







































American Research Journal of Economics, Finance and Management 

Volume 10 Issue 2, April-June 2022 

ISSN: 2836-9416 

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25 | P a g e  

EXAMINING THE NEXUS BETWEEN FACTOR PRICE 
MANIPULATION AND BUREAUCRATIC CORRUPTION: A STATE 

CAPACITY PERSPECTIVE 
 
 
 

Dr. Wei-Chen Lin 
Department of Economics, Chinese Culture University, Taiwan 

 
Abstract: The conventional wisdom suggests that a prudent fiscal stance accompanied by low taxes 
should foster economic growth. However, empirical evidence reveals a paradox: tax revenue-to-GDP 
ratios tend to be higher in developed countries compared to less developed ones. This inconsistency 
between theory and observation can be illuminated through the lens of North's insight, which 
underscores the influence of political structures on tax regimes and economic welfare. 
North (1981) argued that political systems may prioritize maximizing returns for rulers or elite 
groups rather than promoting efficiency and social welfare. Such a perspective leads us to question 
not whether high taxes stimulate growth, but whether the political regime is extractive or inclusive. 
In many less developed countries (LDCs), economic stagnation and low tax revenues can be attributed 
to the extraction practices of corrupt governing elites. 
This article extends North's framework by categorizing LDCs into two groups: weak states and strong 
states. Weak states are characterized by their limited capacity to levy taxes effectively, often hindered 
by resistance from local power brokers. These governments struggle to govern effectively, leading to 
economic failures related to a lack of tax collection, public goods provision, and incentives for sound 
economic behavior. Even in cases of low taxes, the absence of strong governance hampers economic 
progress. 
Keywords: Taxation, Economic Growth, Political Regime, Extractive Institutions, Weak States, 
Strong States. 
 
 
I.  Introduction  
An interesting paradox ubiquitously observed in the literature is a seemingly true proposition that a 
prudent fiscal stance accompanied by a low tax will generally stimulate growth.2However, there is much 
evidence to show that the ratios of tax revenue to GDP are higher on average in developed than in less 
developed countries (LDCs).For instance, the Heritage Foundation (2015) shows that tax ratio for 
Sweden is 50%, for France 48%, and for the US 26%, which is much higher than that for Gabon of 10%, 
that for the Congo of 6%, and that for Chad of 4%. In our opinion, rather than focusing on the 
association between these two variables, the inconsistency between theoretical predictions and 
observational data can be explained by using the insight of North (1981, p. 25):“the politically 
determined structure of society [e.g., tax regimes] does not necessarily maximize the efficiency and 
social welfare; instead, it strives to maximize the returns to the monarchs or politically strong 

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groups.” North argues that there always existsa persistent tension between the political structure which 
maximizes the rents to the elite ruler and an efficient system that encourages growth. He further 
suggests that this kind of elite extraction is the root cause of the failure of societies to experience 
sustained economic growth. Therefore, the insight is not whether a high tax can promote 
growth, but whether the political regime is extractive or not. For most of the LDCs, their 
economic failures and low tax revenues are mainly caused by the extraction of corrupt 
governing elite.  
To further North’s insight into the problem, this article classifiestheLDCsinto two categories: First, 
weak states arecountries in which the main barriers to economic development are those that arise due 
to the lack of state capacity or state power to levy tax effectively. As indicated by Acemoglu (2005) and 
Besley and Persson (2010), most of the LDCs fall into the category of weak states, in which the inability 
to govern stems from the resistance posed by local chiefs, rich landlords, and clan leaders. Basically, 
their economic failures are related to their governments’ inability to dominate subjects, collect taxes, 
and provide public goods. This provides the opposing elites with an opportunity to establish entry 
barriers, regulations and inefficient institutions to extract their economic rents. At this point, even 
though the tax is low, the government still does not provide much of an incentive for economically 
sound behavior.  
Second, a minority of LDCswith strong centralization of authority (e.g., North Korea)have enough 
capacity to tax more resources from their societies. However, as indicated by North, this does not imply 
that the monopoly of legitimate violence will be used to tax and provide public goods. This is because 
pervasive corruption constrains how the country is governed. If the ruler is unable to keep corruption 
in check, then he has to keep the tax rate low to reduce rebellion threat arising from overtax.    
For instance, North Korea is ranked as the third most corruption-ridden country in the word. Instead, 
its personal income tax rate is only 0 - 20%, which is much lower than 11.4% - 41.8% of South Korea, 
not to mention high tax rates of the European countries.  
In both cases, state capacity does not guarantee tax collection, and tax levying also does not necessarily 
reflect a predictable and beneficial effect on public goods provision or economicgrowth, since theself-
interested elite mostly use the ability of the state to tax and coerce citizens in ways that might be 
detrimental to economic performance. Therefore, if political organizations are structured to 
maximize the rents captured by the ruling elite, it is meaningless to discuss whether 
there exists any association between taxation and economic growth.  
One might argue that, since both strong and weak states lead to poor economic outcomes in the LDCs, 
their state capacity should be balanced at an intermediate level between weak and strong states, so as 
to encourage entrepreneurship and achieve an efficient allocation of resources, such as the possibility 
suggested by Acemoglu (2005, p.1203). However, in differentiating from this, this article proposes that 
the key issue is not whether state capacity is balanced or not, or whether the state can collect the tax, 
but rather whether the self-interest of ruling elites is checked by the rule of law or not. We believe that, 
although the contrast between economically weak and economically strong states is an interesting 
point, the power of the elite still has to be constrained by the political power of the citizens, in particular 
their power to replace the ruler.  

