POLÍTICAS NACIONALES

(i) TOWNSHIP AND VILLAGE ENTERPRISES AS A SET OF STRATEGIC ALLIANCES

Overview

This subsection sketches a broad overview of the model. The specific issues that the model raises are considered in more detail later in the chapter. The basic concept, which underlies the theorising, is that the T.V.E consists of a strategic core and a series of external strategic alliances or inter-organisational incentives (see Reve 1989). These ideas are presented in schematic form in figure 5.1. The T.V.E is depicted as a strategic core which can be visualised as “reputation capital” or, in broad terms, "goodwill”. The strategic core or internal structure of the T.V.E is presented, in figure 5.1, as a juxtaposition of ownership and control. The nominal ownership of the T.V.E, consistent with the approach taken in Chang & Wang (1994), is assigned to the local residents, but the rights to control the T.V.E are depicted in dynamic terms. The control rights rest, at the start, with the T.V.G. However, over time, an arrow (in figure 5.1) shows control rights shifting from the T.V.G to the managers and the skilled workers.

There are various strategic expansion paths, in figure 5.1, which are external to the T.V.E. These strategic expansion paths are informal contracts that link the T.V.E to the political centre (the centra! government) and to the other entities in the regional network. The regional network, which encompasses the labour market, regional banks - including rural credit co-operatives - and other enterprises, will often be location-specific. Qian & Xu's (1993) M-Form argument

FIGURE 5.1

The T.V.E. as an Internal and External Strategic Framework

the political centre

legitimate authority

The T.V.E

strategic core = reputation

residents T.V.G

nominal ownership

^ control managers/skilled M rights

workers

labour market credit unions other T.V.Es, private firms and S.O.Es

is important in this respect. With the M-Form structure, the Chinese economy is organised into a multi-layered multi-regional form according to the territorial principle in which each region, at each layer, can be regarded as an operating unit. The regional network for most purposes is consistent with a low level tier in this multi-regional framework, but the basic principles underpinning a regional network (the importance of reputation and informal contracts) need not be

location specific. The notion of a regional network rests first and foremost on the existence of an identifiable group which contracts on the basis of trust and social ties. Here the term "trust” is used to refer to a means of reducing uncertainty and risk and enhancing cooperation in the context of business contracting (see further Deakin et a! 1994, Arrighetti et al 1997, Burchell & Wilkinson 1997).

The vaguely-defined character of much of the contracting within the regional network suggests elements of a clan structure. In transaction-cost terms, these relations represent a distinct form of economic coordination which lies somewhere between market and hierarchies (Arrighetti et al 1997, Powell 1990, Ring & Van de Ven 1992). The notion that the T.V.E can be seen within a regional network of transactions which are, at best, less than arms-length raises many questions. These include: (i) What distinguishes the strategic core from the external inter-organisational incentives? (/e. what determines the boundaries of the firm?) (ii) Why are control rights, within the T.V.E, (at least in the embryonic stages) given to the T.V.G? (and why do control rights, in most cases, shift to managers and skilled workers over time?), (iii) Most of the literature on clans stresses the need for a recognised legitimate authority to underpin the process of building collective norms. Thus, to the extent that T.V.Es can be depicted as clanlike entities between markets and hierarchies what is the source of legitimate authority? The rest of this section attempts to provide answers.

External aspects o f the Township and Village Enterprise

There are a series of informal institutions which support the T.V.E. The practice of informal contracting is widespread and embedded in the regional network. This is widely recognised among local officials. “Concerning actual T.V.E contracts, law officials and policy makers report that such transactions are often based on oral agreements instead of written contracts. Even in the case of written contracts, it is often the case that they are incomplete and unspecific in items, or there is no specific punishment” (Weitzman & Xu, 1994 p.85). While

primary documentation of this phenomenon is lacking on the whole, casual empiricism provides some general examples. First, informal contracts exist in inter-firm transactions. T.V.Es producing similar products often integrate into industrial groups in order to raise funds and promote mutual interests such as sales and purchases. The members of the group, which typically consist of a number of different regional firms with different ownership structures, help each other with fund-raising activities and in times of financial difficulty. Goodhart & Xu (1995) and Liu (1989), amongst others, point out that in most cases the relationship within the group is informal in the sense that long-term reputation is more important than explicit contracts. The concept of germen (buddy-ship, commitment and loyalty) underpins these informal relationships. A series of case studies in Anhui Province noted that most T.V.Es deliberately avoided formal contracts so as to maintain or to strengthen the germen relationship. The reason for this was their belief that defining personal relationships through written contracts undermined the germen spirit (Cai 1990, Wu 1996 p.452).1

