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Pamela Ban is a Senior at Thomas Worthington High School in Worthington, Ohio, where she wrote this paper as an independent study for Mr. Mark McCart in the 2006/2007 academic year.

CHINESE ECONOMIC REFORM:

AN ANALYSIS IN THREE SECTORS

Pamela Ban

China has been the focus of much attention in the past few years; hardly a day goes by without a newspaper article explaining the impact China has on the world. This impact has come as a result of significant economic reforms that China has implemented within the past few decades. This reform process is of particular interest. Market-oriented reforms have created a new economy that differs immensely from the pre-reform strict, doctrinaire socialist economy. Some reform measures were forced by popular pressure while others were established through trial and error; some were based on conventional thought, while oth-ers broke prevalent norms. Nevertheless, China’s reform path has introduced market mechanisms, increased efficiency, and pushed the Chinese economy into international importance. Economic reform has resulted in an improved, market-oriented Chinese economy.

This can be clearly seen through three specific areas. Reform of the agricultural system has forged the link between work and income with the introduction of contracting systems, creating a new economic environment for Chinese peasants. In

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the enterprise sector, trial and error developed a unique gradualist strategy, which has improved state-owned enterprises, developed private sectors, and progressively diminished the state’s influence in enterprise. In the area of foreign trade, evolving attitudes have caused China to open its trade, encourage foreign direct invest-ment, and integrate its reformed economy in the world market.

How has economic reform been implemented and how has it resulted in an improved economy? To answer this question, this paper will concentrate on the reform paths that China has taken in agriculture, enterprise, and foreign trade. Focus will begin on reforms starting in 1978, and follow the Chinese economy as economic reform measures are introduced and implemented in each of the three sectors.

I. Agricultural Reform

Before 1978, China’s agricultural system was characterized by strict control and slow agricultural growth. Within a mere decade however, this all changed, and China increased its agricultural output by almost 50 percent. The reason behind this remarkable shift is China’s market-oriented reform of its institutional system beginning in 1978. Agricultural reform centered on the link between work and income and created a new economic environ-ment for Chinese peasants, which increased agricultural output and growth.

The agricultural system in place under China’s traditional economic system revolved around government leaders’ goal of implementing heavy industry. The state needed to control the production of grain and other raw materials in order to create a favorable economy for heavy industry to thrive in. Thus, in 1955, the Cooperative Transformation Campaign organized peasants into collective economic units to facilitate control, and state-operated advanced cooperatives were established. Three years later in 1958, the government further tightened control and began to combine the advanced cooperatives into people’s communes during the

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People’s Communes Campaign. The government mandated what the collective farming units produced, how much they produced, and from where they received the means of production.

Opposition to this strictly-planned agricultural system found leadership under Deng Zihui, the director of rural affairs in the Central Committee of the Communist Party of China (CCCPC). This faction believed that peasants engaged in farming should have freedom in management, and advocated a form of private ownership. To them, peasants should have the power to buy, sell, or lease land, and to manage and employ labor. Zihui saw collec-tivization as a dangerous and detrimental practice to the Chinese economy. The production-team system that was practiced under collective farming did not maximize agricultural output. Produc-tion teams were comprised of around 20 to 30 households in the neighborhood, and net income was based on the performance of the production team as a whole. Individual peasants did not see direct returns for their efforts, and therefore the incentive to work hard did not exist under the production-team system. Consequently, agricultural outputs and farmers’ per capita net income were significantly low; in 1957, each farmer received an average net income of 73.37 yuan.2

Peasants began to support Deng Zihui’s stance against the collective farming policy and demanded a household respon-sibility system, under which income would be linked to work. Specifically, peasants desired household contracting, a form of the household responsibility system which operated using “task rates.” Under this system, a number of work points were set for each job, and peasants received those work points based on the number of jobs they did. These work points would determine the peasants’ annual net income. Demand for this household contracting system was directly proportional to the political and economic environment, as shown in three specific time periods when agriculture production and the living standard of farmers suffered greatly. The first major push occurred in 1956, after the Cooperative Transformation Campaign established advanced co-operatives. Wenzhou Prefecture in Zhejiang Province, Chengdu Prefecture in Sichuan Province, and Wuhu Prefecture in Anhui

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Province began practicing household contracting. However, the Communist Party, especially its chairman Mao Zedong, steadfastly opposed household contracting, viewing it as private in nature and completely against the principles of Communism. On August 8, 1957, the government took direct action to suppress the practice and commenced a campaign of “mass debates between socialist and capitalist roads,” and household contracting was branded as part of the road leading to capitalism.3

The second major press for household contracting took place in 1959, after a Communism revival and the establishment of the commune system under the People’s Commune Cam-paign. As Jinglian Wu described in his book Understanding and Interpreting Chinese Economic Reform, “rural China was domi-nated by the go-Communism craze, the tendency to exaggerate, the tendency to be authoritarian, the tendency to give arbitrary orders, and the tendency for cadres to behave as the privileged...all these did great harm to farmers.”4 Farmers were victimized to the point where their minimum living standards could not be sustained. For themselves, villages began to practice household contracting. However, unfortunately for the peasants, the timing of this coincided with the government’s Anti-Right Opportun-ism campaign, and household contracting was condemned as “right opportunism,” or “liberalist practices.” This can be clearly seen through the government-controlled press. The newspaper People’s Daily published an article on November 2, 1959 labeling household contracting as “a practice of extreme backwardness, retrogression, and reaction” and that “this poisonous weed...must be uprooted and burned up completely, not even a mite of it is to be retained!”5 Guangming Daily, reinforcing the government’s view that household contracting was a malicious effort to restore capitalism, released an article on December 4, 1959 reporting that household contracting was a “program of right opportunists for capitalist restoration in the countryside.”6

