Before the reforms, the Chinese government had strong distributional object
ives, which it pursued mainly by direct controls over state enterprise wage
rates and hiring decisions. During the reform period, similar controls ove
r state enterprises continued, but use of them had to reflect competition w
ith the new nonstate sector that was mostly free from these controls. Based
on these distributional considerations alone, we can explain: (1) a declin
e in the skills of workers in the state sector as the most able workers lea
ve, (2) higher productivity in the nonstate sector, which consists of the m
ost able workers, (3) accounting losses in the state sector, reflecting the
transfer of tax revenue to finance higher wage payments to the unskilled,
and (4) restructuring within the state sector, to reduce the distortions to
relative wage rates. (C) 1998 Elsevier Science B.V. All rights reserved.