State Capacity and China's Economic Performance

Abstract

This study attempts a first causal examination of the role of state capacity in China’s economic performance. Effective state capacity connotes not just ability to extract tax from citizens but also the ability to convert taxes into public investment. Equally importantly, these capacities must be combined with the ability to induce citizens and firms to make private investment that complement government’s public investment in the production of economic output. State capacity therefore combines extractive, productive and incentive-provision abilities. We use historical variation to identify the effect of state capacity at the level of county governments in modern China. Our estimates indicate that state capacity significantly impacts economic output. A mediation analysis indicates the public investment channels that deliver this impact. We also find that bureaucratic capacity measured by the number of public employees does not necessarily deliver better economic outcomes in China. We suggest that social stability objectives, rather than economic growth, drive public sector over-staffing.