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Hanzhi Deng

May 11th, 2022

How decentralised tax collection in Qing China led to industrialisation

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Estimated reading time: 10 minutes

Hanzhi Deng

May 11th, 2022

How decentralised tax collection in Qing China led to industrialisation

0 comments

Estimated reading time: 10 minutes

Was war and insurrection the trigger for China’s industrial revolution in the late 19th century? The Taiping rebellion of 1851-1864 caused a severe and prolonged disruption of the social order, leading the Qing regime to hand fiscal and military control to local governments. Recent PhD student Hanzhi Deng research findings identify this delegation of power as crucial for creating the conditions for the subsequent industrialisation of China, as local governments used their fiscal capacity to raise taxes, invest in industry, then  reap the financial benefits.

 

That economists have not explained modern economic growth is indeed something of a scientific scandal…’ Dierdre McCloskey, “1780-1860: A survey.”

 

By default, economic historians grapple with the causes of historical growth. Scholars traditionally emphasise investment, culture, education, innovation, and property-rights enhancing institutions as explanations for economic growth. What they have missed is how fiscal capacity contributes to economic growth. My study makes the first quantitative breakthrough to fill this gap by examining the positive link between Qing China’s fiscal capacity and industrialisation.

The early Qing economy was a well-known success. Arable land expansion and population growth were remarkable,the primary and secondary sectors specialised, and the development of a national transportation system increased long-distance trade and accelerated market integration. Yet, China did not undergo its own Industrial Revolution until the mid-19th century.

My study of Qing China shows fiscal decentralization during the Taiping Rebellion empowered local governments to direct public spending toward industrial investment.

How did this happen? In the face of severe social disorder, the precarious Qing central state delegated its power by granting fiscal-military autonomy to local governments. Hence local governments became self-serving ‘stationary bandits’ – local leaders who first tax and then invest in production to capitalise on greater tax receipts from larger revenue streams down the line – and had stronger incentives for institutional experimentation. Local governments continued to do so for decades even after the fall of the Qing Empire.

They strengthened their fiscal capacity by creating a new commercial tax, the lijin, and with this revenue, invested in modern industries and further induced the rise of private firms by providing market-supporting public goods. The ideal measure for local fiscal capacity is therefore the scale of novel commercial taxation (lijin).

To show this, I construct a dataset for local fiscal capacity at the prefectural level, using 266 prefectures in 18 provinces of China Proper to provide significant variation for local fiscal capacity and industrialization.

The Fiscal Reports 1908 provide the only cross-sectional image of prefectural lijin operations. Fortunately, from the 1860s the reports were not changed, so the cross-sectional data reflect a consistent spatial variation throughout the range of years under study.

Since the reports do not contain reliable revenue data, I use the number of lijin stations to measure the scale of operations. I locate 768 lijin stations across China and count them at the prefectural level.  Since the lijin was a tariff on goods in transit, the location of lijin stations must have been selected to capture flows of goods. Station workloads must be comparable; those with light workloads were abolished. I then quantify the profiles of over 4,000 native industrial firms (1860-1927) and count them at the prefectural level, too.

 

Figure 1 – Post-1850 Local Fiscal Capacity Measured by Density of Main Lijin Stations
Figure 1 – Post-1850 Local Fiscal Capacity Measured by Density of Main Lijin Stations

 

Figure 2 – Industrial Modernization Measured by Density of Industrial Firms by 1927

 

To overcome endogeneity, I introduce a major political threat to the Qing reign, the Taiping Rebellion (1851-64), and use local warfare severity as an instrument for local fiscal capacity.

The Taiping Rebellion, an unexpected large-scale insurrection, imposed upon the Qing central state to delegate its fiscal-military power to the local level. Rebels declared opposition to the Qing rule in 1851 and disturbed the social order of many provinces for a decade. The guerrillas, however, never established a closed border, and their expansion strategies were under-unplanned, inducing variation of warfare among the many regions.

With relevant atlases, I quantify battles monthly at the prefectural level and generate two measures for Taiping impact: ‘duration’ that counts the number of months in war, and ‘severity’ that aggregates all military actions by different weights.

First, Taiping-related warfare pushed the local governors and gentry to set up militias beyond central control. Independent local fiscal systems represented by the lijin had to be created to finance local troops. Where there was more severe Taiping-related warfare, the Qing government allowed the local government to collect more lijin.

Second, I show that the Taiping impact on a specific region was random to its initial conditions, and I rule out other channels (population loss and high wage, human capital accumulation, etc.).

My findings show that the Taiping Rebellion brought industrialization only through fiscal capacity.

Both the Qing statesmen and historians described China’s industrialization as a remarkable ‘restoration’ after the mid-nineteenth-century crisis. My study shows the misuse of this term: the fiscal changes in the 1860s dramatically altered the Chinese political economy, and the consequent industrialization differed fundamentally from the pre-1850 Smithian economy.

 

Figure 3 – Number of Both Public and Private Industrial Firms by Year
Figure 3 – Number of Both Public and Private Industrial Firms by Year

 

My study speaks to several strands of literature. First, it emphasizes the role of fiscal capacity in triggering industrialization with novel evidence and visits mechanisms including public goods provision and state-led investment. It also contributes to the Great Divergence debate by outlining the initial stage of China’s industrialization.

Second, it complements the state capacity literature, which overwhelmingly focuses on the revenue side while overlooking spending.

Third, it covers the topic of intergovernmental relations – a key issue for both historical and contemporary China – by describing how local Chinese states played a developmental role once they became self-serving.

Finally, it analyses the impact of war on the economy by introducing the Taiping Rebellion. It challenges the paradigm that China’s modernization was merely a response to Western shocks. Instead, indigenous chaos and consequential institutional changes mattered.

About the author

Hanzhi Deng

Hanzhi Deng

Hanzhi is a researcher in political economy with a particular research interest in historical and contemporary public finance, economic growth, intergovernmental relations, and government-business relations. His recent PhD thesis focuses on the bottom-up fiscal transitions of the late Qing China (1850-1911), revisits the imperatives such as indirect taxation and foreign borrowing, evaluates the achievements of China’s fiscal modernization, and offers a coherent explanation for the behaviours of central and local governments. He holds a BSc in Corporate Finance from Fudan University, an MSc in Political Science from LSE, and a PhD in Economic History from LSE. He is a postdoctoral fellow in Political Science in Fudan University.

Posted In: China | Finance | Industrialisation | Student Research