China

I. The Setting1. China:

a) is very large (about the same size as Canada, 3.7 million sq miles)b) Population is huge and growing

• About 1.2 billion (more than 1/5 of the world's population)• major policy problem

c) Much of its land is uninhabitable or costly to cultivate (only 10% of the land is suitable for cultivation)

• mountains and deserts

d) Much of its resource base undeveloped, e.g., large oil reserves only starting to be exploitede) A poor, developing country (2007—$ 5,400 PC income)f) A rich and very long heritage

2. The Early Years (1949-1976)• Mao Zedong proclaims People’s Republic in

1949• Mao takes leadership as chief of state• Initial tasks

– collectivization of land– nationalization of industry

• Followed typical (Stalinist) planned socialist model– high priority to heavy industry, low priority to

agriculture• aggregate investment 20% - 25% of

national product• 85% industrial investment--heavy industry • 8% state investment--agriculture• by end of Mao period, industry share in

national output much higher than other countries at similar level of development

Collectivization of Agriculture• First step was redistribution of land from the landlords to the

peasants• Major farming equipment provided by village authorities• Collectivization involved organizing households into large prod

teams• Led to the commune

The Rural People’s Commune• Created during the Great Leap Forward (1958-1960)—a period of

massive resurgence of ideology that replaced rational decisions. • Individual households organized into production teams• Production teams combined to form brigades• Brigades combined into a commune (thousands of households in

a commune)• Communes were controlled by the county• County played major role in implementing the plans of the

Ministry of Agriculture and Forestry

Organization of Agriculture Prior to the ReformsMinistry of Agriculture and Forestry

CountyCommuneBrigade

Production TeamHousehold

• Individual’s Incentives in the Commune

– Individuals assigned work for which they earned points as shares of residual income (revenue minus expenses)

– Problems

• little incentive to work hard

• little incentive for individual initiative

• Impact

– Large reduction of agricultural production

Nationalization of Industry

• Slow and orderly transfer from private to state ownership

– by 1956, 68% value of output by state owned enterprises (SOE) and 16% by jointly owned (state-private) enterprises

• Planning mechanisms, priorities and enterprise management are the same as Soviet Union

• Problems (poor quality, shortages, inefficiency, etc.)

Political and Economical Turmoil• Hundred Flowers Campaign (1956-7)—a relatively liberal period

of open discussion of the econ and political system.– Mao unhappy with the Communist Party leadership– invites constructive criticism from intellectuals– reveals deep hostility

• Great Leap Forward (1958-1960)—an econ and social plan to rapidly transform China from a primarily agrarian economy dominated by peasant farmers into a modern, industrialized communist society.– massive resurgence of ideology– last vestiges of rural private property eliminated– commune system established– attempt to initiate rapid growth and industrialization– the plan did not achieve the intended results; economic disaster

after years of solid growth (economy collapses and does not recover to 1958 level until 1963)

Recovery from the Great Leap• Recovery from Great Leap emphasizes

– less focus on output growth and more on quality and efficiency

– more balanced economic development– modernization of agriculture– decentralization

The Cultural Revolution• Mao’s struggle to retake supreme leadership culminates in the

Cultural Revolution– peaks from 1966 to 1969– more upheaval– lost generation of leadership as universities closed and

students sent to the countryside• No increase in GDP from 1965 to 1970

The End of the Stalinist Period

• Mao die in 1976

• Gang of Four Trial

– Mao’s wife and three others arrested and discredited

– Stalinist thinking repudiated

– political maneuverings end in 1978 with rise of Deng Xiaoping

• reform period begins

II. Transition in China

1. The Era of Reform: 1978– More than two decades of stability and stellar growth

– Steady decentralization

– Combination of reform and transition

• “dual-track approach”

Dual Track Reform

• Coexistence of a plan track and a market track

• Two phases

– 1978-1984:

• liberalization of agriculture

• creation of township and village enterprises (TVE)

• spontaneous privatization of service sector

– 1984: dual-track applied to industry

Dual Track in Agriculture: Household Responsibility System (HRS)• In 1978, a village in central province (Anhui) initiated HRS. It

soon gained popularity and thus official endorsement in 1981. • Covered 98% of rural population within 3 years. • Communes disbanded. • Household is a principal unit of agricultural production.• Land distributed to households as 15 year leases (after 1995, for

30 y)• Lease holders required to produce a planned allotment at planned

(fixed) prices, but free to produce and market any amount beyond planned allotment.

