The Dynamics of Political Embeddedness in China

Abstract: Over the past 35 years, markets developed rapidly in China, creating new business opportunities, increasing competition, and heightening uncertainty. But the political system remained autocratic and became decentralized, which gave local officials authority over local businesses and increased their dependence on business to meet official growth targets. We argue that as market development proceeded, politically embedded firms (those with ties to state authorities) bore lower regulatory burdens and had easier access to state-controlled resources, faced less uncertainty, and could more easily grasp new opportunities; therefore, they performed better than politically unembedded firms. Political embeddedness was especially important in more competitive markets because there was more uncertainty there, and for smaller firms because they were not well-positioned to handle increased competition. We investigate two causal mechanisms: access to bank loans and protection from pressures to make loans to business-group members. Analysis of panel data from 1992 to 2007 on all listed firms supports our arguments about firm performance and both causal mechanisms. These results indicate that connections between economic and state actors have highly contingent effects – strong in some contexts, for some firms – and that they operate through flows of funds into and out of firms.