2006: A fixed exchange rate around 8.007 Yuan to $1 now but may break the 8 Yuan barrier later this

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• 2006 A fixed exchange rate (around 8.007 Yuan to
  1 now but may break the 8 Yuan barrier later
  this year) and strong capital inflows gt The
  governments five-year plan, which runs to 2010,
  aims for growth of 7.5 per year (but official
  projections tend to be low). Goldman Sachs
  predicts growth of 8.6 in 2006 and 8.2 in 2007.
  The economy grew 9.9 in 2005.

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• The Chinese Economy Since 1976
• For hundreds of millions of Chinese, the past 60
  years have required adaptation to a series of
  political, economic and cultural revolutions,
  punctuated by cycles of order and chaos,
  liberalization and repression, plan and market,
  social protection and individual responsibility.
• During the mid-90s, after a decade of gradual
  market reform, China recorded the world's most
  rapid rate of economic growth nearly 10 per
  year that hasnt slackened since.
• Based on comparisons of economic performance,
  many observers conclude that the policy of
  gradualism in China had proved more effective
  than the "shock therapy used in Eastern Europe
  and the new CIS countries.

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• Indeed, based on its enormous population, its
  expanding consumer market, and its strategic
  position in Asia, a rising chorus of voices claim
  that China will become an economic superpower in
  the 21st century.
• History and Environment
• With about 1.2 billion people, China constitutes
  more than one-fifth of the world's population.
• In surface area, only Russia and Canada are
  larger.
• Only 10 of China's land is suitable for
  cultivation.
• Thus, with more than 70 of the Chinese labor
  force engaged in agriculture, the average farm
  worker controls less than one acre of land (India
  - 2 acres on average in USA - 100 acres).

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• The Chinese empire was the only giant of the
  ancient world to survive into the twentieth
  century.
• - The post-1949 civil war China provides an
  opportunity to study both the effects of ideology
  on system design and also some major experiments
  with new strategies and forms of motivation.
• CCP came to power Oct. 1949 faced two problems
• Had to consolidate its political position.
• Had to establish itself as the center of a
  reorganized decision-making system.

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• 2. The Peoples Liberation Army and its related
  organizations penetrated into every area of
  economic activity yet do to its military
  orientation the government had neither trained
  personnel nor information to assume complete
  control of the economy in 1949.
• Economy was totally disorganized government
  under Kuomintang in 1930s and Japanese during
  WWII required thorough overhauling.
• Government embarked on a course of gradual change
  despite Marxian theory Mao proposed to skip the
  capitalist stage replacing it briefly with a
  stage of democratic centralism.
• To gain support of rural population and to alter
  the decision-making structure, widespread land
  reform was pursued (collectivization).

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• By 1952 CCP had nationalized most foreign firms.
• By the late 50s, CCP had succeeded in its initial
  goals now faced choice of a system that would
  best promote the ideas of the CCP.
• A period of centralized command and bureaucracy
  framework of system
• Decision-making system with CCP at center
  individual agent under the influence of party
  cadres, trade and labor organizations,
  agricultural communes, and state enterprises at
  the lowest echelons.
• During this whole period there was constant
  friction between two party factions

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• Moderates believed growth as a balanced,
  orderly process careful, methodical planning
  and progress.
• Radical Left (Mao) feared CCP losing sight of
  inherent dynamism of the broader social revisions
  and the confrontation of opposites and was being
  stifled by the preoccupation with bureaucratic
  and technical considerations.
• The Great Leap Forward 1957
• Radical Left gained control put aside 5 year
  plan in favor of The Great Leap Forward in
  which China would elude the timetable imposed by
  the rate of capital accumulation by calling upon
  the vast resources of its industrial and
  agricultural force, thus walking on two legs.

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• Vast initiatives implemented in five months too
  brief for proper preparation organizational
  chaos Russia withdraws support radicals
  forced to abandon the effort due to falling
  agricultural/industrial output.
• Entered a period of Readjustment, Consolidation
  and Repair (1961-65) with the abandonment of
  the GLF, the moderates within the CCP effected
  sharp changes in policy to restore order and to
  repair damage done to economy. Particular
  emphasis was given to agriculture to reduce
  threat of mass malnutrition and starvation.
  focus on communes.
• The Great Proletariat Cultural Revolution (Jan.
  1967)

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• Not intended as a systematic reform SR impact
  on economy was minor basically it was a more
  intense expression of Mao Tse-tungs beliefs.
• Witnesses sweeping change in organizational
  structure from the CCP down to communes.
• Power shifted to newly formed networks of
  revolutionary committees.
• Tremendous decentralization in decision making
  structure.
• Anti-intellectual and professional.
• Time of great suffering.

