The Economic Reform of China: Emerging Market Economy

The Economic Reform of China

What is the meaning of reform?
1.0. Introduction
In the late 1970s, China initiated a full-scale economic reform in rural and urban parts of the country, because of the economic reform China has transformed itself from a centrally planned economy to an emerging market economy and at the same time its economy has achieved nearly a 9.5 percent average growth rate. The pace of China’s growth is not unique — Korea, Singapore and other economies in East Asia grew as fast in the 1970s and 1980s. What is unprecedented historically is its scale. The size of China’s population, market and geography, and the dynamism that flowed from economic reform and transformation are what define its impact on the rest of the world. Despite a still relatively low per capita income, the sheer size of the Chinese economy has made China a significant player in world production, consumption, trade and increasingly international finance and the environment.

The historic decision on “reform and opening-up” made at the Third Plenum of the CCP Eleventh Party Congress on December 18-22, 1978, marked the beginning of China’s reform era. At the time, China had a clear desire to increase productivity and raise living standards by reforming its economic system and structure, but it did not have a clear objective of what the new system would be like. Furthermore, the reform did not have a well-designed strategy or policy measures.

China’s economic reform was often distinguished from the market reform of the Soviet Union and many former socialist countries in Eastern Europe. First, unlike the case of the Soviet Union, China did not change its political system and was able to maintain political stability. Second, China’s reform process did not have a blueprint. Each step was taken after drawing the experience of the previous step. As Deng put it, the process was like a person walking across the river by feeling the rocks in each step. This characteristic was necessitated by the lack of knowledge of what kind of market economy was suitable for China on the part of the leaders. They had to learn by experimentation. Secondly, experimentation helped convince the party members of the validity of the new institutions. The slogan “to build an economic system with Chinese characteristics” was introduced in the early 1980’s and remains in constant use in the early 2000’s. “Chinese characteristics” mean the results of experimentation that are shown to work for China. This slogan also implies that the Chinese leaders are pragmatic and not confined to a set of old Communist ideology. Recall Deng Xiaoping’s famous statement, “it does not matter whether a cat is black or white as long as it catches mice.” Pragmatism over ideology is an important trait of China’s reform process.

China’s reform measures that resulted from experimentation include the “household responsibility system” in agriculture, autonomy and the ”contract responsibility system” for state industrial enterprises, the free economic zones as experiments for foreign trade and investment policies, and the introduction of share-holding companies in Jiang Zemin’s report of September 1997 partly as a result of the successful experience of some small and medium sized state enterprises that was initiated by the individual enterprises themselves.

One advantage of China’s economic condition over that of the Soviet Union at the early stage of reform was that the Chinese farmers knew how to farm as private farmers. Collective farming was introduced under the Commune System only in 1958, twenty years before the reform. The farmers still remembered how to farm and they also had some practice in 1963-1965 during the president of Liu Shaoqi who introduced some elements of private farming after the economic collapse of the Great Leap Forward Movement of 1958-62. On the other hand collective farming had been introduced in the 1930’s, sixty years before the reform of the Soviet economy in the early 1990’s. Russian farmers did not know how to farm as individual farmers. The large increase of agricultural productivity in China served as the basis for further economic growth and reform.

In 1977, Deng Xiaoping made it clear that performance should be the main consideration in the economic and social advancement of individuals. In other words, professionalism and results should count. Furthermore, he emphasized the importance of academics and scientists for the future of the economic development and the international standing of China. He thought that this should be more widely recognized by the Chinese people. During 1978, Deng Xiaoping’s reform philosophy gained growing support in the CCP and its desirability was accepted in December 1978 at the Third Plenary Session of the Eleventh Central Committee. This session proved to be a turning point in the direction of China’s policies for its economic and social development. It was decided at this meeting that the system and methods of economic management in China would be transformed; economic co-operation with other countries would be expanded; special efforts would be made to adopt the world’s advanced technologies and equipment; and that scientific and educational work would be greatly strengthened to meet the needs of modernization. The importance of the four modernizations (modernizing agriculture, industry, national defense, science and technology) was emphasized.

2.0. Meaning of reform

2.1. Agriculture
Beginning in 1978 several major institutional reforms have been undertaken. First is the adoption of the household responsibility system in agriculture. Collective farming under the Commune system introduced by Mao in 1958 in the Great Leap Forward Movement was being practiced. Farmers worked as a team consisting of some forty persons. A farmer could not get extra reward by working harder because all members of the team would share the additional output due to his additional labor. Chinese farmers deserved credit for initiating reform in agriculture. Some farmers realized that if they farmed separately the team could produce more in total and still delivered the same amount of output required by the procurement system for government distribution of agricultural products in the economy.

