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slide2
China is of major interest within the field of comparative economic systems for several basic and important reasons. To begin with, China is a country that adopted the Soviet model but with interesting differences in practice. Moreover, as serious economic reforms emerged in the late 1970s, the path of reform was very different from that of other transition economies—beginning in agriculture and for the most part sustaining many elements of the command era. However, China’s reform combined socialism with important elements of the market and the aggressive use of foreign trade. These reforms have moved China to a position of major importance in the global economy. In 2009 GDP $4.9 trillion, China is the world’s third largest economy after US and Japan. China enters a new century with economic system resembling market socialism and yet with an historical background different from the typical conceptions of market socialism. Thus as an economic system, as an example of systematic change, and as a player in the world economy, China deserves close examination.

I. The Setting

China:

a) is very large (about the same size as Canada, 3.7 million sq miles)

b) Population is huge and growing

2009-1.3 billion (the largest population in the world and more than 1/5 of the world's population)

major policy problem

c) Much of its land is uninhabitable or costly to cultivate (only 10% of the land is suitable for cultivation)

mountains and deserts

d) Much of its resource base undeveloped, e.g., large oil reserves only starting to be exploited

e) A poor, developing country despite rapid growth (2008—$ 5,962 PC income)

f) A rich and very long heritage

slide3
China has the oldest continuous culture in the world, with at least 4000 years of historical records.

China was once the most technologically advanced, most populous, and (from their point of view, anyway) the most civilized country in the world. The Chinese are a very proud people, and often very nationalistic.

Imperial China's political history is one of long periods of stable, autocratic, and socially conservative dynasties, with a dynastic cycle that leads to collapse of the state and periods of terrible chaos. The Chinese have no history of democracy and a great fear of political disorder.

Chinese economic history is full of lost chances. Many of our most important technologies (printing, paper, clocks, gunpowder, and paper money are just a few examples) were first invented in China but not really put to economic use. Chinese fleets traveled to India and Africa before the Europeans but these voyages were halted. The expansion of trade and markets was repeatedly halted by government intervention. China did not make the technological leap. While Europe was undergoing the Great Transformation, China was in a period of decline.

China did not respond to the European challenge, unlike the Japanese who modernized their economy rapidly during the Meiji Restoration. In the Twentieth Century, China began its revolutionary period.

A revolution in 1911 toppled the last Qing emperor, and led to the establishment of the Chinese republic.

Today China remains a poor country despite rapid growth (2008-GDP per capita (PPP) $5,962; India $2,972; Pakistan-$2,644; Hong Kong-43, 922)

slide4
2. The Early Years (1949-1976)

The communist revolution in 1949 put Mao Zedong in power. At the time of the revolution China was a classic poor country with low PCI, significant population and absence of institutions for econ development.

Mao Zedong proclaims Chinese People’s Republic 1949

Mao takes leadership as chief of state

He created a strong central government and began a process of determined Soviet-style industrialization.

Initial tasks

collectivization of land

Took the land from landlords and wealthier farmers and placed it under the peasant control in communes

nationalization of industry in preparation for national planning

Followed typical (Stalinist) planned socialist model

high priority to heavy industry, low priority to agriculture

aggregate investment 20% - 25% of national product

85% industrial investment--heavy industry

8% state investment--agriculture

by end of Mao period, industry share in national output much higher than other countries at similar level of development

slide5
Collectivization of Agriculture

First step was redistribution of land from the landlords to the peasants in preparation for collectivization.

Major farming equipment provided by village authorities

Collectivization involved organizing households into large prod teams

Led to the commune

In the 1950’s the communist government organized 800 million rural people into about 52,000 rural communes

The Rural People’s Commune

Created during the Great Leap Forward (1958-1960)—a period of massive resurgence of ideology that replaced rational decisions.

Individual households organized into production teams (100-250 people)

Production teams (7) combined to form brigades (16)

Brigades combined into a commune (thousands of households in a commune)

The communes received production targets from the state and ensured that these targets were met.