The third key push for household contracting occurred in 1962, when the catastrophic and disastrous effects of the failed Great Leap Forward and People’s Communes Campaign became

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increasingly evident. The collectives could not support the lives of commune members, and more and more farmers were dying from starvation. Anhui Province, in desperation, once again returned to household contracting. Output quota was fixed for each plot, each worker was designated certain responsibilities, and eventually agricultural production was restored. Anhui Province’s actions were, however, publicly disparaged by Mao at a CCCPC confer-ence in January 1962. According to David Zweig, to Mao, a link between work and income represented “the ultimate in material incentives.”7 In response to Mao’s criticism, the Anhui Provincial Committee issued a Resolution on Rectifying the Practice of “Re-sponsibility Plots.”

In spite of this, household contracting had by this time rooted itself as a potential solution to agriculture’s problems of low outputs. As long as the practice could increase outputs, as it did in Anhui, some leaders were willing to entertain the idea. This was evident in June 1962, when the Secretariat of the CCCPC received a work report from rural areas of East China. Half the Secretariat backed the practice of household contracting, while half opposed it. Mao, seeing that more and more leaders were accepting the idea of household contracting, turned the issue into a topic of class struggle to garner support. In the summer of 1962 at another conference of the CCCPC, Mao proclaimed that if any type of household contracting was implemented, the struggle and strife between social classes would be disastrous.8 In September of that same year, Mao gave a speech which intertwined the problem of class struggle with household contracting, stating that household contracting would “paint everything black.”9

Nevertheless, household contracting was tolerated. In 1978, the CCCPC allowed household contracting in remote and poor areas. This alone led to a huge increase in production teams practicing household contracting. In the beginning of 1980, 1.1 percent of all production teams in China participated in household contracting. By the middle of 1980, this figure had increased to 20 percent.10 By 1981, the government, seeing the success resulting from linking work to income, eliminated any other restrictions

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on practicing the household responsibility system, and gave it its full acceptance. By 1984, nearly all agricultural production teams were under the household responsibility system.11

Around the same time of its official acceptance, the household responsibility system underwent a few changes as well. Production teams began to disband into smaller work groups to better recognize individual accountability. The practice of work points was gradually replaced by quota and above-quota prices as the household responsibility system evolved. Peasants were obligated to sell to the state a certain amount of produce at the quota price, but also received an above-quota price for any excess produce. Furthermore, price reform was implemented in 1979, and quota and above-quota prices were increased. The government raised the quota prices of grain, cotton, sugar crops, oil crops, and pork by 17.1 percent, and above-quota prices of grain and oil crops were raised from 30 percent to half their corresponding quota prices.12

Another stage of reform occurred in 1984 when these fixed quotas were abolished and replaced by procurement contracts. Procurement contracts were compulsory sales to the government, and the contract price was a weighted average of the basic quota price and the above-quota price. Peasants were only responsible for paying the State Agricultural Tax and upholding the procure-ment contracts, and were allowed to dispose of excess produce after this in any way they pleased.

What was the reason behind the government’s shift to procurement contracts in 1984? The motivation came from the government’s financial burden. The increases made in quota and above-quota prices resulted in a growth in output starting around 1982.13 According to 1988 figures in the China Statistical yearbook, the government’s financial burden in this area increased from 8.4 percent of the budget in 1982 to approximately 24.6 percent of the budget in 1984.14 Procurement contracts were introduced in part to alleviate the government’s financial burden.

Peasants were allowed to continue to dispose of excess produce in any way they wished. Most sold the excess in market

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fairs, or, in the specific case of grain, to private grain traders who traveled across the countryside. The number of rural market fairs in operation increased from 50,356 in 1984 to 66,569 within a decade.15 According to Justin Yifu Lin’s figures in his study on rural reform in China, the market prices of these market fairs were generally higher than the procurement prices paid by the government.16 Furthermore, another study conducted by Jean C. Oi concluded that the government went as far as to encourage its grain stations to “pay market prices to compete with the private grain traders for peasant grain.”17 However, this practice was abruptly stopped by the government in 1998, when the government declared that all grain was to be sold to the state. Private grain operators were allowed to continue operating, but they were restricted to purchas-ing grain from state grain stores and were forbidden to continue purchasing grain directly from peasants. Why did China come so close to market freedom and then reverse its policies?

To answer this question, one must first consider why China did not permit a complete market to develop or privatize the ownership of land. By this time, China’s land policy was extremely outdated; each peasant household was registered as a farm and was obligated to pay the State Agricultural Tax and meet the com-pulsory sales stipulated in the procurement contracts, whether or not the household wanted to engage in farming. As reforms were implemented in all economic sectors, the Chinese economy had greatly diversified and allowed peasants the opportunity to engage in labor other than farming. Millions of peasants left farming to go into various types of industry, rural and urban. Farming was not the priority, and land was not worked to produce maximum yields. The state could have easily subsidized the peasants who chose to farm the land, and farm technology advancements would be able to further increase produce yields. This strategy was not implau-sible, and could have been a possible solution. For example, even in the early 1980s, some highly technologically advanced peasant villages delegated the task of farming to a few households and were still able to meet the terms of the procurement contracts.

