Elsevier

Explorations in Economic History

Volume 54, October 2014, Pages 107-127
Explorations in Economic History

Size and dynastic decline: The principal-agent problem in late imperial China, 1700–1850

https://doi.org/10.1016/j.eeh.2014.05.002Get rights and content

Highlights

  • I model the principal-agent problem in a large dictatorship.

  • Severe agency problems lead to high corruption and low taxation.

  • Economic expansion could aggravate corruption and fiscal weaknesses.

  • I show that the Chinese state taxed and administered sparingly.

  • Furthermore, China's fiscal capacity contracted steadily during the 18th century.

Abstract

This paper argues that China's size was one reason behind its relative decline in the nineteenth century. A ruler governing a large country faces severe agency problems. Given his monitoring difficulties, his agents have strong incentives to extort the taxpayers. This forces him to keep taxes low to prevent revolts. Economic expansion could aggravate corruption and cause further fiscal weakening. To support the model's predictions, I show that the Chinese state taxed and administered sparingly, especially in regions far from Beijing. Furthermore, its fiscal capacity contracted steadily during the prosperous eighteenth century, sowing the seeds for the nineteenth-century crises.

Introduction

Why was China unable to seize the opportunities presented by the Industrial Revolution to modernize its economy in the nineteenth century? Traditionally, many blame its autocratic regime. Going back to Montesquieu, prominent scholars have argued that China's growth was hampered by an autocratic, managerial, and interventionist state, whose power to collect taxes, confiscate materials, and conscript labor was virtually unlimited. The Chinese state's tendency to suppress private enterprise stifled initiative. Economic stagnation became inevitable thereafter (Wittfogel, 1957, Balazs, 1964).

This argument, however, faces theoretical challenges, for the Chinese emperor was a stable dictator.1 As Mancur Olson taught us, a stable dictator understands that excessive exaction in the short run reduces future tax revenues and increases political instability (Olson, 1993). Such a dictator will therefore demonstrate self-restraint when he expropriates.2

The argument is also inconsistent with the findings of Chinese historians in recent decades. While Kenneth Pomeranz's claim in The Great Divergence that the levels of development in the Lower Yangzi delta and England were comparable in the eighteenth century is a subject of debate, his book has fostered an emerging consensus that the eighteenth-century Chinese economy was more developed than previously thought.3 Commercialization, facilitated by the monetization of taxes and the inflow of silver from Japan and the New World, linked the lives of ordinary people to the world outside their villages (Li, 1998, Wu and Xu, 2000). There is strong evidence suggesting that market integration was high in China before 1800 (Shiue and Keller, 2007).

Importantly, these empirical findings have created a new set of questions. If all was well and good with China in the eighteenth century, why did its fortunes reverse in the nineteenth century? Was China's relative economic decline in the nineteenth century a consequence of historical contingency, or were structural factors at work?

This paper argues that part of the answer can be found in China's size. The vast size of the Chinese empire created a severe principal-agent problem and constrained how the country was governed. In particular, taxes had to be kept low due to the emperor's weak oversight of his agents and the need to keep corruption in check.4 The Chinese state's fiscal weaknesses were long masked by its huge tax base. However, economic and demographic expansion in the eighteenth century exacerbated the problems of administrative control. This put a further squeeze on the nation's finances and left China ill-prepared for the challenges of the nineteenth century.

Reprising the earlier work of Kiser and Tong (1992), I argue that the state in late imperial China (c. 1650–1850) 5 can best be understood in light of a large (and stable) dictatorship where excessive exploitation comes not from the ruler, but from his agents who have shorter decision horizons and less encompassing interests than the “benevolent” ruler himself. While the ruler is motivated not to overtax the population to preempt rebellion, his agents have private incentives to expropriate rent from the taxpayers. If the ruler is unable to keep corruption in check, he will have to keep the tax rate low and his bureaucracy small to mitigate this “tyranny at the bottom” effect.

