EF3461 The Economies of Mainland China and Hong Kong

1. EF3461The Economies of Mainland China and Hong Kong Tutorial 8China’s Economic Reform City University of Hong Kong Dr. Isabel Yan

2. China’s Economic Reform Reference: • Li, Kui Wai, “The Two Decades of Chinese Economic Reform Compared” • Jaggi, Rundle, Rosen and Takahashi (1996), “China’s Economic Reforms, Chronlolgy and Statistics”

3. Reforms of the 1980’s 1. Family responsibility system (1979) Once the government agricultural output quotas were fulfilled, rural households could sell their surplus of agricultural products in the free market. 2. Special Economic Zones • Establishment of five Special Economic Zones (Shenzhen, Zhuhai, Shantou,Xiamen and Hainan) and fourteen open-trade coastal cities. • Privileges: • A 15% income tax rate compared with the 30% charged elsewhere in China. • An above-average growth – about 15% -- for the next 5 years. • Authority to carry out new experiments such as offshore-financing, services and trade that are commonly used in the foreign banks. • Import tariff tariffs exemption for materials used in the domestic construction.

4. - Rise in the aggregate demand: • Accumulated income growth in the rural areas resulted in a rise in aggregate demand, especially in consumer and light industrial goods. • - Growth of income: • Rural reform was a success and the growth of income in the form of “wanyuanhu” (household with income over 10 thousand RMB yuan) soon spread to different parts of the country, especially the coastal regions Economic consequences:

5. - High inflation (economic overheating): Structural Imbalance between heavy and light industry + Inflation = Rise in the aggregate demand for consumer and light industry goods Even though the light industry output as a proportion of total output rose, but since 1983, the share of heavy industry again exceeds the output of the light industry. This imbalance between heavy and light industry plus the rigidity of the industrial structure that failed to tilt the balance in favor of the light industry leads to speculation and inflation.

6. - Speculation on industrial input: Rapid inflation in 1987-1988 generated speculation. Industrial inputs were held up by speculators who found it more profitable to hold on to industrial materials than selling them to enterprises for production. This resulted in a fall of supply of industrial raw materials.

7. 3. Price reform (1984): (i) Price reform in the final products: The “dual-track pricing system”, which was first introduced in rural areas, is extended to a wide range of industrial final commodities in the urban area: Dual-track pricing system: An official price co-existed with the emergence of a market price in the non-official markets, typically in agricultural produce and imported household items.

8. Welfare related goods provided by state-owned enterprises + “Xiahai” (Workers securing a second job) (ii) But lack of reform in the prices of factor of production: (a) Slow in wage reform: In the state sector, wages comprises of two parts: Take home net monetary income Wage = Since nominal wage increase requires increase in state subsidy, wage reform was slow. Consequently, product price rose at a faster pace than wage rates, leading to a decline in real wage.

9. Banks give out credit for non-economic reasons. (b) Restrictions on interest rate – the return to capital: The restrictions on the market price of capital as a result of the interest rate ceiling has effectively kept the opportunity cost of capital below the market price.

10. Cost of Production Producers’ surplus + = LACK OF REFROM! REFROM! Economic consequences: • Severe market distortions: Reform in the price of final products without appropriate reform in the prices of factor of production is like putting a cart before the horse! Market Price: A market price should be determined by sums up the cost of production and the surplus held by producers.

11. 4. Fiscal reform (1983): Fiscal reform in the form of profit tax substituting for profit remittance. For SOE, direct taxation replaces automatic transfer of profits to the budget. Economic consequences: • It gave enterprises more incentive in production • However, the new tax reform was complicated and subject to tax abuse. Tax evasion is common. • “Soft-budget constraint” problem: profitable enterprises were reluctant to pay profit tax, while loss-making enterprises continued to receive state assistance.

12. Reforms of the 1990’s • Before 1994: • Three kinds of exchange rates: • Official rate (set at RMB 5.7 to 1 USD): • Applied to state enterprises • Swap rate • More depreciated than the official rate and closer to the “market rate”. • Applied to export and other selected new industries • [Black market rate] • After 1994: • Market rate (around RMB 8.3 to 1 USD) • [Black market rate] 1. Reform in the Foreign Exchange Market

13. 2. Austerity Plan (released on July 1993) • This was introduced to cool off the overheated economy. • Four parts: (i) Various monetary controls (such as credit restrictions, rise in interest rate and consolidation of the banking system) (ii) Investment priorities were redirected to promote long term infrastructure development (iii) Emphasized “intensive growth” instead of “extensive growth” (iv) Put an end to the price reform on final products.

14. The 16-point Austerity Plan consists of the following measures: 1. Call-in loans where are diverted to speculative schemes. 2. Force workers to buy government bonds that had failed to sell within two weeks. 3. Raise interest rate. 4. Force non-financial institutions to repay funds borrowed from financial institutions. 5. Impose a 20% cut in government spending and ban new car imports. 6. Suspend price reform measures. 7. Forbid the issue of new IOUs to peasants. 8. End dubious fund-raising schemes. 9. Control real estate speculations in the development zones. 10. Reduce the scale of infrastructure projects. 11. Control share-listing procedures on the stock market. 12. Reform the export financing system. 13. Force banks to tighten up their credit approval. 14. Strengthen the central bank. 15. Clear transport bottlenecks which cause goods to pile up. 16. Send inspection teams to supervise compliance with the Plan.

15. Economic Consequence: (i) Remove a major source of previous inflation episodes. 3. Central Bank Reform (1995) • Central Bank law aims at improving the efficiency of the banking system. It: (1) formally legislate the People’s Bank of China (PBOC)’s authority to implement independent monetary policy and free from regional government’s pressure for loans. (2) specifically forbids the PBOC from lending to the Government

16. Potential Economic Consequence(s)/ Problem(s): • The shareholding system can potentially become a “wage-pooling” exercise if workers were forced to acquire the shares, while the management and incentive structure remained. • Lack of legislation on corruption may allow new bosses to engage in questionable practices. • Alternative 1 (preferred in the 15th Party Congress in 1997): The formation of a sharing holding, or joint stock system (“gufenhua”): SOE’s are asked to market their assets . The shareholding will take the form of limited liabilities 4. Reform of State-owned Enterprises (SOE) In 1995, government estimated 40-50%of the SOEs are losing money.

17. Alternative 2: SOEs should come up with their own timetable in the restructure of loans, corporation of management and re-orientation of production. Unsuccessful SOEs would be required to declare bankruptcy at the end of the time period. • Potential Economic Consequence(s)/ Problem(s): • Create a problem of employment.