Editor's note: This is the second part of an article by Shi Zhengfu, director of Center for New Political Economy, Fudan University and chairman of Comway Capital Group.

The socialist market economy with Chinese characteristics consists of a strategic central government, competitive local governments and competitive enterprises.

Four pillars in systems with Chinese characteristics

There is reason to say that the socialist market economy with Chinese characteristics has backed China's miracle. The system consists of a strategic central government, competitive local governments and competitive enterprises. Under the central government's leadership, local governments seek development by encouraging the business sector to innovate.

More specifically, four pillars have played pivotal roles in the mechanism. Local governments compete in the market as economic entities; state-owned enterprises capitalize their assets to gain themselves a vantage point in national economy; central debt and local debts are managed separately; and the country's top-down development strategies, mid-term planning and industrial policies combine with short-term macroeconomic adjustment to form a national management system superior to the passive administrative responses usually seen in Western economies.

The establishment and progress of the institutional arrangement marks a new economic system, different from a regular Western market economy, is in the making. The four pillars together play their part in guiding China's rapid growth.

Competitive local governments and enterprise investment

The tax sharing system, a policy arrangement between the central government and local governments on collecting and spending different taxes, makes local governments the direct organizers and beneficiaries. In competing with each other, local governments must strive for better administration. In this way, local governments are both at a hierarchy in the country's overall governance, and also the players in market competition.

The following are some of the positive roles played by local governments:

1. Favorable land price and tax policies offered by local governments attract more investment. The administration's intervention directly boosts businesses' marginal efficiency on investment. Conversely, businesses pay value-added tax, corporate and personal income tax. Such fiscal revenues, plus increase in employment and extension of business activities to indirectly boost local services as well as the property sector, make the inputs of local governments no longer the conventional government subsidies, but a kind of investment in sharing the future gains of enterprises. Thus such incentive policies become sustainable.

2. Local governments offer mediation services to facilitate contacts, including talks between businesses, and talks between corporate and non-corporate entities, so as to solve problems in gaining approval and financing for projects. This greatly lowers costs compared with the procrastination in Western countries.

In a market economy with Chinese characteristics, you see more than just companies competing with each other; competitive governments also use their administrative leverage, seeking to help local businesses to reduce their cost on imvestment. It is evident that local governments' coordination in economic activities does not suppress market vitality, but boost enterprises' market capacity for action.

3. Local governments improve the approval process to solve bureaucratic issues. A sound market calls for various regulators for public safety, environmental protection and fair play, which causes bureaucracy, a common phenomenon in today's society. Western developed countries have spent recent decades reforming their public sectors, but efforts have been limited; while the governance of developing countries is generally inefficient and marred by corruption.