Research on environmental governance in China has shown that centre–local relations often influence the implementation and efficacy of environmental regulations. By examining changes in resource allocation and rural development between 1982 and 2005 in the region worst affected by desertification in China—the Minqin oasis in Gansu—we argue that changes in macro‐level fiscal and commodity grain policies contributed to severe regional disparity and a reduction in local state capacity in hinterland China. Intergovernmental competition over fiscal revenue encouraged cash cropping and land reclamation, and the continuous decline of the oasis ecology further reduced legitimacy in rural governance. These institutional and ecological constraints shaped the behaviour of grassroots cadres and formed the conflicting interests of the state in resource distribution and environmental conservation that continued to exist until the implementation of a centralized conservation program in 2006. The data came from 157 interviews and 628 policy documents from local archives in Gansu.