Collusion and Economic Growth : A New Perspective on the China Model

In this paper, we propose a political-economy model of China that explains both the rapid economic growth and frequent rate of accidents that have occurred in China. The central government delegates authority to the local government to regulate the production activities of the firm. Under information asymmetry, the local government can collude with the firm and choose “bad” technology, the use of which will lead to faster economic growth and more accidents than the use of “good” technology. We characterize optimal equilibrium within collusion contracts, under which the central government will allow collusion when the cost to eliminate collusion is high. We also characterize the optimal collusion-proof contract, under which the payments, reprimands, and taxes that take place between the local government and the firm are endogenously determined. Our predictions on collusion and growth are supported by an empirical study on the coal industry