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To support this idea, we use a case regarding oriental despotism, whichconcernsa comprehensive 
change in historical Chinese society, including its politics, demography and economy, that occurred in 
the period of the Song dynasty in the 9th to 13th centuries. The literature commonly referstothis as the 

“Tang-Song transition (唐宋變革),” which may be seen as a watershed in the transition from the 

medieval (中古) to early modern (近世) period of Chinese history (Naitō Konan, 1922). Among these 
changes, the most important one with profound political implications was the collapse of the medieval 
aristocracy of local lineages that had dominated China politically from roughly the 1stcentury BC 
through to the 9thcentury AD and the growing powers of central emperors since the 10th century. The 
interesting point is that the state’s capacity to tax in the former period was extremely 
weak dueto the local lineages’ boycott. By contrast, in the latter period, central emperors 
had successfully consolidated the political power and could strengthen the state’s 
capacity totax. However, due to bureaucratic corruption arising from principal-agent 
problem, the government still failed to collect appropriate level of tax for public goods.  
Regarding to this issue, this article shows that, if the power of the elite is not constrained by the rule of 
law, then, regardless of whether political power rested in the hands of central emperors or local 
lineages, and regardless of whether the tax was high or low, poor economic outcomes would still 
emerge. Therefore, the key issue is not whether or not a high tax rate can promote growth, but rather 
whether the political regime is extractive or not. If political organizations are structured to maximize 
the rents captured by the elite, it is meaningless to discuss whether there exists any association between 
taxation and economic growth.  
This result thus suggests the importance of building a better political institutional framework to control 
the power of the state rulers. The remainder of this paper is organized in the following manner. Section 
II presents some basic features of Chinese politics. Sections IIIand IV describe the politically unified 
and fractious periods in Chinese history, respectively. Section V concludes the paper.  
II. Some Features of Chinese Politics 
A. China as a Case Study.  There are two advantages of using Chinese politics as evidence to support 
the proposition of North (1981). First, between 3000 BC and 1800 AD, there were more than sixty 
mega-empires that used to control at least one million square km of territory (Turchin, 2009). However, 
the Chinese empire was the only one that continually maintained an autocratic and unitary state during 
the entire period. Second, China had evolved in relative isolation in the corner of southeastern Eurasia, 
and had maintainedvery little contact with the foreign world for at least three millennia. This naturally 
prevents the possibilities of foreign political interference and offers a fascinating case to investigate the 
relationships among state capacity, tax collection, and politics.   
From both theoretical and practical perspectives, these advantages allow researchers to conduct their 
experiments in a designated environment almost like in a science laboratory.  

B.Tang-Song Transition. This article focuses on a comparison based on the Tang-Song transition (唐

宋變革 

論), which characterizes the changes in Chinese political status from fragmentation to unification. As 
shown by Ge (2008), before Tang dynasty, the 2,135 years of Chinese political development from the 
Qin to Qing dynasties can be roughly divided into two regimes: political fragmentation in the first 
millennium (Qin to Tang, 221BC907AD) and political unification under one ruler in the second one 

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(Tang to Qing, 908-1911). Naitō Konan (1922) also shows that Song dynasty is a period in which China 
witnessed a series of technological innovations, the rise of commercial wealth, and, more critically, the 
replacement of hereditary aristocracy by a system of emperor’s autocracy. However, despite the 
changes in many aspects of society, we barely see any change in government tax revenue. 
In the former period tax collection was low due to ineffective taxation caused bya “weak central statevs. 
strong local powers”. Alternatively, in the latter period, the state capacity held by central emperors was 
strong enough to enable them to collect more tax. However, due to the pervasive bureaucratic 
corruption, the emperors still had to keep taxes low to mitigate the “tyranny at the bottom” effect and 
to preempt the farmers’ revolt(Sng, 2014). Based on these facts, the following sections of this paper will 
use the theoretical perspective of the new institutionalism to investigate how taxation and politics were 
interrelated during these two periods.    
III. Political Fragmentation Period: Weak State Capacity  
A. Weak Central Emperors. Before the Song dynasty, Chinese politics exhibited a type of political 
fragmentation. As in medieval Europe, the central emperors faced impenetrable restraints from the 
resistance of local nobles to state predominance. In fact, most of the economic rents gained from the 
autocratic ruling accrued to the local noble lineages. Besides, the evidence also suggests that the 
economic failure of fragmented China is directly related to the central government’s inability to extract 
resources through taxation from the locals (Ma, 2012).  
Seen from the viewpoint of politics, the regional noble lineages had strong influences on both central 
and local governments. They had enough political power to dismiss the authority of emperors, which 
can be evidenced by several facts. First, although the dejure tax was extremely high, however, the 
landlord lineages not only held the right to be exempted from tax obligations, but were also bestowed 
with the privilege of legal immunity. In the local power structure, theyheldthe ultimate power of land 
expropriation, such as mining, fishing, and commercial privileges. Nevertheless, the common land-
owners were subject to a full tax liability that they could not afford, and hence were forced to dedicate 
their land to noble lineages and turned themselves in as slavesso as to evade the tax on labor and land. 
These slaves or serfs settled in nearby satellite villages and played a key role in cultivation. As a later 
section will show, this institution is in essence a redistribution mechanism that transfers income from 
middle-class entrepreneurs to lineage landlords through the lineages’ manipulation of factor prices to 
employ labor at the subsistence wage. It is unlikely to generate a spirit of entrepreneurship in society 
that will promote economic growth.  
Second,government officials, at both the central and local level, were appointed based on the 

recommendation of regional noble lineages through the cha ju（察舉）andchiu-p’inchung-cheng (九

品中正). Hence, it is not surprising that central governments were ruled by these aristocratic elites who 
colluded to monopolize the affairs of state by dominating the appointment of officials and practicing 
endogamy. They developed and implemented state policy within closed cabinet meetings chaired by the 

Chancellor (宰相). A Chancellor had considerable power and shared final decisions with the emperor 

and could challenge or even veto (封駁) imperial edicts drafted by the imperial secretariat.   
Therefore, the bureaucrats had enough power to act independently of, and against the interest of the 
emperors, since they were supported by the political power from the local all the way up to the national 
level.   

