The Reform toward Market Economy in China

1. The Reform toward Market Economy in China Dr. Yin Chen 尹晨 Associate Professor School of Economics, Fudan University

2. 30 years of reform and open-up • On Dec. 18, 2008, China held a meeting in Beijing to celebrate the 30th anniversary of its reform and opening-up drive, which turned the once poverty-stricken country into the world's 3rd largest economy

3. 30 years of reform and open-up • Communist Party of China's (CPC) leaders Deng Xiaoping and Chen Yun at the 3rd Plenary Session of the 11th CPC Central Committee in Beijing held from December 18 to 22, 1978 • In that meeting, the important decision of reform and opening up policy was made.

4. Main content • How did planned economy come into being? • Planned economy was inefficient • Main steps of China’s reform • Main aspects of China’s reform • Gradual transition vs. shock therapy

5. 1. How did planned economy come into being? • Choice of heavy-industry-oriented development strategy (HIODS) • Alternatives of capital accumulation • Shortage of resources • The adoption of planned economy • Achievement

6. 1.1. Choice of heavy-industry-oriented development strategy (HIODS) • Heritage • Industry as a symbol of power • Necessity for security • Demonstration of Soviet Union • Choice of HIODS

7. 1.1.1 Heritage • After 8-year anti-Japanese war and 4-year civil war, at the founding of the People's Republic of China in 1949, the Chinese government inherited a war-torn agrarian economy • 89.4% of the population resided in rural areas • Industry consisted of only 12.6% of the national income • No complete industrial system • Nearly no heavy industry

8. 1.1.2 Industry as a symbol of power • At that time, for most countries, especially developing countries, a developed heavy-industry sector was the symbol of the nation's power • Steel and oil refining, chemical and plastics, industrial machinery, mass transit (railways, airlines, shipbuilders) , mining

9. 1.1.3 Necessity for security • Korean War broke out in 1950 • With the resulting embargo and isolation from Western nations, to develop domestic heavy industries, particularly military industries, became a necessity for China’s national security

10. 1.1.4 Demonstration of Soviet Union • The Soviet Union's outstanding record of nation building under planed economy in the 1930s, when Western market economies experienced the Great Depression, provided the Chinese leadership with a very good example

11. 1.1.5 Choice of HIODS • After recovering from the Korean War in 1952, the Chinese government set heavy industry as the priority sector of economic development and chose heavy-industry-oriented development strategy (HIODS)

12. 1.2. Alternatives of capital accumulation • HIODS demanded huge amount of capital • Theoretically, there were three alternatives of capital accumulation: • War or colonial governance • Foreign capital inflow • Foreign trade • Domestic accumulation

13. 1.2.1 War or colonial governance • Great Britain, Spain, Portugal, and etc., accumulated capital by war and colonial governance in history • On the contrary, China has long been a victim of war and colonial exploitation since 1840s, nearly every industrialized country had invaded China • So the first choice was impossible in the 1950s

14. 1.2.2 Foreign capital inflow • In the 1950s and 1960s, Japan, South Korea, Singapore and some other Asian countries or regions got huge amount of foreign capital inflow with which achieved good economic development • As the result of Korean War, no capital flowed into China from the 1950s to 1970s from Western World • In the early 1950s, China got some loans from Soviet Union. But soon after the worsening of bilateral relationship, loans from outside were suspended

15. 1.2.3 Foreign trade • As the result of Korean War, China’s trade with western countries was limited, with Hong Kong as the only transit center • Soon after the worsening of bilateral relationship, trade between China and Soviet Union drop sharply

16. 1.2.4 Domestic accumulation • No capital from outside • The only choose was domestic capital accumulation

17. 1.3. Shortage of resources • However, in the early 1950s, the Chinese economy was faced with shortage of resources: • Economic surplus was small and scattered due to the nature of a poor agrarian economy • Foreign exchange was scarce and expensive because of embargo and that exportable goods were limited and primarily consisted of low-priced agricultural products

18. 1.4. Planned economy • Plans and administrative controls replaced markets • State enterprises under plan • Farmers under plan • Consumptions under plan

19. 1.4.1 Plans and administrative controls • Since non-priority sectors were competing with the priority sectors for the low-priced resources, plans and administrative controls replaced markets as the mechanism for allocating scarce credit, foreign reserves, raw materials, and living necessities, ensuring that limited resources would be used for the targeted industries and projects

20. Puppet • Every action was under direct control • Puppet-like economic units: firms, workers, farmers, households

21. 1.4.2 State enterprises under plan • Few non-state enterprises • The state enterprises were like puppets under plans and control • They had no autonomy of employment, plan of production, supplies of inputs, marketing of products, and disposal of profits • Inputs were allocated into manufacturing firms by the state under plan, and state took all of output • The same happened in commercial firms

22. 1.4.3 Farmers under plan • State plan also shaped the evolution of farming institutions in China • Factory-like communes began to be established in rural areas in the late 1950s, where farmers worked together and got hour-based salary

23. Farming worker • Farmers became farming workers, and had no property of land, tools, and gains • Hour-based salary

24. Farmers’ dining hall • Ate in communes’ dining hall • No autonomy in consumption

25. 1.4.4 Consumption under plan • In cities, with low-price input (food, cotton, wage, necessities) and high-price industrial output, profit was invented and accumulated • Kornai: plan economy= shortage economy • Shortage in necessities led to coupon system