However, in light of this, the government did not privatize land nor let a complete market to develop due to two main objec-

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tives. First, the government did not want to become dependent on food imports. The Chinese government was extremely concerned with food security and supply. Although the state encouraged development of rural industries, it did not want grain production to become a minor or secondary task for peasants. Second, as the government began to reform state-owned enterprises, a significant number of these workers were laid off. The state found it easier to make former peasants leave industry and keep the original work-ers if the peasants were able to go back to farming. By keeping all households registered as farms, the government was maintaining a job cushion.18

Look at the state of grain outputs during 1984-1987, and the government’s anxiety over maintaining food security and supply can be seen a little easier. In 1985 the government went as far as to even set aside procurement contracts. Peasants were enjoying great economic freedom. They began to increase the proportion of cash crops in their farming to increase their profit margin. Naturally, the percentage of field area dedicated to grain production decreased while the percentage of the field area de-voted to producing cash crops increased.19 With grain outputs stalled and even dropping, state interference began to increase in order to ensure food security and supply, and state procure-ment contracts were once again initiated. Data shows that after this occurred, grain production reversed its decline and started increasing again.20 1985 remains the year in which peasants had the most economic freedom.

Going back to 1998 with this information, the reason behind the government’s action of reversing its policies and eliminating market forces is more obvious. State interference increased and culminated in 1998, all due to grain production. Although market fairs still continued to operate at a reasonable rate, from 1998 to 1999, the number in existence dropped from 65,050 to 63,593; within another year this figure dropped even lower to 62,416.21 The state’s anxiety over food security and supply, especially in the area of grain production, has jeopardized and threatened the future status of market freedom. The agricultural market

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continues to be regulated by a combination of market forces and state intervention.

Nevertheless, the agricultural reforms that China took were extremely significant. The institution of the household responsibil-ity system increased agricultural output. Since households were allowed, in most cases, to control any excess produce after state quotas or compulsory sales were met, the incentive to increase output existed. The formation of the link between work and in-come created an incentive and successfully increased agricultural output and growth; from 1978-1984 alone, total agricultural growth increased 48.64 percent.22 46.89 percent of this growth is directly related to the institutional shift to linking work to income.23 This increase in growth was extraordinary. Figures such as these had not existed since 1949, when the People’s Republic of China was founded.24

China was able to change its agricultural system in such a short time period because farmers were not only supportive but they also pressed for change. Disastrous effects on agricultural production from events such as the Great Leap Forward and the Great Cultural Revolution nearly wiped out all rural economics, making local leaders more inclined to “break the law” and imple-ment a new system. The rest of the population did not object to the reform since it did not have any negative effects on other social groups.25 National leaders saw the positive effect of linking work to income on agricultural outputs, and gradually accepted the new system. Although the government’s anxiety over food security and supply has curtailed and prevented market freedom from reaching its full extent, China’s agricultural system has nevertheless estab-lished the link between work and income, incorporated market forces, and increased agricultural production and growth.

II. Enterprise Reform

The reform of the enterprise sector is integral in transform-ing a centrally planned economy to a more market-oriented one as it establishes the microeconomic foundation that is required

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for a modern market economy. China’s reform path in this area broke prevalent norms. Instead of the mass privatization, “big bang” strategies that were applied in Central and Eastern Europe, China’s enterprise reform took on a more gradualist transition. This gradualist strategy has proven to be extremely successful. State-owned enterprises (SOEs) were reformed through several central ideologies and private sectors were established steadily and flourished quickly, overall progressively diminishing the state’s influence in enterprise.

The traditional SOEs, as they existed before reform, were seen by the government as a way to fulfill political and economic objectives in line with their goal of promoting heavy industry. The government completely controlled the allocation of the factors of production. Just as in the traditional agricultural system, the government determined what, how many, and how to produce, in addition to mandating where raw material came from and who the consumers would be. Output was sold to the state at government-regulated prices. Market forces were eliminated. There was neither a product market nor a production factors market, and supply and demand was, in most part, ignored. The process of meeting demand was replaced by the role of meeting government goals. Furthermore, SOEs operated in extremely broad and wide-ranging fields, sometimes in fields ill-suited for government interference.26 In addition, important economic factors such as input and output prices, investments, and taxes, were all determined and regulated by the state. SOEs’ close relationship with the government gave them the power to greatly influence the modification of these bar-riers to their favor, instead of being forced to optimize business plans.

Naturally, this system was characterized by various prob-lems. Those who allocated resources did not have the essential information required to do so efficiently; decision-making power concentrated in the central government was detrimental because the central government was too separated from the environments, interests, and problems facing enterprises. Enterprises did not have sufficient funds to spend on technological advancements

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and research; managers did not have the opportunity to develop, innovate, or plan.27 Even authority over seemingly routine issues such as wage determination, employment levels, production scheduling and forecasts, and raw material acquisitions was not given to managers.28 In addition, there was no effective way for ad-ministrators to monitor enterprises and check whether enterprises were putting resources to optimal use. Since input and output prices were fixed, enterprise accounting profits or losses could not reflect whether resources were being used efficiently.29 There was no incentive for workers or managers to increase productivity. Furthermore, during the decades before reform, the total factor productivity (TFP), which measures the efficiency of capital and labor use of SOEs, remained the same or even dropped.30 During the period 1957-1978, SOEs experienced an annual TFP growth rate that fluctuated closely around zero, conditional on the capital and labor weights chosen.31 Capital and labor were directed into industries, but the enterprise system was not efficient in using them.