The capital market provides a second example of informal contracting. The legal rights of creditors are not well protected and more generally collaterals are uncertain because of imperfect information. Therefore, it is common for T.V.Es to provide each other with mutual guarantees or borrow from individuals within the T.V.E. T.V.Es also often borrow on the basis of a guarantee from the T.V.G, but the actual guarantee is very rarely formalised. Instead, the process is consultative, where the T.V.G's views and priorities are sought. If the T.V.E's loan application has the support of the T.V.G, it is nearly always approved on the basis of an implicit understanding that the T.V.G. (and therefore, the local community) will absorb the risk.2 Naughton (1994, 1995) argues that T.V.G sponsorship greatly enhanced T.V.Es’ access to capital which is an important reason for their growth. He writes (1995 p. 153): “By contrast, the experience of other transforming socialist economies has been that new start-up businesses proliferate, but ... have difficulty getting access to capital and as a result remain small, undercapitalised and dependent on formal capital markets”. These points

relate to collectively-owned T.V.Es which is the chapter’s main focus. Nevertheless, it is worth noting that even among privately owned T.V.Es informal capital markets are popular. A common practice in Wenzhou, where most T.V.Es are private, is zhouhui (forming an informal credit union). The credit union is formed between people who know each other well and is based on business trust rather than formalised contracts (Goodhart & Xu 1995 p.35).

The third example of informal contracting occurs in the labour market. Collectively-owned T.V.Es tend to operate without explicit labour contracts or follow practices that lie outside the scope of formal arrangements. For example, Goodhart & Xu (1995, pp.34-35) note that if the T.V.E is facing economic hardship a common practice is to close the firm down for a short period to reduce costs. Another reason for periodic closure in the past was that prior to the tax reform measures T.V.Es received tax concessions in the first three years of their life. Thus, it was common for T.V.Es to close down towards the end of the first three years and re-open with a different name. When the T.V.E closes down it typically makes subsistence payments to its workers which are a fraction of the worker’s original wages. This practice often takes place on an informal basis and, thus, lies outside written labour contracts. It gives T.V.Es greater flexibility to take advantage of tax loopholes and in times of financial difficulties. The results from field research confirm the advantages of informal arrangements

in the labour market. In Lin et a/’s (1992) sample of industrial T.V.Es in Yuanping County, Shanxi Province “there were almost no cases in which employees were dismissed because of lack of demand” (Lin et al 1992 p.262). Other field research suggests that workers are quite willing to take wage cuts in times of economic hardship. In 1986 the State Statistical Bureau (SSB) and the Developmental Institute of the People’s University sampled workers in 200 rural enterprises (most of which were T.V.Es) in Hubei, Sichuan, Guangdong, Zhejiang, Jiangsu, Anhui, Hebei, Liaoning, Shanxi and Gansu. The first half of 1986 was a period of contraction and wages levels in the sample enterprises fell.

A total of 77% of workers said that they were satisfied taking a wage cut given the economic conditions while just 4% expressed dissatisfaction. Among those who expressed neither satisfaction nor dissatisfaction (19%), 71% showed “understanding and sympathy for the enterprises and were willing to continue to work there”. When asked about whether it was better to cut jobs or wages 36% of workers favoured a reduction in wages rather than jobs which is double those who favoured cutting jobs (18%) - (results reported in Zhou & Hu 1987 p. 131). The close relationship between agriculture and rural industries also contributes to making the rural labour market flexible. Workers are willing to accept temporary lay-offs and/or substantial wage cuts because opportunities exist for most to return to agriculture. To illustrate, in the joint SSB and People’s University sample, 61% of workers retained their share of contracted farmland (Zhou & Hu 1987 p.131). Hence, agriculture and rural industry complement each other. For example in the Hela Commune Agricultural Machine Plant in Wuxi "in the busy farming season [workers in the factories] went back to work in their fields and in the slack season they worked in the plant. Whenever labourers were needed for intensive operations in vegetable farming and fishing, they were also released by the plant. Thus there was a flexible allocation of labour time among various branches of the rural economy” (Mohanty 1993 p.35).3

