Justin Yifu Lin receives an interview from Social Sciences in China Press during a break of The International Academic Forum in China 2021 on Oct. 14 in Beijing. Photo: Yang Chonghai/CSST

The relationship between the government and the market is a worldwide concern in economics. Whether the government should function as a coordinator and facilitator of national economic development to enhance market effectiveness or whether it distorts the market and exacerbates market failures bears a great deal on a country’s economic growth rate, transformation and upgrading, and the quality of economic performance.

Government types, related theories

The government generally falls into three types in terms of its behavior. The first type is the facilitating (youwei) government. A facilitating government will take the initiative to overcome market failures, smooth fluctuations in the economic cycle, make the market more effective, boost economic growth, help those impacted by economic development and cyclical fluctuations, and maintain the normal operation of the economy and the stable development of society. The second type, the inactive (buwei) government, is indifferent to market failures and cyclical fluctuations, adopting a laissez-faire attitude to let the market run unchecked. The third type is the wayward (luanwei) government, which excessively interferes in market order, causing market distortions, rent-seeking and corruption, resource misallocation, and a widening income gap.

Which type a government belongs to on the basis of the role it plays in economic development depends on whether the government is capable of coordinating development, and more on its behavioral motivation.

Currently, there are two prevailing hypotheses regarding government behavior in mainstream economics. The first is “interest groups capture.” It argues that government behavior represents an equilibrium reached amid the rivalry between diverse interest groups. The decision-making process of government officials is subject to the interest groups, and government policies become instruments for the latter to safeguard their interests. To these interest groups, the fewer members there are, the more united they will be, the greater influence they will generate, and the more able they will be to dominate government decision-making. Consequently, government decisions are made out of the interests of the minority, instead of all the people. As such, if the policies are against all the people and market rules, the government will be a wayward one.

The second hypothesis zooms in on officials’ personal interests. Based on the principle of individual rationality, government decisions are made to satisfy officials’ personal interests, rather than those of the people. The dominance of officials’ personal interests is likely to cause inaction or wanton acts by the government.

However, the results of the two views don’t conform to the assumption of mainstream macroeconomics that the government is a benevolent social planner that can maximize the utility of all households. Therefore, there is probably a third hypothesis in the motivation of government decision-making: “serving the people.”

As early as 1944, when the Communist Party of China (CPC) Central Committee was based in Yan’an, northwest China’s Shaanxi Province, to carry out revolutions, Mao Zedong had stated that the fundamental aim of the CPC is to serve the people wholeheartedly. In recent years, General Secretary of the CPC Central Committee Xi Jinping has emphasized many times the importance of upholding the people-centered governance philosophy. Over the past 100 years since the CPC’s founding, Party members have adhered to this original aspiration and mission and made it the code of conduct for Chinese government officials. Such a behavioral orientation is in line with the thought of benevolent governance (renzheng or wangdao) in traditional Chinese culture, and with the requirements for being a benevolent social planner.

Figuring out what motivates the government to make decisions is vital to understanding the government-market relationship. Government decisions dictated by interest groups or for the sake of officials’ personal interests will result in undue government interventions that will invite misconduct like rent-seeking and corruption. The two behavioral motivations provide a basis for the “limited government” theory proposed by English philosopher John Locke, who holds that the government’s role is limited to education, law, and national defense.

Under the framework of the limited government theory, the government lacks the initiative to proactively address market failures or smooth economic cycles, thus leading to its inaction.

In the “serving the people” proposition, by contrast, the interests of the great majority of the people are the starting point of government decision-making. In order to better meet people’s material and cultural demands, as well as their need for a good life, officials of governments at all levels must actively overcome market failures to promote high-quality economic development. Especially when the economy is impacted negatively, they should take necessary measures to help and support the people, thereby maintaining economic and social stability. This lays a behavioral foundation for the facilitating government theory.

Nonetheless, there is a lack of unified policy indicators, regional differences in the condition and model of policy implementation, or the endogenous problem resulting from the causal relationship between policy results and motives, for identifying the primary motivation of government decision-making from empirical perspectives.

