The effects of wage distortions on the transition: Theory and evidence from China

Before the reforms, the Chinese government had strong distributional objectives, which it pursued mainly by direct controls over state enterprise wage rates and hiring decisions. During the reform period, similar controls over state enterprises continued, but use of them had to reflect competition with the new nonstate sector that was mostly free from these controls. Based on these distributional considerations alone, we can explain: (1) a decline in the skills of workers in the state sector as the most able workers leave, (2) higher productivity in the nonstate sector, which consists of the most 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.