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On the other hand, the central emperor was weak vis-à-vis the local lineages. The post of the emperor 
sometimes even became the property of the aristocratic families and their relatives. Sporadically, 
emperors could be dethroned or even murdered if the interests of the aristocracy were violated. 
Although the emperors in the Sui and Tang dynasties attempted to implement examination systems to 
recruit civilian scholars to staff the government and replace the lineage officials, however, these policies 
did not last for long due to the bitter opposition from the lineages (Quan, 1972).  
B. Structure of Economic Equilibrium.  To investigate this issue, this article extends the models of 
Acemoglu (2006, 2010) and Sng (2014) to explain the relationships between state capacity and taxation 
in historical China. We hope that this might provide some hints to understand the causes of low tax 
collection in contemporary LDCs.  
Consider an infinite horizon economy populated by a continuum 𝐿+𝜃𝑚 +𝜃𝑒 of risk neutral agents. There 
is a unique non-storable final good denoted by y. Agents are divided into three groups. The first 
comprises a total mass of farmers, 𝐿>1, whose only action in the model is to supply their labor 
inelastically. In addition, assume that the subsistence wage is zero for convenience of analysis. Second, 
there are two sets of potentially competing producers: (1) middle-class entrepreneurs; (2) local elite 
(noble lineages or bureaucrats). The middleclass group has a total population 𝜃𝑚 >1 of entrepreneur 
agents, who hire farmers (𝑙𝑚) to produce y. They can work as an owner of a farming business, a self-
employed farmer, or a household farming in which the labor forces are mainly family members. The 
local elite has size 𝜃𝑒 and hires farmers(𝑙𝑒)to produce and become entrepreneurs. The sets of elite 
producers and middle-class producers are denoted by 𝑆𝑒 and 𝑆𝑚, respectively.    
Each agent in local elite and middle-class has an access to the following Cobb-Douglas production 
technology to produce:  

,  (1)  

where𝑙𝑗 (𝑗∈𝑆𝑒 or 𝑆𝑚)denotes the labor employed by agent j, and𝑘𝑗denotes the capital (mainly land). The 
key difference between an elite producer and a middle-class producer lies in the productivity, meaning 
that the productivity of a middle-class agent is higher than that of a local elite agent 𝐴𝑚 ≥𝐴𝑒. Also assume 
that there is a maximum scale of production, so that each entrepreneur can hire at most λworkers, i.e., 
𝑙𝑗 ≤𝜆.  
As to the policy side, there is a linear tax rate on production for local lineages and middle-class (
𝑚 ≥0), respectively. The proceeds of taxes can be redistributed as nonnegative lump-sum transfers to 

the agent in the groups of elites, middle-class, and farmers(𝑇𝑒 ≥0, 𝑇𝑚 ≥0 and𝑇𝑓 ≥0).Since the farmers 
constitute the majority of the population, 𝑇𝑓is thus specified to include a public goods provision.   
𝐿𝑇𝑓 +𝜃𝑚𝑇𝑚 +𝜃𝑒𝑇𝑒 ≤ 𝑗∈𝑆𝑚∪𝑆𝑒 𝜏𝑗 𝑦𝑗 (2)  
Since only farmers can be employed, the labor market clearing condition can be expressed as:  
 𝑗∈𝑆𝑒∪𝑆𝑚 𝑙𝑗 𝑑𝑗≤𝐿.   (3)  
C. Factor Price Manipulation. We now characterize the first best solution of the allocation of labor to 
different entrepreneurs (𝑙𝑒 and 𝑙𝑚). Since, under a given set of tax and the wage (𝜏𝑗and ), the transfers 
do not affect the economic equilibrium, the planner takes𝐴𝑗as given and chooses𝑙𝑗 and𝑘𝑗to maximize 
the net output (total surplus) for both the elite and middle-class entrepreneurs: 

  

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In which w is the wage and the capital price is normalized to 1. The maximization of equation (4) yields:  

 
, and(5)  

 

  

In equation (6), , which represents the marginal product of a farmer. If the wage 

rate is above𝑀𝑃𝐿, the producer will not employ any workers; if it is equal to 𝑀𝑃𝐿, the employment will 
be any amount between 0 and λ; and if it is lower than 𝑀𝑃𝐿, the producer will prefer to hire as many 
workers as possible until the maximum rate  is reached. We now use this model to illustrate how the 
elites ’rent extraction may lead to economic inefficiency. This is done by introducing political 
institutions to the model such that local elites could decide the policies, which include the levying of a 
high tax on middle-class producers as an entry barrier.  
During the fragmentation period, the combination of policy tools constituted an entry barrier 𝐵𝑀for the 
lineages to expropriate rents. The barrier not only prevented the entry of middle-class agents wishing 
to become entrepreneurs and to hire labor, but also turned them into slaves. The concrete method was 
to set an extremely highde jure tax rate for the middle-class farmers. The tax, was so high 
that the middle-class farming entrepreneurs could not afford to pay it, and hence they were forced to 
dedicate their land to noble lineages and sell themselves as slaves in order to evade the tax.   
Besides, the elite would never have taxed themselves 𝜏𝑒 =0, and middle-class farmers have evaded all 
of the tax by abandoning their land and citizenships. Hence, the de facto tax was zero. Also note that 
since local elites control the state, central emperors had no power to tax.  
Next, for a given set of taxes and entry barriers, , the middle-class producers choose the labor 

employment optimally and the labor market clears. By substituting (5) into (4) and incorporating an 
entry barrier for each individual middle-class farmers caused by an unaffordable tax, we can 

obtain the profit function for the middle-class entrepreneurs:  
  