Each of these informal relationships - in inter-firm transactions, in the capital market and labour market - represent strategic alliances. Nakatani (1984), writing in the context of the J-mode, suggests that informal institutions perform the role of an implicit mutual insurance scheme, in which firms are both insurers and insured at the same time. The evolution of informal institutions, according to Nakatini (1984), represents a direct response to imperfect capital markets.

“One of the essential functions of the capital market is to allocate risks efficiently among different investors in the economy, but, if the capital market is imperfect and management is in a position to worry about the

business risks, in some way or another, then the grouping of firms can be regarded as an ingenious solution to the problem of non-existence of contingent markets for management risk” (Nakatani 1984 p. 229).

These comments, while directed at the J-mode, explain part of the reason for the formation of informal institutions in the T.V.E sector. Most commentators recognise that the capital market in China, at least outside the state sector, is underdeveloped (see eg Cheng & Malcom 1994). However, as far as capital markets go, the allocation of risk, of course, is not their sole function. The capital market also serves as an avenue to channel savings from individuals to enterprises. The informal arrangement where T.V.E residents pool their financial resources (ie. jizi) in order to fund the T.V.E is one institutional response in this regard, but the role which informal institutions play as strategic alliances in the T.V.E sector run deeper than this. The stress placed on informal institutions rather than formal contracts seems to be a response to deficiencies in the explicit institutional framework - strong legal structure, well defined property rights etc. - rather than just an underdeveloped capital market.

The informal links which the T.V.E nurtures (ie. strategic expansion paths) serve a similar role to that which Nakatani (1984) discusses, but in a broader sense. The development of informal institutions between T.V.Es serves to allocate the risk, for example, associated with contractual hold-up in the absence of a well defined legal framework for settling disputes. The distinction between "soft” and "hard” contracting is relevant in this regard (see MacNeil 1980, Williamson & Ouchi 1981 pp.361-362). The concept of hard contracting refers to standard arms-length transactions where there are formal contracts governing the relationship. The concept of soft contracting, on the other hand, presumes a much closer relationship between the parties where formal contracts are much less complete. Thus, with soft contracting, an elaborate informal governance

structure (to borrow Williamson’s term), which includes inter alia accepted norms of behaviour, substitutes for the role of explicit or written sanctions.

The strategic expansion paths fill the role of an extended informal governance structure in the T.V.E. soft contracting setting. The design of the transaction represents a decision variable. To illustrate, think of relational contracting involving different degrees of “softness”. This involves considering a spectrum where there are two extremes: (i) where the relationship is deterministic - ie specified, in its entirety in a formal contract and (ii) where the relationship is informal meaning no formal contracting at all. The design of the transaction is a decision variable because moving along this spectrum involves trade-offs. Moving from deterministic to informal contracting, for example, involves sacrificing certainty for added flexibility. The extent to which the parties to the transaction will be prepared to make this trade-off, will depend on their confidence in the trading relation. But, the trading relation, it will be argued below, is a function of reputation. The T.V.E’s reputation for meeting its informal obligations, in this sense, acts as the real surrogate for explicit rules.

The strategic expansion paths represent an attempt on the part of the T.V.E to place itself in a position where potential costs will be minimised in the event of a dispute. The incentive for the T.V.E is to develop bilateral (transaction specific) trust relations. This involves nurturing its informal relationships with other entities in the regional network, such as helping other T.V.Es to raise capital, as a means to promote goodwill. This also involves avoiding courses of action detrimental to the trust relations it builds up. The immediate parties to the soft contract are the ones that stand most to benefit if the exchange is successful and have the most to lose if the contract falls through. Thus it is in the interests of the T.V.E to meet its informal responsibilities even if there is no formal sanction if it does not. This is true because even outside the specific bilateral (transaction specific) relationship, if one of the parties defaults, its wider reputation as a reliable soft contractor will be dented, thus affecting its ability to

enter into other transaction specific relations. The need for an explicit legal framework is reduced because implicit contracts tend to be self enforcing.4

