AUTONOMY AND INCENTTVES IN CHINESE STATE ENTERPRISES* THEODORE GROVES YONGMIAO HONG JOHN MCMILLAN BARRY NAUGHTON When the responsibility for output decisions was shifted firm, and when firm e allowed to retain more of their profits, managers of Chinese state-owned enterprises strengthened workers'incentives. The managers paid more in bonuses and hired more workers on fixed-term contracts. The new incentives were effective: productivity increased with increases in bonus payments and in contract workers. The increase in autonomy raised workers'incomes(but not managers'incomes)and investment in the enterprise, but tended not to raise emittances to the state I CHINAs INDUSTRIAL REFORMS In deciding the best way to reform a planned economy, one of the crucial questions is about the prospects for improvements in state-owned firms' notoriously low productivity. Can changes in policy induce state firms to perform better? We shall offer evidence that in one reforming economy, China, state-owned firms'produc tivity has been significantly improved by the introduction of some lementary incentives Beginning in 1978 and continuing throughout the China reformed its industrial sector. Enterprises that had d been largely controlled by the state were given some market or market like incentives(though by the end of the decade, twelve years into the reforms, they were still a long way from looking like capitalist firms). State-owned enterprises were allowed to keep some fraction of their profits, where before all profits had to be remitted to the state Enterprises began to sell some of their outputs and buy some of their inputs in free markets, rather than selling and procuring everything at state-controlled prices. Managers were given mone- tary rewards explicitly based on their firm s performance, and the right to decide what to produce, how much to produce and how to produce it was shifted from the state to the enterprise [Byrd 1991 Naughton 1994 "We thank ulia Lawrence Katz and three ref comments, and the Fo 1994 by the President and Fellows of Harvard College and the Massachusetts Institute of The Quarterly Journal of Economics, February 1994