We also obtain the profit function for the elite entrepreneurs who were exempted from tax, and hence 
did not face entry barriers:  

  

By following Acemoglu (2010) and setting an employment constraint as shown below:  
.                        (8)  

If this constraint holds, then there will be enough middle-class entrepreneurs to employ all workers, 
but there can never be full employment for labor demand coming only from the elite groups. Finally, 
by combining equations (6), (7-1) and (8), one can obtain the equilibrium wage  

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.         (9)  

Given this model of wage determination, if the elite set 𝐵𝑚 =0, they will generate zero profits, but 
farmers are paid their marginal productivity. On the contrary, by setting (and they will 

certainly do so), they can ensure that they will become entrepreneurs by drivingmiddle-class producers 
out of the market. More importantly, this kind of entry barrier could also push the equilibrium wage 
rate down to zero(or the subsistence wage) by manipulating labor prices and enslaving farmers. Since 
𝑤𝑡 =0<𝑀𝑃 , each elite entrepreneur could hire λworkers and earn a profit of . At this point, the 

total net output becomes   
,                               (10)  

And all output is produced by elite entrepreneurs. But, there is no tax or public goods provision.  
There are three sources of inefficiency under entry barriers due to the unfair tax system. First, from the 
viewpoint of efficiency, since𝐴𝑚 ≥𝐴𝑒, it is better to let middle-class entrepreneurs produce the entire 
output. This arrangement not only maximizes the total surplus, but also guarantees a wage rate that is 

better than the subsistence wage (i.e., ). However, the real world results were 

actually the opposite of the ideal one: the farming slaves had to work for a subsistence wage; 
and the high-efficiency producers were driven out of business by the low-efficiency ones. 
Second, since𝜃𝑒 <𝐿 𝜆, the elite producers cannot provide employment for the entire workforce. There 
always remains some unemployment. Finally, the inefficiency of slave farming would reduce 
agricultural productivity even in the case of large-scale slave farming (Schaefer and Schmitz, 1979).  
D. Political Conflicts.  Since there are two sets of competing elites to extract economic surplus of the 
commoners (central emperors/local elite), the political wrangling as to who could grab the surplus 
should be determined by the political power of central emperors and local lineages. Evidently, the local 
elite grabbed all the surplus created by famers in the fragmentation period. However, as explained in 
the following section, the allocation of power was altered by two exogenous events, rice technology 
innovation and the improvement and renovation of the canal system, which both by coincidence took 
place during the Song dynasty.  
IV. Political Unification Period: Strong State Capacity  
A. From Political Fragmentation to Political Unification. Prior to the Song dynasty, the political 
structure granted the lineages huge benefits, and allowed them to manipulate factor prices through 
unfair and inefficient taxation regimes. However, from the Song dynasty onwards, the balance of power 
had decisively tilted towards the emperors and that allowed the central emperors to take over all 
governmental functions and achieved enough political power to suppress local lineages. By the Ming 
dynasty, even the post of chancellorship was abolished and replaced by the secretariat of the emperors 

(殿閣大學士), who, like faithful servants, could be dismissed at will by a capricious emperor. This 
enabled the emperor to wield ultimate power without institutional constraints.   
The only restraint on the emperors was the insurrection constraint, meaning that, if 
farmers at the bottom of the ladder were pushed below subsistence by excessive imperial 
abuses, they would resort to a violent rebellion to overthrow the imperial power.  

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This transformation from fragmentation to unification provides a vital division between medieval and 
modern times of China. It encompasses at one end the collapse of the medieval aristocracy at 
the fall of the Tang, and at the other end the unification of China under the emperor’s 
autocratic regime staffed by mobilized bureaucrats dedicated to fortifying the central 
government. The highly centralized power of the emperors can be seen by the change in the 

