Reform and Development: A Historical Account

Junhui Qian 2014 September

Outline •

The Pre-Reform Economy

• The Command Economic System in China • Big-Push Industrialization • Policy Instability • Strategy and Process of the Transition • Phase-one: reform without losers (1978-1992) • Phase-two: reform with losers (1992-)

Remember a few names… Zhou Enlai, 1955, in Bandung of Indonesia. Mao Zedong, in cultural revolution Deng Xiaoping (left) and Liu Shaoqi (right) Zhou Enlai, the Premier, 1976

The Command Economic System • Ownership • Command-based resource allocation • No role for price in resource allocation • Micro-management of factories

The Price Distortions • Factory products were expensive, while farm products were cheap.

• Compulsory procurement of grain from farmers (since 1953).

• Consumer goods were expensive, while wages were low, albeit higher than the return from farming. • Restriction on labor mobility from the farm to the city. • Implications: • The state-owned enterprises were relatively profitable, despite the inefficiency. • A modern tax system was not necessary, since the government could raise more than 25% of GDP as budgetary revenues.

Big-Push Industrialization • Investment share was high • Most (more than 80%) of investment went to heavy industry • Industry’s share of GDP climbed from 18% in 1952 to 44% in 1978, while agricultural share declined from 51% to 28%.

Why China Chose Big-Push Industrialization?

• Emulation of the Soviet Union • “Dependence Theory” of Economic Development • There are core (developed) countries and periphery countries. Developed countries produce industrial products and export them to developing countries, which export primary goods. According to the theory, periphery countries are dependent on the core countries and are exploited.

• Preparation for War

However, heavy-industrialization was inherently difficult • Construction period was long • Key technology and equipment had to be imported • Initial capital outlay was high

Compare with Industrialization in Hong Kong and Taiwan

Assessing the Big-Push Industrialization • Misallocation of resources • Absence of incentives • In terms of aggregate output, China achieved at best mediocre growth. • In terms of welfare improvement for the average Chinese people, the achievement was even less applaudable. The living standard of Chinese people was even lower than the number suggests.

GDP per cap (Mainland v.s. Taiwan, in USD) 3500 3000 2500 2000 1500 1000 500 0 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 China2 cgdp Taiwan cgdp

The Great Leap Forward “Steel Mills” in the countryside Grains from “harvests” were hauled away.

Great Famine (1959-1961)

Policy Instability • • • • • • • • • • • Economic recovery 1949-1952 The twin-peaks of the first five-year plan 1953 and 1956 Retrenchment: The “Hundred Flowers” of 1956-1957 The Great Leap Forward 1958-1960 Retrenchment: Crisis and Readjustment 1961-1963 Launch of the “Third Front” 1964-1966 Retrenchment: The Cultural Revolution 1967-1969 Preparation for war 1970 Retrenchment: Consolidation and drift 1972-1976 The leap outward and the end of Maoism 1977-1978 A final turning point: The Third Plenum of 11 th CCP Central Committee, Dec 1978

Cultural Revolution (1966-1976)

Legacies of the First Three Decades of PRC • The economy stagnated at an extremely low level. • Almost everybody was a loser by the end of the Cultural Revolution. • • On one hand, there was a deep willingness to experiment and reform.

On the other, political stability was treasured.

Outline • The Pre-Reform Economy • The Command Economic System in China • Big-Push Industrialization • Policy Instability •

Strategy and Process of the Transition

• Phase-one: reform without losers (1978-1992) • Phase-two: reform with losers (1992-)

Remember some faces Deng Xiaoping, the Paramount Leader Zhao Ziyang, Premier and General Secretary Zhu Rongji, Premier

Reform without losers (1978-1992) • Land-contracting in the countryside • Dual-track system and managerial reform in the city

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

Growing Out of Plan: 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 • These led to the tragic Tiananmen Incident in 1989.

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 with losers (1992-) • Market reunification • Privatization • • Recentralization Joining WTO

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.

Summary of Reform and Development • Reform, which was often initiated under pressure from “below”, took places concurrently with economic development.

• • The process of development drove market transition forward. “Development” was often more emphasized than “Reform”.