This dissertation contains three essays. In Chapter 2, I investigate the causal factors of the soft budget constraint (SBC) problem. Based on a panel dataset from a survey of Chinese enterprises, the test results support the policy burden hypothesis but not the ownership hypothesis. The findings emphasize the importance of creating a sound social security system in the process of China's enterprise reform.

The other two essays focus on the upgrading of counties to cities in China. Chapter 3 examines its role in providing local governments with incentives on economic growth. Using a large panel data set covering all counties during 1993-2004, I find that the official minimum requirements for upgrading are not enforced in practice. Instead, a county's economic growth rate plays a key role in obtaining city status. Furthermore, I conduct an empirical test to distinguish between a principal-agent incentive mechanism and political bargaining. The findings are consistent with the hypothesis that the central government uses upgrading to reward local officials for high growth, as well as aligning local interests with those of the center. This essay highlights the importance of both fiscal and political incentives facing the local government.

Chapter 4 examines the consequences of upgrading by looking at various economic, fiscal and public service outcomes. I find that city status increases government size and revenues, and creates more urban employment opportunities. However, there is no significant improvement in local public services after counties were upgraded, and their high growth rates dropped. These results are interpreted by analyzing the incentive structure of local government officials.