appointment of officials through the imperial examinations ( 科舉 ) rather than through the 
recommendations of the local lineages. Although the imperial examination system was initiated in the 
Sui and Tang dynasties, however, the candidates were largely restricted to the graduates of official 
schools already monopolized by elite lineages (Ma, 2012). Moreover, passing the exam merely means 
being qualified to be a candidate of bureaucrat. It still needed the approval of the lineages to be a formal 
officer. Therefore, the fair and competitive system that allowed more people to sit for the examinations 
and to facilitate the formation of a new bureaucracy did not begin until the Song dynasty. The opening 
up of the examination system for bureaucratic recruitment undoubtedly weakened the pre-existing 
social structure rooted in the hereditary control of the aristocratic lineages. More importantly, because 
the plebeian officials lacked of the support from local political elites, they unsurprisingly did not have 
sufficient power to counterbalance the power of the emperor. Basically, the Song dynasty marked the 
transition from feudalism to central rule.  
But, why could the central emperors have political power to repress the nobles, to implement imperial 
examination, and to possess the ultimate authority after Song dynasty? As is well known, a dictator’s 
capacity to control his serving men varied with the technical and organizational conditions under which 
he operated. Hence, the answers in the literature are diverse, ranging from heavy reliance on the 
construction of large-scale irrigation work making bureaucratic despotism inevitable (Wittfogel, 1957) 
to military conflicts between Han and Nomadic societies (Ma, 2015). Nevertheless, this article focuses 
on the influences of rice technology innovation and the Grand Canal on the state’s capacity to 
levy taxes.  
B. State Capacity and Taxation.  Due to China’s huge territory, its state capacity to tax encountered 
two significant difficulties: tax evasion and the transportation cost of taxed grain. However, these 
difficulties were progressively overcome in the post-Song era.  
B-1: Prevent Tax Evasion by Taxing Land Rather Than People.  Due to the small population relative 
to land mass, land per capitain the pre-Song era (e.g.,0.15square kilometers in the Tang dynasty) was 
much higher than that of the post-Song (e.g.,0.07 in the Ming dynasty), as indicated by Table 1. 
Therefore, in the former case, the constraint on agricultural production was labor rather than land, 
which made the labor price much higher than the land price. For instance, the Han Wooden Strips 

found in Inner Mongolia (居延漢簡) show that a female slave was worth 20,000 coins in the Han 
dynasty, but 50 mu of land was only worth 5,000 coins. This means that a female slave was worth 200 
mu of land, which was enough land for 10 farming households to cultivate crops in the Song dynasty 
(Ho, 1990).  
Owing to the low value of land in the pre-Song era, the principal source of tax revenue was based on 
labor rather than on land. However, in a vast country like China, information asymmetry often led to 
serious underreporting of population (especially the number of adult males), that in turn led to tax 
evasion and an enfeebled state capacity. Nevertheless, after the Song dynasty, China’s fiscal revenue 

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begun to shift from a “tax on labor” to a “tax on land.” (Please refer to Table 2.) As indicated by Wang 
(1973), land taxes accounted for 74% of officially-recorded revenue in 1753 AD and became the main 
source of government revenue. Since land tax cannot be evaded, this change thus facilitated the building 
of the state capacity to collect tax residency information and secure tax revenues.   
The basic reason that allowed a shift in the tax base from labor to land was a huge population which 
enhanced the land’s value. More importantly, the huge population could not be sustained for 
long without technical progress in rice production.    
After the Song dynasty, there was a dramatic population increase driven by a food increase due to 
technological innovation in rice production (e.g., the adoption of early-ripening strains of rice and the 
intensive development of irrigation systems). Technical progress in rice production mainly occurred in 

the rice-growing territory of Southern China. Henan Tz《河南志》shows that the productivity of the 
rice wetlands in Southern China was four times higher than that of the wheat dryland in Northern 
China.  
As shown by Elvin (1973), this innovation not only made Chinese fields produce the highest yields in 
the world, but was also the most important factor in stimulating population growth. Before the Song 
dynasty, China’s population largely remained at a stable size of 50-60 million (Maddison, 2007). After 
the technical progress in rice and its extensive cultivation in central and southern China, the Chinese 
population grew rapidly to 100 million in the Ming dynasty and to 400 million by the end of the Qing 
dynasty in the 1900s. The dramatic population increase unsurprisingly raised the relative scarcity and 
value of land, and that allowed central emperors to substitute it for labor as the main tax base. Since 
the land is immovable and cannot be hidden. This change thus facilitated the development of an 
efficient tax administration.  
B-2 Reduce Transportation Costs by Constructing the Great Canal. Rice technology innovation would 
not have been worthwhile in a subsistence economy without the ability to transport the rice from the 
surplus-producing area to the populous market area (especially the capital city). Therefore, 
transportation improvement driven by technical progress of canal navigation was another factor 
that strengthened the state’s capacity to levy taxes. Since China was vast in terms of territory, the far-
flung regions could only be linked to the central capital by networks of slow preindustrial transport. In 
pre-Song China, transportation costs seriously limited the ability to raise taxes. The government had to 
waste a lot of resources to deliver taxed grain from the collecting place to the capital or military front. 

For instance, Pingjin Hou in the Shiji (史記．平津侯主父列傳) shows that, in the Qin dynasty, it took 

up 192 tams(石) of forage to feed the mules in order to transport one tam of grain from Langya 

Shandong (山東琅琊) to Hetao (河套). Hence, the delivery of taxed grain involved extremely high 
transaction costs. These difficulties unsurprisingly weakened the political power of the central 
government to control local authorities. Hence, as long as communications were poor 
(highways and navigation canals not well developed …) and as long as a natural economy 
prevailed, the ranking officials tended to hold their office land hereditarily (Wittfogel, 
1957, pp.355-356).   
However, the improvement of the canal system greatly enhanced the ability to transport the taxed grain.  
Early Chinese canals (from Qin to Tang) were mainly developed for military use given the limited traffic 
volume (Kelly, 1997).   

