The road to capitalism: Competition and institutional change in China

We develop a theory of institutional change and apply it to analyze China's transition toward capitalism. We focus on how product market competition i nduces institutional change through the interaction between bureaucrats and managers in regional government-controlled economies. When cross-regional competition is sufficiently intense, each region has to cut production cost s. Given that the efforts of managers are not verifiable, local governments may have to grant total or partial residual shares to the managers. In gen eral, intense product competition stimulates the rise of a private property system. We submit our theory to a vigorous empirical test using China's in dustrial census data of more than 400,000 firms. The test supports strongly our postulation that cross-regional competition is the driving force behin d China's transition toward capitalism. (C) 2000 Academic Press.