Communes were controlled by the county

County played major role in implementing the plans of the Ministry of Agriculture and Forestry

slide6
Vertical organization—structure of decision making

Organization of Agriculture Prior to the Reforms

Ministry of Agriculture and Forestry

County

Commune

Brigade

Production Team

Household

Each level above the individual hhld could hold land, and other production materials under communal ownership, and each carried out a range of production activities.

slide7
Individual’s Incentives in the Commune

Individuals assigned work for which they earned points as shares of residual income (revenue minus expenses)

This system of payments was highly arbitrary. The work demanded vary regionally, seasonally and from commune to commune. Contrary to any good incentive system, peasants had little idea in advance what they would earn.

This system resulted in problems:

little incentive to work hard

The workers were equally paid whatever efforts they contributed.

little incentive for individual initiative

Impact—large reduction of agricultural production

Nationalization of Industry

There was a gradual transition from private to socialist industry compared to the Soviet model

Slow and orderly transfer from private to state ownership

by 1956, 68% value of output by state owned enterprises (SOE) and 16% by jointly owned (state-private) enterprises

Planning mechanisms, priorities and enterprise management are the same as Soviet Union—5 year plan, the plan is the law

Problems (poor quality, shortages, inefficiency, etc.)

slide8
Political and Economical Turmoil

Chinese econ development through the 1970’s was characterized by political and econ turmoil:

Hundred Flowers Campaign (1956-7)—a relatively liberal period of open discussion of the econ and political system.

Mao unhappy with the Communist Party leadership

invites constructive criticism from intellectuals (open discussion and criticism of the system)

When the criticism came reveals deep hostility to the CCP

Great Leap Forward (1958-1960)—an econ and social plan to use Chinese population to rapidly transform China from a primarily agrarian economy dominated by peasant farmers into a modern, industrialized communist society.

Was a period of massive resurgence of ideology that replaced rationality

last vestiges of rural private property eliminated

commune system established

Agri was reorganized into massive communes of thousands of hhlds

attempt to initiate rapid growth and industrialization; this goal was often pursued in harsh way such as forcibly shifting farmers away from their land led to mass starvation in the early 1960s.

the plan did not achieve the intended results; economic disaster after years of solid growth (economy collapses and does not recover to 1958 level until 1963)

slide9
Mao stepped down as State Chairman of the PRC in 1959 but he retain Chairman of the Communist party. The new State Chairman (Liu Shaoqu) and Deng Xiaoping (CCP General Secretary) were left in charge to execute measures to achieve econ recovery.

Recovery from the Great Leap

Recovery from Great Leap emphasizes

less focus on output growth and more on quality and efficiency

more balanced economic development (not only heavy industry but agri)

modernization of agriculture

Decentralization (local decisions)

In addition to organizational changes and policy shifts, the 1960’s witnessed a wide spread educational campaign. There was an effort to educate the population in the ways of Mao. This campaign laid the foundations of the Cultural revolution.

The Cultural Revolution

Mao’s struggle to retake supreme leadership culminates in the Cultural Revolution

peaks from 1966 to 1969

Include domination of ideology; revolutionary class struggle continues, involving peasants class

The Cultural revolution was an upheaval of ideas, an abandonment of much that had preceded it. Put the Mao’s ideology as state ideology, to reeducate people in Mao’s ideology

The Cultural revolution had a dramatic effect on China’s educated classes

lost generation of leadership as universities closed and students sent to the countryside, students were sent to hard industrial labor or labor in the countryside

No increase in GDP from 1965 to 1970

slide10
The early 1970’s was a period of recovery from the events of the cultural revolution. However, there were some events that pointed to:

The End of the Stalinist Period

Mao die in Sept. 1976

Gang of Four Trial, Oct. 1976

Mao’s wife and three others on the left tried to sustain the Cultural revolution, arrested and discredited

political maneuverings end in 1978 with rise of Deng Xiaoping

By Chairman Mao's death in 1976, the Chinese economy was isolationist and stagnant and Chinese material living standards had failed to improve (though extreme poverty and starvation was reduced, and average life expectancy had increased dramatically).

Inefficient farming communes (Most Chinese lived on inefficient farming communes)

state monopoly (Industrialization had mostly affected the cities, and the state held a virtual monopoly)

Inefficient state-owned factories (Inefficient state-owned factories relied on direct state funding and produced shoddy products, and turned over all their profits to the state; State banks were created to help finance state expenditures)

Private ownership and incentive was virtually nonexistent.

reform period begins

slide11
II. Transition in China

The Era of Reform: 1978

More than two decades of stability and stellar growth

Steady decentralization

Combination of reform and transition

“dual-track approach”

Dual Track Reform

Coexistence of a plan track and a market track

Eventually the planned economy with its targets/quotas and fixed prices would be dismantled but unlike in the former SU, it did not happened suddenly and did not lead to an econ collapse.