The first mainstream program reforming SOEs concen-trated on the idea of expanding enterprise autonomy. During the Third Plenum of the 11th CCCPC in December 1978, government leaders admitted that enterprises lacked autonomy. In 1979, the economist Hong Ma advocated that “the economic management system reform should begin with expanding enterprise autonomy to expand the enterprise decision-making power concerning human, financial, and material resources, as well as planning.”32 The idea of “expanding enterprise autonomy” was the process of transferring more decision-making power and control from the government to enterprise management; this was a type of “power-delegating” reform.

This idea spread successfully, and in July 1979, the State Council released documents which encouraged reform by expand-ing enterprise autonomy nationwide. By June 1980, enterprises running under this system accounted for over 94 percent of total enterprise profit. In Shanghai and Tianjin, the figure was 80 per-cent.33 At the end of 1980, the Chinese government also adopted

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the idea of profit retention. SOEs no longer had to relinquish all profit to the state; rather, they were permitted to keep a negotiated, preset percentage of the profit. In essence, this practice of profit retention, a type of “profit-sharing” reform, echoed the system of linking work to income that was incorporated in Chinese agricul-tural reform. Variations of power-delegating and profit-sharing comprised the first major enterprise reform program.

However, although this reform increased production and income initially, the newly found enthusiasm for efficiency was not long lasting. Shortly, fiscal deficits returned and increased, inflation materialized, and economic order, in general, was lost. The increased fiscal deficits that were generated by the profit retention program were, according to Robert Hsu, inconsistent with the “fiscal balance” of the state macroeconomic plan, and was accordingly replaced with profit taxes around 1983-1984.34 This tax system, which levied a 55 percent35 profit tax for large and medium sized SOEs, was designed to make enterprises more liable for business profits and losses.36

Around the approximate time period, in 1983, the con-tracting system was introduced to the enterprise sector. This was the same contracting system used in agriculture, but adapted for SOEs. The enterprise contracting system was essentially a specific form of power-delegating and profit-sharing. A contract is estab-lished between the contracting party, which was one of many state organizations, and the contracted party, which was the business. The terms of how decision-making power and profit are divided are stipulated in each contract. In most cases, any superfluous profit would be retained by the contracted party or be divided and shared between the two parties by a pre-negotiated propor-tion. In addition, any commodities produced beyond the plans could be sold on a newly developed “dual-price” system, which operated with market forces. In early 1983, the Secretariat leader of the CCCPC strongly encouraged the implementation of the enterprise contracting system “in all urban industries and com-mercial enterprises,” and within two to three months, the practice was allowed nationwide.37 By the end of 1987, 78 percent of SOEs were operating under the enterprise contracting system.38

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However, the effectiveness of the system was yet to be revealed. The enterprise contracting system did not alleviate the problems plaguing the Chinese economy; it upset the economic balance once again and led to rising inflation. The decentral-ization of fiscal power granted local governments the ability to influence local economies; consequently, local leaders earnestly pursued quick growth, causing inflation to rise rapidly. The central government, in turn, reestablished central control and imple-mented price ceilings and credit quotas in an effort to “rein” the economy back in.39 In addition, even with the implementation of the enterprise contracting system, the heart of the problem still existed. Enterprise property rights remained undefined, which caused discord between the contracting and contracted parties and led to mutual contract breaches. Furthermore, enterprises still had no complete accountability for profits or losses.

Why was full accountability not granted to enterprises? Enterprise leaders shared residual control with the state, as decision-making power was divided between the two. Residual claim on income was also shared between enterprise leaders and the state, as profit was divided between the two. However, the state is the only one with an equity investment, as the state is the sole owner of the enterprise. Therefore, enterprise leaders share residual claim and control, but do not share risk. They never assume responsibility for the losses, but always have a claim on profit. This problem was present in any reform that consisted of any type of power-delegating and profit-sharing, leading to a circle of problems with reform.40 Government intervention was the only way to check insider control, but government interven-tion was the direct opposite of reform intentions. Furthermore, full accountability could not be given to enterprises without the transfer of ownership. This would remain a crucial problem in SOE reform.

By the early 1990s, a new avenue of enterprise reform took shape. The Third Plenary Session of the 14th CCCPC in November 1993 marked the ending of power-delegating and profit-sharing reform and began the period of corporatization. The Decision on Issues Regarding the Establishment of a Social-

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ist Market Economy was released, proclaiming that future SOE reform should concentrate on “the institutional innovation of enterprises” and “establish a modern enterprise system [modern corporations].”41 According to the Decision, the corporate system should be characterized by clearly defined property rights, power, and responsibilities, scientific management, and the distinct separation between enterprise and government.42 The Decision also had many ramifications on the Chinese economy as a whole; it established the “socialist market economy,” and finally allowed market forces to play a larger role in the allocation of resources. However, sweeping privatization fell short of acceptance and public ownership was still emphasized as a core idea.43 Nevertheless, the Decision was a step toward a more market-oriented economy.

The Decision was closely followed by the Company Law of the People’s Republic of China in December 1993, which more clearly stipulated how corporatization was to work. Going into effect midyear in 1994, 100 SOEs were chosen to be the first to be corporatized. Within two years, these SOEs were to become limited liability companies (LLCs) or shareholding enterprises (SHEs). Article 3 of the Company Law stipulated the difference between the two: in LLCs, a shareholder is liable to the extent of his capital input, in SHEs, the company’s capital is equally divided into shares and a shareholder is liable to the extent of his shareholdings.44 However, in a LLC, the state is the only one with equity investment. LLCs can either be a “wholly state-owned” LLC, when there is only one state entity investing, or an “ordinary state-owned” LLC, when there are multiple state entities investing. In either case, a LLC remains a state-owned enterprise; the only difference between a LLC and a traditional SOE is that the state may divide its investments by investing in the company through various entities. On the other hand, SHEs must, according to the Company Law, be incorporated through share offer. With SHEs the state must hold, at minimum, 35 percent of the total shares, with the rest offered to the general public. The state does not have to invest in 51 percent of the shares and be the majority owner; the shares held by the general public often are so spread out that the 35 percent requirement often ensures that the state

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is the largest shareholder.45 Therefore, the state could reduce its expenditures in this area without relinquishing control.