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From economic considerations, it is unfeasible to use canal transportation to move taxed grain from 
surplus districts to the capital. However, after the Song dynasty, the central government began 
constructing and renovating a national waterway network – the Great Canal, which provided great 
convenience to imperial taxation. The change was based on two reasons. First, on the supply side, 
technical progress in industrial transport raised the carrying capacity of Great Canal. As indicated by 
Joseph Needham (1954), the industrial technology in China reached its peak in the Song dynasty, which 
caused China to become a global leader in many fields of technological progress, such as the invention 
of “navigation lock” to raise and lower ships between stretches of water of different levels on canal 
waterways. Second, on the demand side, huge transportation demand arising from marketable surplus 
of rice output created a derived demand for the transportation systems. Both factors henceallowedthe 
government capable of developing a canal system through the construction of new waterways and the 
improvement of existing ones by deepening, removing rapids, and adding locks. Over that period of 
time, this waterway network was the world’s largest artificial waterway, and came increasingly to be 
used for transporting taxed grain from Southern to Northern China, in which the capital city was located 
(Wittfogel, 1957).  
Through the 30,000-mile-long national network of canals and navigable rivers, all economically 
important regions of China had been linked into a single territory (Chi, 1936),and 30-40% of 
agricultural products were marketed during the early 12thcentury (Perkins, 1969). Brandt et al. (2014) 
also indicate that, roughly, one-fourth of these shipments were used in long-distance trade. Besides, a 
wide literature surveyed by Quan (1972) also shows that the Grand Canal facilitated the northward 
shipment of taxed grain to the capital, and allowed the central government to tax entrepreneurs 
nationwide.  
Seen from the viewpoint of politics, the waterway network played a key role in strengthening the 
political power of central emperors. It helped the emperors to exert political control over the locals. 
Prior to the Song dynasty, the central government was faced with the difficult logistical task of 
transporting large quantities of taxed grain from the south to support the imperial court and armies 
that were concentrated in the north.   
However, the Great Canal provided central emperors with the ability to transport grain cheaply over 
long distances and helped to strengthen the state capacity. This not only transferred political 
power from local lineages to central emperors, but also changed the source of economic 
inefficiency from factor price manipulation to bureaucratic corruption.    
Bureaucratic Corruption under Strong States.  When the state’s capacity to tax was strong, it “seems” 
likely that the central emperor could levy taxes efficiently and raised the ratio of tax to GDP. However, 
the real world is far from being that simple. Although central emperors might eliminate entry barriers 
created by local lineages, and might avoidthe inefficiency resulted from factor price manipulation, so 
that high efficiency producers (middleclass farmers) could produce without interferences. However, 
they are still subject to a practical difficulty to tax enough. This is because China’s size is too large to 
avoid the principal-agent problem. Huge size of territory imposed substantial complexity and difficulty 
in transmitting information over distance, especially in the premodern world. In addition, regional 
differences in climate and crops also bestowed local agents (bureaucrats) with high flexibility in 
implementing central government decrees, and made gathering information for anti-corruption 

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investigations more difficult. Given these information asymmetries, it was difficult for a central 
emperor to monitor the tax over-collection by local bureaucrats. Thisgavelocal bureaucrats strong 
incentives to extort the farmers and engage in corruption.  
Although the evidence is sketchy and fragmented, it still suggests that low threat of detection of 
corruption led to a pervasive corruption. For instance, Sng and Moriguchi (2014) indicate that regional 
diversity forced the government to collect land taxes ina variety of ratios between crops and silver 
money. This means that the farmers had to pay part of their taxes in kind, which, depending on the 
region, might be rice, wheat, millet, or other staple crops. The remaining part of the tax denominated 
in silver also had tobe paid in copper coins when and where silver was scarce. To deal with such kind of 
diversity, the central government had no choice but to allow native magistrates to set commutation 
rates based on local conditions. However, the heterogeneity across regions made it difficult to monitor 
the tax over-collection by local administration and led to endemic corruption.  
One popular form of over-collection was the manipulation of commutation rates, wherein 
magistrates demanded households to  
pay taxes in copper (instead of the officially stipulated silver or grain) and set the commutation rate 
above the market rate … commoners paid up to 16,000wen of copper cash for every shi of rice that 
they owed in taxes, when the market price of rice was less than 3,000 wen per shi (Sng and Moriguchi, 
2014, p.457).  
Historians also agree that bureaucratic corruption grew over time in Ming and Qing dynasties (de Bary,  
1993; Rowe, 2009). In particularly, Ni and Van (2006) empirically estimate that corruption consumed 
more than 20% of China’s agricultural output in 1850. Ma and Rubin (2019) also find that, in 1884, the 
unofficial income for officials above the provincial level was 63 million taels, amounted to 81% of the 
total official tax quota. On an individual basis, a magistrate in the early 19th century could embezzle 
30,000 silver taels annually, which were about 12.8 times of his legal income, 2340 taels (Chang, 1962). 
Besides, the corruption ranged from bottom to top. Provincial level officials relied on the contributions 
from the lower level officials (magistrates), who were asked to pay for bribes, and were often punished 
for any shortfall in quota payments. Worse still, the rulers were completely unable to keep corruption 
in check through any monitoring institution. These problems were difficult to resolve under the 
existing political institution as efforts from the center to monitor bureaucrats only multiplied the 
problem of monitoring the monitors. Indeed, internal staffers sent initially as imperial 
plenipotentiaries to control the outer layers of administration often found themselves turned into a 
new layer of formal bureaucracy superimposed on the external bureaucratic structure stationed 
outside the imperial capital. The subsequent dispatch of another layer of inner court personnel to 
monitor the previous monitors could end up repeating the process, leading to what many historians 
referred as the “externalization” [localization] of [central emperor’s] inner staff(Ma, 2012, pp.16-
17).Hence, the improvement in fiscal capacity merely turned the political conflict from a contest 
between central emperors and local lords into a contest between central emperors and local 
bureaucrats.                                                                                                                                                                                                  
The Qing dynasty and was extended northward to connect with commodity flows along the Liao River 
in Manchuria (Brandt et al., 2014).  

