18 The People’s Republic of China

BOX 1

China
Area (thousand sq. km.) / 9,597
Currency / yuan
Population 2000 (millions) / 1,261
Population Growth Rate 1990-2000 / 1.1%
GNI per capita 2000 / $840
GNI per capita PPP 2000 / $3,940
GDP Growth 1990-2000 / 10.3%
Inflation Rate % per annum 1990-2001 / --
Value Added as % of GDP 2000 / Agriculture / 16%
Industry / 49%
Services / 34%

INTRODUCTION

With a population of more than 1.2 billion persons, the Chinese economy casts a very long shadow over the world. If the current rate of economic growth, which has already transformed much of the country, is maintained, China will be one of the world’s largest economies in the 21st century. With a long history as a unified state, its huge population, and a considerable resource base, China should indeed be a major player. However, for the past century and a half, invasion, imperialism, civil wars, instability, and poor management have all played a role in keeping that vast potential unrealized.

Nevertheless, the growth of the economy in recent years has been quite spectacular, averaging close to 10 percent per annum during the 1980s and 1990s, and never less than 4 percent per annum, even during a slow spell in the late 1980s. This rate of growth has resulted in a more than fourfold rise in gross national product between 1980 and 1995, and if it can be sustained national income will double about every seven years. The world’s largest economy in population will rapidly become highly significant in terms of both production and investment. In 1996 Borensztein and Ostry calculated that if the 8 to 9 percent annual real growth (envisaged in the five-year plan covering 1996 to 2000) were sustained until 2013, Chinese gross national product (GNP), corrected for purchasing power parity, will surpass that of the United States.1 In fact, Chinese growth slowed in the years 1997 to 1999 while that of the United States accelerated; nevertheless it is likely that sheer size and numbers will put China on a par with the United States sometime in the next 50 years. The living standards of the average Chinese, reflected by both growing incomes and increased consumer durable ownership have already risen sharply.

Recent Chinese growth has its roots in substantial productivity gains per worker (particularly in agriculture and light industry), a more efficient deployment of the workforce, and an increase in employment. Employment has risen at an annual rate of about 3 percent and has been sufficient to more than absorb the considerable population “bubble” caused by the high birthrates of the 1960s. Despite immigration from the rural areas to urban conurbations, the urban unemployment rate, which was over 5 percent in the 1960s, fell to about 2 percent by the late 1980s.

Of course, China started from a very low base. Income measured at current exchange rates was only about $250 per person in the mid-1970s. Purchasing power comparisons generally give a better picture of overall living standards, but even these show consumption on average of roughly $1,000 per person, one-sixth of the figure in the Soviet Union and only 6 percent of that for the United States. Moreover, China has low levels of national wealth. World Bank estimates put wealth per head (including natural resources and human capital) at about $6,600, about one-fiftieth of that of Germany and among the lowest in the world.

CENTRAL PLANNING, 1952–1959

The triumph of the Communists over the Nationalists in the civil war that closely followed the end of World War II led, in October1949, to the creation of the People’s Republic of China. The Nationalists withdrew to the offshore island of Taiwan and created there a very successful state and economy, which we will examine in chapter 13. The communist Chinese leadership set out to imitate the economic system developed in the Soviet Union over the previous 25 years. Private industry and commerce were nationalized and sweeping agricultural reform took the land from the landlords and wealthier farmers and placed it under peasant control in communes. As in the Soviet Union, a great deal of investment was poured into heavy industry, with faith in the power of capital-intensive technology and economies of scale to produce high rates of economic growth.

The Soviet model was followed by reliance on five-year plans. Soviet planners and technicians were imported and a formal planning apparatus put into place. However, in the early 1950s the Chinese economy was by no means in a parallel position to that of the Soviet Union, leading to problems in the application of a centrally planned model. One fact was that China’s population was much larger (by a factor of 4), and its communications and transportation systems were much less well developed. In any system of centralized planning, the availability of reliable information at the center is crucial.2 In the Chinese case, problems impeding the flow of information to the center and back to the enterprises proved to be even worse than in the Soviet Union, and this had a fundamental impact on the success of the planning experiment.

Moreover, the Chinese economy was not as highly unified and integrated as that of the Soviet Union. Poor transportation and the historically high degree of regional self-sufficiency (exacerbated during the period of “warlordism” in the 1920s and the struggle with the Japanese) meant that gains from centralizing the economy were much more difficult to grasp. A greater degree of power remained in the hands of municipalities and provinces, and even the prefectures and townships, than had been the case in the Soviet Union.