While this shareholding system was introduced in the enterprise sector, it was not filtered through the enterprise sec-tor as much to make an effect. The corporatization plan was not a radical change in enterprise ownership, as it included mostly LLCs and only a handful of SHEs. With the state still as the owner, the former problem of enterprise leaders sharing residual claim but not risk still existed. Accordingly, financial performance of enterprises did not improve, as managers still did not strive to minimize costs and losses. From 1994-1997, losses increased 64 percent, jumping from 48 billion to 78 billion yuan.46

In 1997, the corporatization program was discontinued. The government, seeing the success that the SHEs had during the corporatization reform, decided to transform loss-making enterprises into publicly listed companies, thereby beginning the period of shareholding system reform. The government mandated that SOEs be reformed by restructuring corporate governance, by breaking up monopolies, and by converting SOEs into shareholding enterprises by initial public offering (IPO). In 1998, administrative function was separated from enterprise function, and monopolies were broken up and reorganized into competitive enterprises. In the case of natural monopolies, the government limited those monopolies’ functions down to a narrow and most-needed extent and strictly monitored their actions.47 Lastly, IPOs were listed in domestic and foreign securities market.

No analysis of Chinese enterprise reform is complete without a look at the development of the private sector. In 1987, the 13th National Congress of the Communist Party encouraged the development of the private sector, and in April 1988, at the First Session of the National People’s Congress, the Constitution of the People’s Republic of China was successfully amended to include a reference to developing private sectors. Article 11 of the Constitution mandates that “the State permits the private sector to exist and develop within the limits prescribed by law. The private sector is a supplement to socialist private sectors. The

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State protects the lawful rights and interests of the private sector, and exercises guidance, supervision, and control over the private sector.”48 In 1993, the Third Plenary Session of the 14th CCCPC reorganized and accepted the increasing number of non-state enterprises, while once again emphasizing that the focus of the economy would still be public ownership.

SOEs could not meet every need of the market, and pri-vate businesses met the missing needs. They also helped with the problem of unemployment, which gave them the support of local governments.49 In 1998, the government faced a critical problem when SOE reform forced more than 10 million people into un-employment. The development of the non-state sector became a high priority. In the late 1980s and early 1990s, the annual real growth rate of private firms was 140.6 percent, and state firms’ output share was 48.4 percent.50 As non-state enterprises became more critical, the federal government began to modify its poli-cies and regulations to allow the gradual development of larger private enterprises. This gradual development is a key charac-teristic of China’s reform. Non-state sectors developed gradually while state sectors maintained the prominent position. When this was attempted in the Soviet Union and other Eastern European countries, it failed. China was able to do this, according to Jeffrey Sachs and Wing T. Woo, because there was a surplus labor force, which was absent in the Soviet Union, and because Chinese SOEs were still in the dynamic process of reform.51

Overall, enterprise reform has influenced the autonomy, incentives, and competitiveness of SOEs. Decision-making power was decentralized and transferred to enterprise management, giv-ing managers authority over amounts and types of inputs, methods of production, and output prices. Incentives were created with the advent of various profit retention practices, corporatization was introduced, and the shareholding system was evolved. With the development of the non-state sector and the reform of SOEs, state influence in enterprise and industry has gradually declined. Back in 1978, the state sector was responsible for 77.63 percent of gross output value, and the non-state sector accounted for 22.37

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percent of gross output value.52 As enterprise reform continued, the state sector’s share declined while the non-state sector’s share increased. By 1994, the state sector only accounted for 34.06 percent of gross output value, with the non-state sector being responsible for 65.94 percent.53

Competition is now common within the non-state sector, between the non-state and state sectors, and within the state sector. Furthermore, as competition affects the state sector, state enter-prises press for additional release from state regulation. Enterprise profits have soared, averaging 36 percent annual increases since 1999 among both non-state and state sectors.54 Returns on equity have also increased. From 1998 to 2005, state-owned enterprises’ returns went from 2 percent to 13 percent, and private enterprises’ rose from 7 percent to 16 percent.55 In addition, China’s TFP is no longer the stagnate rate of the 1960s and 1970s. In the past decade, China’s TFP growth rate has been the fastest in the world.56 These results reflect the success from expanding the private sector and restructuring SOEs.

Economic reform in China’s enterprise sector is a dynamic process. As reform creates new environments, new problems will arise. However, what is significant is the extent of reform that China was able to undergo within the period of approximately two decades. Trial and error has yielded an improved state sector, and the acceptance of non-state sectors has created a new economy that differs immensely from the pre-reform doctrinaire socialist economy. The success from enterprise reform forecasts more years of robust growth.

III. Reform of Foreign Trade Attitudes

Ten years ago, a Chinese assistant foreign minister stated, “China is not any kind of power. It is not at present. And it will not be one in the future.”57 How perspectives have changed. Today, not a single person doubts China’s rising economic power. It is hard to believe that merely three decades ago, China was nearly completely isolated from the rest of the world. Since then, China

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has opened up its economy, entered the international scene, and risen to prominence, integrating itself in the world economy.

