Abstract:
The paper deals with the economic reforms undertaken by the Chinese government during the last century and the current one. In this paper one will have idea about the several reform initiatives
undertaken and the contexts on the basis of which these initiatives were brought in scene. The paper also includes the several approaches which paved the way for the establishment of different governmental policies to develop and reform the economic conditions of China following the consequences and dangers brought by these reformation policies. In the final part some lessons are included which is the result of the negative effects of these reform along with many shining positive ones.
undertaken and the contexts on the basis of which these initiatives were brought in scene. The paper also includes the several approaches which paved the way for the establishment of different governmental policies to develop and reform the economic conditions of China following the consequences and dangers brought by these reformation policies. In the final part some lessons are included which is the result of the negative effects of these reform along with many shining positive ones.
Introduction
In the last quarter century between 1978 and 2004, the People’s Republic of China (China) has transformed itself from a centrally planned economy to an emerging market economy and at the same time its economy has achieved nearly a 9.5 percent average growth rate. During this period, China’s gross domestic product (GDP) per capita increased by about seven times and the living standard of ordinary Chinese people has improved significantly. To explain the impressive achievement, this paper provides an overview on major initiatives, approaches, and consequences of Chinese economic reforms in the past quarter century. In order to achieve the goal of the CAD strategy, China’s pre-reform economic structure had three integrated components: (1) a distorted macro-policy environment which featured artificially depressed interest rates, over-valued exchange rates, low nominal wage rates as well as low price levels for living necessities and raw materials; (2) a planned allocation for credit, foreign exchange, and other materials; and (3) a traditional micro-management system of State-owned enterprises (hereafter SOEs) and collective agriculture. In this way competition was suppressed, and profits ceased to be the measure of an enterprise’s efficiency
Major Initiatives of Chinese Economic Reforms
The historic decision on “reform and opening-up” made at the Third Plenum of the CCP Eleventh Party Congress on December 18-22, 1978, marked the beginning of China’s reform era. At the time, China had a clear desire to increase productivity and raise living standards by reforming its economic system and structure, but it did not have a clear objective of what the new system would be like. Furthermore, the reform did not have a well-designed strategy or policy measures.
Instead of being designed a priori, the choice of specific reform measures and the sequence of transition reflected the government’s pragmatism toward the problems or crisis that emerged in the economic system and the opportunities that can be utilized to mitigate or solve the problems. The government’s philosophy toward specific reform measures is best reflected by Deng Xiaoping’s famous saying: “No matter it is a white cat or black cat, as long as it can catch mouse, it is a good cat.” The sequencing of reform measures is best described by another Chinese saying: “To cross a river by groping the stones.”
In retrospection, the first parts of Chinese economic reforms in the late 1970s and early 1980s involved implementing the contract responsibility system in agriculture, by which farmers were able to retain surplus over individual plots of land rather than farming for the collective. This was followed by the establishment of township and village enterprises (TVEs) owned by townships and villages. In addition, an opening-up policy was introduced by which China began to expand international trade and allow foreign direct investment. These initiatives immediately increased the standard of living for most of the Chinese population and generated support for later, more difficult, reforms.
The second phase of reforms in the late 1980s and early 1990s was aimed at improving the governance of SOEs through the enlargement of enterprise autonomy, creating market institutions and converting the economy from an administratively driven planned economy to a price driven market economy. Particularly, the difficult task of price reform was achieved using the dual-track system to prices and exchange rate, in which some goods and services were allocated at state-controlled prices, while others were allocated at market prices. Over time, the goods allocated at market prices were increased, until by the early-1990s they included almost all products.
- Opening-up Policy
In 1978, China was largely a closed economy, with a trade-to-GDP ratio of 9 percent. Based on the successful experience of “export processing zones” in other Asian countries in the 1960s and 1970s, China decided in 1979 to establish four special economic zones (SEZs): Shenzhen, across the border from Hong Kong, Zhuhai, opposite Macao, Xiamen, across from Taiwan, and Shantou, on the coast of northern Guangdong. The SEZs were designed to import high technology, increase exports, earn foreign exchange, create jobs, assimilate foreign managerial and entrepreneurial skills, and attract foreign investment.
Reforming the foreign trade regime is another aspect of China’s opening-up policy. Prior to 1978, China had a few state-owned foreign trade corporations under the Ministry of Foreign Trade, all of which had little knowledge of the market economy and limited expertise in marketing Chinese products abroad. Since 1978, China has initiated a partial break-up of the monopoly control of foreign trade by a decentralization of trading rights to foreign trade organizations at provincial and lower level and too many enterprises. In addition, China has also devaluated the currency several times to a more realistic level. With the establishment of SEZs, foreign-invested enterprises (FIEs) gradually played an important role in exports and imports. In this process, China benefited enormously from its links with Hong Kong and the overseas Chinese, who helped the country develop its export industries through their international business network.
