INR4707-Chapter2Notes.pdf INR 4707
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Chapters 2, 4, 7, 13,16,17,18, 20 book notes. I wrote down the important stuff only from the Chinese Economy book by Barry Naughton (2007), Got an A in the Class
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INR 4707 The Chinese Economy Chapter 2 Notes The Chinese Economy Before 1949 The most common interpretation is that China s economy failed in the nineteenth and early twentieth centuries and that 1949 therefore was a real turning point However there are those that argue that the traditional Chinese Economy was well suited for economic development Thus this particular group of economists stresses continuity between the features of the traditional economy and the rapid growth experience that became so obvious after 1949 The traditional view of Chinese society pre1949 is defended by historians who cite features as the increased pressure on living standards from population growth the absence of qualitative change in agricultural technology the continuing pressure of class division and extraction of rents and other surpluses from the poorest farmers and the risk of famine and disease that threatened the majority of the population To this group the turning point at 1949 is the result of a social as well as economic revolution They see the traditional society as being crippled by unfair distribution of control over land and other income producing assets In their view corrupt political power prevented the emergence of economic growth that could provide benefits to a broad spectrum of the population One side economists believe that China s economic growth is due to the continuity that dates prior to 1949 they stress that there were many favorable conditions already in place that allowed for China s economy to takeoff in such dramatic fashion The other side historians stresses the social discontinuity the presence of radically different social conditions on either side of the 1949 divide In that view the sudden acceleration of growth indicates that some new set of conditions was in place that enabled a takeoff 21 The Traditional Economy 11271911 211 HighProductivity Traditional Agriculture Chinese traditional society was composed of a population in which 90 were living in the countryside Farmers employed a sophisticated agricultural technology that allowed for a high yield of crops but which at the same time depended on the massive and intensive application of human labor Farmers used a traditional triad of farm technology which consisted of 1 elected seed varieties 2 organic fertilizer 3 Irrigation European visitors were impressed by the high yields and the intense utilization of resources they observed The persistent recycling of wastes changed the INR 4707 Chapter 3 Notes The Socialist Era 19491978 Big Push Industrialization and Policy Instability 31 The Big Push Development Strategy After 1949 the PRC followed a socialist heavyindustrypriority development strategy or Big Push strategy Strategic industries with most upstream and downstream linkages eg Steel industry capital intensive The government made most investment decisions coordinated by the plan instead of the market economy The government controlled the bulk of the economy directly and used its control to pump resources into the construction of new factories Investment virtually all of which was government investment increased rapidly to over a quarter of national income By 1954 China s investment rate was 26 of GDP Between 1952 and 1978 industrial output grew at an average rate of 115 Industrial share of total GDP climbed steadily from 18 to 44 while agriculture s share declined from 51 to 28 China with its heavyindustrypriority strategy focused on industries in the upper and middle stages of the industrial economy such as the steel industry An industry such as steel had important downstream linkages because if it supplies highquality low cost steel to machinery and equipment makers it will lower their costs and stimulate development Steel also has important linkages upstream because its growth increases demand for coal iron ore and specialized machinery stimulating the growth of those industries as well Such an approach goes easily with a strategy of national selfreliance and limited openness to the outside world Hong Kong and Taiwan by contrast specialized first in textiles food products and other light consumer goods They concentrated on the downstream end of industrial value chains Hong Kong and Taiwan were also open to foreign markets Cheaper production because of access to lower cost inputs from the world market faster absorption of world technology and faster learning about export markets led to more rapid growth of living standards and ultimately to a more rapid convergence to world best practice 32 The Command Economic System in China The government owned all large factories and transportation and communication enterprises Planners issued commands that assigned production targets to firms and directly allocated resources and goods among different producers Pricing The socialist state intentionally assigned prices to the products of industry owned by the government that were relatively high and assigned prices to the products of agriculture owned by peasant collectives that were relatively low Agriculture seemed to be a lowreturn activity while manufacturing appeared to be highly profitable Surpluses of governmentcontrolled firms made up the main source of government revenue State owned industrial enterprises were thus extremely profitable and served as cash cows this meant that a modern tax system was not required Nomenklatura system A small elite subset of the general population who held various key administrative positions in all spheres of the country s activities government industry agriculture education etc This allowed the Communist Party to have control over jobs within the public sector Control over financial ows and credit was also exerted from the top typically through a state monopoly banking system or monobank Ideological and social control was especially tight The Communist Party rigorously controlled speech and even thought Migration to urban areas was also tightly restricted 33 Policy Instability China s history since 1949 has been a stormy one Changes and even reversals of direction were common in many areas of economic policy Shifts in economic policy often came with sharp political con ict Mao Zedong often portrayed the resulting policy changes as part of his own personal struggle against political opponents Each time the growth of investment in a single year surpassed 20 it signaled a leap forward Each leap is a phase of more rapid investment growth but also corresponds with a period of political mobilization and institutional transformation Leaps also tend to be radical or leftist phases of maximum social change Each leap was followed by a phase of retrenchment consolidation and slower investment growth Thus investment cycles correspond to policy cycles and recurrent policy con ict 331 Economic Recovery 19491952 China faced immediate economic problems Wartime damage to industry and agriculture had been substantial and hyperin ation was raging Chinese intervention in the Korean War also led to a trade boycott against China by the capitalist powers The new communist government was committed to building socialism in China under the Soviet economic model but at the same time being prudent and careful with their decision making In the countryside the party pushed through a radical land reform Between 1950 and 1952 42 of China s arable land was redistributed The Communist Party thus was able to consolidate support among average and poor farmers and destroyed the economic political power of landlords In urban areas the new government took over many factories from the Japanese Capitalists who were willing to stay in China were encouraged to expand production at their factories The government s own investment was focused on the Northeast which was critical to the Big Push development strategy since it contained the largest and most important heavy industries By 1952 economic recovery and rehabilitation had become a resounding success 332 1953 and 1956 The Twin Peaks of the First FiveYear Plan During the 1950s every aspect of Chinese society was subject to massive in uence from the Soviet Union In the first peak 1953 investment was ramped up quickly as part of the beginning of nationwide investment planning on the Soviet model Compulsory agricultural procurement was adopted At the heart of the first FiveYear Plan was the construction of 156 large industrial projects to be built in inland regions or in the Northeast The Soviet Union provided massive training and technical assistance across the board During the second peak of transformation the High Tide of Socialism in 19551956 the transformation to public ownership was abruptly pushed through private ownership was virtually extinguished during 6 months Mao criticized the slow pace at which farmers were joining agricultural cooperatives and his personal intervention was of crucial importance In 1954 only 2 of farm households enrolled in cooperatives or collectives By 1955 it rose to 14 and by 1956 it rose to 98 Attention then turned to the cities where during early 1956 private factories and shops were turned into cooperatives or else joint publicprivate factories with substantial control exercised by the state The year of 1956 was thus the first year that China operated a fully socialist economy 333 Retrenchment The Hundred Flowers of 19561957 In 1956 Nikita