Transition to Market Economy (Part I)

Junhui Qian2013 September

Remember some faces

Deng Xiaoping, the Paramount Leader

Zhu Rongji, Premier

Zhao Ziyang, Premier and General Secretary

Outline

• Strategy and Process of the Transition• Phase-one: reform without losers (1978-1992)

• Land-contracting in the countryside• Dual-track system and managerial reform in the city

• Phase-two: reform with losers (1992-)• Market reunification• Privatization • Recentralization • Joining WTO

Basic Assumption

• System transformation take places concurrently with economic development.• The process of development would drive market transition forward

and guarantee its eventual success. • “Development” is often more emphasized than “Reform”.

Basic “Strategy” of Phase I

• Early reforms never actively eliminated or reduced distortions. Instead they loosen controls on resources so that distortions encouraged resources to flow into those less regulated hands. • Individuals and communities saw those “niches” available that they could

exploit and became rich. • Rarely was there a “level playing ground”, but the process set up an

economic dynamic leading to more intense competition. • Gradually the process went so far that the overall balance between

command and market economy began to shift. • From this point, achieved in mid-1990s in most sectors, a new phase of

economic reform could begin.

It Started from the Countryside

• The old game could not go on: the terms of trade for farmers were too bad, so farmers resisted the bargain. • Procurement targets were stabilized and slightly reduced; • procurement prices were raised; • most importantly, prices for farm deliveries above the procurement

target were raised dramatically.

Land Contracting System

• Local units (collectives) were encouraged to experiment. Soon they gravitate toward a controversial solution: contracting individual pieces of land to farm households. • Farm households took over management of the agricultural production

cycle on a specific plot of land, subject to a contractual agreement that they turn over a certain amount of procurement (low price) and tax (zero price) grain after the harvest. The remaining's are farms’. • The solution was controversial, but it received support from the

leadership. After all, it was not a privatization, which would be much more controversial.

The Result

• By 1984 grain output had surged to 407 million metric tons, more than one third higher than in 1978, and farmers actually reduced working days. • There was enough grain for

everybody in China, and the centuries of a China fundamentally short of food were over!• No one was a loser.

The Rise of Township and Village Enterprises (TVE)• TVE’s were outside the production plan. They were allowed to

produce and market goods in shortage, and even to compete with some of the existing state-owned enterprises. • Rural incomes increased rapidly, and reforms gained the support of

the bulk of the rural population. • Although some SOE’s faced more competition, there were still no

absolute losers.

Different Models of TVE’s

• Southern Jiangsu Model• Organized by collectives (with some capable leaders), capital intensive

manufacturing, relatively closed to migrant workers.

• Wenzhou Model• Private small businesses, high degree of division of labor,

• Pearl Delta Model• Foreign, or foreign-collective jointly owned, trade processing, open to migrant

workers.

TVE Employment

Legitimization of Private Ownership

• Some entrepreneurs disguised their firms as collectives, thus gaining the shelter of a “red hat” that falsely signified public rather than private ownership; others purchased informal protection from powerful individuals or agencies.• A succession of amendments to China’s 1982 constitution slowly expanded

recognition of the nonpublic economy.• “complement” to the state sector (1988)• “important component” (1999) of the “socialist market economy” (itself a new term dating

from 1993).• The “Law on Solely Funded Enterprises,” which took effect in 2000, guarantees state protection

for the “legitimate property” of such firms, but without using the term “private” or specifying any agency or process to implement this guarantee.

• “citizens’ lawful private property is inviolable.” (2004)• 2007: Law on Property Rights, for the first time, explicitly places privately held assets on an

equal footing with state and collective property.

Extension to Industrial and Commercial Sector• Inspired by the success in the rural area, reformers extended reform to the

industrial and commercial sector. • Reform overall was decentralizing, shifting power and resources from the

hands of central planners to local actors, while core interests were protected, often through contracts. • This process allowed entry barriers to be reduced and market forces to grow. • By 1993, though, this particular pattern of reform had largely run its course.

The market sphere had expanded sufficiently that the economy had “grown out of the plan.”• The focus of policy-makers shifted, as it became increasingly necessary to

build a firmer institutional basis for the market economy that was developing.

Elements of the Transition Through 1992• Dual-track system• Growing out of the plan• Particularistic contracts• Relaxed monopoly over industries• More flexible prices• Incremental managerial reform instead of privatization• Pushing reforms in the margins of the planned economy• Institutions of the planned economy used in stabilization• Continued high saving and investment

Steel Industry as An Example

Two Steps Forward, One Step Back

• In retrospect, the first phase reform was very successful, but this was not self-evident at the time. • Reform was always contested, and the achievements of reform were

constantly subjected to harsh scrutiny from conservatives who were skeptical of reform. • One result of this policy competition was a pattern of “two steps

forward, one step back.”• Reforms seemed to advanced strongly in certain years (1979, 1984,

1987–1988) and retreat in other years (1981–1982, 1986, 1989).

Challenges At The End of 1980s

• Inflation brought by an acceleration of price reform• Corruption due to the dual-track system• The vengeance of the conservatives against the reform• All these led to the tragic Tiananmen Incident.

Three Years of Backsliding (1989-1991)• Inflation was quickly controlled.• The conservatives found it extremely difficult roll back the reforms.

The market proved to be resilient and powerful. • As the overall economy stagnated and it became clear that the

conservatives had no viable alternatives, Deng Xiaoping came back with a vengeance. • In early 1992, Deng took a “Southern Tour” and he claimed

“Development is the only hard truth,” “It doesn’t matter if policies are labeled socialist or capitalist, so long as they foster development.”

Phase-Two Reform

• Zhu Rongji came to the scene. • Zhu established himself as the dominant voice in policy-making in

mid-1993, while he was still vice premier, and was then formally elevated to premier in early 1998.• In contrast to Zhao, Zhu had a strong, decisive personality and often

made quick, personal decisions. Zhu presided over much of the second period of economic reform, until he stepped down as premier in 2003.

Elements of the Phase-Two Reform

• Market unification and regulatory reform (for a level playing field)• Re-centralization• Macroeconomic austerity• Big-bang opening to the world (WTO)• Restructuring, downsizing, and privatization of the SOE’s

• Hold the big, release the small• Separation of the government and the enterprise• Split monopolies (e.g., oil industry)• Listing• The big share holder: State-owned Assets Supervision and Administration

Commission (SASAC) of the State Council (2003)

Comparison of the Two Phases

Recentralization

The Decline of SOE’s

Change in Ownership (Industrial Output)

From: Qian and Wu (2003)

Change in Ownership (Retail)

From Qian and Wu (2003)

The New Millennium

• China joined WTO in 2001. This marked the successful transition to a market economy. • Wen took over Zhu’s job of steering the economy in 2003, while at the

same time Hu Jintao replaced Jiang Zemin as the Party boss. • One important agenda of the Hu-Wen regime was to achieve a

“harmonious society”. • One important event was the cancellation of rural tax. • The key words of the era include: rising housing price, “twin

surpluses”, stock boom and crash, etc.