• 91% of agricultural output planned in 1978, only 5% in 1993• Semi-ownership of land caused increase in labor productivity

which released labor into small-scale entrepreneurship, e.g. crafts, services

• Released labor into township and village enterprises (TVE)

Dual-Track in Industrial Ownership Structure• Old track state owned enterprises (SOE) vs new track non-SOEs• Two types of new track ownership structures

– Township & Village Enterprises (TVEs) and purely private– Most dynamic sector of the economy

• Owned or supervised by townships or villages (not state-owned)• Can be collective enterprises, private firms, joint ventures.• TVEs formally owned &controlled by villages &local communities

– in most TVEs, communities actually involved very little in operation of the enterprises, TVEs act essentially as private firms

• SOEs are unprofitable and a major drain on the state budget (1985-10% unprofitable, 1990-28%, 1995-50%)

• Most of the growth in China in non-state sector• SOEs persist for two main reasons

– SOEs represent “commanding heights”– SOEs employ 18% of the work force

• SOE reform—in 1995 China initiated the “modern enterprise system,” which aimed to transform the SOEs into modern corporations; “corporatization”—state ownership & independent management

Dual-Track Regional Development

• Certain places (mostly coastal) targeted for faster transition

• Begins in 1980 when four southern coastal sites were designated Special Economic Zones (SEZ)--Shantou, Shenzhen, Xiamen, Zhuhai, Hainan Island added in 1988

• Twenty cities subsequently approved as Economic and Technological Development Districts (ETDD)

• SEZs&ETDDs exempted from most controls on foreign investment and private ownership

• Result is much faster growth, especially in non-state sector

• Regional disparities a major problem

Economic Growth

Nation Guangdong Fujian Zhejiang Jiangsu Shangdong

Average annual growth 9.3% 19.7% 17.3% 18.9% 16.4% 16.3%SOE growth 10.1 9.5 9 9.1 9.2TVE growth 19.5 19.6 24 17.8 18.5

Foreign and joint ventures 58.6 50 38.6 42.3 37.3

Comparison with other East Asian Countries —China’s growth since 1978 has been high, but not as high as Japan’s or the Four Tigers

China, Japan, and the Four Tigers

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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Year

Inde

x of

Per

Cap

ita G

DP

(PP

P)

China (Year 0=1978)

Japan (Year 0=1950)

South Korea (Year 0=1958)

Taiwan (Year 0=1950)

Hong Kong (Year 0=1958)

Singapore (Year 0=1965)

China

Hong Kong

S. Korea

Singapore

Japan

Note: 1950 is five years after the end of WWII and is the first full year of the PRC 1958 is five years after the end of the Korean War and the UN embargo of PRC 1965 is the first year of Singapor's independence. 1978 is the year PRC begins transition

Taiwan

d) International trade—open door policy• International contacts between people (officials, tourists,

students, scholars, etc.)• Foreign trade and investment, especially in Special Economic

Zones.

2. Sources of Growth• Initial conditions

– in 1978, most labor (71%) agricultural• marginal productivity was very low• agricultural reforms caused large rise in productivity and

encouraged formation of TVEs from the freed-up labor• movement of low-productivity labor into higher

productivity TVEs is the major source of growth• opposite of Soviet Union, Central and Eastern Europe

where most labor was in SOEs which collapsed with transition

– very little was planned in China at start of reform compared to Soviet Union

b) Integration into global economy– exports gave ready employment for freed up agricultural labor in labor

intensive production in TVEs– allowed China to import modern technology– encouraged foreign direct investment which increased capital stock,

access to modern technology, and efficient western management

c) High saving rate– Chinese saving rate high even by Asian standards (China--23% of

disposable income, Japan: 21%, Taiwan: 18%, Germany: 13%, US: 8%)

d) Centralized control discredited– Great Leap Forward and Cultural Revolution were disasters obvious to

everyone– allowed Deng Xiaoping to institute reforms without much resistance

e) China is the largest recipient of foreign investment in Asia. Huge investment from Hong Kong, Taiwan, and overseas Chinese (labor intensive industries which were losing comparative advantage in Hong Kong and Taiwan moved to mainland China)

