Session 6 China Miracle

A Successful Transition Econ-omy

China before Reform

• Communists took over China in 1949. • Agriculture 70%, Industry 30%.• Great-Leap strategy for development.- People’s Communes in agriculture.- State-Owned Enterprises (SOEs) aimed

at developing heavy industry under economic embargo of Western coun-tries. Shortcut impossible!

China before Reform 2

• China exported not labor-intensive but capital-intensive goods (barter trade to balance out left-over), restricting import only to absolute necessities.

• Measures of import restriction : tariffs, quotas, licensing requirements, im-port substitution lists, a system of reg-istration for selected imports, and commodity inspection requirements.

China before Reform 3

• China’s share of world trade dropped from 1.5 percent in 1953 to only 0.6 percent in 1977.

• Exchange rate was fixed at over-val-ued level to implicitly subsidize the import of high priority capital goods.

China before Reform 4

• Import from the Western countries needed foreign exchanges

• Excess demand for foreign exchanges called for rigid control

-entire foreign exchange earnings of ex-port to be surrendered to government;

-individuals may hold foreign currency only under state approval;

-strict controls on the capital outflow.

Performance After Reform

• GDP grew from US$261.3 billions in 1979 to US$7.3 trillions in 2011, sur-passing Japan’s US$5.9 trillions and chasing US US$17.6 trillions. (World’s total GDP was US$69.9 trillions in 2011.)

• Per capita GDP grew from US$100.- in 1978 to US$5,449.- in 2011, demon-strating annual growth rate 12.9% for 1978-2011.

Economic Reform in 1978

• The Third Plenary Session of the 11th Chi-nese Communist Party Congress in De-cember 1978.

- Enterprises and farmers were given more autonomy in management and produc-tion.

- Resource-allocation (commanding)system and macro-policy were adapted to accommodate this augmented autonomy.

Key Content of Reform

• Agricultural sector shifted away from col-lective system to household responsibil-ity system as of 1979, encouraging the growth of township-village enterprises (TVEs).

• Government allowed private business, and directed the state-owned enter-prises (SOEs) to exercise some auton-omy in management and to hold some portion of profit.

Household Responsibility System

• The Decision on Certain Issues Con-cerning the Acceleration of Agricul-ture Development in September 1979. The Central Committee of the Chinese Communist Party, stipulated that pro-duction contract with household was not to be allowed, with the exception of the special needs of some sideline productions and isolated households.

HRS 2

• Commune allocated farming land to farmers on the condition that each farmer was to turn in a fixed amount of agricultural product after harvest.

• This fixed amount covered the state procurement and the Commune’s use, set at the level same as before.

• Farmers became residual claimants.

HRS 3

• Some People’s Communes adopted responsibility contracts with house-holds, even before Reform, whenever agriculture ran into difficulty.

• But the practice was illegal as it was not ideologically consistent with Communism.

• The Decision was the first official le-galization of the practice of HRS.

Performance of HRS

• Agricultural production increased at average annual rate 6.05% during 1978-1984, which was the highest since 1949.

• HRS contributed for 46.89% of in-crease.

• China succeeded in feeding 20% of the world population with the grain crops produced from less than 10% of the world arable acreage.

Agricultural Production

78 79 80 81 82 83 84 85 86 87 88

State 47.8 54.0 50.2 52.1 56.2 91.2 102.4 59.6 53.3 56.9 50.5

Procurement

Total 304.8 332.1 320.6 325.0 354.5 387.3 407.3 379.1 391.5 403.0 394.1

production

Ratio (%) 16 16 16 16 16 24 25 16 14 14 13

Units: million tons, %

Dual Pricing System

• Agricultural surplus in private hands increased substantially, as residual earning was added to official income.

• Private market transaction expanded under law of demand and supply.

• Dual pricing system consisted of planned price for government pro-curement and distribution, and mar-ket price.

Township and Village Enterprises

• Cooperative type of organizations voluntarily emerged to handle prod-uct and surplus that HRS made available.

• HRS freed some of land and labor from planned agricultural activity.

• TVEs that initially produced what ru-ral sector needed, began to produce commodities for profit.

SOEs Reform

• Workers had been paid by seniority, and government had been solely re-sponsible for profit and expenditure of SOEs before reform.

• A test program to share manage-ment power and profit between gov-ernment and SOEs was implemented on fourteen selected SOEs.

SOEs Reform 2

• Each SOE retained decision making on pay to workers and profit retention.

• Central government delegated fiscal au-thority and resource allocation autonomy on SOE to corresponding local govern-ment.