One measure of the difficulty of implementing centralized planning is how few goods were brought under formal control. Even at the height of planning in China, only 500 commodities fell under mandatory central control, in contrast to the more than 20,000 commodities that were part of the Soviet material balance plans.

THE GREAT LEAP FORWARD, 1958–1961

The end of the first five-year plan in 1958 coincided with reforms to the planning system that recognized the impracticability of “taut”3 central planning in the Chinese economy, allowing the necessity, and even the desirability, of a high degree of provincial initiative. However, the potential for success of the revised system will never be known because the development path of the economy was disturbed by the intrusion of political rhetoric, in the form of Mao’s Great Leap Forward, a political initiative to harness the ideological fervor of the Chinese population to the task of raising industrial output. At the same time as China continued to pour investment into capital-intensive heavy industry, Mao and the leadership exhorted the population to increase the output of basic industrial goods through labor-intensive enterprises in rural areas. This approach of using both capital- and labor-intensive technologies to produce the same goods was characterized as “walking on two legs.”

Although labor-intensive enterprises were found in many industries, including building materials, mining, food-processing, and machine-building, the political leadership defined the key industry as steel. Mao Tse Tung urged a sharp increase in steel production through the development of small-scale furnaces, and it is estimated that some two million small furnaces were established during the first two years of the Great Leap Forward, employing some 80 million people on a full or part-time basis. Official statistics show that industrial output grew sharply at the outset of the Great Leap Forward; net material product was up by 22 percent in 1959 alone, but it soon became apparent that this was being achieved at great cost, and much of the growth was actually an illusion. For example, the steel produced in rural furnaces was, in general, of poor quality and expensive in terms of factor cost. Moreover, much of the “new” output consisted merely of the melting down and recycling of steel and iron that had already been produced; ornamental and structural steelwork was pulled down and fed to the furnaces. Woods and forests were cut down, and even buildings were cannibalized, to provide charcoal and fuel.

After an initial period of feverish activity, the incentives of revolutionary fervor and rhetoric cooled. The recycling of previously produced material slowed as stocks became exhausted, and the depletion of woodland made charcoal increasingly short in supply. The countryside became scarred and the environment adversely affected. China’s Soviet advisors were frustrated by what seemed a perverse rejection of socialist rationality, and in an atmosphere of growing antagonism between the two nations, technical assistance was suspended in 1960.

Net material product in China fell sharply in 1961 and 1962, but greater stability was reestablished in 1963 and a period of relative calm saw a rise in industrial output. Continuing investment in heavy industry helped the rebound, and industrial output rose sharply between 1963 and 1966. Chinese technocrats filled the void left by the departing Soviets, pursuing central planning once more, though with a greater degree of pragmatism. The high degree of provincial autonomy left local governments free to use their flexibility to increase output in whatever way they chose.

THE CULTURAL REVOLUTION, 1966–1970

In 1966, however, political furor again swamped the economic system due to the inception of Mao’s Proletarian Cultural Revolution. Exactly what prompted the Chinese leader to embark on that course at that moment in history is still open to dispute. In part he seemed convinced that only complete rejection of western influence would enable Asia, including China, to be economically self-reliant. He was also genuinely convinced that Stalinist economic management had resulted in a new structure of class and privilege as obnoxious to him as the old. Finally, and perhaps decisively, he felt a need to strengthen his own political position vis-à-vis the technocrats and bureaucrats. The Cultural Revolution resulted in Chinese society being turned upside down. Bureaucrats, planners, and technocrats were stripped of authority and sent off to the countryside for “political reeducation,” while power shifted to radical political cadres. There were considerable economic costs to the turmoil. Again the economy lurched into a sharp recession with material output falling by about 15 percent in both 1966 and 1967; it rebounded again in the last years of the decade as some form of normality returned.

By the beginning of the 1970s it was clear that the era of Mao and Chou En Lai was nearing its close, so political factions began maneuvering for power. On the left, the gang of four, led by Mao’s wife, tried to sustain the Cultural Revolution. On the right, a moderate and technocratic leadership sought the restoration of rule by bureaucracy and party. Both Mao and Chou died in 1976 and nominal power passed to Mao’s chosen successor Hua Qua Feng. However, by this time the moderates were in ascendance and Deng Xiaoping, a highly capable administrator, was rehabilitated from the indignities inflicted on him during the Cultural Revolution and restored as party leader.