Two phases

1978-1984:

liberalization of agriculture in an effort to increase agri production, the gov’t restructured the agri

creation of township and village enterprises (TVE) or rural firms, who were allowed to compete with the state firms (collectively owned enterprises, on hard budget constraints)

spontaneous privatization of service sector

1984: dual-track applied to industry

slide12
Dual Track in Agriculture: Household Responsibility System (HRS)

In 1978, a village in central province (Anhui) initiated HRS. It soon gained popularity and thus official endorsement in 1981.

Xiaoping emphasized that state firms and government agencies should be led by those who have some expertise, not by those who showed proper revolutionary fervor.

Covered 98% of rural population within 3 years.

Communes disbanded.

Household is a principal unit of agricultural production.

Land distributed to households as 15 year leases (after 1995, for 30 y)

Lease holders required to produce a planned allotment at planned (fixed) prices, but free to produce and market any amount beyond planned allotment.

The production decisions and profits were transferred from the commune to the household. When the HRS was introduced, the collectivization was effectively brought to an end

91% of agricultural output planned in 1978, only 5% in 1993

Semi-ownership of land caused increase in labor productivity which released labor into small-scale entrepreneurship, e.g. crafts, services

Released labor into township and village enterprises (TVE)

Light industry

free to make decisions, no plan targets, to sell at mkt prices, own employment practices

slide13
China began its reforms with complete state ownership of industry, transportation and commerce. Reforms began with changes in ownership relationships in agri and small-scale trade, manufacturing and services. State ownership is a main feature of mkt socialism

Dual-Track in Industrial Ownership Structure

Old track state owned enterprises (SOE) vs new track non-SOEs

Two types of new track ownership structures

Township & Village Enterprises (TVEs) and purely private

Mostly in small and medium industries—retail, textile, restaurants

Most dynamic sector of the economy

Owned or supervised by townships or villages (not state-owned)

Can be collective enterprises, private firms, joint ventures.

TVEs formally owned &controlled by villages &local communities

in most TVEs, communities actually involved very little in operation of the enterprises, TVEs act essentially as private firms

Introduction of more competition

Small family firms were encourage to compete

State firms were encourage to compete with each other, and new types of firms were allowed to compete in formerly monopolistic sectors.

slide14
SOEs are unprofitable and a major drain on the state budget (1985-10% unprofitable, 1990-28%, 1995-50%)

Most of the growth in China in non-state sector

SOEs persist for two main reasons

SOEs represent “commanding heights”

State ownership of heavy industry

SOEs employ 18% of the work force

SOE reform

in 1995 China initiated the “modern enterprise system,” which aimed to transform the SOEs into modern corporations;

Instead of privatization occurring, the form of state ownership itself was to be transformed from direct state supervision and management to state “shareholding” operated by “independent” managers backed a the state asset-management commission & supervisory committee. State-owned enterprises (SOE) were to be “corporatized”;

“corporatized” firms are SOE where the state maintains majority ownership but the management is independent.

SOE were given improved managerial incentives, allowed to keep much of their own profits for reinvestment and worker bonuses, and forced to rely on loans from state banks rather than direct government grants.

Eventually, the planned economy, with its quotas and its fixed prices, would be dismantled, but unlike in the former Soviet Union it did not happen suddenly and did not lead to an economic collapse.

Gradually abolition of planned economy

slide15
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

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

SEZs&ETDDs exempted from most controls on foreign investment and private ownership that bring investments, foreign technology and mkt access.

Result is much faster growth, especially in non-state sector

Regional disparities a major problem

slide17
International trade—open door policy

China opened to the world, tourism was allowed, students to study abroad, the special econ zones were established to bring in foreign technology, investment and mkt access.

International contacts between people

officials, tourists, students, scholars, etc.

Foreign trade and investment, especially in Special Economic Zones.