The Commune system was changed as the team was reorganized by distributing its land to individual households to farm separately, each getting the additional reward for additional labor after delivering a fixed amount of output to the team for delivery to the government procurement agencies. Such practice was introduced and spread in many areas of the country. In 1978, Deng recognized its beneficial effects and adopted it as a national policy and called it the “household responsibility system.” Agricultural output increased rapidly in China. The farmers became richer. The success of reform in agriculture served as the foundation of reform in other sectors not only by increasing the supply of food but also by changing the ideological thinking of Communist Party members in support of a market economy.

2.2. State-owned Enterprises
Reform of Chinese state enterprises is an example of a gradual approach to economic reform through experimentation. The first was to give state enterprises some autonomy in production, marketing and investment decisions rather than simply carrying out the decisions under a system of central planning. The experiment began in late 1978 with six enterprises in Sichuan Province. By the end of June 1980, 6,600 industrial enterprises that were allowed to make such autonomous decisions produced about 45 percent of the total output of all state industrial enterprises. The second was to make them financially independent, allowing them to keep the earnings as their own profits after paying taxes to the state, rather than as revenue belonging to the government. The third was to introduce a responsibility system similar to the household responsibility system in agriculture, first to selected parts of the enterprise under the important reform Decision of the Central Committee of the Communist Party in October 1984, and later to an enterprise in 1987. Under the responsibility system, a part of an enterprise was allowed to keep the remaining profit after surrendering a fixed amount to the enterprise controlling it.

In 1987, further reform of the state enterprises was carried out under the “contract responsibility system.” After paying a fixed tax to the government having jurisdiction over it, each state enterprise was allowed to keep the remaining profit for distribution to its staff and workers and for capital investment. Within one year in 1987, almost all state enterprises were under the new “contract responsibility system.” The idea of such a system sounded appealing to the economic officials who designed it, as witnessed by the author who participated at meetings with these officials. However, the incentives provided under the system turned out to be less impressive than expected. First, the so-called fixed levy to each enterprise was not really fixed but was subject to change depending on the profits of the enterprise. The tax was increased when the profits were higher than expected. This partly destroyed the incentives provided by a fixed levy, which would not interfere with the optimal marginal cost and benefit calculations of the enterprise. Secondly, the additional revenue was not put into good use. The managers could not receive sufficient compensation because a high salary to management was socially and ideologically unacceptable. When profits were high the workers received additional compensation in the form of durable goods such as color TV sets and refrigerators because money wage had to follow a fixed scale nationally. The additional reward was not dependent on additional effort. Third, investment policy might not be optimal in the sense that risk taking by a manager was not sufficiently compensated. Forth, the quality of the managers was poor in general because they were not trained under a free market system. Bureaucracy and personal connections determined the selection of manager to a considerable extent.

Significant steps on state enterprise reform were taken in the late 1990’s as stated in the important report of Jiang Zemin to the Congress of the Communist Party in September 1997. China government was to give up ownership and control of small and medium sized state enterprises while keeping the control of large enterprises. Shares were issued for a small or medium enterprise, to be purchased by its managers and staff. The state would give up most of its shares. This would help an infusion of capital to the enterprise. In many instances, the incentives provided to the workers who share a part of the profits were significant. The large enterprises can be transformed to various forms depending on the circumstances, but most of these enterprises were to become shareholding companies of one kind or another, with the state controlling the majority shares. From my point of view, changing the form of ownership on paper alone could not and does not make the enterprise efficient. First, the management itself may not be improved. The lack of qualified managers of modern corporations in China cannot be resolved by such reform. Second, many managers were still selected by personal connections under the Chinese bureaucratic system. One manager told the author that the new system did not change the supervision and authority his former bosses. These same people now became members of the board under the new system. Some managers also complained that the time spent on committee and board meetings increased under the new system. In some instances, the government was willing to sell the entire enterprise to a foreign investor, especially a person of Chinese decent living in Hong Kong or a South Eastern Asian country. There are examples of successful transformation of large state enterprises.