Khrushchev denounced Stalin and revealed the crimes of Stalinism Khrushchev then set of global shock waves by declaring that all socialist countries had the right to determine their own path to build socialism Chinese leaders responded by relaxing the political environment while coping with increasingly serious economic problems caused by the stresses and strains associated with rapid growth Nearly five million workers had been absorbed into the state sector in 1956 Average wages had grown rapidly and new bank credit was available to rural areas At the same time however agricultural output stagnated By mid 1956 policy makers stressed the importance of careful gradual change and criticized the earlier policy as reckless advance By September 1956 the Communist Party convened in the eighth congress and openly discussed an economic system that chartered a role for the market and even contemplated the revival and coexistence of different forms of ownership Economic liberalism spread gradually into the political domain and by early 1957 party leaders were calling for open political discussion a movement labeled the Hundred Flowers To some these policies suggested an alternative path to a distinctive Chinese socialism more moderate and market oriented than the Soviet model But this promising future would not be as Mao suddenly spoke out against the Hundred Flowers The turning point that signaled the emergence of the Leap actually came in mid 1957 when Mao suddenly attacked liberal critics who had spoken out in the Hundred Flowers Mao initiated a broad AntiRightest Campaign that targeted nonparty intellectuals and anyone with an independent mind Some 800000 intellectuals were condemned removed from their jobs and even sent to labor camps 334 The Great Leap Forward 19581960 GLF A bold leap toward a fully communistic society within a few years The Leap is considered to be a simple intensification of the Big Push strategy The most basic economic outcome of the GLF was a massive increase in the rate at which resources were transferred from agriculture to industry The essence of the GLF was the attempt to resolve contradictions by doing everything simultaneously regardless of real resource constraints Elements of the GLF 1 Communes Communes were established in the countryside A commune was a large scale bigger than any collective combination of governmental and economic functions It was used to mobilize labor for construction projects provide rural smallscale industries 2 Material incentives and monetary rewards were rejected Bonuses were eliminated in state industry and free markets in the countryside were shut down 3 Control over economic decisionmaking was decentralized 4 A walking on two legs technology policy was established in which simple technologies appropriate to a poor nation were to be combined with advanced industrial technology The top leaders made two fateful decisions 1 First they reduced the supply of production resources labor and even land available for agriculture and especially for food production 2 Second they increased the procurement of grain the compulsory deliveries of food to the state The first decision implied that there would be less food produced in the countryside the second that the state would take more out The reason as to why this was done is because Party leaders began to in ate the numbers as to the actual economic growth of China They became over confident and blinded by their own ideological fervor and the breakdown of their statistical eyes and ears In rural China millions of ablebodied workers were drawn out of agriculture to work in rural factories including highly publicized backyard steel mills Much of the output from the steel mills was unusable junk However the fundamental problem was not the poor quality of industrial output but rather the drain of resources and manpower away from agriculture that was entirely unsustainable In 1959 the party convened a work conference at Lushan to decide on measures to address serious imbalances that were already emerging including local food shortages But again Mao decided to launch a bitter attack on the critics of GLF including Peng Dehui minister of defense Agriculture had been seriously weakened by misguided policies that had destroyed valuable land in an attempt to build water control projects build mines and factories and cut down forests 1960 Great Chinese Famine Harvests were declining and food stocks were being exhausted As the system careened into 1960 local food shortages were ballooning into regional shortages and China was facing a massive subsistence crisis There was also relatively poor weather which made the situation much worse Khrushchev recalled all Soviet advisers from China About 2530 million excess death due to the famine the largest famine of the 20 century anywhere in the world 335 Retrenchment Crisis and Readjustment 19611963 A new set of policies were rammed through at the beginning of the year Investment was chopped back and some 20 million workers were sent back to the countryside Bonuses and other material incentives in industry were revived Existing production was reoriented to the extent possible to provide greater inputs into agriculture China which had been exporting food during the 1950s entered the world grain market for the first time and became a net importer of food 336 Launch of the Third Front 19641966 A New Expansion Hijacked by Radicalism The Third Front was a massive construction program focused on China s inland provinces especially in Sichuan and Guizhou The objective was to create an entire industrial base that would provide China with strategic independence By building factories in remote and mountainous interior regions Mao hoped to ensure that China s industrial base would not be vulnerable to American or Soviet military pressure During 1965 and 1966 investment and industrial production surged as the first stages of inland construction were completed 337 Retrenchment The Cultural Revolution 19671969 The Cultural Revolution was an era dominated by leftist political rhetoric During this period Mao encouraged groups of students called Red Guards to overthrow the entrenched Communist Party leadership except for Mao himself It is usually seen as an attempt by Mao to use young people to revive the revolutionary spirit and cleanse China of bureaucratic tendencies or to purge Mao s opponents in the power structure From an economic standpoint the Cultural Revolution was surprisingly not a particular important event 338 The Maoist Model A New Leap in 1970 Investment surged and consumption was restrained as all efforts went to industrial construction During this period China was operating under something approaching martial law Along with militarization of society came a systematic attempt to revive some of the ideals of the GLF Once again material incentives were criticized and bonuses eliminated once again an attempt was made to develop rural and urban industry simultaneously 5 elements of the Maoist model 1 Militarization of the economy Uniformed army officers were often managing production facilitlies Austerity was encouraged 2 Decentralized operation of the economy Rural industries were encouraged particularly the Five Small Industries that directly served agriculture 3 Relative autarky was practiced Economic links with the outside world were minimized and regions within China were expected to achieve as much selfsufficiency as possible 4 There was an almost complete absence of material incentives bonuses or piece rates There were few markets of any kind for farmers and no market for grain 5 Market driven labor mobility virtually ceased Urban school leavers were sent to the countryside and the government directed manpower and resources to remote inland areas but migration and urbanization halted 339 Retrenchment Consolidation and Drift 19721976 During 1971 economic problems began to emerge once again Industrial growth was once gain outpacing agricultural growth by too wide a margin The steadily swelling ranks of industrial workers were putting pressure on food supply In late 1971 Lin Bao a key Cultural Revolution leader and the head of the military was suddenly purged Also a rapprochement was engineered between China and the United States marked by the visit to China of President Richard M Nixon in 1972 The premier Zhou Enlai took the lead in introducing a new more moderate course Investment was cut back and the priority given to the Third Front was dramatically reduced Some investment was shifted to coastal regions where it could be completed more efficiently Economic relations with the capitalist world were reestablished and a decision was made to spend 43 billion to import industrial equipment Mao brought the moderate Deng Ziaoping a prominent victim of the Cultural Revolution back to power at the end of 1974 However Deng was again ejected from power in 1976 3310 The Leap Outward 1978 and the End of Maoism Mao Zedong died in September of 1976 The new leader Hua Guofeng envisaged a massive investment push that called for the creation of 120 major projects all large in scale and most in heavy industry Hua Guofeng s 10Year Plan was based on the idea that China would use petroleum earnings to pay for highquality industrial capital goods 7 billion worth of contracts were signed but China did not have the oil to pay for the expensive contracts The entire leapoutward strategy collapsed as it became apparent to all that it was infeasible 3311 A Final Turning Point The Third Plenum and the Beginning of economic Reform The December 1978 Third Plenum initiated a new era in the Chinese