3) The Chinese Economic Systema) Corporate Governance and Property Rights

– private property rights lacking (business cannot turn to legal system to enforce contracts)

– relational contracting– the ultimate guarantor for property rights is the Chinese

Communist party– 2007 (March)—new property law adopted. The law covers the creation, transfer,

and ownership of property, and is a part of the ongoing effort to gradually develop a civil code. Hu Jintao (President and Communist Party Leader, 2002) and Wen Jiabao (Prime Minister, 2003) have taken a centrist position, protecting property rights for the rising middle class and farmers, while promoting a "harmonious society" that strives to distribute wealth more equitably, to increase social expenditures on health and education, and to alleviate some of the excesses of pollution and corruption that have accompanied rapid growth.

b) Capital Markets– Companies receive funding thru banks, not thru stock markets– Chinese companies operate with high debt burdens

c) Privatization– SOEs continue to be a huge drain on economy

d) Agriculture– incomplete ownership of land

– disincentive to improve land (reduces potential productivity of land)

e) Finance– near monopoly of state on banking

– savings channeled to inefficient capital formation in SOEs

– China’s commercial banks have a high ratio of non-performing loans (NPLs)

f) Trade relations– joining WTO—12/01

– trade relations with the US (MFN status), EU, Taiwan, and other Asian countries

g) International finance– full convertibility

h) Social safety net

– not as immediate need as in other transitional economies• rural population to large extent self-sufficient

• continued support of SOEs reduces urban unemployment

• lack of political reform prevents the poor from having a voice

– as SOEs privatized, unemployment will soar

– rural population has much lower income and access to health care

– high rate of savings and self- reliance and family support

– the dramatic rise in inequality (Gini Coefficient, China 0.40, USA 0.40, India, 0.38)

– Human Capital Investment• Difference between rural and urban

• Difference between developed and under-developed area

• They are both potential source of inequality

Per Capita Income 1978 - 2001 (in RMB yuan)

133.6 191.3397.6 423.8 462.6 544.9 601.5 686.3 708.6 784

921.6

1221

1577.7

1926.12090.12162 2210.32253

2366

343.4477.6

739.1899.6

1002.21181.4

1375.71510.2

1700.6

2026.6

2577.4

3496.2

4283

4838.9

5160.3

5425.1

5854

6280

6860

0

1000

2000

3000

4000

5000

6000

7000

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

rural urban

Yucai Schools (Urban)

Poor Village Schools

i) Regional policy

– most growth from Special Economic Zones and Development Areas

– huge income differential between coastal and interior provinces

j) Population policy

– slowing population growth

– slowing/preventing migration to cities

4) Transition in China—Summary

– Strategy• From central planning to indicative planning

• From indicative planning to market allocation of goods and services

• Grow out of the plan” instead of ``shock therapy”

• Transition and growth at the same time

– Transition– Replacement of administrative allocation by market allocation

– Replacement of administered prices by market prices

– To achieve this objective China used the dual track approach, which established autonomy and incentive.

– Reforms began smoothly and econ growth accelerated

– Nobody was made obviously worse and opponents were bought off (Pareto Improvement)

– Interdependence between SOE & non-state sector

– The dual-track system of prices introduced in the mid-1980s to facilitate the transition of China from a centrally planned to a socialist market economy has essentially been phased out, reducing to a single-track, market-based system, with the following exceptions:

» In 2001/07, the remaining planned prices are to be abolished with the exception of: the prices of natural gas, oil, edible oils, grains, tobacco, water, salt, and products related to national security

Phasing Out the Dual-Track

1978 1985 1988 1991 1993 1995 1998 1999 2001Plan price 94.4 37.0 24.0 22.2 10.4 17.0 9.1 6.7 2.7Guide price 0.0 23.0 19.0 20.0 2.1 4.4 7.1 2.9 3.4Market price 5.6 40.0 57.0 57.8 87.5 78.6 83.8 90.4 93.9

(percent of output value, selected years)

Source: Price Yearbook of China (various years)

Note: "Guide prices" are government-administered prices, but with reference to market supply and demand

– China’s market transition is incomplete but in some sense successful up until now

– Gradualism continues to guide experiments in advancing reforms

– Agricultural reform:• incomplete ownership of land

– disincentive to improve land

– reduces potential productivity of land