In terms of trade liberalization, tariffs were reduced from 56 percent on average in 1982, to 23 percent in 1996, to 15 percent by 2001, and to 9.9 percent by 2005. In addition, China gradually lowered its nontariff barriers. It progressively removed limitations on trading rights. The number of FTCs increased from less than 1,200 in 1986 to more than 35,000 in 2001. China’s nontariff barriers were completely removed by 2005. China has gradually relaxed restrictions on market entry of FIEs. Increasingly, FIEs have been permitted to sell their goods and services in Chinese markets. In December 2001, China joined the World Trade Organization (WTO) to ensure further opening of its market to foreign competition and accessing foreign markets for its local enterprises.
- Agricultural Reform
In the beginning of Chinese economic reforms, the government had not intended to change the collective farming institutions with a household responsibility system (HRS). In the resolution adopted by the Third Plenum of the CCP Eleventh Party Congress, any type of household-based farming arrangement was explicitly prohibited. Nevertheless, a collective in a poverty-stricken area began to try out secretly a system of leasing a collective’s land and dividing the obligatory procurement quotas to individual households in the collective in the late 1978.
Observing the advantage of the HRS in improving agricultural production, the central authorities later conceded to the existence of this new form of farming, but required that it be restricted to poor agricultural regions, mainly hilly or mountainous areas. However, the restriction was ignored in most regions and Beijing conceded again in late 1980. By the end of 1983, 98 percent of agricultural collectives in China had adopted this new system.
- Decentralization of the Government
As early as 1979, China started to devolve government authority in the form of delegating fiscal and administrative powers from the central government to the provincial and lower level governments. The significance of the decentralization effort was evidenced by the fact that, in 1997, the central government controlled only 27 percent of total government expenditure, compared with 51 percent in 1978. Over the last quarter century, the central government also relinquished substantial power in other aspects of economic management, including authorizing local governments to approve large investment projects, transferring many formerly centrally administered SOEs to localities, and allowing localities to play a more important role in setting local industrial policies and using resources from financial institutions. Despite their side effects, these decentralization efforts greatly stimulated the local authorities’ enthusiasm and provided them with substantial resources in promoting local economic development.
- Growth of the Non-State Sector
During the reform era, obviously, the engine of growth in China came not from SOEs, but non-state enterprises. Between 1978 and 1993, the share of non-state enterprises increased from 22 percent to 57 percent, which happened without any privatization of SOEs and was entirely the result of fast entry and expansion of new non-state enterprises, particularly TVEs. In the period of 1981-1991, the number of TVEs, employment, and the total output value grew at an average annual rate of 26.6 percent, 11.2 percent, and 29.6 percent, respectively. As a result, the share of TVEs’ output in the total value of industrial output increased from 7.2 percent in 1978 to 38.1 percent in 1993.
Rural industry already existed under the traditional system as a result of the government’s decision to mechanize agriculture and to develop rural processing industries to finance the mechanization in 1971. The economic reforms created two favorable conditions for the rapid expansion of TVEs: (1) a new stream of surpluses brought out by the HRS provided a resource base for new investment activities. (2) The relaxation of rigidity in the traditional planned allocation mechanism provided access to key raw materials and markets.
- State-Owned Enterprise Reform
Unlike the spontaneous nature of farming institution reform, the reform in the management system of the SOEs was initiated by the government. The reform has undergone four stages. In each stage of the reform, the government’s intervention was reduced further and the SOEs gained more autonomy.
The first stage (1979-1983) emphasized several important experimental initiatives that were intended to enlarge enterprise autonomy and to expand the role of financial incentives within the traditional economic system. In the second stage (1984-1986) the emphasis shifted to a formalization of the financial obligations of the SOEs to the government and exposed enterprises to market influences. The government instituted a “two-track system” in which SOEs must first fulfill the production quota and sell at the government-set prices and then could produce beyond quota and sell at market prices.
During the third stage (1987-1992), the contract responsibility system, which attempted to clarify the authority and responsibilities of enterprise managers, was formalized and widely adopted. The last stage (1993-present) attempted to introduce the modern corporate system to the SOEs. Steeper reforms toward privatization have taken place since the government decided to “let go of the small and hold on to the large” in 1997. By 2000, more than 80 percent of small and medium-sized enterprises completed their transformation through ownership diversification, which includes restructuring, mergers, leasing, contracting, joint-stock companies, and bankruptcies. Publicly listed companies are mostly large ones. In 2002, the government started to allow cross-national mergers between foreign and Chinese state enterprises and thus opened a new channel for reforming state enterprises.