In the 1960s, the Chinese government held a monopoly over foreign trade, and completely controlled imports and ex-ports. China ended its political and economic relationships with the USSR, withdrew from the world, and focused on becoming self-sufficient. World trade figures illustrate China’s isolation from the rest of the world. In 1962, the world trade volume was $2.66 billion, and China’s trade activity accounted for a mere 1.5 percent of this. Even as the world trade volume grew, reaching $14.80 billion in 1977, China retreated further and further away from international trade, accounting for only 0.6 percent of world trade.58

Despite this, China could not remain in complete isola-tion. By the mid 1970s, the government realized that it could not match the industrialization of the Western world independently; China was unable to close the gap in industry, technology, or management by itself. Therefore, the government partially re-stored economic relations with the United States, other Western countries, and Japan. In 1978, China signed a $7.8 billion trade contract with the U.S. for chemical fertilizers and metallurgy, and in this one year, China’s trade activity increased 39 percent.59 On the other hand, China was still not willing to open its economy to foreign countries; the trade opened up in the 1970s was intended to build independence and self-reliance.

However, the Chinese government slowly realized that trade was integral to economic development. In September 1978, at the Third Plenary Session of the Central Advisory Commission of the Communist Party of China, Deng Xiaoping declared that the last 30 years of closed-door policy hindered China’s economic development, and pressed for reform and “opening up” to take advantage of foreign capital and foreign advanced technology. In his speech, he stated that “if we isolate ourselves and close our doors again, it will be absolutely impossible for us to approach the level of the developed countries in 50 years.”60 Government leaders looked at Japan and Hong Kong’s economic development

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success with export-oriented systems, and decided to pursue the policy of export-orientation.

China’s economy, with Deng Xiaoping’s leadership, has been opened in stages on a regional basis. In the 1980s, opening began in select coastal cities that were close to other East Asian countries. In May 1980, Guandong and Fujian were granted open economic policies to develop export-oriented industries and attract foreign investment. In August 1980, Shenzhen, Shuhai, Shantou, and Xiamen became the first four Special Economic Zones (SEZs). SEZs were given special flexible policies and treat-ment. “Imported goods for self-use” were free from tariffs and industrial or commercial taxes, and imports primarily for resale were given a 50 percent discount off standard taxes. In May 1984, 14 coastal cities (Dalian, Qinhuangdao, Tianjin, Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou, Guangshou, Zhanjiang, Beihai) were given similar open economic privileges, but were not designated SEZs. In February 1985, the Yangtze River Delta, and the Pearl River Delta, among other areas, were also declared to be open economic regions. By 1988, the last SEZ was established in Hainan.

Opening up these areas allowed for rapid development in their respective regions and, in addition, encouraged the open-ing up of the entire nation. The open regions made successful use of international resources and were involved in international competition. The first four SEZs alone experienced an increase of 44.4 billion yuan of industrial output within the first five years, with an annual growth rate of about 50 percent.61 China’s export-oriented industries developed rapidly: in 1990 alone, the total export volume of the coastal provinces amounted to $40 billion. This number was approximately two-thirds of China’s total export volume.62 The open regions greatly strengthened themselves with the assistance of foreign capital investment, technology, and management, and experimented with new economic systems and operating mechanisms. They tested new reform models and provided a foundation for reform for the entire nation.

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The success, advancement, and experience gained by China in the 1980s, through opening up, set an extremely solid basis for further pursuits in the next decade. In the 1990s, China followed a “four-along” strategy of opening up. The four specific regions focused on were “along the coast,” from the Bohai Sea to the Gulf of Tonkin, “along the border,” with both northern and southern borders, “along the river,” in particular the Yangtze River Valley and the Pudong area in Shanghai, and “along the railway,” with regions located along railroads across the entire nation.63 Pudong, a district of Shanghai, used to be mainly farmland and country-side until the government concentrated economic development reform in 1990, when the “Pudong New Area” was created. Pudong was to be the “head of the dragon” for the opening up of regions along the banks of the Yangtze River. Pudong has successfully emerged as a crucial financial and commercial center of China. It is the home to the Shanghai Stock Exchange, the major stock exchange in China (with the other being the smaller Shenzhen Stock Exchange), and the Lujiazui finance and trade zone.

Foreign direct investment is crucial to China’s economic development. Ever since China has begun the process of opening up, special policies have been implemented to encourage foreign countries to invest in China. In July 1979, The Law on Joint-Ventures using Chinese and Foreign Investment was adopted, legalizing foreign investment in China. In 1986, the government formally permitted the existence of entirely foreign-owned enterprises. Furthermore, the State Council backed the Provisions of the State Council of the Encouragement of Foreign Investment. The 22 articles in the Provision outlined preferential tax treatment for foreign joint-ventures, and granted them the freedom to import inputs, an increased promise of autonomy from bureaucratic in-tervention, and quicker licensing procedures, among others. In addition, foreign ventures were given privileged access to basic resources such as water, electricity, and transportation, and were provided with interest-free loans.64

These preferential policies and incentives were critical in making China the largest recipient of foreign direct investment (FDI) among developing countries. It has become a norm to invest

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in China. Out of the world’s top 500 non-financial corporations, over 400 have projects in China. Over 400 research and develop-ment bases have been created by multinationals.65 In particular, the Yangtze River Delta and the Pearl River Delta have become important areas of the information technology industry. However, most of the FDI is used towards labor-intensive production. Over half of the total foreign investment went towards the manufacturing industry; around 70 percent of foreign enterprises in China are dedicated to manufacturing.66 By 2002, China exceeded the U.S. to become the country with the most foreign direct investment in the world.67