Size plays a crucial role in the hypothesis as it shapes the ruler's ability to monitor his agents and the agents' incentives for rent seeking. Specifically, size carries two dimensions in the hypothesis: geographic and economic. Geographic size matters because the costs of transmitting information over distance matter, especially in the premodern world. Moreover, a geographically large polity usually comes with regional diversity that makes collecting useful information more costly. Regional differences in climate, crops, per capita income, and other socioeconomic conditions often imply that local agents must have some flexibility in implementing central government decrees. Yet that very flexibility also makes it harder for the ruler to determine whether an agent who pursues a different path is doing so for private gain or in response to local conditions. Finally, when political power is highly centralized, monitoring and sanctioning would inevitably involve the ruler. All else equal, the larger his domain, the higher the risk that his attention may be spread too thin.

The effect of economic size on state finances is more ambiguous. Economic expansion enlarges the tax base, but it also increases the rent-seeking incentives of state agents. This puts pressure on the ruler to lower his rate of extraction to ensure that taxpayers are exploited in a sustainable manner. This paper constructs a simple model to show that if the principal-agent problem is sufficiently severe, the negative effect of economic expansion (a lower tax rate) could eventually overwhelm its positive effect (a bigger tax base) so that economic expansion actually hurts the ruler and weakens his ability to maintain stability and order.

The issue of size is particularly relevant to China, given that for the last two millennia, the landmass between the Great Wall and the South China Sea was more often than not under the rule of a single central authority. China's vast size implies that obtaining timely and accurate information has always been a challenge to its ruler. In 1853, when the Taiping rebels captured Wuchang, a major city about 1200 km from Beijing, the news took eight days to reach the capital (Xie, 2002). Mao highlighted the challenges that size posed to centralized control when he told Nixon during the latter's visit to China, “I have not been able to change [China]. I have only been able to change a few places in the vicinity of Beijing” (Kissinger, 1998, 60).

Apart from proposing a model that is consistent with the findings in recent scholarship, this paper also develops novel evidence that can be brought to bear on the hypothesis. First, I examine regional differences in land tax burdens and the spatial distribution of administrative units in China in 1820. These show that both land tax per capita and the number of counties per unit area were significantly higher in regions adjacent to Beijing than in regions far away from it. In other words, the Chinese state became progressively weaker and smaller as one moved farther away from the capital.

Next, using archival and published historical fiscal records of the Qing dynasty, I reconstruct the Qing state's annual tax revenues between 1650 and 1850. The time series depict a hump-shaped pattern. In real terms, the regime's tax revenue peaked early in the eighteenth century and contracted steadily from then on, even as the economy continued to grow through extensive expansion.6

Finally, I present historical evidence indicating that the contraction of the Qing state's fiscal capacity—i.e., its ability to raise revenue for public spending—led to a gradual and sustained decline in state-provided public goods from the second half of the eighteenth century onward. The decline predated the military and socioeconomic troubles of the nineteenth century, suggesting that even before an expansionist West began taking steps to open up China by force, the seeds of a turbulent nineteenth century had already been sown.

This paper is related to several strands of the literature. Several important works by Chinese historians discussed at length the existence of agency problems in the Chinese state from a non theoretical perspective (Zelin, 1984, Kuhn, 1990). Shiue (2004) found evidence from disaster relief operations that the Qing government did not operate as a unitary and wholly coordinated entity.7 More recently, Ma (2011) and Brandt et al. (2014) have applied the agency framework to analyze the evolution of China's political economy in the last millennium. This paper provides a formal model and new data that complement these studies.

This paper also makes contact with the burgeoning literature on state capacity (Besley and Persson, 2010, Dincecco, 2011). My hypothesis is based on the view that, at the very least, a functioning state must have the capacity to ensure the security of property and person (Smith, 1776, North, 1990). However, it is also compatible with arguments that see a more proactive role for the state in economic development—to resolve coordination failures (Rosenstein-Rodan, 1943, Murphy et al., 1989, Epstein, 2000), to remove inflexibilities in the existing property rights regime (Rosenthal, 1990, Bogart and Richardson, 2008, Lamoreaux, 2011), or to implement social policies that allow the society to escape from the Malthusian trap (Doepke, 2004).