THE FIRST PHASE OF REFORM, 1978–1993

Because the economy had stagnated, and in some areas declined, during the period of the Cultural Revolution and the rule of the gang of four, Deng resolved to find new approaches to promote growth. December1978 saw a profound shift in the direction of the Chinese economy as the Central Committee of the Communist Party of China (CCP) issued a communiqué that, in effect, launched the modern period of reform, moving the Chinese economy away from a planned economy and toward a market one.

Agricultural Reform

The first reforms were aimed at revitalizing the rural sector, whose fortunes had flagged during the previous three decades. The high percentage of the population engaged in agriculture and the necessity of creating an agrarian surplus to fuel industrial growth and feed a growing population made agricultural reform essential. While heavy industrial output had experienced sustained high growth during the previous 15 years, agriculture had remained dormant. Grain output per person employed had risen by less than 10 percent during a 25-year period, despite considerable expenditures on infrastructure, informational outreach, and factor inputs, especially fertilizers. The key to raising output lay in radical reform of the collectivized agricultural system so painfully created in the 1950s and 1960s.

Under collectivization, agricultural production had been organized into communes (typically with a population of about 40,000 people). These were further subdivided into brigades and production teams. Decisions about what to grow and how to grow it were passed to the communes from superior political units (the prefecture and provincial governments) and were as a result quite often inflexible to local conditions. Worker remuneration was generally through sharing the net production of the brigade on a per worker basis taking little account of individual or family productivity. This resulted in a chronic absence of incentives and a pervasive “free rider” problem. Households were allowed small plots for the own cultivation, from which the surplus could be sold in the local markets, and productivity was in general much higher in these small niches in the system.

The reforms that began in 1979 were largely the result of local initiative and were, in fact, opposed at the outset by the State Council in Beijing. Motivation for reform was the belief that productivity in the agricultural sector could be greatly increased simply by raising the economic incentives to family units. Initially this took the form of enlarging the size of the private plots and increasing the procurement price that the state paid for crops that were produced privately. Local officials were encouraged by the success of this limited action, and the reforms evolved into the household responsibility system (HRS), which became the dominant arrangement in agriculture after 1982.

Under HRS quite large plots of collectively held land were leased to households for a fixed period of time, initially 15 years for annual crops and up to 40 years for tree crops. In return for tenure, each household was responsible for providing a share of the production team’s output quota based on plot size. Production in excess of this “contract” could be sold either on the free market for what it would fetch or to the state at negotiated prices. By 1984, 93 percent of China’s cultivated land was contracted to households, but, and this is highly illustrative of the progress of China’s reforms, it was not until 1985 that the state passed legislation formally sanctioning it.

Agricultural production rose sharply after the reforms. Annual growth of output was twice the rate experienced in the 1960s and 1970s, illustrating the importance of individual incentive in agriculture. Labor productivity in agriculture rose at an even higher rate, producing a labor surplus in most of the rural collectives, which ultimately provided the workforce for the rapid expansion of rural light industry. Higher food prices moved the terms of trade (defined as food prices divided by manufactured goods prices) sharply in favor of the farmers and resulted in a substantial increase in real income in the rural sector. However, the authorities in Beijing were concerned about political unrest among urban workers and were unwilling to allow the burden of increased farm incomes to be passed directly to urban consumers in the form of higher food prices. The government provided substantial subsidies, which resulted in a growing fiscal deficit.

The state next tried to reduce the size of the subsidy by cutting the procurement prices for grains, but farmers responded by shifting resources out of grain production and into more profitable, less regulated commodities like vegetables and meat. Grain output fell as a result in the mid-1980s. The government’s response was to raise the procurement prices of grain once more, but this time it tried to avoid the fiscal consequences by increasing the prices paid by urban consumers. This step toward price liberalization led to the ultimate deregulation of the grain market; by May1993 grain prices were decontrolled in about 80 percent of the country and prices determined by the interplay of supply and demand.

The Rise of Rural Enterprise

The rapid rise in agricultural output, labor productivity, and incomes set in train a further development in the rural areas: the emergence of township and village enterprises (TVEs) as the most dynamic sector in the Chinese economy. TVEs are industrial activities that are collectively owned by the communes. They were made possible by a progressive rollback of restrictions on the nonagricultural activities of collectives, culminating in 1984 when local authorities were given the power to sanction communal industrial activity. The new enterprises absorbed much of the excess labor created by high birthrates and rising labor productivity in agriculture, while increased rural incomes provided the seed money for the initial investments.

Although they are collectively owned, TVEs are much more akin to western firms than state-owned enterprises (SOEs) for several reasons:

1.They face a hard budget constraint and are seldom bailed out by government subsidy. Moreover, in the absence of government support, banks are inclined to extend credit only on strictly economic terms.4