On Gray Income and the Contract Responsibility System: Two Fundamental Issues in China's Economic Design Since the Deng Xiaoping Era

 On Gray Income and the Contract Responsibility System: Two Fundamental Issues in China's Economic Design Since the Deng Xiaoping Era

Abstract

Deng Xiaoping's reform and opening-up policy has brought unprecedented growth to China's economy, gradually transforming it from a planned economy to a socialist market economy. However, during this transformation, some institutional designs and informal economic behaviors have gradually emerged, becoming fundamental issues that have long plagued the healthy development of China's economy. This paper will delve into the phenomena of "gray income" and the "contract responsibility system," which have arisen since the Deng Xiaoping era and continue to this day. It will analyze their formation mechanisms, negative impacts on economic efficiency, equity, corruption, and the construction of the rule of law, and point out their essence as deep-seated structural issues in China's economic design.

1. Introduction

Since Deng Xiaoping initiated the reform and opening-up in 1978, China's economy has achieved remarkable growth. From the household contract responsibility system in rural areas to the decentralization of state-owned enterprises in cities and the introduction of market mechanisms, a series of reforms have greatly unleashed productivity. However, during this "crossing the river by feeling the stones" process, due to imperfect institutional design, lagging laws and regulations, and the blurred boundaries between power and market, some unexpected but far-reaching phenomena have emerged. Among these, "gray income" and the "contract responsibility system" are not only products of the early reform period but have also evolved into "endogenous defects" within China's economic system, posing long-term challenges to its sustainable development.

2. Gray Income: A Breeding Ground for Rent-Seeking and Opportunism

2.1 Definition and Formation of Gray Income

"Gray income" typically refers to non-normative income that lies between legal income (such as wages and bonuses) and illegal income (such as embezzlement and bribery), or income that is not entirely legal but difficult to classify as criminal. It arises from the process of institutional transformation, the control of scarce resources by public power, information asymmetry, and regulatory loopholes.

During the Deng Xiaoping era, while the planned economy transitioned to a market economy, the market mechanism was far from sound. Public powers such as the dual-price system, material distribution rights, approval rights, and land use rights remained in the hands of the government or state-owned units. This provided ample space for "rent-seeking" behavior:

Covert forms of power-money transactions: Officials provide conveniences for businesses or individuals using their approval and monopoly powers, while businesses or individuals repay through forms such as "consultation fees," "advisory fees," "gifts," and "dry shares," which are often hard to trace back to direct bribery.

Revenue generation impulse within institutional units: Many government departments and public institutions, facing insufficient fiscal allocations, are encouraged to generate revenue by providing services, processing permits, and collecting various fees, often leading to excessive and non-standard charging.

Welfare benefits in monopolistic industries: In state-owned monopolistic industries such as telecommunications, electricity, and finance, the lack of sufficient market competition often results in employees enjoying excessive benefits, hidden subsidies, and high bonuses, which are also classified as gray income.

Information and opportunity asymmetry: Some individuals exploit internal information or special relationships to gain excess profits during the transfer of state assets, land development, and project bidding.

2.2 Negative Impacts of Gray Income

The existence of gray income has multiple negative impacts on Chinese society and economy:

Exacerbation of social injustice and wealth disparity: The acquisition of gray income is closely related to power, relationships, and information privileges, rather than market competition and individual abilities, severely distorting the income distribution pattern and leading to the concentration of social wealth among a few privileged classes, aggravating income gaps and social conflicts.

Harm to market fairness and efficiency: The presence of gray income distorts market signals and resource allocation. A company's success may no longer depend on the competitiveness of its products and services but rather on its ability to "manage relationships," stifling innovation and reducing overall economic efficiency.

Fostering corruption and bureaucracy: Gray income blurs the boundaries between legal and illegal, providing a "training ground" and "cover" for more severe corrupt practices. It strengthens the incentives for rent-seeking, prompting officials to alienate public power for personal gain, exacerbating bureaucracy and administrative inefficiency.

Erosion of the rule of law and social trust: The existence of gray income indicates loopholes in the enforcement of laws and regulations, which are even selectively ignored. This damages the authority and fairness of the law, eroding public trust in the government and market.

Tax base erosion: Due to its covert nature, gray income is often difficult to tax, leading to a loss of state fiscal revenue and exacerbating injustices in the tax system.

3. Contract Responsibility System: A Double-Edged Sword Under Decentralization

3.1 Rise and Evolution of the Contract Responsibility System

The "contract responsibility system" was first widely applied in rural reforms, namely the "household contract responsibility system," which greatly stimulated farmers' production enthusiasm. Its core is the separation of land ownership and management rights, allowing farmers to dispose of surplus products after completing state tasks. This successful experience was quickly promoted to urban state-owned enterprises and public institutions.

In the reform of state-owned enterprises, the goal of the "contract responsibility system" was to address the inefficiency of state-owned enterprises. The government "contracted" the management rights of enterprises to managers, stipulating profit remittances, with excess profits to be retained internally. This stimulated the enthusiasm of enterprise managers to some extent, injecting vitality into state-owned enterprises in the early stages of reform.