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• By 1970 Mao had to back off disruptions/starvati
  on in the millions
• Moderates held sway although Mao and his radicals
  present in Politburo
• Transition of Power 1976-1978
• In 1976, China was shaken by the death of Zhou
  Enlai in January, an earthquake in July that
  killed 240,000 people, the death of Marshal Zhu
  De in July, major floods on the Yellow river in
  August, and the death of Mao Zedong in September.
• An intense battle for succession erupted between
  Deng Xiaoping, Zhou's handpicked successor, and
  Jian Qunig (Ching), who was Mao's widow, a leader
  of the Cultural Revolution, and a member of the
  radical Gang of Four.

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• The power struggle, together with mass
  demonstrations, riots, and natural disasters
  interrupted economic growth in 1976 and caused
  Deng Xiaoping to fall from power once again.
• Hua Guofong - compromise candidate - had the Gang
  of Four arrested in an attempt to consolidate
  power - grudgingly rehabilitated Deng Xiaoping
  for a second time - China reached crossroads in
  1978 at Party Congress over Hua's ambitious
  industrialization scheme (7 year plan to build
  120 large scale projects) Industrialization
  scheme was found to be unrealistic and Deng made
  serious political ground. Following decisions
  were made in this Congress
• 1. The focus of the party's work would shift
  from political agitation and class struggle to
  socialist modernization and improvement of
  living standards.

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• To remedy the effects of long-term ruination and
  neglect, economic modernization would begin in
  the agricultural sector, supported by a
  substantial increase in agricultural prices paid
  by the government.
• Work incentives would be strengthened in the
  communes, based on the Marxian prescription for
  early stages of socialism "To each according to
  his work.
• Local authorities and industrial and agricultural
  enterprises would gain greater autonomy under the
  guidance of unified state planning.
• The Party would continue to play a leading role
  in society, but clear lines would be drawn
  between the responsibilities of the Party,
  government, and enterprise leaders.

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• Socialism with Chinese Characteristics
  (1979-Present)
• Early in 1979, Deng initiated an enormous
  agricultural reform - the household
  responsibility system - that led to dissolution
  of the people's communes.
• In 1980 Deng rose to power after the Gang of Four
  were convicted of crimes causing more than 34,000
  deaths during the cultural revolution and Hua
  offered his resignation (he was implicated as an
  accomplice in conspiring to overthrow Mao in
  1971).
• With Deng in power China entered a remarkable
  period of economic transformation.
• a Introduced a new philosophy of pragmatism
  (1983), displacing the leftist ideology of Mao.

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• 1984 Central Committee called for development of
  a "socialist commodity economy with the following
  4 major features
• 1 China would continue "on the whole" to have
  a planned economy, but planning would become
  indicative macroeconomic guidance would replace
  mandatory targets.
• 2 Markets would establish a "rational price
  system," which would be "the key to reform of the
  entire economic structure" never-the-less,
  markets would not allocate or control ownership
  of labor, land, mines, banks, railways, or state
  owned enterprises (SOEs).
• 3 The economic functions of the government
  would be defined more narrowly, and the
  enterprises would be allowed to make more of
  their own decisions.

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• 4 State enterprises would remain "the leading
  force" in the economy, but other forms of
  collective, individual, and foreign joint venture
  ownership would be encouraged.
• 5 Special enterprise zones begun (1980 in
  south of country).
• After 1984, the scope of market activity grew
  very rapidly. Price controls lifted across the
  board.
• Also in 1984, the rural communes were disbanded
  with ownership of their industrial holdings
  transferred to the new units of local government
  TVEs township and village enterprises.
• 1 Between 1984-1995 they created 95 million
  new jobs, and their rates of productivity growth
  were twice as high as those in the state sector.

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2 Reasons for... Strong kinship links among
rural villagers create implicit property rights
in a setting of collective ownership. Chinese
public finance has been decentralized since 1984,
so financial benefits and burdens of the TVEs are
felt locally. Communities with TVEs engage in
stiff competition with one another to attract
local and foreign investment. TVEs have acted
flexibly to supply light industrial goods and
services that were neglected by the state
system. Many of the TVEs have taken advantage
of their freedom to form supply and technology
alliances with state industries and foreign
investors.
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• Chinese leaders have a lasting enthusiasm for
  philosophy and ideology.
• Articulated in October 1987 by Premier Zhoa
  Ziyang... at l3th Party Congress...
• China would continue to operate in the primary
  stage until al least 2050.
• 2. Primary stage of socialism idea of
  professor Li Yining a Marxian rationale for a
  wide range of market reforms and ownership
  arrangements argued that China did not achieve a
  high level of capitalist development before its
  socialist revolution, so it must employ
  institutions usually associated with capitalism
  to prepare it for a higher stage of socialism.
  (Same reasoning used by Lenin in the 1920s to
  justify his New Economic Policy in Russia)