economy and in Chinese politics Deng Zioping returned and was granted the position of paramount leader There was now an opening of discussion of a number of previously taboo topics In the economic realm a host of new policies were adopted 34 Legacies of the Socialist Period 341 The Legacy of Policy Instability This legacy had some important consequences after 1978 First it generated profound dissatisfaction with the standard socialist system even among CCP leaders While there was no fundamental rejection of the socialist system in the late 1970s there was a remarkably deep willingness to experiment and revise Examples of this was the willingness to experiment with different economic policies during the Maoist years such as the Hundred Flowers and decentralization Second the sharp political divisions meant that CCP leaders could disassociate themselves from the failures of the past by blaming mistakes on Mao Finally China s leaders could find in the past in periods of experimentation or economic recovery policy models that might be appropriate in an era of economic transition The most significant sources of inspiration were the 1956 1957 Hundred Flowers and the agriculturalpolicy experiments in the early 1960s immediately after the GLF famine 342 The Shortcomings of the Development Strategy There were a number of adverse factors associated with the socialist development strategy First the singleminded pursuit of industrial development meant that consumption was neglected Second employment creation was relatively slow Underemployment particularly in rural areas remained a serious problem Third much of the industrial investment was not only capitalintensive but also relatively demanding technologically Plants were often large complex multistage commitments that took years even decades to construct and put in operation Thus the economic return was often low in the sense that capital was tied up for many years without producing output 343 Human Capital Base There was improvement in health and education 23 of the population was literate in 1982 life expectancy at birth climbed to 60 19641982 INR 4707 Chapter 4 Notes Market Transition Strategy and Process By at least the mid1990s China had successfully moved away from the command economy and adopted a functioning market economy Nevertheless many of the institutions necessary for a market economy are rudimentary and further market building and institutionalization are necessary In this chapter the focus is on the overall process of market transition The first phase included the introduction of markets into nearly every area ownership was diversified and competition created all within the framework of the existing institutions The main accomplishments of the second phase have been the remaking of the institutional setup to make it compatible with a market economy the dramatic shrinkage of the state sector and the creation of conditions enabling fair competition among all market participants 41 The Chinese Approach to Transition Eastern Europe and Russia Big Bang strategy The predominant objective of these committed reformers was to move as rapidly as feasible to a modern market economy To converge to the model of neighboring Western European economies and wanted to shed the legacy of Communism as quickly as possible to begin a rapid convergence to this model to start all over from the bottom up Reformers moved too quickly which created a protracted economic downturn and social upheaval China Gradualist strategy Chinese reformers lowered barriers and gradually opened up their system giving individuals and groups the opportunity to act entrepreneurially and meet market demands Early reforms created pockets of unregulated and lightly taxed activity within the system Rural communities were allowed to run township and village enterprises outside the plan because doing so would contribute to local investment and economic growth Foreign businesses were allowed to operate freely in special economic zones because that approach would increase investment in China and might convince foreign corporations to transfer technology to China Early reforms also loosened control over resources so that those distortions encouraged resources people money initiative to ow into these less regulated pockets Reformers wanted to dismantle the command economy while maintaining economic growth Astonishingly there was never any big bang This process was achieved with a minimum of economic disruption and relative social stability 42 How did Reforms Start The Initial Breakthrough in the Countryside The dramatic success of rural reforms cleared the way for continuing and progressively more profound change The rural reforms began with a simple policy decision the government should reduce the pressure under which farmers had operated for the previous 30 years At the end of 1978 China s leaders made a decision to ease the terms of trade with agriculture and give farmers a chance to catch their breath Procurement targets were stabilized and slightly reduced procurement prices were raised and most importantly prices for farm deliveries above the procurement target were raised dramatically Collectives began contracting individual pieces of land to farm households The institution of contracting land to households spread rapidly throughout rural China and became nearly universal by the end of 1983 Agricultural production began to surge By 1984 grain output had surged to 407 million metric tons more than 13 higher than in 1978 There was enough grain for everybody in China Farmers increased grain output while actually reducing the number of days spent in the grain fields Instead they sharply increased their labor input into nongrain crops and nonagricultural businesses The number of workers in township and village enterprises TVEs locally run factories increased rapidly and output from this sector surged as well 43 A TwoPhase Framework of Economic Reform Rural reforms had been achieved with little economic or social disruption largely because a type of dualtrack system had been adopted When farmers contracted for their land they agreed to turn over a certain amount of grain to the government the rest was released to the market Reformers saw in this experience a model of using contracts to stabilize some crucial pieces of the existing economic system while freeing up other pieces The economic reforms from 19781993 are characterized by being overall decentralizing shifting power and resources from the hands of central planners to local actors while core interests were protected often through contracts 44 Elements of China s Transition through 1992 It was Zhao Ziyang himself who was responsible for the day to day policy making that steered the Chinese transition through this first period Zhao s key challenge was to extricate the economy from the grip of commandeconomy institutions which he was able to do China avoided a Sovietstyle collapse by disentangling itself gradually from the institutions of the planned economy 441 Dual39I rack System The Chinese term shuangguizhi refers to the coexistence of a traditional plan and a market channel for the allocation of a given good The dual track implied a tWo tier pricing system for most goods a single commodity had both a typically low stateset planned price and a typically higher market price 442 Growing Out of the Plan Up until 1984 the quantity of steel allocated by central government planners increased in step with production A tiny share of output was sold independently by enterprises After 1984 though the quantity allocated by the central government leveled off and nearly all the increment in output was channeled onto the market that is left to the control of enterprises to sell at the best price they could obtain In the early 1990s quantities allocated began to decline in absolute terms and then dropped precipitously around 1993 After that point the economy had grown out of the plan More output was channeled onto the market 443 Particularistic Contracts In order to make the dualtrack system Work planners signed individual contracts With every stateowned enterprise These contracts specified tax payments and contributions to the materialbalance plan In practice this policy meant there was no regular tax system the de facto tax rate Was specific to an individual enterprise 444 Entry In China the protected industrial sector was effectively opened to new entrants beginning in 1979 Large numbers of startup firms especially rural industries rushed to take advantage of large potential profits in the industrial sector and their entry sharply increased competition and changed overall market conditions in the industrial sector 445 Prices Equating Supply and Demand Beginning in the early 1980s a significant proportion of transactions began to occur at market prices and in 1985 market prices were given legal sanction for exchange of producer goods outside the plan The gradual decontrol of consumer goods prices steadily brought most consumer goods under marketprice regimes 446 Incremental Managerial Reforms Instead of Privatization Statesector managerial reforms were carried out as an alternative to a more radical policy privatization State firms faced increasing competition so government officials were experimenting with ways to improve incentives and management capabilities within the state sector This experimental process focused on a steady shift in emphasis away from plan fulfillment and toward profitability Urgent privatization forms a belief that statesector performance cannot be improved that reformers would then face the difficult task of