26. Food Coupon

27. 1.4.4 Consumption under plan • People living in cities bought nearly everything, including living necessities such as crops, edible oil, cloth, watch, bicycle, etc., by both money and coupons • People could not buy anything only with money

28. 1.5 Achievements of Planned Economy • Set up a comprehensive heavy-industry system within 20 years • Steel works, tankship, oil well, dam, railway, rocket, satellite

29. 2. Planned economy was inefficient • Low allocative efficiency • Low technical efficiency • Low rate of total factor productivity growth • The only way out was reform

30. 2.1. Low allocative efficiency • In China, capital was relatively scarce and labor was abundant • Therefore, the comparative advantages of the Chinese economy lie in labor-intensive sectors • Guided by market forces, profit incentives would have induced entrepreneurs to adopt capital-saving and labor-using technologies and to allocate more resources to labor-intensive industries* • HIDOS and planned economy had low allocative efficiency

31. 2.2. Low technical efficiency • Managers had no incentive for using resources economically • Workers had little incentive to work efficiently • Farm workers had a low incentive to work

32. 2.2.1 Low incentives for managers • Because profits ceased to be a yardstick of efficiency, managers had no incentive for using resources economically • Overstaffing, underutilization of capital resources, and overstocking of inventories were popular in China's state enterprises

33. 2.2.2 Low incentives for workers • No bonus • Little difference of wages • Since income was not related to effort, workers had little incentive to work efficiently

34. 2.2.3 low incentives for farmers • Farming workers • Little difference of hour-based salary • Farming workers had a low incentive to work because the link between reward and effort was weak

35. 2.3. Low rate of total factor productivity growth • Total factor productivity grew by only 0.5 percent between 1952-81, a quarter of the average growth rate of 19 developing countries (World Bank), even much lower than developed countries

36. 2.4 The only way out was reform • China’s income per capita in 1978 was under $100 • More and more people were discontented with the status quo: 1976 Tian’an Men Square Event • The only way out was to reform • Reformists defeat the conservatives after Mao’s death with the support of people in 1976

37. The 3rd-up of Deng Xiaoping • Communist Party of China's (CPC) leaders Deng Xiaoping and Chen Yun at the 3rd Plenary Session of the 11th CPC Central Committee in Beijing held from December 18 to 22, 1978, during which the important decision of reform and opening up policy was made.

38. The reform was originated from the agricultural sector Reform towards market economy then turned into cities All-round reform accelerated from 1992 No one had a well-designed blueprint for China’s reform “Crossing a river by feeling for the stones.” ------Deng Xiaoping, chief designer of China’s reform 3. The main steps of China’s reform towards market economy

39. 3.1. The reform was originated from the agricultural sector • Replacement of commune with HRS • Full official recognition of HRS • End of commune • Amazing performance • A reform from bottom to top

40. 3.1.1 Replacement of Commune • Efficiency of commune was low • Trial and secret reform by farmers in Xiaogang Village, Anhui province, in 1978 • Household responsibility system （ HRS ）** • A year later Xiaogang Village brought out yields far larger than other neighboring collectives

41. Pioneers in Xiaogang village • In December 1978, 18 farmers in Xiaogang village, east China's Anhui Province, signed a secret agreement with blood fingerprint to divide commune-owned farmland into pieces for household contract. • If some of them were put into jail for the contract, other members promised to feed the children of those who were caught to 18 years old.

42. HRS家庭联产承包责任制 • Commune leased land to households • Gains went to: national procurement quota, collective rent, and household-take residual • So what you did was closely related to what you got. Farmers worked more, they got more residual and more income • Incentive compatible

43. 3.1.2 Full official recognition of HRS • After several years of debate, full official recognition of the household responsibility system as a nationally acceptable farming institution was eventually given in late 1981 • By the end of 1983, 98 percent of agricultural collectives in China had adopted the new system • In 1993, the government allowed the lease contract to be extended for another 30 years after the expiration of the first 15-year contract

44. End of Commune • In 1980, Xiangyang County of Guanghan City in Sichuan Province set up a County Government and dropped the name of "People's Commune" from its title

45. End of Commune • An aggregate of more than 56,000 communes was cancelled by June 1985. • County governments and village committees were set up to take place of the egalitarianism communes, thus separating government functions from rural economic organizations

46. New farming unit • Farmers are reaping in their contracted fields, using reaping machines

47. 3.1.3 Amazing performance • China’s cropping sector experienced an amazing 42.2% growth of output in the years 1978-84 • Nearly no deference of weather or agricultural technologies between 1976-84 • Half of the growth, over 20% growth, was driven by productivity change brought about by this institutional reform – Lin Yifu • As the first step of China's rural economic reform, the system has enhanced farmers' enthusiasm in production and liberated rural production forces.

48. 3.1.4 A reform from bottom to top • It was created by farmers at roots • Then got official recognition from authority and spread to the nationwide • A reform from bottom to top

49. 3.2. Reform then turned into cities • Government initiated • First stage (1979-83): several important experimental initiatives • Second stage (1984-86): introduction of profit tax and dual-track system • Third stage (1987-92): contract responsibility system • Last stage (1993-present): modern corporate governance system

50. 3.2.1 Government-initiated reform • Unlike the farming institutional reform, reforms of state enterprises in urban areas were initiated and pushed by the government • From top to bottom