- Financial Reform
Even after China’s economic reforms began in 1978, the People’s Bank of China (PBoC) continued to function not only a central bank but also a loan-issuing bank. A first step toward a true central banking system occurred in September 1983 when the PBoC was reconstituted in its modern form. Four newly separated specialized banks established in the early 1980s began directing lending activities in their particular spheres of influence: the Industrial and Commercial Bank of China, the China Construction Bank, and the Agricultural Bank of China handle domestic transactions, while the Bank of China specialized in international transactions.
In 1997, the government issued US$ 32.5 billion in bonds to help recapitalize the four big state-owned banks and, in 1999, established four financial asset management companies to purchase and manage bad loans from the state banks. By June 2005, the four asset management companies had disposed of 717.4 billion yuan’s worth of nonperforming loans, with a cash recovery rate of 20.7 percent.
In order to fulfill China’s commitment of the WTO to liberalize financial markets by the end of 2006, the Chinese government has accelerated financial reforms since the end of 2003. The recent financial reforms included a widening of interest rate margins, a liberalization of mechanisms for setting rates, modifications of banking laws, and the transformation of state-owned banks into joint-stock banks. In particular, in the beginning of 2004, the State Council decided to transform the Bank of China and the China Construction Bank into joint-stock banks. As a result, at the end of 2003 the State Council allocated US$ 45 billion of official foreign exchange reserves to recapitalize these two banks.
- Moving toward to a Market Economy
At the outset of reform, China desired reform in order to increase productivity and improve living standards, but at no time did the leadership think that it was going for a full market system. The “Decision on Issues Concerning the Establishment of a Socialist Market Economic Structure,” adopted by the Third Plenum of the CCP Fourteenth Party Congress in November 1993, was the turning point on China’s road to markets. Since 1994, China’s transition has moved into a new stage which aimed to replace the planned system with a market system.
Approaches of Chinese Economic Reforms
Chinese economic reforms are not guided by a well-founded theory or followed a pre-determined blueprint. In general, these reforms were not the results of a grand strategy, but as immediate responses to pressing problems. In some cases, such as the closing of SOEs, the government has been forced by events and economic circumstances to do things that it did not want to do. In retrospection, there are three salient approaches to explain the features of Chinese economic reforms: (1) a pragmatic and incremental approach; (2) a micro-first and self-propelling approach; and (3) dual-track and growing-out-of-plan approach.
- A Pragmatic and Incremental Approach
Two major principles appear to underlie Chinese economic reforms. The first principle is pragmatism, which is embodied in Deng Xiaoping’s dictum to seek truth from facts. The criteria for success are determined by experiment rather than by ideology. The second is incrementalism. Instead of announcing and implementing a national program, typically, an idea is implemented locally or in a particular economic sector, and if successful after extensive experimentation it is gradually adopted throughout the nation.
Incrementalism has many advantages in promoting economic reforms in the way that experimentation can provide useful structural learning experience and new revenues for the potential supporters for the reform program in the next stage, and most importantly, create market supporting institutions, such as legal and financial systems. That is, incrementalism could reduce the transitional costs and increase the reform benefits; minimize the uncertainty of economic reforms and maximize the possibility of success.
- A Micro-first and Self-propelling Approach
Justin Yifu Lin, Fang Cai, and Zhou Li argue that Chinese economic reforms were characterized as a “micro-first and self-propelling approach”. They summarize this approach as follows: First, the government took measures to improve the micro incentives by granting partial managerial autonomy and profit-sharing to the micro units (such as HRS, SOEs, TVEs, and local governments) so as to increase incentives for expanding production. In addition, the government encouraged the local and private initiatives in institutional innovations in this stage.
Second, the government introduced a dual-track price and allocation system allowing the resources to be allocated increasingly by the micro units to the previously suppressed, more productive sectors, while maintaining the normal production of the SOEs. Third, the government liberalized the price when the commodity was largely allocated by the market track. Fourth, the government gradually introduced and strengthened the necessary market institutions during the above process.
- Dual-track and Growing-out-of-plan Approach
The basic principle of the dual-track approach is as follows. Under the plan track, economic agents are assigned rights to and obligations for fixed quantities of goods at fixed plan prices as specified in the preexisting plan. In addition, a market track is introduced under which economic agents participate in the market at free-market prices, provided that they fulfill their obligations under the preexisting plan. As the economy grew, the proportion of resources that was allocated according to the planned prices became increasingly small. As a result, the economy is able to “grow out of the plan” on the basis of the market track expansion by state or/and non-state enterprises (Naughton 1995).