privatization Conversely the sense that privatization is not imminent lends urgency to the attempt to improve monitoring control and incentives in the state sector 447 Disarticulation Early reforms followed a strategy of disarticulation in which successive sections of the economy were separated from the planned core The early establishment of special economic zones SEZs is the most obvious example of such policies export oriented enclaves were created that had initially almost no links to the remainder of the economy 448 Initial Macroeconomic Stabilization Achieved through the Plan When China s reformers faced serious macroeconomic imbalances in 19791981 they used the institutions of the planned economy to cut back investment and relieve pressure on the economy 449 Continued High Saving and Investment Continued high saving and investment were made possible by a gradual takeover of national saving from government by households The steady increases in household income and the increasing opportunities in the economic environment led to a rapid increase in household saving Reduced government saving was due to a steady erosion in government revenues which itself was ultimately traceable to the dissolution of the government industrial monopoly Total national saving remained high thereby sustaining high levels of investment and growth 4410 Conclusion of FirstPhase Reforms Reduction of the state s monopoly led to rapid entry of new firms Entry of new firms resulted in increased competition while got state sector mangers accustomed to responding to the marketplace Nevertheless the state sector began to grow more slowly than nonstate firms that were entering new markets The economy gradually grew out of the plan as both the plan itself and the state sector as a whole became less dominant elements in the economy Robust saving and investment powered economic growth The phrase two steps forward one step back is used to describe reforms that seemed to advanced strongly in certain years and retreat in other years 45 The Tiananmen Interlude During 19881989 one of the severe cycles of macroeconomic imbalances led to a serious political crisis Urban discontent in 1989 was fueled by a number of factors rising inflation that eroded real incomes anger at corruption and arbitrary privilege and rising expectations about political and economic change there was also the unexpected death of Hu Yaobang who had been an important reformist leader This led to months of demonstrations in China s main square Tiananmen Conservative leaders ordered the military to clear the square by force and ultimately Zhao was ousted After the Tiananmen Square political crisis a period of conservative ascendancy followed between 19891991 However conservative attempts to roll back reforms were completely without success Urban in ation which had seemed so corrosive in 1988 was in fact quickly controlled and market forces corrected other imbalances in the economy with a speed that surprised conservatives and left planners far behind In 1992 Deng took a Southern Tour in which he gave a ringing endorsement to the concept and reality of the SEZs Deng reemphasized the need for accelerated economic reform and specifically reaffirmed a nonideological pragmatic approach to experimentation Development is the only hard truth Deng declared It doesn t matter if policies are labeled socialist or capitalist so long as they foster development 46 The Second Phase of Reform 1993Present Key features of the second phase of reform can also be conceptualized in terms of prerequisites regulatory changes and outcomes The outcomes of this policy regime were a shift from in ation to price stability a dramatic downsizing of the state enterprise sector the acceptance of a moderate amount of privatization and the emergence of a reform with losers 461 Prerequisites 4611 Market Reunification By the end of 1993 materialbalance planning was abolished altogether Particularistic contracts with individual enterprises were also allowed to lapse 4612 Recentralization During the course of more than 15 years of reform China s fiscal position had eroded significantly dropping from 338 of GDP in 1978 to only 108 Fiscal decline was also the logical result of a transition strategy that stressed decentralization of authority and benefits along with releasing resources from government control to the marketplace Key fiscal reforms provided a new broader tax base for the economy and led to a steady revival of government budgetary collections From 1995 onward a modern tax system was gradually built up and by 2004 state revenues had jumped back up to 20 4613 Macroeconomic Austerity There was a gold rush mentality of speculation and financial excess which quickly led to a surge of bank credit and accelerating in ation As a result Zhu Rongji initiated a tough period of macroeconomic austerity in mid 1993 462 Regulatory Approach and Administrative Restructuring By the 1990s with the economy having grown out of the plan the most important tasks were to improve the legal and regulatory environment create a level playing field and reduce some of the most obvious distortions in the economy 4621 Fiscal and Tax System Fiscal reforms in 1994 were designed to arrest the slide in budgetary revenues but also to transition to a broader tax base by implementing a 17 valueadded tax and other business taxes These taxes had relatively low rates compared to the old system but they were uniform and applied to all economic actors 4622 Banking and Financial System The Peoples Bank of China was established as a central bank in 1983 but it remained beholden to government officials at both central and provincial levels The bank was finally given a workable organizational structure in late 1998 when a restructuring plan abolished the provinciallevel branches and set up nine regional branches along the lines of the US Federal Reserve Board The central bank began to play an active role in determining and implementing monetary policy Banking authorities began to tackle the enormous problem of lax financial supervision and nonperforming loans in all state banks In 1999 four asset management corporations were established to take over some of the nonperforming loans of the four big state commercial banks and begin to liquidate them for as much residual value as possible Eventually in April 2003 the PBC supervisory functions were spun off to the newly created China Bank Regulatory Commission 4623 Corporate Governance The passage of the Company Law in 1993 contained provisions for all state owned enterprises to gradually reorganize as limitedliability corporations with clarified corporate governance institutions The systematic restructuring of corporate governance was combined with selective listing of stateowned companies on China s newly opened stock markets which grew significantly during the late 1990s 4624 External Sector Membership in the WTO China had finally acceded to the WTO in December 2001 However accession involved Chinese acceptance of an extraordinarily broad range of regulatory undertakings designed to allow China to harmonize with international standards Moreover WTO accession implied an important further step in the degree of openness of the Chinese economy and in the extent to which foreign goods and companies could compete in China 463 Outcomes 4631 From Inflation to Price Stability After 1996 Chinese in ation was tamed Although cycles were not completely eliminated another expansionary phase emerged after 2002 the overall macroeconomic context swung sharply toward price stability The context of price stability and increased competition greatly intensified the product market pressure on Chinese firms especially public enterprises 4632 State Enterprise Restructuring and Downsizing Public firms faced increased product market competition and pressure on the one hand and reduced access to funding from government banks on the other Gradually stateowned enterprises moved toward a significant restructuring and downsizing encouraged by the government sometimes it even involved privatization 4633 Privatization Privatization often in the form of management buyouts became common in the TVE collective and SOE sectors after the mid1990s More generally private businesses have been given gradually increasing recognition and legitimacy By the end of 2004 the urban private sector without counting foreigninvested firms employed about twice as many workers as the traditional state sector 55 million compared with less than 30 million SOEs 4634 Reform with Losers Reform after 1993 clearly imposed significant losses on substantial social groups Most directly affected were stateenterprise Workers who had been a relatively privileged group in the past Millions have been laid off and further millions have abandoned failing firms Subject to employment uncertainty for the first time since the establishment of the PRC some state Workers suffered precipitous losses in income and social standing 47 Contemporary Challenges INR 4707 Chapter 7 Notes Population Growth and the OneChild Family China Faces timebomb of Ageing Population Demographic dividend An unusually high proportion of working age citizens In 2000 there were 6 workers for every over 60 By 2030 there will be barely 2 In 2009 there were 167 million over60s about 18 of the population By 2050 there will be 480 million while the number of young people will have fallen 71 The Demographic Transition China was already the most populous country in the world by a large margin in the 1800s Despite the fact that birth rates are high in traditional societies population growth