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China’s Incomplete Contracts

This year’s Nobel Prize in Economic Sciences went to Harvard’s Oliver Hart and MIT’s Bengt Holmström for their pioneering work on the economics of property rights and contracts. At a time when China is attempting the difficult transition to a more market-oriented economy, the value of these contributions could not be clearer.

HONG KONG – This year’s Nobel Prize in Economic Sciences went to Harvard’s Oliver Hart and MIT’s Bengt Holmström for their pioneering work on the economics of property rights and contracts. At a time when China is attempting the difficult transition from a system of incomplete contracts to a strong property-rights regime, the real-world importance of these contributions could not be clearer.

No contract can specify every eventuality. So contracts must, instead, spell out the allocation of “control” rights – who can make decisions in which circumstances. For a centrally planned economy attempting to allocate more authority to the market, such contracts are invaluable – at least at first.

This has not been lost on Chinese reformers. From the mid-1980s to the early 1990s, they introduced both the “rural household responsibility system” and the “enterprise contract responsibility system” for state-owned enterprises (SOEs). Those systems essentially delegated more decision-making rights, as well as certain profits, to farmers and workers, so that they had a stronger incentive to work more efficiently within state-owned communes and firms.

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