2. Sources of Growth

a) 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 and private enterprises (agrofood process, light industry) from the freed-up labor

movement of low-productivity labor into higher productivity TVEs is the major source of growth

opposite of Soviet Union, Central 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

slide18
b) 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

FDI—investment by foreign investor in the form of acquiring substantial shares in domestic companies

c) High saving rate

Chinese saving rate high even by Asian standards (China--23% of disposable income, Japan: 21%, Taiwan: 18%, Germany: 13%, US: 8%)

d) Centralized control discredited

Great Leap Forward and Cultural Revolution were disasters obvious to everyone

allowed Deng Xiaoping to institute reforms without much resistance

e) China is the largest recipient of foreign investment in Asia.

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)

slide19
3) The Chinese Economic System

Large state enterprises are state owned, while agri & small-scale businesses are private

No “standardized “rule of law” in the form of civil or common law, the supreme law comes from the authority of the communist party & of top government officials, whose word is above the formal law or regulations.

China is considered mkt socialism b/c has the 2 main features: state ownership and mkt allocation

a) Corporate Governance and Property Rights

The formal property rights are weak. These property rights are guaranteed by an implicit contract with state or party authorities, who agree to exercise the property rights.

business cannot turn to legal system to enforce contracts

Chinese contracts are primarily regulated by relational contracting rather than the rule of the law.

the ultimate guarantor for property rights is the Chinese Communist party

2007 (March) new property law adopted.

The law covers the creation, transfer, and ownership of property, and is a part of the ongoing effort to gradually develop a civil code. Hu Jintao (President and Communist Party Leader, 2002) and Wen Jiabao (Prime Minister, 2003) have taken a centrist position, protecting property rights for the rising middle class and farmers, while promoting a "harmonious society" that strives to distribute wealth more equitably, to increase social expenditures on health and education, and to alleviate some of the excesses of pollution and corruption that have accompanied rapid growth.

slide20
b) Capital Markets resembles the capital mkts in Europe and other parts of Asia in that:

Companies receive funding thru banks, not thru stock markets

Commercial banks are the major source of financing for Chinese companies;

as a consequence of relying on bank loans, Chinese companies operate w/ high debt burdens.

Banking system

Near monopoly of state on banking till 1983.

Banking system consists of the Central bank (PBOC) and big 4 state-owned commercial banks--Bank of China, Industrial and Commercial bank of China, Agricultural Bank of China and China Construction bank.

Before 1983, People’s Bank of China (PBOC) assumed all the functions of regulation and had control of all banking business. However, in 1983, four specialized banks were established to take over the banking business from PBOC, allowing PBOC to focus on regulation and monetary policy. The big four remained as specialized banks until 1994 when three policy banks were established to take over the policy-directed lending functions—China Development bank, Export and Import bank of China, Agricultural Development bank of China.

Through the early reform period banks remained property of the state and gave loans under the direction of gov’t and party officials, giving preferences to state enterprises.

Interest rates are regulated on loan and deposit

savings channeled to inefficient capital formation in SOEs

slide21
as a consequence of state direction of credits, China’s commercial banks have a high ratio of non-performing loans (NPLs)

are loans that are not being served w/ interest and principal payments and will be probably not be repaid.

Chinese banks face a major bad loan problem, bank staff is relatively inexperienced, need to reform.

Gradual reform of banking system

Establishing of various kinds of banks

In the banking business, the four state-owned commercial banks, namely, ICBC, CCB, BOC and ABC are still the biggest players though their dominance is in gradual decline. At the end of 2007, the Big Four accounted for 50% of China’s total banking assets. Another important type of banking institutions is the 13 joint-stock commercial banks, including Bank of Communications and China Merchant Bank. Currently, joint-stock commercial banks are the most dynamic in China’s banking sector. Their asset expansion is double the pace of the Big Four. By the end of 2007, their market share had increased to 18% from 14% at the end of 2003.

Development and implementation of market-oriented banking system

accounting standards for the banks.

Liberalization of interest rates. Market-based interest rate reform is intended to establish the pricing mechanism of the deposit and lending rates based on mktss and dd. The central bank would continue to adjust and guide the interest rate development, which allows the market mechanism to play a dominant role in financial resource allocation.

With Chinese membership to WTO, domestic banks must compete with foreign banks, and the foreign banks have the same rights as domestic banks.

