Value and rent : a contract theory of public economy, with application to China's public finance

Abstract

This study consists of two parts. The first part derives a unified theory about urban land rent and urban public finance, and the second part includes an empirical study on China’s local public finance based on the insights derived from the theoretical analyses. It is usually considered that rent and taxation has different economic implications. However, this study reveals the common fundamentals of these two concepts, that both rent payment and tax imposition acts as the distributive rule to maintain economic organization and cooperation. The theoretical analysis starts from the reflections on the theories of public finance and fiscal decentralization, which fail to provide a consistent explanation on the provision of public goods. This failure may originate from the inability of the equilibrium approach to incorporate dynamic phenomena such as investment, property and rent, which indeed pertain to the irreversibility of time or the existence of uncertainty. Although the dynamic issues have not been completely settled by the current economic theory, the approach of economic contract or social contract based on the insights of Coase, Alchian, Cheung and Barzel has provided a best conceptual framework to deal with the dynamic issues. The mainstream “voluntary exchange” theory of public finance may also be viewed as a kind of social contract theory. Specifically, the provision of public goods can be viewed as the behavior of collective investment with consequent collective property to incent the investment. Especially, the peculiarity of public goods investment may originate from the adoption of public finance as a credit instrument, where public benefits are provided in advance with public costs collected in the form of taxation or exactions in future. The concept of local public goods, or local public finance, indeed implies two respects – locational fixity and local property rights. The rent value of local public goods is usually implied within the value of adjacent land. As the compensation for the investment into public goods, a regular payment is required, either in the form of adjacent land rent, or in the form of taxation. This compensation mechanism underlies the similarity between rent and taxation. The second part of this thesis includes an empirical study on China’s local public finance. The analysis of local economy reveals the contradiction of local public policy. On the one hand, local economy prefers expanding export, which enhances the local budget surplus and local Ricardian rent. This process is accompanied by urban land expansion and immigration from outside. On the other hand, the growth of the urban economy increases the expenditure on public goods, which decreases the local budget surplus. The empirical study on China’s local public finance supports the theoretical prediction. Unlike the impression from intuition, the study points out that the efforts of local governments to enhance the scale of urban economy may also lead to unexpected undesired consequences, which may even undermine the wholesome of public economy.