East Asia is an important source of China’s foreign direct investment. The numbers are staggering. Hong Kong itself is responsible for around $204.9 billion of investment as of 2002. Japan’s accumulated investment amounts to $36.34 billion, and Taiwan’s is $33.11 billion.68 These East Asian countries originally held a trade surplus with the United States, a trade surplus which has since diminished due to their trade relations with China. East Asian countries take advantage of China’s cheap production fac-tors. A triangular trade is formed, China processes imports from East Asian countries and then exports the product to the United States, Europe, and other developed markets. This effect is most pronounced in Japan’s case. According to a report by the Centre d’Etudes Prospectives et d’Informations Internationales in Paris, Japan has shifted its export market from exporting goods to Western countries to exporting product parts and components to China.69 Japan’s import market has changed from importing finished goods from Western countries to importing finished goods from China.70 China is now East Asia’s major trading partner. The trade surplus has shifted from between East Asia and the U.S. to between China and the U.S. and between East Asian countries and the U.S. By 2001, China became the primary source of U.S. trade deficits. In January 2004, China experienced a trade surplus of $11.5 billion with the U.S. alone.71

China’s trade surplus mainly comes from its manufactur-ing industry. China is unsurpassed in its ability to provide low-cost

78 Pamela Ban

manufacturing. China is responsible for manufacturing 70 per-cent of the world’s toys, 60 percent of the world’s bicycles, and 50 percent of the world’s shoes.72 Former manufacturing intensive countries such as Mexico and South Korea will have to contend with China’s manufacturing powerhouse. China can already as-semble, manufacture, and ship its products over to the U.S. more cheaply than Mexico can produce them. Even though Mexico is right below the U.S. and has the privileges of NAFTA on its side, in 2003, China has surpassed Mexico in exporting to the U.S.73 Worldwide, in 2004, China took its place behind America and Germany as the world’s third-largest exporter.74

China’s opening up to foreign investment and its welcoming of international trade has greatly altered the economic makeup of the Asiatic region. World Trade Organization membership has allowed China to increase its appeal to foreign investors. East Asia is not the only region actively linked to China; China has increas-ingly drawn in immense quantities of parts for final assembly from countries all around Asia. Thailand, Malaysia, Singapore, the Philippines, and Indonesia are major players in the “triangular trade,” along with the other East Asian countries such as Taiwan and South Korea. China’s accession to the WTO and the opening of its trade has benefited numerous countries. In 2003, China’s demand for capital goods and components pulled Japan out of its 15-year recession.75 Chinese demand for raw materials has been satisfied by Southern Asia’s rubber, crude oil, and natural gas, to the benefit of those countries.76 In 1978, China’s dependence rate on foreign trade was 9.8 percent; by 2000, this figure increased to 43.9 percent.77 China is being linked closer and closer with Asian production networks all over the continent, and the Chinese economy has become increasingly reliant on foreign trade.

China, however, is not content with merely manufactur-ing toys. It has entered the high-tech product market, exporting the likes of computers, DVD players, and cell phones. In 1998, America imported $5.0 million of Chinese made notebook com-puters. By 2004, this figure jumped to $7.7 billion.78 In the year after that, 43 percent of China’s exports were in electronics, computers, and telecoms equipment.79 Nevertheless, contrary to

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the fear that China’s ascent in the high-tech industry threatens U. S. national security, China’s position in the high-tech industry is not what it seems. Its high-tech exports are very much like its toy exports—it assembles a computer as it assembles a toy. Most of China’s high-tech “exports” are, in reality, exports assembled from imported components. However, that does not say that China is not developing its own place in the high-tech industry. Already, the Chinese firm Huawei is a mobile handset supplier to Vodafone, and China’s own car industry has secured around 25 percent of its domestic market.80

The isolated China is no more. Evolving attitudes have opened up China’s economy to foreign trade, benefiting both China and foreign countries. China has been able to exploit its comparative advantage in areas such as manufacturing, establish-ing itself as a force to be reckoned with in the global market. And by integrating itself in international markets, China now affects numerous countries around the world and has aroused worldwide interest. When Deng Xiaoping made his speech pushing to open China up 30 years ago, he might not have predicted that China would achieve its current prominence. Yet, it was this push that started China’s ascent as an international economic power.

Within the last few decades, China has undergone a period of significant reforms that has left it with an improved, market-oriented economy. Linking work to income in agricultural produc-tion has increased agricultural output and growth, reduced the threat of chronic shortages, and established a solid foundation for economic prosperity and political stability. The development of the non-state enterprise sector is a clear indication that the market mechanism has been brought into play. In addition, the growth of the private sector and the restructuring of SOEs have resulted in productivity gains, improvement in profits, and increases in returns on equity. Furthermore, open foreign trade attitudes have allowed China to benefit from international markets and achieve a principal role in world trade.

China did not easily accept market-oriented reforms. They were not implemented effortlessly, nor were they welcomed

80 Pamela Ban

without resistance. They were not developed overnight, nor were they always in line with standard models. Perhaps no one in the beginning predicted that these reforms would thrust China into its economic prominence of today. However, it is these economic reforms that have driven China along the road of success.

An ambitious, reformed Chinese economy will affect the entire world. China’s economic reform is by no means finished. As it continues to be carried out, continued attention is needed, as knowledge of China’s reforms is vital in understanding the challenges that China faces.

