TRANSITION IN THE PEOPLES REPUBLIC OF CHINA

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TRANSITION IN THE PEOPLES REPUBLIC OF CHINA
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Preview The Character of Chinese Economic Reform

• Gradualism
• touching stones to cross a river. China
  proceeded on its own path by a process of
  experimentation, moving forward slowly only in
  areas where policies had been tested and seen to
  work.

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• Partial Reform
• Decentralization
• Accommodating Spontaneous Reform
• Economic Liberalization without Political
  Democratization

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The Era of Reform1978 --

• Two decades of stability
• no cultural revolutions or great leaps
• Two decades of stellar growth
• Steady decentralization
• Combination of reform and transition
• dual-track approach
• Cao, Fan, and Woo (1997) Chinese Economic
  Reforms Past Successes and Future Challenges in
  Economies in Transition Comparing Asia and
  Eastern Europe, Woo, Parker, and Sachs (eds),
  MIT Press

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Dual-Track Reform/Transition

• 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

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• Ideal dual-track pattern
• opening free market while planned supply
  unchanged at set planned price
• adjust planned price up toward free price as
  planned supply quantity fixed or lowered
• meanwhile market supply is growing so fixed
  absolute planned supply gets smaller as
  proportion of total supply
• final elimination of planned price when planned
  supply becomes almost irrelevant

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Dual-Track in Agriculture

• Communes disbanded, a new arrangement Household
  Responsibility System (HRS) carried out
• Land distributed to households as 15 year leases

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• Lease holders required to produce a planned
  allotment at planned prices, but free to produce
  and market any amount beyond planned allotment.
• In this way, the incentive problem is solved.
• 91 of agricultural output planned in 1978, only
  5 in 1993

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• Semi-ownership of land caused increase in labor
  productivity which released labor into
  small-scale entrepreneurship
• crafts
• services
• Released labor into township and village
  enterprises (TVEs), the most dynamic sector in
  the Chinese economy

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Dual-Track in Industrial Ownership Structure

• Old track state owned enterprises (SOE) versus
  new track non-state owned enterprises
• Two types of new track ownership structures
• TVEs and purely private

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• TVEs formally owned and controlled by villages
  and local communities
• in most TVEs, communities actually involved very
  little in operation of the enterprises
• act essentially as private firms
• some really private but community agrees to
  register as TVE in return for bribes
• wearing the red cap in exchange for the tax
  breaks and lesser red tape enjoyed by TVEs over
  private firms

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Although they are collectively owned, TVEs are
much more akin to western firms than the SOEs for
several reasons

• They face a hard budget constraint and are seldom
  bailed out by government subsidy.
• As new enterprises, TVEs fell outside the scope
  of the rather rigid planning system and were from
  the beginning unfettered by mandatory controls.
• Unlike SOEs, TVEs had no captive market for their
  products and from the start success depended on
  identifying demand and meeting it with quality
  products.

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• TVEs were allowed to sell their products at
  market prices, and given the fact that they were
  operating largely in competitive markets, this
  implied a continuing pressure to contain costs
  and advance productivity.
• TVEs were not encumbered by the social
  expenditures required of state enterprises. In
  common with many socialist countries, SOEs in
  China were responsible for a range of social
  services including childcare, education, and
  health care that raised labor costs.

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• TVEs were also able to be much more nimble in
  their employment practices (hiring and firing)
  and were able to establish performance-based
  compensation systems, which maximized individual
  incentives and raised productivity.
• TVEs are allowed to retain profits and keep them
  within the enterprise as investment. Initially
  the TVEs were assisted by concessional tax
  treatment that was helpful in building capital in
  the infancy stage.

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• The emergence of TVEs had a rapid impact on
  Chinas economy. By 1996, there were some 23.3
  million TVEs within China, employing more than
  135 million workers, or about 20 percent of total
  national employment.
• The rural enterprise sector as a whole
  accounted for only 19.2 percent of industrial
  output in 1978, but this had risen to about to 50
  percent by 1996.

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• SOEs are unprofitable and a major drain on the
  state budget
• Most of the growth in China in non-state sector
• SOEs persist for two main reasons
• represent commanding heights
• they employ 20 of the work force
• they are a wonderful source of corruption
• a major challenge for the future is the phasing
  out of SOEs

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Reforming SOEs

• SOEs still consumes more than 40 of total
  industrial labor but manages to produce only
  about 25 of the output, reflecting serious
  inefficiencies.

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• Started in 1986, early reform efforts tried to
  replicate the success of responsibility system in
  rural areas.
• Under the contract responsibility system (CRS),
  by which SOEs contracted for a four-year period
  to a production quota to be delivered to the
  state, and to specified financial payments it
  would make to the state in lieu of the profit
  remittances that the enterprises had formerly
  paid. Any output above the quota level could be
  disposed of by the enterprise at market prices.

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• These arrangements did provide great incentives
  for the enterprise. The industrial output of the
  SOEs rose sharply in response.
• But the CRS resulted in a two-tier price system
  potential gains from arbitrage between the state
  and private sectors and from the deliberate
  understatement of quota outputs. This led to a
  sharp increase in corruption.

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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

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

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Why SEZs? Why not Big Bang?

• The government wish to restrict some activities
  and policies to a limited geographical area as
  experiment first. It might be desirable to limit
  the impact in order to analyze the effects before
  generalizing the policies.
• Recall fording the river by feeling for the
  stones

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Coastal Growth
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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 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
• good macroeconomic balance

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• 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

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• High saving rate
• Chinese saving rate high even by Asian standards
• saving rate in China is 23 of disposable income
• Japan 21
• Taiwan 18
• Germany 13
• US 8

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• Centralized control discredited
• Great Leap Forward and Cultural Revolution were
  disasters obvious to everyone
• allowed Deng Xiaoping to institute reforms
  without much resistance
• The Chinese Diaspora
• 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
• Hong Kong managers could easily commute

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Challenges

• Legal system/rule of law
• private property rights still lacking
• business cannot turn to legal system to enforce
  contracts
• self enforcement
• protection from political elite
• corruption
• Privatization
• giving up the commanding heights
• SOEs continue to be a huge drain on economy

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• Agricultural reform
• incomplete ownership of land
• disincentive to improve land
• reduces potential productivity of land
• Financial reform
• near monopoly of state on banking
• savings channeled to inefficient capital
  formation in SOEs

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• Trade relations
• joining WTO
• trying to improve trade relations
• with US
• MFN status
• with EU
• with Taiwan
• with other Asian countries
• International finance
• full convertibility

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• Social safety net
• current hodge-podge
• not as immediate need as in other transitional
  economies
• rural population to large extent self-sufficient
• continued support of SOEs reduces urban
  unemployment problem
• 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

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• Regional policy
• most growth from Special Economic Zones and
  Development Areas
• huge income differential between coastal and
  interior provinces
• Population policy
• slowing population growth
• slowing/preventing migration to cities
• Macroeconomic policy
• reform of tax structure
• stabilization