is slow because death rates are also high birth rates 30 40 1000 and death rates 20 40 1000 The total fertility rate TFR is around 6 which is the measure of the total number of children a typical woman bears during her lifetime Death rates were high and disease crop failure and civil war undoubtedly caused population to decline in the worst years Between 1850 and 1950 estimated population growth was 03 per year Population growth resumed after 1949 and China s first modern census in 1953 counted 594 million people During the modernization process population vital rates change in fairly regular ways First nutrition and sanitation improve and as a result population health increases As a result of improved health death rates decline Infant mortality rates drop fairly quickly as improvements in maternal care and nutrition take place and a handful of deadly communicable diseases are controlled In the early 1950s rapid improvements in sanitation more equal distribution of available food and control of the most important communicable diseases began to drive death rates down Birth rates remained high and by the mid 1950s the population was growing more than 2 per year China began its own population explosion What causes birth rates to decline 1 Families require fewer births to reach their preferred number of children or target family size because infant survival rates increase and because birth control technology improves 2 The more important factor is that social changes associated with modernization lead families to prefer smaller families and this preference translates into a smaller target family size Social changes redefine the costs and benefits of children to the parents As families move to cities the mother can contribute more to the family s income by working outside the home rendering it more expensive to have her stay home and take care of children the opportunity cost of the mother s time becomes greater Additionally families leaving agriculture have less use for child labor 3 A child s education becomes more highly valued and the costs of supporting children through the end of the educational process becomes greater Therefore parents trade quantity for quality They have fewer children to spend more on education for each child they have 72 China s Demographic Transition China made the demographic transition under unusual circumstances and in less than 20 years vs about a century in the European countries In 1960 China faced a demographic crisis due to the final year of the GLF The GLF caused about 30 million excess deaths from starvation andor aggravated disease conditions which led the surge in deaths and the collapse in births Considerations of longrun trends 1 Despite have a large population with relatively low income levels the sustained decline in death rates occurred because the Chinese government emphasized public health and preventative medicine and promoted a large network of basiclevel health care workers Life expectancy increased substantially from an estimated 41 years in the early 1950s to an official figure of 71 in the 2000 census 2 Birth rates stayed high from the early 1950s through 1970 it was at its highest in 1963 due the phenomenon of replacement births wherein households that had been postponing births or had lost family members during the famine years now had an unusually large number of births as conditions improved 3 Between 1970 1977 China s birth rate decreased by 50 Chinese fertility rate has fallen rapidly and is now probably below replacement level 4 Chinese urban fertility drops fastest and stays lowest among some Asian countries but Chinese rural fertility is the highest Urban society in China has many features that are associated with smaller target family size Urban China displays high female labor force participation high female educational attainment high educational aspiration for children good access to health and contraceptive services and a relatively good social security system Rural households do not have any of the aforementioned features rural households have higher target family sizes because children can contribute to agricultural household income at quite a young age 73 The Role of Government Policy Shortly after China s first modern census in 1953 the government initiated family planning This early program was modest in scope providing contraceptive information and services on a voluntary basis Abandoned in the late 1950s because Mao argued that China s big population was an advantage and that human labor and creativity would allow people to wrest a living and create a better society despite limited resources The Chinese government launched its first allout family planning initiative in 1971 This policy was known as wanxishao or laterlongerfewer meaning later marriages longer spacing between children and fewer children in total The legal minimum age of marriage was increased and couples were urged to wait before having a second or third child There was also the Two child but Wait Policy The OneChild Policy Thomas Malthus argued that food production increased arithmetically while human population grew exponentially He said that man cannot escape from hunger and famine that war famine and disease would check population growth rates China s leaders worried that continued population growth would outstrip the nation s population carrying capacity and obstruct economic development In September 1980 the government formally adopted the OneChild Policy and a target population of 12 billion in the year 2000 The OneChild Policy seeks to convince Chinese families that the most desirable number of children is one and it provides an array of sanctions and penalties for women who have to or especially more than two children The policy called for mandatory insertion of intrauterine devices IUDs for women with one child sterilization for couples with two or more children and abortion for unauthorized conceptions By 1984 domestic resistance and international controversy led the Chinese government to a substantial relaxation of the policy this became known as the OneandaHalfChild Policy The government officially renounced forced sterilization and forced abortion Provincial governments developed implementing legislation that allowed second children to couples if their first child was a girl and or if hardship factors were involved How was the OneChild Policy Implemented Implementation of the OneChild Policy has been delegated to local government Officials at the provincial level and below are evaluated in part on their success in lowering population growth rates in their locality As a result local officials are under substantial topdown pressure to control births and they sometimes resort to actions that contravene declared central government policy such as coercive sterilization or abortion In order to avoid charges that China was seeking to control the populations of nonHan ethnic minorities the OneChild Policy was not applied to minority groups in fact birth rates for ethnic minorities are about double the rate of Han Chinese The OneChild Policy subjects all Chinese households to monitoring of fertility and births In urban areas work units may be assigned birth quotas and couples may sometimes have to wait their turn before being allowed to have even their first child Couples who pledge to have a child receive a 0nechild certificate that entitles them to various privileges including preferential access to day care and schooling If a couple becomes pregnant after their allotted one or two children they will first be subject to pressure from local family planning workers to abort the fetus If the couple goes ahead with an unauthorized birth they will be subject to various penalties such as fines equal to a household s annual income or more If families are unable to pay their belongings may be confiscated or their house might even be knocked down 74 Consequences of the OneChild Policy Regional Variation urban and coastal areas little coercion is required to implement the policy poor and rural areas fertility is significantly above what is permitted by the policy An extremely unbalanced sex ratio Boys are culturally and materially more valuable to many peasant households than girls which leads to an extremely unbalanced sex ratio There are 119 boys born per 100 girls rises to 130 boys per 100 girls in some rural areas 24 million Chinese men of marrying age could find themselves without spouses by 2020 Missing girls More than 12 million girls were missing in the 2000 census In some areas female infanticide may persist but most observers feel that this is not a major cause of the imbalance Many baby girls are simply unregistered with the authorities and not reported to census takers either The most important factor is probably the availability of sexselective abortions since the early 1980s ultrasound machines which can determine the sex of the baby in utero have become widely available throughout China including the countryside 75 Changing Age Structure of the Population China has the advantage of a young population with low dependency rates That is both young and old dependents represent a relatively small share of the population China s Dependency Rate declined to just below 50 in 2000 and it dropped further to 40 in 2005 Declining Dependency Rates led to the rapid growth in per capita GDP over the past 2 decades extremely high domestic saving and investment rates and a young population more adaptable and able to accept the rapid social changes Growth of the workingage population will drop off quickly and reach zero growth after 2015 will lead to