The role o f reputation in defining the “strategic core ”

The T.V.E, in figure 5.1, is depicted as a "strategic core” which, it was earlier claimed (without supporting argument), can be seen as reputation capital. However, this raises an important issue not addressed so far. What is the theoretical basis of the strategic core, and what distinguishes the strategic core from the external strategic alliances? A possible answer to this lies in marrying Kreps’ (1990) work on reputation effects with the notion of asset specificity which has been stressed in most of Williamson’s articles (see eg Williamson 1979 1981 1989). Asset specificity, which Williamson repeatedly claims is the most important transaction dimension, refers to the extent to which the investment is idiosyncratic or transaction specific. Williamson (1979) distinguishes between three different degrees of asset specificity. These are non-specific, semi­ specific and highly specific. He argues that classical market contracting will be efficacious when assets are non-specific to the trading parties, but bilateral market contracting will take over if assets are semi-specific and internal organisation will displace bilateral contracting if the assets are highly specific.

These ideas can be developed in the context of the strategic core/strategic alliance differentiation (see Rumelt 1982, Reve 1989). The strategic management literature maintains that the strategic core should be limited to core assets which are essential to meeting the firm’s strategic objectives. These core assets can be used to realise the firm’s objectives through bilateral governance (nurturing strategic alliances) and/or classical market contracting. In this sense the line which separates the strategic core (internal to the firm) and the strategic alliances (external to the firm) depends on how transaction specific the asset is. The boundaries of the firm are restricted to its core assets which, in Williamson’s terms, are highly asset specific. Outside of the firm,

assets which are semi-specific can be obtained through strategic alliances or bilateral trust relations, and non-specific assets can be exchanged in the market.

The core (specific) assets of the firm can be of a number of different sorts. Williamson (1989 p.143), for example, mentions site, human asset and physical asset specificities among others. But it is impossible to make generalisations about core assets of this sort. There are, for example, some T.V.Es whose core assets include technological resources and others whose core assets revolve around particular management practices. The literature on the strategic firm, as mentioned above, suggests that the firm’s core assets form the basis for realising economies in semi-specific assets via bilateral trust relations (see eg Reve 1989 pp. 146-151). Of course, when the external institutional framework (legal system, property rights etc) is well developed such as in western European capitalist societies the importance of bilateral soft contracting will be reduced. There will always be some informal contracting based on flexible governance and social convention (see Macualey 1963, Williamson 1975 pp. 107-108, Al-Najjar 1995), but the existence of a well-defined institutional framework provides more opportunities for deterministic exchange. However, where the explicit institutional structure is not strong, as in the T.V.E sector, the manner in which core assets act as the basis for strategic alliances takes on added significance. However, the problem is that simply listing a range of disparate core assets that T.V.Es might or might not have as the extant literature does, is not a theory of how T.V.Es, which often have widely differing core assets, are able to cultivate bilateral relations in a soft contracting setting. The notion of reputation effects developed in Kreps (1990) provides the mechanics for more general theorising. This proposition rests on three points. The first two (I hope) should be readily acceptable. The third is, perhaps, more debatable. The first point is that reputation is an intangible core asset. There is widespread acceptance that core assets can be, and often are, intangible (see

accepting that there are certain standard norms of behaviour that define a T.V.E and are specific to that particular T.V.E. These norms of behaviour, which determine the T.V.E's reputation, can be mimicked but they cannot be facilely transferred (or redeployed in Williamson’s language) without loss in productive value - ie. reputation is highly asset specific. If the idea that reputation is a core asset is accepted it is a small step to recognise the second point that all T.V.Es have “reputations" relating to standard of service, whether it meets its implicit obligations etc. The third point is that reputation, in a broad sense, is an umbrella for firm specific core assets. When outside entities decide whether or not to enter into an informal (ie. a non-deterministic) relationship with the T.V.E, it is on the basis of whether the T.V.E has a culture or routines which are