases by 15% of the
average probability of promotion (.75).
• Regressions robust in
– Change of weights in average growth rates,
– Non linearity in tenure effect
– Measurement error in age 65 (year of birth available, not month)
using age 64 and 66.
– Differenciating between normal and forced retirement by only
looking at leaders below 65 or sample only before 1983
Decentralization and yardstick
competition compared.
• The sole incentive effect of decentralization is
that a higher tax base can be in the interest of
local government. Implicit argument that local
leaders get direct and indirect rents from more
tax revenues associated to more economic
growth.
• It seems the effect of yardstick competition is
very strong as long as a career in the
bureaucracy is seen as very attractive for the
most brilliant people.
• Decentralization gives local government the
policy instruments to respond well to the
yardstick competition. So their effects must be
seen jointly.
Implications.
• This analysis gives a view of how the specific institutions
in China contributed to economic growth.
• It also has implications for further reform.
• Picture is one where growth and reform happen not by
simple shrinking of the role of government, leaving room
for free markets. Image of a system where the
bureaucracy and the organization of government are
geared towards growth objectives and market promotion
(bird in a very large cage, paraphrasing Chen Yun).
• Meritocracy and decentralization act as substitutes for
rule of law and separation of powers.
• The meritocracy that was able to achieve spectacular
growth should be able to achieve other objectives such
as climate change if a strong political will existed.
Implications
• System with mainly accountability from above.
Accountability from below (local elections) only used as
instrument of personnel control. Weak accountability at
the highest level necessitated mandatory retirement of
leaders, good and bad. Substitute for absence of
democracy but represents a specific solution to the
“succession problem” .
• Breaking the meritocracy and accountability from above
(centralized personnel control) are likely to break the
engine of growth in the absence of (unlikely)
compensating changes.
• The system has however scope for gradual reforms
towards separation of party and state, getting gradually
rid of the dual power structure. “Parallel” careers
possible within the meritocratic system. Also scope for
more media freedom and judicial independence.
Dangers in the long run
• Strong development of large private firms may reduce
the attraction of a career in the bureaucracy (see
however France).
• More leniency towards corruption over time is a nearly
inevitable development. The meritocratic system will
gradually stop functioning once corruption becomes too
strong and the lack of accountability at the highest level
cannot over time create enough resistance to counter
the expansion of corruption.
• This is not a short term prospect but Chinese history
shows that brilliant dynasties could be brought down by
corruption.
• A bold “ counterweighing” reform could be election of
party chief like “within party primary”.
• Copying Singapore and Hong Kong not so easy.
Meritocracy is therefore key.
• External environment will also be a danger (North East
Asia, South East Asia, Taiwan, US).