slower overall GDP growth Once labor force growth drops to zero the only source of growth of the modern labor force will be migration from agricultural employment The end of the demographic dividend will be caused by fewer workers and more pensioners which will mean a slower rate of increase in output over the next 40 years China is set to see the proportion of elderly to working age people quadruple between now and 2050two elderly people for every five workers Beijing has wanted to raise the birth limits incrementally 76 Conclusion The One Child Policy will cause the number of retirees and the future elderly dependent ratio to increase quickly It has also led to serious gender imbalances that may ultimately lead to discontent and further problems It has also led to the collapse of a credible birth reporting system A rapidly urbanizing and developing Chinese society perhaps no longer requires the extreme measures of the One Child Policy INR 4707Chapter 13 Notes Industry Ownership and Governance Since 1978 China has gone through an industrial revolution China s industry has grown at a real annual rate of around 15 since 1980 By the end of 1999 industrial output was 10 times what it had been in 1978 Institutional change in industry was central to the transition from a planned to a market economy Stateowned industry was at the core of the command economy while privatization and corporate governance was at the core of the beginnings of the Chinese market economy The most important external factor that drove institutional change in Chinese industry was the entry of new firms such as TVEs private and foreigninvested firms that steadily created an intensely competitive product market China has emerged as the industrial workshop of the world 131 Ownership Change A Diverse Industrial Base Entry of new firms was the dominant force that drove a realignment of the ownership composition of Chinese industry While the scale of change has been enormous there has also been continuity most strikingly in the continued role of SOEs 1311 Ownership Change in the First Period of Transition The dominant SOEs carried many burdens SOES were responsible for the welfare health and political indoctrination of their workers Managers had little flexibility and low rewards and they were required to fulfill plan targets and carry out numerous other commands given by various parts of the bureaucracy In the 1980s China began experimenting in incentive mechanisms that is they strengthened the incentives that motivated SOE managers which then allowed for them to shift their orientation toward profitability The new entrants the TVEs came into the reform era largely unburdened by the external obligations of SOEs this is why they expanded so rapidly once allowed into the market place Industrial output of SOEs began to decline rapidly from 77 in 1978 to only 28 in 1999 and back up to 35 in 2004 Collective enterprises also declined from 22 to 6 while private sector actually increased from 0 to 59 of total industrial output 1312 Ownership Change from 1996 through the Present A new wave of industrial reforms began in the mid1990s a milestone was the adoption of the Company Law in 1994 The Company law provided a uniform legal framework into which different ownership forms fit The Company Law provided a framework for corporatizing SOES that is converting traditional SOES into the legal form of the corporation more appropriate to a market economy The corporate form also facilitated eventual privatization and provided an option for new hybrid ownership forms In a sense adoption of the Company Law signaled the intent of policymakers to create a common legal framework in which any ownership form could operate potentially creating a level playing field for competition The adoption of the Company Law signaled the beginning of a new round of institutional change The impact of the gradual reorganization of SOES was overshadowed by the massive downsizing of the state sector Tens of thousands of SOES and urban collective firms were shut down Laidoff workers totaled 40 of the SOE workforce and the urban collective workforce shrank by more than twothirds In 1997 the Communist Party adopted a policy called rasping the large and letting the small go In grasping the large policymakers sought to focus their attention on the largest typically centrally controlled firms in the area of energy and natural resources for example reorganize them into even larger and more competitive enterprise groups and restructure and refinance them while keeping them under state control In letting the small go policymakers were giving local governments much greater authority to restructure their own firms and in particular to privatize or close down some of them In 2003 control of those firms Petrochina and Sinopec large firms that had an annual output of more than 5 million RMB 600000 was transferred to a new organization the State Asset Supervision and Administration Commission SASAC which was designated as the agency responsible for exercising the central government s rights of ownership of nonfinancial firms These firms included petroleum and refining metallurgy electricity and military industry plus telecommunications The persistence of the largescale heavily capitalized and concentrated centrally controlled state sector provides a significant element of continuity in the Chinese industrial ownership structure 132 Industrial Finance Under the planned economy SOEs enjoyed protected markets and generated ample profits for the state In 1978 at the beginning of reforms SOE profits were huge totaling 14 of GDP Entry of new firms especially TVEs created increased competition and the excess profits of SOEs were gradually competed away By 1996 profits were almost zero As SOEs turned over less money to the government so the government provided much less money to SOEs for investment In 1978 the government budget funded 62 of all fixed investment in stateowned units most of it going to industry But budgetary grants declined to less than 3 of industrial investment by 1997 The decline in budgetary finance forced SOEs turn to the banking system for financing SOEs turned increasingly to bank credit without much concern about their future ability to repay and the indebtedness of SOEs steadily increased Debtequity ratio was 12 under the command economy but climbed steadily and reached a peak of 211 by 1994 132 Industrial Finance 2 Since 1994 however SOE debt levels have declined and stabilized to 147 by 2001 Banks tightened their lending standards and began to behave more like commercial banks after the mid 1990s The government was now willing to let nonviable firms fail As a result many of the most highly indebted firms simply closed up during the mid 1990s forcing banks to write off large amounts of unpaid debt The government injected billions into the banking system to allow banks to write off bad loans and restructure debt for existing firms thought to be viable The government injected a sum equal to at least 30 of GDP into the banks allowing them to write off bad loans State owned industry s overall financial position improved in part because of the reduced interest burden in the wake of mass loan writeoffs and in part because the worstperforming firms had been closed Most new finance of firms continues to be from banks rather than through capital markets More than 80 of enterprise funds in recent years have come from banks with a small role for net fundraising from the stock market and an insignificant role for corporate bonds Thus substantial reliance on bank credit continues to be an important characteristic of Chinese industrial SOEs and there is no guarantee that debtequity levels will not begin to climb again 133 Transforming Corporate Governance in the State Sector To transform a socialist enterprise into a profitoriented company required change in multiple dimensions At a minimum the enterprise needed to change its organizational form its objective function the performance for which a manager is rewarded and the prices or signals to which it responds and it needed to face a hard budget constraint that is it needed to be responsible for its own financial performance and debts A soft budget constraint is said to exist whenever a lossmaking company continues to receive financing A completely soft budget constraint then refers to a situation where a firm can consistently lose money for a prolonged period and continue to receive financing or make new investment without bearing any risk or failure Without hard budget constraints managers are free to purse goals like expansion prestige and promotion without worrying about profitability As a result managers develop a virtually unlimited demand for new investment funds known as investment hunger and expansion drive Since demand for investment would expand indefinitely socialist economies would always be resource constrained 1331 Creating Corporate Governance Transition A Corporate governance Refers to the set of mechanisms that induce individuals with de facto control over assets to make decisions that max the value of the company to the owners During the initial period reformers experimented with a variety of incentive devices strongly increasing the rewards given to managers and tying incentives closely to profitability Between 19791983 profit sharing was employed Here enterprises were allowed to draw a specified percentage usually less than 10 from total profit if major targets were fulfilled Between 1986 1989 profit contracting was employed This meant that any profit earned above the contracted level was kept almost