For instance, the commune (and later the households) was assigned the obligation to sell a fixed quantity of output to the state procurement agency as previously mandated under the plan at predetermined plan prices and to pay a fixed tax to the government. Subject to fulfilling this condition, the commune was free to produce and sell whatever it considered profitable, and retain any profit. Under the dual-track, the state procurement of domestically produced grains between 1978 and 1988 remained essentially fixed, while there was almost a one-third increase in grain output.
Industrial liberalization also shows how the economy could grow out of the plan. For coal, China’s principal energy source, the planned delivery was increased somewhat from 329 million tons in 1981 to 427 million tons in 1989, but the market track increased dramatically from 293 million tons to 628 million tons in the same period. For steel, China’s major industrial material, the plan track in absolute terms was quite stable, but the share of plan allocation fell from 52 percent in 1981 to 30 percent in 1990. In the cases of both coal and steel, because the plan track was basically “frozen,” the economy was able to grow out of the plan on the basis of the market track expansion by state or/and non-state enterprises.
Consequences of Chinese Economic Reforms
Chinese economic reforms have been brought enormous impact on China’s economic landscape. Between 1978 and 2003, China’s GDP increased by more than nine times and the average growth rate was 9.5 percent; while China’s GDP per capita increased by about seven times and the average growth rate was 8.2 percent. In addition, this paper explores three major consequences of Chinese economic reforms: the diminishing role of the state sector, global integration of the Chinese economy, and the contribution of FDI in China’s economic development.
- Diminishing State Sector
By 1978, shares of all nonpublic enterprises had shrunk to zero, and China’s gross industrial output value (GIOV) was produced entirely by SOEs (77.6 percent) and collectively owned enterprises (22.4 percent). The reforms have brought remarkable changes to the state sector. First, the share of GIOV produced by SOEs decreased from 77.6 percent in 1978 to 13.0 percent in 2003. Second, SOEs have been consolidating through mergers, bankruptcies, and regrouping. The number of industrial SOEs declined from 118,000 in 1995 to 23,228 in 2003.
Third, China’s SOEs have nearly completed separating themselves from the social functions of providing housing, day care, hospitals, and schools for their employees. Fourth, as a generic term, “state enterprises” now often refer to SOEs with 100 percent state ownership and state-holding enterprises with mixed ownership. The government has also relaxed the restriction that the state in a state-holding enterprise must hold more than 50 percent of the shares (or the absolute majority) to a plurality. In 2003 the proportion of GIOV produced by state-owned and state-holding enterprises was 37.5 percent.
- Integrating China into the Global Economy
After quarter-century economic reforms, the Chinese economy has been deeply integrating into the global economy. In 1978, China was largely a closed economy, with a trade-to-GDP ratio of 9 percent. By 2004, this figure reached 70 percent. China’s foreign trade rose from US$ 21 billion in 1978 to more than US$ 300 billion in 1997 and more than US$ 1,150 billion in 2004. The ranking of China in the world’s trading nations jumped from thirty-second in 1978 to third in 2004. After 2001, China was often described as a “world factory” to describe China’s high market share in global manufacturing export market.
Nevertheless, is China really a “world factory”? According to statistics of the Chinese customs, in 2002, China was the top producer for more than 100 products in the world. These products stretched over more than 10 kinds of industries, such as the electric appliances, communication equipment, textiles, medicine, machine tools, chemicals, etc. Among them, machine tools, tractors, containers and chemicals accounted for some 85 percent of the total global output, followed by the textiles (70 percent), telephones and displays of communication equipment (50 percent and 42 percent respectively), and televisions and electrical appliances (29 percent).
According to research by the United Nations Conference on Trade and Development, Chinese products accounted for 6.1 percent of the global export market in 2000, increasing from 1.6 percent in 1985, led by the extensive expansion of manufactured goods that are based on non-natural resources, increasing from 1.5 percent in 1985 to 7.8 percent in 2000. Among those not based on natural resources, the export market share of products with low technology increased from 4.5 percent in 1985 to 18.7 percent in 2000; the export market share of products with medium technology increased from 0.4 percent in 1985 to 3.6 percent in 2000; and the export market share of products with high technology increased from 0.4 percent in 1985 to 6 percent in 2000. These results indicate that although China is quite competitive in products with low technology, she is not at all weak in high-tech products.