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a Until 2050, to develop Socialism with
Chinese Characteristics, the government should
encourage individuals to engage in market
exchange and pursue individual wealth, but it
should carefully preserve the political monopoly
of the Communist Party. b Reforms proceeded
most rapidly
in agriculture, population policy, and
foreign trade, and were
accompanied
by modest efforts in industry and finance.
Special economic zones - localize
experiments. c reforms seemed to go
smoothly until second half of 1985 at which time
a wave of consumer price inflation began gt
caused a temporary tightening of economic
controls.
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d Despite a new "anti-bourgeois
liberalization" campaign supported by Party
conservatives, the Thirteenth Party Congress in
1987 reaffirmed China's commitments to
ideological pragmatism, economic reform, and the
Open Door (...of foreign travel, trade and
investment), but it continued to oppose national
political reform at the national level (it had
been supported at local level since early
80's). e The conservatives succeeded in having
Hu Yaobang, the reform-minded General Secretary,
resign and when he died in April 1989, university
students honored his memory with a memorial
service in Tienanmen Square subsequent events
well known
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d Conservatives in Party again gained ground
and pushed for recentralization of authority and
imposition of controls on prices and foreign
investment. f Still, in 1992 Deng Xaiping led
another campaign for acceleration of economic
reforms, culminating in the declaration of the
1992 Party Congress that China would build a
"socialist market economy. Constitution
amended in 1993 to acknowledge that China was
operating in the "primary stage of socialism",
that its immediate goal was to build a "socialist
market economy , and that effective reform would
require continued "opening to the outside world."
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• g After Deng's death in 1997, Deng's successors
  declared their continuing allegiances to his
  pragmatic ideology and policies today chief of
  state President Hu Jintao (since 15 March 2003)
  and head of government Premier Wen Jiabao (since
  16 March 2003)
• Financial market reform
• Banking Peoples Bank of China at the center
  (primarily controlled by the Ministry of Finance)
• gt disequilibrium Sm ? Dm
• Interest rates and exchange rates still
  centrally determined.

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• four publicly owned banks under PBOC Bank of
  China, Construction Bank, Industrial and
  Commercial Bank, Agricultural Bank.
• much of Chinese financial reform centers on
  this system.
• By late 1980s central authorities recognized the
  need for developing a private financial system
  paralleling the state system.
• 1990 ... Shanghai exchange officially opened.
• 1991 a stock market was established in Shenzen,
  adjacent to Hong Kong, trading shares of joint
  venture companies with foreign participation.
• Chinese Securities Regulation Commission created
  in 1993.
• A, B and H shares

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• A shares about 600 companies denominated in
  Yuan and can only be traded in domestic equity
  markets among Chinese nationals (1/2 are SOEs).
• 2. B shares first issued in 1993 about 60
  companies denominated in US and can only be
  traded in international equity markets among
  non-Chinese nationals.
• 3. H shares denominated in Hong Kong dollars
  represents stock of Hong Kong based companies
  trading in domestic equity markets.
• T bonds and T- bills are important yet private
  trading only began in 1995. During the Asian
  financial crisis, 1997, Chinas government began
  to fiscally stimulate the economy. There is not
  an active secondary bond market so standard
  western techniques for implementing monetary
  policy unavailable.

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• Taxation
• The corporate income tax is theoretically 33.
• In practice, a raft of preferential policies
  reduce the tax paid by foreign-invested
  enterprises (FIEs). A 15 rate applies in special
  economic zones, and a 24 reduced rate applies in
  14 coastal open cities.
• There is also a considerable amount of tax
  evasion that occurs.
• Preferential policies for FIEs is to be phased
  out and a uniform tax rate for domestic and
  foreign enterprises applied.
• Tax breaks will still be offered for investment
  in the west and north-east and in high-technology
  industries.

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• Current problems issues
• Growing income disparities between rural workers,
  with declining incomes, and urban workers
  enjoying rising incomes and standards of living
  gt migration to urban areas with the consequence
  of a growing number of unemployed city dwellers.
• Since the 1990s, leases of 30 years or less have
  been granted on the tiny plots of land given to
  rural citizens after the communes were disolved,
  but peasants have not been able to use the land
  as collateral for loans or to sell it. Land
  seizures and low income growth is creating
  resentment.
• The National Development and Reform Commission,
  China's chief economic planning agency, has said
  that if growth is 8 this year, China would be
  able to provide jobs for only 11m out of a total
  of 25m urban unemployed and new entrants to the
  urban workforce.