entirely by the firm Profit contracting gave more authority and autonomy to mangers which in turn created problems Managers increasingly exercised the residual control rights over enterprise assets it also became more difficult to monitor the manager s consumption Mangers bought and sold products at both planned and market prices creating opportunities to pocket the margin between the two 1332 Creating Corporations Transition B Chinese reformers significantly hardened the budget constraints faced by enterprises The total number of industrial SOEs dropped from 120000 in the mid 1900s to only 31750 in 2004 including all state controlled corporations The new wave of enterprise reform was enabled by an economywide package of complementary institutional reforms Tax reform in 1994 eliminated profit sharing and the practice of profit contracting Banking reforms from 1995 created more professional and independent bankers Social security reforms in the mid 1990s provided alternative funding for millions of workers and retirees in failing firms protecting most pensions and providing some welfare and unemployment benefits Housing privatization created millions of new urban property owners some of whom were laidoff workers Schools and clinics were gradually spun off into independent entities 13321 Corporatization and the Company Law Objectives and Principles Corporatization The Company Law provides a vehicle for the diversification of ownership including partial or complete privatization and the creation of a legal level playing field Objectives of corporatization Give the firm greater autonomy the manager should no longer be obliged to take orders from multiple agencies Depoliticization and profit maximization shareholders now share a common interest of profitability Encouraging specialized government oversight specifying ownership rights and responsibilities and linking these with the appointment power to the board of directors the corporate form encourages the designation of an attentive government monitor with a strong derived interest in profitability 13322 The Chinese System in Practice Slow implementation At the end of 2003 there were still 23000 traditional industrial SOES producing 13 of state sector output The majority of firms reorganizing under the Company Law do not actually have functioning boards of directors Oversight Agencies SASAC was established in 2003 to carry out the government s functions as investor and owner of state assets They supervise ll7 nonfinancial enterprises as of October of 2012 State ownership in 4 sectors National security natural monopoly important public goods or services and important natural resources including pillar industries and high tech sectors 134 Privatization and Hybrid Ownership Privatization has become very significant in China since the end of the 1990s The dominant form privatization to insiders the existing managers and workers of the firm often at concessionary prices Zhucheng 85 of the publicly owned firms were sold to insiders Lianziang Lenovo Converted to a corporation the founding managerial teams were allowed to take a 20 stake in the company as founder s equity MBOs highly controversial in China SASAC has banned insider privatization required competitive bidding encouraged firms to be sold through regional propertyrights exchanges but these requirements are still easily evaded because it is extremely dispersed and nontransparent INR 4707 Chapter 16 Notes International Trade In 2005 China s total goods trade exports plus imports amounted to 64 of GDP far more than other large continental economies such as the United States Japan India and Brazil which have tradeGDP ratios around 20 Yet China began trade liberalization with one of the most closed economies in the world Before 1979 China s total tradeGDP ratio never exceeded 10 161 Background China was not always a closed economy From 1949 through 1960 China was quite open to trade and aid which came almost entirely from the Soviet bloc During the 1950s China shut down most of the Pacific trade After the economic crisis and famine in the late 1950s China began along slow retreat into international economic isolation By 1970 trade with the Soviet Union accounted for only 1 of total China trade The early 1970s were thus the low point of China s relations with the world economy during the period of Maoist self reliance and strategic selfsufficiency From the mid1970s the economy began to recover from the worst of the Cultural Revolution and supplies of light consumer manufactures for export began to increase again Around the same time petroleum output from China s main field at Daqing began to increase rapidly and some oil was available for export 162 The Process of Trade Reform In the late 1970s the domestic economy was rigorously separated from the world economy by a double air lock that controlled ows of both goods and money The first air lock was the centrally controlled foreigntrade monopoly Twelve national foreign trade companies F T Cs exercised monopolies over both imports and exports The second air lock was the foreignexchange system The value of the Chinese currency the renminbi RMB or yuan was set arbitrarily and it was not convertible Individuals had no ability to exchange renminbi for foreign currency without special authorization which was very difficult to get The double air lock system was designed to insulate the domestic economy from the world economy while allowing a few key commodities to pass through the air locks The FTCs bought and sold domestic commodities at planned prices and world commodities at world prices The socialist price system was thus completely insulated from the in uence of world prices 1621 Initial Reform Steps In 19781979 Chinese policy makers opened up new trade channels in the southern provinces of Guangdong and Fujian China s first step in opening came in 1978 when Hong Kong businesses were allowed to sign exportprocessing EP contracts with Chinese firms in the Pearl River Delta In this way the export production network already created by Hong Kong could expand into China but Chinese industrial firms were not exposed to import competition 4 special economic zones SEZs were set up in Guandong and Fujian SEZs allowed imports in duty free as long as they were used in the zone to produce exports Policies like the SEZs and export processing allowed China to selectively promote exports alongside what was still primarily a system of import substitution industrialization 1622 Liberalizing the ForeignTrade System Devaluation Before reform China maintained an overvalued currency In 1980 RMB15 100 by 1986 RMB35 100 In 1994 RMB83 100 After devaluation export became profitable and more expensive imports provided a check on import demand Demonopolization of the ForeignTrade Regime The number of companies authorized to engage in foreign trade was allowed to expand dramatically Industrial ministries were allowed to set up FTCs The old export procurement plan was abandoned in 1988 Significant changes in pricing principles FTCs became much more cost sensitive FTCs sought out cheap producers of labor intensive goods which were often TVEs The share of exports produced by TVEs increased rapidly accounting for one fifth of procurements by FTCs by the mid 1990s On the import side the system steadily adapted to transmit world price signals through to the domestic economy Imports began to be priced according to the agency system in which domestic prices equal the world price plus a commission paid to the importer Creation of a System of Tariffs and Nontariff Barriers As reformers dismantled the planned trade system they erected high tariff walls and substantial nontariff barriers to maintain protection of the domestic market The unweighted mean tariff was 43 and the tradeweighted mean tariff was 32 The most important NTB was the severely limited extension of trading rights Import Substitution and Export Promotion By the mid 1980s China had moved from a planned trading system to a system of high tariffs multiple nontariff barriers and abundant administrative discretion a system that was in many ways typical of developing country ISI strategies China also adopted selective measures of export promotion designed to offset the antiexport bias for at least some products A partial system of rebates of valueadded taxes for exports began in 1985 and expanded in the 1990s 163 A Dualist Trade Regime The ExportProcessing System After 1986 Chinese policymakers started supporting the Coastal Development Strategy All types of firms in the coastal provinces including TVEs were allowed to engage in these processing and assembly contracts The exemption from duties on imported inputs provided a significant cost advantage to those in the EP regime Foreigninvested enterprises FIEs had a privileged status in the foreign trade system different from most domestic enterprises The EP regime and foreign invested enterprises together were the motor of China s export expansion FIEs have increased their share of total exports every year starting from only 1 in 1985 and reaching 58 in 2005 From a small base FIEs gradually became important players in China s export growth and then between 1992 and 2005 they accounted for fully 63 of incremental exports The liberalization of the environment for foreign investment has played a fundamental role in China s export success 164 Toward an Open Economy From the mid 1990s China began to move in the direction of a genuinely open economy Membership in the WTO was a powerful motivating factor 1641 Currency Convertibility 18 months after the 1994 foreign exchange reforms