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D. Corruption Leads to Low Tax and Under-Provision of Public Goods. In Ming and Qing, China was 
a typical small peasant economy, in which 50%-60% of farmers were tenants (Perkins, 1984). On the 
other hand, as corruption become rampant, most of the wealth was concentrated in the hands of few 
bureaucratic families. Therefore, the landlords were also bureaucrats who passed the 
imperial examinations (Moore, 1966). 
Under such production relation, the middle-class farming was conducted by the small farming in which 
a household rented the land (𝑚) from the land lords, and labor forces (𝑙𝑚 ) were mainly family members. 
Because𝐴𝑚 >𝐴𝑒, and there were enough middle-class farming households to employ all workers (𝐿>𝜃𝑒𝜆), 
the misallocation of resources resulting from factor price manipulation disappeared. Hence, total 
output was larger than that in the case of the period of fractiousness (see equation 10) and became  

  

The economic intuition is easy: with the factor price manipulation mechanism, the objective of the local 
elites is to impoverish the middle-class as much as possible so as to prevent them from competing for 
labor, whereas for revenue extraction, the emperors would like the middle-class to produce and 
generate more revenue. Ideally, this kind of production arrangement has the potential to fuel a 
burgeoning middle class that leads to wages higher than subsistence level, more tax revenue, and pubic 
goods provision in China. However, bureaucratic corruption destroyed this potential, because the 
corruption of local bureaucrat would force the emperors to levy a low tax rate and provide an 
insufficient public goods for economic development. First, assume that a middle-class farmer had to 
pay 𝑙𝑚𝐶𝑚 to local bureaucrats as the bribery or extortion. Second, his profit function wassubject to 
corruption and tax, but did not have to face entry barriers:  

.     (12)  

Since the middle-class farming can ensure full employment, the equilibrium wage became:  
  

Equation (13) is different from (9) by the source of unfairness and inefficiency. In (9), local lineages 
decided entry barriers to drive middle-class producers out of the market, and pushed the equilibrium 
wage rate down to subsistence wage. Conversely, in (13), it was the central emperor who decided the 
tax rate .The higher the tax rate is, the more likely that 𝒘∗ would be lower than subsistence 
wageand triggers the rebellion.Hence, as indicated by Sng (2014), the emperors were forced not 
to overtax the farmers to preempt rebellion. This means that they had to set a tax rate not to exceed 
marginal productivity minus the corruption of bureaucrats. After some manipulation, this leads to  

(14)                

The higher bureaucratic corruption was, the lower the tax rate that the emperor had to set in order to 
preempt rebellion. At this point, low tax revenues and pervasive corruption predictably led to extremely 
low provision of public goods(𝑇𝑓 →0.) and poor economic performances, which is the same as that of 
the fractious period. The crucial point is that no-revolt constraint applied only to emperors 
but not to local bureaucrats. In this setting, pervasive bureaucratic corruption was pre-given and 
determined by exogenous factors, such as: large corruption rents (population growth increased 
economic surplus available for corruption), and low probability to be detected (large size and 
heterogeneity rendered the detection of corruption particularly difficult).  

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As in the fractious period, it is still the case that local elite extracted the farmers, rather than central 
emperors. Kiser and Tong (1992), Brandt etal. (2014), and Ma and Rubin (2019) unanimously indicate 
that the state in late imperial China can best be described as a large dictatorship where excessive 
exploitation came not from the emperors, but from their agents who had shorter decision horizons and 
less encompassing interests than the “benevolent” emperors themselves. Sng (2014) and Sng and 
Moriguchi (2014) also empirically show that norevolt constraint applied only to emperors but not to 
local bureaucrats. Hence, the emperors were motivated not to overtax the population to preempt 
rebellion, but, on the other hand, his agents had sufficient private incentives to expropriate rent from 
the farmers. 
Basically, this setting is a typical principal-agent game, in which the sequence of events is as follows: 
first, the emperors have to set a tax rate low enough to ensure a farmer’s income to be higher than or at 
least equal to “taxes plus corruption “as shown in equations (13) and (14).Second, the nature gives a 
positive and high-level of𝐶𝑚. At this point, in order to ensure 𝑤∗ ≥0,even though the emperor is a 
dictator, in practice, he still could hardly obtain any surplus exceeding 𝑦 −(𝑤∗+𝐶𝑚)from a 
farmer.10Therefore, high corruption in the second                                                           
10    

stage would force the ruler in the first stage to keep taxes low to mitigate the “tyranny at the bottom” 
effect as referred to by Sng (2014).As he shows,“… the Qing state taxed lightly. Its annual tax revenue 
between 1650 and 1850 averaged around four billion liters of rice in real terms. This is equivalent to 
less than 4% of China's hypothetical output in 1800 (Sng, 2014, p.118).” More importantly, it is the 
informal extractions from local bureaucrats that can explain the apparent simultaneity of low tax and 
insufficient public infrastructure to support modern industrial growth. This makes the source of 
inefficiency results from bureaucratic corruption rather than factor price manipulation.   
E. Bureaucratic Corruption and Government Inefficiency.  Bureaucratic corruption inevitably 
created resource misallocation and governmental inefficiency. For instance, due to the pervasive 
corruption, the emperors had to implement a vertically integrated monitoring system to avoid 
corruption. However, the use of the power vertical as a pillar of political order inevitably involved huge 
agency costs, such as monitoring performance, gathering information, and enforcing decisions, 
especially at the local level (Gel’man and Ryzhenkov, 2011).   
This led to a highly inefficient administrative structure. Even the emperors set up multiple layers of 
bureaucracies in order to ensure the monitoring system, however, the problem is that the monitoring 
is done by individuals who may themselves be corruptible. This means that more anti-corruption 
institution, in fact, increased rather than decreased corruption. In the end, nothing gets accomplished 
since everyone is corruptive. More importantly, this kind of regime of brought about an environment 
that was inhospitable to the incentive of entrepreneurship (such as business and industry) without 
which a jump from the traditional technology to the modern technology is not possible. Not to mention 
that the low taxation also led to a sustained decline in public goods provision which caused the military 
and socioeconomic failures of the 19th century.    
Although some literature identifies the source of the problem as the empire being too 
large for the principal to effectively monitor the agents’ behaviors, this article 
emphasizes that the root cause of the failure still lies in the lack of checks on elite power. 