• This contract responsibility system showed improvement in efficiency and was expanded to more than 6,000 SOEs.

Unclear Property Right

• Managers, who used to have close connection with the Party, abused delegated power to re-tain as much profit as possible, leaving too small portion to state.

• Under no well-functioning official external gov-ernance, managers often embezzled state property.

• Managers paid too much working incentives in order to increase their pies.

• Unclear boundary of autonomy and loopholes counteracted much of efficiency gains.

Second Round of SOE Reform

• System of stock company was introduced, and poor governance only fortified manage-rial autonomy and corruption.

• Tax reform replaced profit remittance by cor-porate tax.

• Manager-responsibility system was intro-duced to make SOEs respond more resiliently in competition against TVEs for input materi-als.

• State mandatory plan was phased out to re-duce state control in resource allocation.

The Role of SOEs

• The visible state sector—SOEs and en-tities directly controlled by SOEs, ac-counted for more than 40 percent of China’s nonagricultural GDP.

• SOEs and their subsidiaries benefit from

- preferred access to bank capital, - below‐market interest rates on loans

from state‐owned banks,

The Role of SOEs 2

- favorable tax treatment, - policies that create a favorable com-

petitive environment for SOEs rela-tive to other firms, and

- large capital injections when needed. • Further, Chinese SOEs also appear to

dominate China’s expanding gov-ernment procurement market.

The Role of SOEs 3

• The government uses SOEs to facili-tate structural change in the Chinese economy, to acquire technology from foreign firms, and to secure raw ma-terial sources from abroad.

• Economic base for the Party and leaders.

• Sporadic corruption scandals under domination of political power.

The Economist, October 6, 2012

• The dark truth is that bamboo capitalists are increasingly getting squeezed by the state. …For years from the late 1990s state-owned enterprises (SOEs) appeared to be in retreat. Their num-bers declined (to around 114,000 in 2010, some 100 of them cen-trally controlled national champions), and their share of employ-ment dropped. But now, even while the number of private com-panies has grown, the retreat of the state has slowed and, in some industries, reversed. ….

• Though fewer in number, today’s SOEs are more powerful than ever. Their shrinking number is the result of a concerted effort to consolidate disparate SOEs into national champions in a range of “strategic industries”, which range from telecoms to shipbuilding.

• Liberal reforms got a boost with China’s WTO entry in 2001—but slowed after 2006, and then, argue critics, went into reverse as the stimulus spending of the past few years flowed to SOE cof-fers.

Reality behind the Muscular Ap-pearance

• SOEs are monopolists in domestic mar-ket, and their share of export had fallen from 25.7% (1998) to 9.8% (2000).

• SOEs accounts for only 35% of patent registration, 25% of technological inno-vation, and 20% of developing new commodities, while commanding 81.9% of net profit and 90.4% of assets.

• Giants depending upon dwarfs?

Trade Liberalization

• Trade with West shifted China’s trade away from barter to the one based on comparative advantage.

• Measures for import and foreign ex-change control were repealed as China entered the WTO in 2001.

• Average statutory tariff was reduced from 56 % in 1982 to 15 % by 2001.

Trade Liberalization 2

• The Chinese comparative advantage promoted export of light manufactured goods first, getting rid of foreign ex-changes gap.

• Expatriate high-tech manpower returned home to work for upgrading Chinese in-dustry, and demonstrated rapid catch-up in advanced technology.

• China stood up as a gigantic factory of the world.

China’s Trade

• China is the largest exporter and the second largest importer in the world.

• Trade/GDP ratio was 50.1% in 2011. Export/GDP=26.1%, Import/GDP=24%.

cf. Trade/GDP ratio = 38.5% (2001), 51.9% (2003), 67% (2006)

• The same ratio is around 30% for USA, Japan, India, Brazil, below 50% for France, UK, Italy, Russia, and above 50% for Canada and Germany, 100% for South Korea.

Investment from Abroad

• Reform opened the China market to foreign capital.

• Capital from Hong Kong, Taiwan, Sin-gapore and other overseas Chinese flew in first to reduce savings in-vestment gap .

• And then other countries like Japan, Korea, USA, and Europe expanded investment.

Dual Track Liberalization

• Liberalization did not intrude upon traditional planned sector and the latter tolerated the former.

• State stimulated farmers incentive successfully, while controlling the same size of agricultural surplus, un-der household responsibility system, although its counter-part was less ef-fective in corporate reform.

What Next?

• Rural discontent.• Corruption in ruling class.• One party dictatorship.• SOE problems.• Collapsed world market; US, Europe,

Japan….