Big Contract in Small Village—Xiaogang Village and Rural Reforms

Incentives, which are important for performance, are often embedded in invisible institutions, that is, being non-physical or intangible, they are not directly observable to the naked eyes. Through the prism of Xiaogang Village, the birthplace of China’s rural reforms, this story provides an insider’s view on how “secret,” “private,” and “illegal” contracting among villagers had unintended consequences—consequences which changed the rural institutional foundation from the “people’s commune system” to the “household responsibility system” and which subsequently unleashed tidal waves of productivity increase way beyond rural areas in China. The story also sheds lights on how decisions were made by “rational people,” both inductively and deductively, or abductively, under conditions of uncertainty. Rather than absolute, human rationality is contextual, and the institutional context can be a powerful source of productivity gains.