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Endnotes

1 Jinglian Wu, Understanding and Interpreting Chinese Economic Reform (Mason: Thomson Higher Education, 2005) p. 96

2 Ibid., p. 104 3 Ibid., p. 106 4 Ibid., p. 106 5 Ibid., p. 107 6 Ibid., p. 107 7 David Zweig, “Opposition to Change in Rural China:

The System of Responsibility and People’s Communes,” Asian Survey 23, no. 7 (1983) p. 881

8 Wu, p. 108 9 Ibid., p. 10810 Justin Yifu Lin, Fang Cai, and Zhou Li, The China

Miracle: Development Strategy and Economic Reform (Hong Kong: The Chinese University Press, 2003) p. 144

11 Justin Yifu Lin, “Rural Reforms and Agricultural Growth in China,” The American Economic Review 82, no. 1 (1992) p. 38

12 Ibid., p. 3813 Ibid., p. 4014 Ibid., p. 3615 Him Chung, China’s Rural Market Development in the

Reform Era (Aldershot, England: Ashgate, 2004) p. 4616 Lin, p. 3717 Jean C. Oi, “Two Decades of Rural Reform in China: An

Overview and Assessment,” The China Quarterly 159, Special Issue (1999) p. 623

18 Ibid., pp. 622-62319 Lin, p. 38 (Table 3)20 Ibid., p. 3821 Chung, p. 4622 Lin et al., p. 14523 Ibid., p. 14524 Ibid., p. 14525 Wu, p. 11426 Ibid., p. 19027 Ibid., p. 14228 Gary H. Jefferson and Thomas G. Rawski, “Enterprise

Reform in Chinese Industry,” The Journal of Economic Perspectives 8, no. 2 (1994) p. 50

82 Pamela Ban

29 David Dollar, “Economic Reform and Allocative Efficiency in China’s State-Owned Industry,” Economic Development and Cultural Change 39, no. 1 (1990) p. 92

30 Ibid., p. 8931 Ibid., p. 104 (endnote)32 Wu, p. 5833 Ibid., p. 14534 Robert Hsu, “Changing Conceptions of the Socialist

Enterprise in China, 1979-1988,” Modern China 15, no. 4 (1989) p. 512

35 Wu Zengxian, “How Successful Has State-Owned Enterprise Reform Been in China?” Europe-Asia Studies 49, no. 7 (1997) p. 1239

36 Hsu, p. 51237 Wu, p. 14638 Ibid., p. 14739 Zengxian, p. 123940 Wu, p. 15241 Ibid., p. 15442 Ibid., p. 15443 Zengxian, p. 124044 Shu Y. Ma, “The Chinese Route to Privatization: The

Evolution of the Shareholding System Option,” Asian Survey 38, no. 4 (1998) p. 381

45 Ibid., p. 38246 Ibid., p. 38247 Wu, p. 15748 Ibid., p. 15849 Ibid., p. 15850 Thomas G. Rawski, “Chinese Industrial Reform:

Accomplishments, Prospects, and Implications,” The American Economic Review 84, no. 2 (1994) p. 272

51 Wu, p. 18552 Zengxian, p. 124253 Ibid., p. 124254 “Profits and Prophecies,” The Economist (21 October

2006) p. 8855 Ibid., p. 8856 Ibid., p. 8857 Reaching for a Renaissance,” A Special Report on China

and its Region, The Economist (31 March 2007) p. 458 Wu, p. 29259 Ibid., p. 293

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60 Ibid., p. 29461 Ibid., p. 29762 Ibid., p. 29663 Ibid., p. 29764 K.C. Fung, Hitomi Iizaka, & Sarah Tong, “Foreign

Direct Investment in China: Policy, Trend and Impact,” in International Conference on China’s Economy in the 21st Century held in Hong Kong, June 24-25, 2002 http://www.hiebs.hku.hk/working_paper_updates/pdf/wp1049.pdf

65 Wu, p. 30066 Ibid., p. 30467 Ibid., p. 30068 Ibid., p. 30269 “The Export Juggernaut,” A Special Report on China and

its Region, The Economist (31 March 2007) p. 1170 Ibid., p. 1171 Oded Shenkar, The Chinese Century (Saddle River:

Wharton School Publishing, 2005) p. 972 Ibid., p. 373 Thomas Friedman, The World is Flat (New York: Farrar,

Straus, and Giroux, 2005) p. 1074 “The Export Juggernaut,” p. 1075 Ibid., p. 1076 Ibid., p. 1077 Lin et al., p. 19478 “The Export Juggernaut,” p. 1179 Ibid., p. 1180 Ibid., p. 11

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Dollar, David, “Economic Reform and Allocative Efficiency in China’s State-Owned Industry,” Economic Development and Cultural Change 9, no. 1 (1990) pp. 89-105

“The Export Juggernaut,” A Special Report on China and its Region, The Economist 31 March 2007, pp. 10-12

84 Pamela Ban

Friedman, Thomas, The World is Flat New York: Farrar, Straus, and Giroux, 2005

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86 Pamela Ban

email22 May 2007

Dear Mr. Fitzhugh,

First I would like to thank you for deciding to publish my essay on the Florida Ship Canal in this Summer’s issue of The Concord Review. When I received the letter of notification I was just ecstatic! It has been quite a few years since anyone at my school has achieved this recognition and the faculty and administration are already encouraging more students to submit their history papers to The Concord Review. I also want to update you on my plans for next year; I will be attending Washington and Lee University in Lexington, Virginia beginning in the Fall of 2007. Thank you again for publishing my essay and for creating The Concord Review and allowing students with a passion for history to share their knowledge around the globe.

Sincerely,Caroline BovayOak Hall SchoolGainesville, Florida