- FDI’s Contribution to China’s Economic Development
In the last fifteen years, FDI has been tremendously contributed to China’s economic development in various aspects. Since 1994, China has continued to be the largest FDI recipient in the developing world; its annual inflow has been only next to that of the United States. At the end of 2002, the number of approved foreign-invested enterprises (FIEs) in China had reached 424,196. The contractual FDI was US$ 828.1 billion; the realized FDI was US$ 448 billion. Of more than 420 thousand of approved FIEs, over 200 thousand have closed or ceased operation, which accounts for 48 percent of FIEs in total. There are around 220 thousand existing registered, functioning FIEs (Ministry of Commerce 2003a).
In 2002, the ratio of realized FDI in China to GDP was 4.3 percent in 2002. Basically, the contribution of FDI to China’s economic development takes six different forms (See Table 2).
(1) Investments. In 1993, FDI made up 12.1 percent of China’s total social fixed asset investments. In 2002, it was 10.1 percent. From 1993 to 2002, the annual average of FDI as a proportion of total fixed asset investments in China was 12.5 percent.
(2) Industrial output and value-added. The industrial output of FIEs as a proportion of Chinese industrial output increased from 9.2 percent in 1993 to 33.4 percent in 2002. In addition, the value-added of FIEs as a percentage of Chinese industrial value-added increased from 11.0 percent in 1994 to 25.7 percent in 2002.
(3) Exports. The value of goods exported by FIEs in 1993 was US$ 91.7 billion, increasing to US$ 169.9 billion in 2002. In addition, the proportion of exports by FIEs to all China’s exports increased from 27.5 percent in 1993 to 52.2 percent in 2002.
(4) Foreign exchange. In 2002, foreign exchange balances held in China’s banks by FIEs amounted to US$ 47.1 billion, which accounted for 72.7 percent of the foreign exchange balances held in China’s banks by corporations. In addition, FIEs accounted for 63.7 percent of the increase in corporate foreign exchange balances.
(5) Tax revenues. In 1993, tax revenues from FIEs were RMB 22.7 billion, which was 5.7 percent of China’s total tax revenues. In 2002, tax revenues from FIEs were RMB 348.7 billion, which accounted for 21 percent of China’s total tax revenues (Ministry of Commerce 2003).
(6) Employment. At the end of 2002, direct employees in FIEs were over 23.5 million accounting for 11 percent of China’s urban workers.
Overall, from the results of econometric analysis by Chinese scholar Jinping Zhao, 2.7 percentage points of China’s annual average GDP growth rate of 9.7 percent during the 20 years from 1980 to 1999 came from the direct and indirect contributions of FDI; i.e., a significant contribution of about 28 percent to China’s economic growth. A study undertaken by Wanda Tseng and Harm Zebregs, economists in the IMF, shows that FDI contributed 3 percentage points to China’s average economic growth rate of 10.1 percent in the 1990s; i.e., a contribution of around 30 percent to China’s economic growth.
Conclusion
In the last quarter century, China has been experiencing three dimensional transformation of the economy: from a planned economy to a market economy, from an agrarian economy to an industrial economy, from a relative closed economy to a relative open economy. During the reform process, China adopted an incremental, micro-first, and dual-track approach to the transition. Based on the above discussion, we may learn seven major lessons from Chinese economic reforms. First, the most important principle for a successful transition from a planned economy to a market economy is pragmatism. Second, the incremental approach generates the momentum from earlier reform success and thus provides a political basis for the further reforms. Third, the micro-first approach creates constant pressure to complete the transition process to a market economy. It is imperative for a transitional economy to complete the reforms in macro policy environment after the reforms in micromanagement institution and resource allocation mechanism. Only by removing the institutional incompatibility can the economy set forth a sustained, smooth growth path. Finally successful reforms rely on political support, which in turn depend on delivering tangible benefits to a large majority of the population. Compensating potential losers in the reforms is both a political and economic issue, and reforms that do not create many or big losers can be politically acceptable ex ante and sustainable ex post. The dual-track approach has been a concrete mechanism to achieve this objective.
References:
- Jin, Fang. 2003 “Deepened International Division of Labor and the Impact on the Status of China,” (in Chinese) in Lu Zheng ed., Zhongguo Neng Chengwei Shijie Gungchang Ma? (Can China Become A World Factory?). Beijing: Economic Management Publisher. pp. 75-83.
- Lau, Lawrence, Yingyi Qian, and Gérard Roland. 2000. “Reform without Losers: An Interpretation of China’s Dual-Track Approach to Transition.” Journal of Political Economy, 108(1), pp. 120-143.
- Lin, Justin. 2004. “Lessons of China’s Transition from a Planned Economy to a Market Economy,” Working Paper No.E2004001, China Center for Economic Research, Peking University.