This paper complements two recent works that explore the effects of territorial size on governance. Stasavage (2010) studies the evolution of representation in early modern Europe and argues that representative institutions were less effective in large territorial states as high communication and travel costs prevented representative bodies in these states from convening regularly. Olsson and Hansson (2011) show that territorial size affects the rule of law negatively in modern developing countries, and weak rule of law is more commonly observed when the capital city is not centrally located.

To keep the discussion focused and its scope manageable, I take as my point of departure a unified and politically centralized Chinese empire. This, I argue, is a reasonable assumption given the time frame that my analysis covers.8 While this paper focuses singularly on the inefficiencies of a large state, it is important to note that political unification also brought significant benefits to China—above all the peace dividend, as highlighted by Rosenthal and Wong (2011). However, a comprehensive cost-benefit analysis on the size of late imperial China is beyond the scope of this paper.9

Section snippets

Historical background

The Qing dynasty ruled China from 1644 to 1912. It was founded by the Manchus, an ethnic minority group from Manchuria who conquered China proper after the Ming dynasty was toppled by a peasant uprising in 1644. Historians usually divide the 267 years of Qing rule into four periods (Table 1). The early Qing focused on military conquest and political consolidation, which were accomplished by the 1680s. With the restoration of peace, interregional trade resumed and flourished, and China entered a

The model

Based on the sociopolitical structure discussed above, I develop a simple model to analyze the politics of taxation in Qing China. Consider a game of taxation in a Chinese county involving the ruler, a representative tax agent, and a peasant population. Let Y denote the aggregate income of the peasants. To keep the model simple, assume that the ruler observes Y perfectly.

The ruler sets a tax rate τ.14

Empirical evidence: distance and agency costs

The model assumes that the severity of the principal-agent problem in a dictatorship increases with distance from the ruler. It predicts, as a consequence, that the tax burden or tax per capita should decline with distance from the capital to compensate for the weakening monitoring (Proposition 1).26

Empirical evidence: fiscal decline through the golden age

Proposition 3 suggests that when agency costs are sufficiently high, the aggregate tax revenue will first increase but eventually decrease as the population expands. Admittedly, my simple model has no predictive power as to when the tax revenue will begin to contract and how strong the contraction will be. Instead, the relevance of Proposition 3 lies in a broader message: a regime plagued with a severe principal-agent problem is likely to face significant difficulties expanding its revenue over

Reduction in public goods provision

An implication of Proposition 3 is what the historian Ian Morris calls the “paradox of development”: social development creates the very forces that undermine it (Morris, 2010). If the underlying principal-agent problem is severe, a regime that successfully maintains stability and fosters economic expansion may become a victim of its own success as slow or negative revenue growth could severely constrain its ability to deal with problems that accompanied the economic expansion. This section

Conclusion

At first glance, the late imperial Chinese state is a puzzle. It was absolutist, yet weak. It taxed lightly, yet the effective tax burden on the peasant was relatively heavy. It seemed inefficient, yet it was able to survive for more than two centuries. It was able to support rapid Smithian growth, without which the more than doubling of the Chinese population during the eighteenth century would have been impossible, yet it imploded when the opportunities and challenges of industrialization

Acknowledgments

This paper is a revised version of Chapter 2 of my dissertation, written under the supervision of Joel Mokyr, David Austen-Smith, Matthias Doepke, and Melissa Macauley. I am indebted to them for their guidance and encouragement. I also received many helpful comments from Chiaki Moriguchi, Costel Andonie, Loren Brandt, Kenneth Chan, Joseph Ferrie, Avner Greif, Robert Keohane, Mark Koyama, Debin Ma, Riccardo Masolo, Deirdre McCloskey, Helen Milner, Thomas Rawski, Gary Richardson, Jean-Laurent

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