To effectively solve the endogenous problem, doing quasi-natural experiments is an effective way. The 2021 Nobel laureates of economics, namely David Card, Joshua Angrist, and Guido Imbens, employed quasi-natural experiments, rather than randomized controlled trials, to analyze and test the possible economic and social impacts brought by minimum wage hikes.

Applicability of Chinese experience

Consumer vouchers usually refer to coupons that the government issues to the public with financial funds, and people can use to shop or consume goods or services with the nominal value deducted in designated consumption places or on the internet. When the COVID-19 breakout affected economic development and residents’ life in spring 2020, the Department of Market Operation and Consumption Promotion of the Chinese Ministry of Commerce encouraged regions and enterprises where conditions permitted, on the premise of ensuring justice and openness, to hand out varieties of consumer vouchers and shopping coupons for certain groups, commodities, and fields of consumption.

Thereafter, regional governments across China successively rolled out specific consumer voucher schemes and executed them by stages and in batches. Statistics show that in March 2020, three provinces and eight cities issued consumption coupons. By May of that year, a total of 26 provinces and 157 cities joined the campaign, and by October, 30 provinces and 241 cities were involved.

Obviously, local governments at all levels were playing a predominant role in the issuance of consumer vouchers. Regions with a large economy, considerable financial strength, and a high proportion of the tertiary industry took the lead.

The quasi-natural experiment concerning government decision-making differences on consumer voucher distribution in the wake of the COVID-19 outbreak can reveal the motivation behind decisions made by different local governments in China.

The identification of the motivation is inseparable from three features of the coupon issuance campaign. First, the policy was implemented nationwide with a common goal. It was one of the few nationally unified policies at that time. Second, the distribution and design of consumer vouchers were highly consistent across regions, thus ensuring the sufficient execution in various places under the same central policy, and substantially reducing the difficulties in the implementation of quantitative policies. Third, the suddenness of COVID-19 and the uncertain severity of the epidemic objectively required local governments to rapidly make related decisions in accordance with local industrial structure, interest group patterns, and personal characteristics of government leaders. The aim was to overcome the possible causal relationship between local economic development and personal interests of local leaders, local economic structure, and interest group patterns, which would make it difficult to reflect the government’s decision-making motivation of serving the people.

Our study finds that neither local interest groups nor personal characteristics of government leaders constituted a decisive factor in the issuance of consumer vouchers. The main reason for decision-making differences between Chinese local governments was regional disparities in urban economic fundamentals embodied by the tertiary industry that was hit especially hard and featured the largest number of employees.

In the face of such a major public security incident as COVID-19, Chinese local governments helped small and medium-sized businesses, as well as micro-enterprises and disadvantaged subjects to get over difficulties by issuing consumer vouchers in a flexible and diverse manner, adopting a series of concrete measures to guarantee people’s livelihood, stabilize enterprises, and promote growth.

The finding of this study proves that the Chinese government is a facilitating government, which practiced the policy starting point of serving the people by stabilizing economic development and improving people’s living standards. It is not a wayward or inactive government manipulated by interest groups or swayed by the personal interests of decision makers.

Generally, in the research of the government’s behavioral motivation, the proposition of serving the people also deserves academic attention and more empirical studies, in addition to the mainstream views of interest groups capture and officials’ personal interests. Studies on the proposition of serving the people will make a difference on macroeconomics. As the theoretical model of modern macroeconomics is usually grounded in the benevolent social planner assumption, only macroeconomic theories that reflect the government’s decision-making motivation of centering on and serving the people on the micro level will be more applicable.

Justin Yifu Lin is a professor and dean of the Institute of New Structural Economics at Peking University. This article was edited and translated from his speech at The International Academic Forum in China 2021. Shen Yan, a professor from the National School of Development at Peking University, and Sun Ang, a professor from the School of Finance at Renmin University of China, also contributed to the article.