W.K.Y. Fung et al Journal of Development Economics 61(2000)111-135 (i) By the nature of ownership, there exist two sectors in the economy: a state sector and a non-state sector. The state sector is relatively large, measured either by the number of employees or the amount of resources it commands. However, when compared with the non-state sector, as a whole, it is extremely inefficient (i) While the non-state sector faces hard budget constraints and relies mainly n its internal source of financing. the state sector faces soft budget constraints and enjoys the advantage of being subsidized by the government for its production as well as capital investment. 1i)The real sector of the economy is considerably liberalized, with the markets for consumption goods, capital goods, and labor services becoming increasingly competitive. However, the reform in the financial sector is rather limited. The government still plays a key role in allocating the financial resources of the economy by absorbing most of the household savings, setting the quantity f bonds available to the public, regulating interest rates on the financial asset and determining which agencies can issue bonds and how bank loans are allocated (iv)Because the state-owned enterprises can no longer generate sufficient savings for the state and the government has great difficulty in collecting taxes from the newly developed non-state sector, government savings have declined. On the other hand, due to the rapid expansion of the non-state sector, private savings have been increasing considerably. Given the drastic change in the structure of national savings, the state banking system has become more important in resource allocation, channeling most savings from the household sector to investors (v) The state banking system is a quasi-fiscal institution. As the only low risk financial intermediary available, it offers extremely low real returns on bank detest anes th saim loses a de f to t hen deres itrs. Fu rther, by charging In China, the non-state sector includes private enterprises, joint-ventures, urban collectives and ownship and village enterprises(TVEs), which are owned by local governments and communities ince the late 1980s, the non-state sector has been the major contributor to the impressive economic growth performance experienced in China. For discussions on the special features of the sector and its impressive growth performance, see Byrd and Lin(1990)and Weitzman and Xu(1994). According to Jefferson and Rawski (1994), the growth rates of average TFP(Total Factor Productivity)for the collective sector were about 5% in the period of 1980-1988 and 4.7% during the period of 1988-1992. The growth rates of average TFP for the state sector were lower than that for the their estimation ccording to a survey conducted by the Chinese Academy of Social Sciences in a Research Project on Private Enterprises and Entrepreneurs in 1995, private businesses are faced with the scarcity of resources and institutional supports. Insufficient capital poses a major difficulties for private busi- esses. The survey indicated that the three major sources of initial business capital for the pi nterprises were personal saving, loans from friends or relatives, and personal loans from other people Only 11.8% of them reported that their primary source of capital came from the banking system(See Project Group for Research on Private Entrepreneurs in Contemporary China, 1996) See McKinnon(1994), Qian(1994), and Naughton(1995)M.K.Y. Fung et al.rJournal of DeÕelopment Economics 61 2000 111–135 ( ) 115 Ž .i By the nature of ownership, there exist two sectors in the economy: a state sector and a non-state sector. 8 The state sector is relatively large, measured either by the number of employees or the amount of resources it commands. However, when compared with the non-state sector, as a whole, it is extremely inefficient. 9 Ž . ii While the non-state sector faces hard budget constraints and relies mainly on its internal source of financing, the state sector faces soft budget constraints and enjoys the advantage of being subsidized by the government for its production as well as capital investment. 10 Ž . iii The real sector of the economy is considerably liberalized, with the markets for consumption goods, capital goods, and labor services becoming increasingly competitive. However, the reform in the financial sector is rather limited. The government still plays a key role in allocating the financial resources of the economy by absorbing most of the household savings, setting the quantity of bonds available to the public, regulating interest rates on the financial assets, and determining which agencies can issue bonds and how bank loans are allocated. Ž . iv Because the state-owned enterprises can no longer generate sufficient savings for the state and the government has great difficulty in collecting taxes from the newly developed non-state sector, government savings have declined. On the other hand, due to the rapid expansion of the non-state sector, private savings have been increasing considerably. Given the drastic change in the structure of national savings, the state banking system has become more important in resource allocation, channeling most savings from the household sector to investors. 11 Ž . v The state banking system is a quasi-fiscal institution. As the only low risk financial intermediary available, it offers extremely low real returns on bank deposits and thus imposes a de facto tax on depositors. Further, by charging interest rates on bank loans at well below the market clearing level, the banking 8 In China, the non-state sector includes private enterprises, joint-ventures, urban collectives and township and village enterprises TVEs , which are owned by local governments and communities. Ž . Since the late 1980s, the non-state sector has been the major contributor to the impressive economic growth performance experienced in China. For discussions on the special features of the sector and its impressive growth performance, see Byrd and Lin 1990 and Weitzman and Xu 1994 . Ž. Ž. 9 According to Jefferson and Rawski 1994 , the growth rates of average TFP Total Factor Ž. Ž Productivity for the collective sector were about 5% in the period of 1980–1988 and 4.7% during the . period of 1988–1992. The growth rates of average TFP for the state sector were lower than that for the collective sector Jefferson et al., 1992 . McGuckin and Nguyen 1993 reached a similar conclusion in Ž . Ž. their estimation. 10 According to a survey conducted by the Chinese Academy of Social Sciences in a Research Project on Private Enterprises and Entrepreneurs in 1995, private businesses are faced with the scarcity of resources and institutional supports. Insufficient capital poses a major difficulties for private busi￾nesses. The survey indicated that the three major sources of initial business capital for the private enterprises were personal saving, loans from friends or relatives, and personal loans from other people. Only 11.8% of them reported that their primary source of capital came from the banking system See Ž Project Group for Research on Private Entrepreneurs in Contemporary China, 1996 .. 11 See McKinnon 1994 , Qian 1994 , and Naughton 1995 . Ž. Ž. Ž