2.3. The Banking and Financial Sector
When the planning system was being changed from “compulsory” planning to “guidance” planning as stipulated by the October 1984 Decision of the Central Committee of the Communist Party a macro-economic control mechanism was to be introduced which required a more modern banking system. Before economic reform, the People’s Bank was a mono-bank that had branches to accept deposits from the public. Its other functions were to issue currency and to extend loans to state enterprises according to the need specified and approved by the planning authority. It had no authority to decide on these loans. Commercial banks did not exist in the sense of being able to extend credits to enterprises according to the criterion of profitability. In 1983 the People’s Bank was nominally transformed into a central bank. Specialized banks, including the Industrial and Commercial Bank of China, Agricultural Bank of China and the People’s Construction Bank of China, were established and given some autonomy in the extension of credits in the early 1980’s in the same way that state industrial enterprises were given autonomy to make production decisions. This led to the rapid increase in the supply of currency in 1984 by 50% and an inflation rate of 8.8% by the overall retail price index in 1985. Reforms of the banking system to serve a market economy (as the Central Committee of the Chinese Communist Party declared China’s economy to be a socialist market economy in October 1992) progressed gradually in the late 1980’s and early 1990’s. In November 1993, the Third Plenum of the 14th Central Committee of the Communist Party decided to accelerate reform of the financial sector by giving more independence to the People’s Bank as a central bank and transforming the specialized banks to commercial banks. Two significant dates are March 18, and May 10, 1995, when the People’s Congress passed respectively the Law on The People’s Bank of China and the Commercial Banking Law. Although there the provisions of these laws were not actually carried out in practice, the laws provide a blueprint for the banking system and serve as a convenient framework for us to understand the working of the system. Banking reform is one important example to demonstrate the rule that institutions cannot be changed by legislation alone.

Besides the banking system, other financial institutions were changed. In 1981 the government formed the China International Trust and Investment Corporation (CITIC) to attract foreign capital. Similar investment trusts under the sponsorship of provincial governments followed. Stock markets in Shanghai and Shenzhen were established in the early 1990s. As pensions were provided under a new social security system, pension funds became an important source for savings and investment. The domestic insurance business, after being suspended for over twenty years, was reopened. Foreign insurance companies have been allowed to operate in China. The financial sector can be expected to expand further as foreign companies enter under the provisions of the WTO.

2.4. Education system
Concerning the education system, while China had a combination of private and public schools at all levels before 1949, the education system was drastically changed in the early 1950’s. All schools were brought under government control, with private schools and universities taken over by public educational organizations. Higher education was modeled after the Soviet education system. Universities were broken up into colleges specializing in technical training. The special technical schools were administered by the government units requiring the services of their graduates. The operation of the education system was seriously interrupted by the Cultural Revolution, with many colleges and universities closed and school enrollment drastically reduced. Ever since economic reform started China’s educational system quickly returned to normal and began to improve. Universities were opened after the interruptions of the Cultural Revolution. Students were given opportunities to take examinations to enter universities and graduate schools. Intellectuals who had been criticized and mistreated were restored to their previous status and given due respect. People were eager to learn. Students seized upon their educational opportunities and studied diligently. The population as a whole wanted to absorb new ideas and knowledge from the outside world since they had been deprived of such knowledge when China was closed to the outside world. Foreign scholars and professionals of all kinds were invited to China to lecture, in schedules so full that even enthusiastic lecturers became exhausted. The Ministry of Education and the State Education Commission from 1985 to 1998, sponsored programs to cooperate with foreign educational institutions to improve education in China. At the same time individual universities were given the freedom to invite foreign scholars to lecture and they did so effectively. Students were sent abroad to study, and were permitted to go abroad by their own initiatives. Modern textbooks were adopted in university courses. Efforts were made to translate modern texts into Chinese and to write new texts in Chinese. As time went on, the skill in modern languages especially English improved rapidly and texts in English began to be adopted.

3.0. Conclusion
In summary economic reform consisted of changes in agriculture system, reform of state enterprises, reform of banking and financial sector, and education system, which the changes taking place step by step depending on the results of and experience gained in previous steps. Many shortcomings of the China’s economic reform remain, but rapid economic growth continues. China’s economic development cannot be understood without taking into account its historical, political and cultural background. Based on the above discussion, we may learn seven major lessons from Chinese economic reforms. First, the most important principle for a successful transition from a planned economy to a market economy is pragmatism. Second, the incremental approach generates the momentum from earlier reform success and thus provides a political basis for the further reforms. Third, successful reforms rely on political support, which in turn depend on delivering tangible benefits to a large majority of the population. In addition, there are high international hopes that China will continue to be an engine contributing to global economic growth for some time to come and signs of economic recovery in China have strengthened global economic confidence in recovery from the current economic recession.