Transition to Market Economy (Part II)

1. Transition to Market Economy (Part II) Junhui Qian 2013 October

2. Outline • Growth and Structural Change • Labor and Human Capital • Ownership and Governance

3. Data Issue • There are no better alternatives to the official data. • Problems of Chinese data • Inadequate correction for inflation • Inadequate accounting for the expanding scope of the economy • Vulnerability to official manipulation • Transition to a new data-collection system in 1998

4. Investment

5. Comparisons • Investment ratio has been higher than in Big-Push era. • Japan invested 35-37% of GDP in gross fixed capital formation during 1970-1973. • Korea sustained a very high fixed investment rate from 1990–1997, peaking at 39% in 1991. • For brief periods in the mid-1990s, Thailand and Malaysia invested over 40% of their GDPs in fixed capital (1993–1996 and 1995, respectively). • Unlike Thailand and Malaysia, China was not dependent on foreign investment, but mainly on domestic saving.

6. Is it true that the reason why China grew so fast is simply “Because it invested so much”?

7. The Productivity Story • A key element of the recent Chinese experience is one of consistently high investment that appears to be sustained by a gradual increase in the productivity performance of the economy. • The persistent FDI into China is one evidence supporting the above story. • The experience in the socialist era offers a counter example against the Harrod-Domar model, which implies that investment is the sole engine for growth. • Explaining the China growth is challenging. At a minimum, skill, institutions, and policies have to be adequate to support productive investments, and national actors have to be willing to defer consumption, maintain their own saving rates, and plow resources back into investment.

8. Structural Change in Employment

9. Employment by Ownership

10. Unemployment During the Second-Phase Transition

11. Urban Employment

12. Education

13. Return to Education Source: Zhang et al. (2005)

14. Results from Regression Study • Data: CGSS 2005, 5778 observations, publicly available. • Results from the multiple linear regression: , , ***

15. Composition of GDP

16. SOE Reform: Ownership and Governance • Discussion: Why is ownership important? • The Company Law of 1994 paved way for the diversification of ownership of the SOE’s, including privatization.

17. Grasping the Large and Letting the Small Go • The 15th Communist Party Congress (Sep 1997): Grasping the large and letting the small go. • The “large” were often controlled by the central government, while the “small” were often in control of local governments. • The “large” were (and are) often protected by entry barriers (real or regulatory), while the “small” were often subject to market competition.

18. State Industrial Enterprise Profit

19. Governance Reform • Objectives: • (Incentive) Turn the SOE’s from socialist work units into profit maximizing companies. • (Constraint) Make the management responsible for the solvency risk.

20. The Soft-Budget Constraint Problem • A soft budget constraint is said to exist whenever a loss-making company continues to receive financing. • To give more discipline to enterprise managers, grants gave way to bank loans (拨改贷). However, due to the soft-budget constraint problem, bank loans soared.

21. Debt-Equity Ratio

22. Hardening the Soft-Budget Constraints • “Zombie” enterprises were shut down. • Banking reform turned state banks into commercial banks. • Tax reform weakened the link between SOE’s and their bureaucratic superiors. • Social security reform and housing reform helped reduce the bargaining power of SOE’s.

23. Reading Assignments: • *Chapter 6, 8, 13. • Chapter 9 of Demystifying the Chinese Economy, Justin Yifu Lin, Cambridge University Press 2011.