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There has always existed persistent tension between the political structure that maximizes the rents to 
the elite rulers and the efficient system that reduces transaction costs and encourages growth. For this 
reason, the system of centralized rule merely replaced the problem of there being a conflict between the 
central emperors and local lineages with a set of principal-agent problems within a centralized 
hierarchy (Laffont and Guessan, 1999; Ma, 2012).  
F. Farmers’ Position. Dynastic struggles largely involved matters between central emperors and 
local lineages (or bureaucrats), but were completely unrelated to the lives of the farmers. Despite the 
change in the distribution of political power between central and local elites, the farmers’ position 
remained the same in that their wages were still at the subsistence level, there being no improvement. 
Regardless of whether they were in a strong or weak state, the political institutions were always 
developed to be beneficial for the ruling elite at the expense of the people. This argument can be verified 
by the long-run analysis of Perkins (1969, pp.16–17) and Maddison (2007), which shows that the annual 
consumption of grain for a Chinese farmerconstantlyremained within a range of about 10% on either 
side of 285 kg from the 13thto the 20th centuries. Adam Smith even wrote that “The poverty of the lower 
ranks of people in China far surpasses that of the most beggarly nations of Europe. …  many thousand 
families have no habitation on the land, but live constantly in little fishing boats upon the rivers and 
the canals. The subsistence which they find there is so scanty that they are eager to fish up the nastiest 
garbage thrown overboard from any European ship.” (Wealth of Nations, Chapter VIII, p. 86).   
V. Concluding Remarks  
This article draws on the insights of new institutional economics to investigate the relations among 
state capacity, taxation, and economic performance in historical China. The results show that, 
throughout the history of autocratic rule, most of the agricultural surplus was extracted by the elites in 
the form of factor price manipulation or corruption. However, regardless of whether the political power 
was concentrated at the central or local level, the backward outcome of bureaucratic governance would 
emerge. Based on unfavorable outcome, our results imply that efficient resource allocation requires an 
environment that allows a well-functioning political replacement mechanism to control the power of 
the rulers and to ensure tax revenues are used for the provision of public goods.  
Therefore, the insight is not whether or not a high tax can promote growth, but rather whether the 
political regime is extractive or not. This provides a solid framework to explain why the governments of 
developed countries mostly impose significantly high tax burdens, and function better than the weaker 
states in sub-Saharan Africa. It also appears that: (1) although China’s historically autocratic framework 
might be effective in exploiting the potential of a traditional technology and in increasing the ruling 
elite’s benefit, it cannot ensure the welfare of the public; and (2) the same setting has given rise to an 
environment that is inhospitable to the incentive of entrepreneurship without which a jump from the 
traditional technology to the modern technology is not possible.  
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University Press. Wittfogel, K.A. 1957. “Chinese Society: An Historical Survey.” Journal of Asian 
Studies 16(3) 343-364. 

Table 1: Chinese Population and Land  

 

Period   

(1)   (2)   (3)   

Population 
(thousands)   

Land 
(square 
kilometers)   

Land per 
capita  
(square 
kilometers)   

West Han 
(157 BC)   

60,000   666   0.11   

East Han  (28 
AD)   

60,000   655   0.11   

Jin   
(236 AD)   

na   616   na   

Tang  (685 
AD)   

50,900   890   0.15   

Song   (1010 
AD)   

100,000   483   0.05   

Ming  (1447 
AD)   

100,300   750   0.07   

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Qing  (1711 
AD)   

130,800   1,284   0.09 *   

Sources: Maddison, A. 2007. Chinese Economic Performance in the Long Run 960-2030 AD. OECD.   
* Although in the Qing dynasty, the land per capita (0.09) seems to be larger than that in the Song 
dynasty (0.05), this merely reflects the fact that the Qing dynasty’s territory was larger than that of the 
Song dynasty due to the addition of Xinjiang (the “new frontier”), which is a remote desert region 
incapable for cultivation.  

   Table 2：Classification of the Chinese Tax System  
  

  Tax Based on Labor  Tax Based on Land  

Spring and Autumn   Xiāngdìérshuāizhēng  

(相地而衰征)  

  

Spring and Autumn   Chūshuìmǔ  

(初稅畝)  

  

West Han  Biānhùqímín  

(編戶齊民)  

  

Sui and Former Tang   Zu yongdiao  

(租庸調)  

  

Later Tang  
  

Liǎngshuìfǎ  

(兩稅法)  

North Song  
  

Fāngtiánjūnshuìfǎ  

(方田均稅法)  

Later Ming  
  

Single whip law  

(一條鞭法)  

Qing     De dīngyín  

(地丁銀)  

 

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