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• Needed reduction in number and extent of state
  owned enterprises (SOEs public services,
  construction, defense, steel) inefficient, over
  staffed and drain on public funds.
• SOEs now account for less than one-third of GDP,
  against almost all of it in the early 1980s. But
  that still leaves nearly 140,000 of them,
  employing 40m people. The state sector still
  accounts for more than half of all industrial
  assets, only ten percentage points down on 1998.
  More than one-third of these SOEs are making no
  return on their investment and need to be closed
  down or sold off.
• Needed improvement of regulatory framework,
  accounting standards and reduced corruption The
  Opacity Index
• Need for a deep, efficient secondary debt market.

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• Most important for the long run China admitted
  to the WTO on November 10, 2001 Will demand
  deeper and more rapid reform at all levels of the
  economy.
• - Will force China to integrate with the global
  economy.
• Is Chinas economy overheating today?
• Not a minor point for China has accounted for a
  quarter of global GDP growth (measured at
  purchasing power parity) over the past five
  years. In the first quarter of 2006 growth came
  in at 10.2!
• Essentially it will unless the central bank
  regains control of the money supply. To slow down
  the economy the PBOC raised the one year lending
  rates last month for the first time since 2004.
• Important to understand that a sustained 10
  growth rate in itself will not cause overheating.

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• The issue essentially has to do with asymmetric
  development and irrational allocation of capital.
• The Big 4 Banks allocate 80 of all loans in
  China.
• Many feel a cleanup of the banking sector is a
  prerequisite for permitting the yuan to float.
• As a stopgap measure, the government is
  toughening enforcement of capital controls such
  as cracking down on the illegal ways in which
  banks connive with their customers to dodge
  restrictions on bringing in speculative capital.
• This has allowed the People's Bank to raise
  interest rates with the hope that it wont
  attract additional inflows of capital, but it
  will only buy then a little extra time.

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• Although China may not be seriously
  overheating, there are signs that it could do so
  soon. The main risk of excessive growth is not a
  surge in inflation, but the inability of China's
  financial system to allocate capital efficiently.
• Excessive borrowing is likely to lead to another
  wave of bad debts (especially in the consumer
  loan area). On some estimates, these already
  amount to 40-50 of all bank loans.
• In a developed economy, the obvious solution
  would be to raise interest rates. But it is a
  truism of economics that a country cannot control
  both its exchange rate and its interest rate
  simultaneously.
• While the yuan remains pegged to the dollar, the
  People's Bank can do little about monetary
  conditions. Huge inflows of capital put upward
  pressure on the yuan. To hold it down, the
  central bank must buy foreign currency, which
  injects new liquidity into the banking system.

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• As a result, banks have excess reserves,
  undermining the impact of a rise in reserve
  requirements or interest rates.
• The central bank has tried to mop up the extra
  liquidity by selling bonds. But such
  sterilization is getting harder.
• China's foreign-exchange reserves climbed to
  875 billion in the first quarter of 2006 (now
  highest in the world).
• Unless investors are offered higher interest
  rates, they will be reluctant to buy more bonds.
  But higher interest rates would attract yet more
  capital inflows.
• So, China needs to adjust its currency, not
  because it may be too cheap, but to regain
  control of monetary policy. In the medium term
  China needs to allow its exchange rate to float.
• That cannot happen, however, until the banking
  system is in better shape. Three of the four
  state banks are technically insolvent.

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• If they are unsuccessful, it has been predicted
  that inflation could be double that by the end of
  the year (6).
• Then the question would not be whether China is
  growing too quickly, but how fast it will slow
  down.
• Still, for a quarter-century, China has
  officially enjoyed average annual GDP growth
  rates of more than 9. Even allowing for
  occasional over-and underestimates, average rates
  have been higher than those achieved by any other
  Asian country during a similar period of rapid
  development.
• China suffered sharp slowdowns in the early
  1990s and again later that decade, but quickly
  recovered. Those who predicted a hard landing for
  the country's economy two years ago as it applied
  the brakes have been proved wrong.
• Growth in 2006, barring some calamity, looks
  likely to be only slightly lower than last year's
  9.9. Few expect a protracted slowdown in the
  remaining years of this decade.

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• China's economy has a number of strengths beyond
  its rapid growth. Government finances appear
  reasonably healthy, with national revenue growth
  averaging 18 a year since 1994, a deficit of
  1.6 of GDP and public debt of less than a
  quarter of GDP.
• This gives the government some room to pump up
  the economy if need be. China has one of the
  world's highest saving rates, at some 40 of GDP,
  and foreign-exchange reserves that will breach
  the 1 trillion US dollars barrier later this
  year.
• The country is making some headway against its
  problems, partly by design and partly thanks to
  rapid growth.
• High growth, the party believes, is still vital
  to its grip on power. And for the foreseeable
  future this will mainly come from the same
  sources as it does now investment and exports.
• ????