In 1992 funds raised through sale of new stock and bonds has accounted only for b/w 2-14% of a total financing, in 2001-equity mkt finance was only 8% of total

slide22
d) Privatization of smaller state owned companies

China has allowed the private sector to grow but in core areas as state banking and other “commanding heights” industries (transportation) the state wishes to maintain control

SOEs continue to be a huge drain on economy

There is no too much evidence that restructuring of SOE has improved performance; the productivity has fallen.

e) Agriculture

incomplete ownership of land

disincentive to improve land

reduces potential productivity of land

f) Trade relations

joining WTO—12/01

trade relations with the US (MFN status), EU, Taiwan, and other Asian countries

g) International finance

In July of 2005 China abandoned the Yuan peg with the US$ and linked its currency to a basket of currencies.

The nation’s long-term goal is to make the full convertibility currency gradually

The Chiness currency is convertible on the current account (trade) but it is only partly convertible on capital account (FDI and portfolio)

slide23
h) Social safety net

not as immediate need as in other transitional economies

rural population to large extent self-sufficient

continued support of SOEs reduces urban unemployment

lack of political reform prevents the poor from having a voice

the state establishes a system of social insurance, social assistance and medical care

the state enterprises are suppose to pay a soc sec tax =20% of their payroll plus another 8% for health and unemployment insurance;

China is also experimenting w/ privatized soc sec accounts

The state system covers primarily employees in urban state enterprises and excludes those out of the labor force and those living in the countryside

the state system covers less than 20% of the population.

The privatized soc sec accounts are meant to cover the remainder

as SOEs privatized, unemployment will soar

rural population has much lower income and access to health care

high rate of savings and self- reliance and family support

the dramatic rise in inequality

Chinese mkt reforms have changed the income distribution dramatically, lead to increase in inequality; it is exactly what would be expected from the move to private enterprises.

Now the income distribution is similar to other relatively poor Asian countries and the US

Gini Coefficient, China 0.40, USA 0.40, India 0.38.

Human Capital Investment

Difference between rural and urban

Difference between developed and under-developed area

They are both potential source of inequality

slide27
i) Regional policy

By 1993 more than 9,000 zones had been created, leading to substantial growth of foreign investment by foreign enterprises bringing in new technology, services and increasing competitiveness.

most growth from Special Economic Zones and Development Areas

huge income differential between coastal and interior provinces (4-5 times)

j) Population policy

To control the huge population of 1.3 billion, “one child” policy (more than 2 decades old policy) restricts urban couples to only one child, while allowing rural couples to have a second child if the first one is a girl.

slowing population growth

slowing/preventing migration to cities

slide28
4) Transition in China—Summary

Strategy

From central planning to indicative planning

Allowed plan and market to exist together

From indicative planning to market allocation of goods and services

Grow out of the plan” instead of ``shock therapy”

Transition and growth at the same time

Transition

In converting its planned econ to a market econ, China faced 2 principal challenges:

Replacement of administrative allocation by market allocation

Replacement of administered prices by market prices

To achieve this objective China used the dual track approach, which established autonomy and incentive.

Reforms began smoothly and econ growth accelerated

Nobody was made obviously worse and opponents were bought off (Pareto Improvement)

Interdependence between SOE & non-state sector

phasing out the dual track

The dual-track system of prices introduced in the mid-1980s to facilitate the transition of China from a centrally planned to a socialist market economy has essentially been phased out, reducing to a single-track, market-based system, with the following exceptions:

    • In 2001/07, the remaining planned prices are to be abolished with the exception of: the prices of natural gas, oil, edible oils, grains, tobacco, water, salt, and products related to national security
Phasing Out the Dual-Track

(percent of output value, selected years)

Source: Price Yearbook of China (various years)

"Guide prices" are government-administered prices, but with reference to market supply and demand

slide30
China’s market transition is incomplete but in some sense successful up until now

Gradualism continues to guide experiments in advancing reforms

Chinese reforms differ in form and consequences from the approach taken in the CEE. China avoided the sharp contraction of output, surging inflation and elevated unemployment that characterized transition in all CEE.

Chinese growth accelerated with the reform. Employment grew. Agriculture in China was dominant, while the CEE were industrial economies.

The main point of difference is the relative pace of political and econ reform.

In CEE political occurred rapidly and ran ahead of econ reform. In China the reverse—econ reform evolved much more rapidly than political reform