However, the contract responsibility system soon exposed its inherent flaws:

Short-term behavior: Contractors, in pursuit of short-term profit maximization, often neglect the long-term development, technological upgrading, and environmental protection of enterprises. They may excessively deplete corporate assets and exploit equipment and infrastructure without the motivation for investment and maintenance.

Asset loss and rent-seeking opportunities: During operations, especially involving asset disposal and mergers, contractors may have opportunities to transfer state assets at low prices to related parties or individuals for substantial profits. Contractual agreements are often not rigorous enough, leaving operational space for such behaviors.

Lack of regulation and information asymmetry: The government, as the "contractor," often faces information asymmetry regarding the actual operating conditions and asset status of enterprises. The lack of effective performance evaluation and supervision mechanisms makes it easy for contractors to exploit loopholes.

Blurred boundaries of responsibility: In some administrative and public institutions, such as hospitals, schools, and even certain government functions, attempts have been made to introduce "contracting" models. This has led to a commercialization tendency in public services and even phenomena where public interests are harmed for profit, blurring the boundaries of the government's responsibility to provide public services.

3.2 Far-reaching Impacts of the Contract Responsibility System

While promoting efficiency, the expansion of the contract responsibility system has also laid the groundwork for many subsequent issues:

Legacy issues of unclear property rights: The contract responsibility system itself has not fundamentally resolved the property rights issues of state-owned enterprises; it has merely superficially separated management rights from ownership. This has sown the seeds for disputes over asset evaluation and equity distribution in later state-owned enterprise reforms.

Breeding ground for corruption: The bidding, bargaining, and subsequent profit distribution processes during contracting provide convenience for rent-seeking and corruption.

Disorder in market order: In some public service areas, the introduction of the contract responsibility system has led to a decline in service quality and arbitrary charging, affecting market order and social equity.

Constraining the establishment of modern enterprise systems: The short-term incentives and individual responsibilities emphasized by the contract system conflict with the sound corporate governance structures, long-term strategic planning, and specialized management required by modern enterprise systems.

4. Intrinsic Relationship and Cumulative Effects of Gray Income and the Contract Responsibility System

Gray income and the contract responsibility system do not exist in isolation; there are intrinsic logical relationships and overlapping negative effects between them:

Contracting as a platform for gray income: Many forms of gray income are derived from the power, information, and resource distribution space provided by the contract responsibility system. For example, after a state-owned enterprise is contracted, the contractor may convert corporate income into personal gray income through methods such as inflating costs, transferring profits, and selling assets at low prices.

Gray income reinforces the short-term nature of contracting: Due to the temptation of acquiring gray income, contractors are more inclined to liquidate corporate resources in the short term to quickly obtain personal benefits rather than making long-term investments or planning for sustainable development.

Joint erosion of the rule of law and fairness: Both rely on institutional loopholes, regulatory failures, and power interventions, collectively damaging the principles of fair competition in a market economy and the spirit of the rule of law. They together shape an economic culture that prioritizes "relationships" over "rules."

5. Conclusion and Outlook

Gray income and the contract responsibility system, as two fundamental issues in China's economic design since the Deng Xiaoping era, profoundly reflect the pains and challenges of transitioning from a planned economy to a market economy. They are not the goals of reform but rather byproducts of incomplete reforms, imperfect systems, and insufficient constraints on power.

Although the forms and manifestations of these issues have changed with the deepening of the market economy and the advancement of the rule of law (for example, the public "contracting" model has been replaced by modern enterprise systems in many areas, but its essential spirit—emphasizing the short term, prioritizing relationships, and neglecting rules—continues to influence some economic behaviors), their fundamental impacts have not yet been completely eliminated.

To fundamentally resolve these issues, China's economic design needs to continue deepening reforms:

Improve property rights systems: Clarify property rights and improve corporate governance structures to fundamentally eliminate the space for the loss of state assets and rent-seeking.

Deepen market-oriented reforms: Break down administrative monopolies, introduce sufficient competition, and eliminate breeding grounds for rent-seeking.

Strengthen the rule of law and regulation: Establish a sound legal and regulatory system, enhance independent, transparent, and effective regulatory mechanisms, and effectively constrain power.

Advance political system reforms: This is a fundamental solution, aiming to limit excessive government intervention in the economy and achieve a separation of power and capital, fundamentally eliminating the soil for gray income and rent-seeking behavior.

Cultivate a culture of fair competition: Through education and publicity, shape business ethics and social values that emphasize honesty, integrity, and fair competition.

The historical experiences of gray income and the contract responsibility system provide valuable lessons for China and other transitioning economies: economic reform is not only a technical adjustment but also a reshaping of deep-seated institutional designs and social values. Only by facing and addressing these fundamental issues can China's economy truly achieve healthy, sustainable, and inclusive development.