current account convertibility was achieved but China retains the fixed exchange rate 1642 World Trade Organization Membership China became the 143 member of the WTO on December 11 2001 China agreed to lower average industrial tariffs to 94 by 2005 and this rate was actually achieved in 2004 The agreement lowered average agricultural tariffs to 15 which was also easily achieved 165 Outcomes Rapid Growth and Structural Change Each stage of the liberalization of China s foreigntrade system has been associated with a surge in exports and imports 1651 Exports As late as 1985 petroleum was China s largest single export accounting for 20 of export earnings By 1995 all of China s top export commodities were laborintensive manufactured goods The really fundamental changes in the composition of China s exports date to 1985 when we begin to see the impact of the Coastal Development Strategy the fullfledged rollout of the EP trading regime and the increased participation of FIEs in export growth The renewed liberalization of the trading regime signaled by WTO accession has led to a renewed surge in China s trade After 2002 growth of both exports and imports surged above 20 per annum and stayed high In 2003 the share of machinery and electronics items surpassed 50 of total exports 1652 Imports Capitalintensive products have continued to account for about 23 of imports such as steel chemicals synthetic fibers plastic and raw materials Chinese trade overwhelmingly corresponds to comparative advantage principles and is likely of enormous benefit to the Chinese domestic economy 1653 High Technology Trade China is not yet a technology power Virtually all of the hightech electronic goods that China exports about 88 in 2005 are produced under the EP trading regime China is overwhelmingly concentrated on the final assembly stage of production 166 Regional Composition of Trade within China Unequal Distribution of Trade within China The share of China s total exports produced by Guangdong Fujian and Hainan rose dramatically from 16 in 1978 to 46 during the mid1990s but declined to 36 in 2005 Guangdong province is still the single largest exporting province accounting for 31 of China s exports in 2005 The tradeGDP ratio for Guangdong is 178 Since the mid 1990s the Lower Yangtze has begun its own dramatic process of trade related growth This region accounted for 38 of Chinese exports in 2005 TradeGDP ratio 90 The northern regions were a major force in China s trade before the 1980s but have declined steadily in relative terms The share of the three Northeastern provinces slipped below 5 and the region was in danger of becoming economically marginalized INR 4707Chapter 17 Notes Foreign Investment For more than a decade China has been one of the world s most important destinations for FDI Investment began to pour into China after 1992 and annual in ows have been over 40 billion dollars since 1996 FDI in ows were at 63 billion dollars in both 2004 and 2005 China has accounted for about 13 of total developing country FDI inflows in recent years Three distinctive characteristics have marked investment in China over the past decade 1 Foreign direct investment has been the predominant form in which China has accessed global capital as opposed to portfolio capital or bank loans 2 An unusually large proportion of Chinese FDI inflows are in manufacturing industry as opposed to services or resource extraction 3 FDI in ows have predominantly come from other East Asian economies especially Hong Kong and Taiwan 171 FDI in the Chinese Economy Beginning in 19921993 the stream of incoming FDI turned into a ood What changed in 1992 to unleash a flood of foreign investment into China Chinese policy shifts were signaled by a string of remarkable speeches Deng Xiaoping made during a famous Southern Tour in the spring of 1992 When Deng succeeded in relieving the anxiety about China s overall policy direction foreign investors responded quickly because the institutional foundations and FDI friendly policies had already been put in place From 1992 China began selectively opening its domestic marketplace to foreign investors New sectors especially real estate were opened to foreign participation and manufacturers were increasingly granted rights to sell their output on the Chinese market For the first time the huge potential size and rapid growth of the Chinese market played a direct role in attracting foreign investment During the 1980s FDI never exceeded 1 of GDP FDI briefly exceeded 6 of GDP in 1994 but it then settled back to 5 of GDP and has grown more slowly than nominal GDP since then In ows into Guangdong and Fujian scaled to GDP were of course well above the Chinese national average For the 11 years from 19932003 the average annual incoming FDIGDP ratio was 13 for Guangdong and 11 for Fujian These in ows were sufficiently large to transform these regional economies FDI brings a bundle of management experience marketing channels and technology along with the basic in ow of resources FDI has become China s predominant source of technology transfer FDI has played an important role in industrial growth technology transfer and trade expansion 172 Zones The Gradual Liberalization of the Investment Regime The establishment of the first SEZs in China in 1979 became a symbol of the government s commitment to external liberalization With potential opposition from conservatives zones permitted incremental progress within a rigid system They also served as test beds for domestic economic reforms The SEZs also exemplified the pattern of Chinese policymaking during the first era of reform dual track incremental reforms that started by creating a new system alongside the existing one A second wave of liberalization began in 1984 in which 14 new Open Cities including Shanghai were designated along the coast and all set up Economic and Technological Development Zones ETDZS that offered many of the same provisions as the SEZs Moreover they were authorized and encouraged to bargain aggressively with potential foreign investors to facilitate investment in ow At the beginning of the 1990s a third wave of opening of the Chinese economy was announced by the creation of another SEZ that being the Pudong East Shanghai special zone which was created in the heart of China s most developed region for the first time Moreover 18 new ETDZs were approved in 1992 1993 Urban real estate was opened up to foreign investment attracting massive in ows especially from Hong Kong A central government document 1992 No4 allowed experiments in retail and many other service sectors By 2003 there were well over 100 investment zones recognized by the central government There were hundreds of zones run by local governments without central support Now every province has at least one zone 17 3 The Investment Regime Today China has a generally favorable regime for foreign investors today Taxes are moderate investment protection agreements are in place with most countries and an apparatus for arbitration is available The most striking features of the investment regime are its relatively decentralized nature and the high degree of discretion retained by government officials This decentralized regime often favors foreign investors because foreign investors can play localities off against each other in search of a favorable package Eager municipalities may provide concessionary terms on land rental and utility rates While these multiple provisions may benefit the foreign investor they also create difficulties It is not always clear who has the ultimate power to approve a given set of tax rates or land use agreements Some local governments display high levels of professionalism while others are hobbled by corruption lack of training and lack of oversight and transparency National laws and regulations are reasonable but local governments in many cases have no incentive to enforce national regulations and they may have powerful incentive to violate them Navigating the complex institutional environment can be costly for foreign investors 173 Evolution of the Forms of FDI In the 1980s FDI was dominated by contractual joint ventures J Vs and joint development projects Contractual JVs are exible agreements of association that do not necessarily create an enduring legal entity and they are particularly useful in situations in which investment is combined with some kind of service agreement such as hotels After the mid1980s China began to strongly encourage the use of equity joint ventures EJ Vs which became the dominant mode of investment Their predominance EJVs during this period re ected the commonly held beliefs on the foreign side that longterm partnerships were necessary to operate in the Chinese environment and on the Chinese side that such partnerships would facilitate the sharing of information and technology EJVs began to be unpopular because foreign investors found that their incentives were not always closely aligned with those of their Chinese partners While foreign managers were primarily concerned with earning a profit or establishing market share Chinese managers were often concerned with maintaining employment building a larger firm and accessing foreign technology As China evolved toward a market economy foreign investors increasingly felt they could operate independently without the assistance of a Chinese partner and without the con icting motives so often involved in an EJ V The share of FDI in the form of wholly owned subsidiaries of foreign companies has climbed steadily and in 2004 it accounted for exactly twothirds of total realized FDI in ows 174 Sources of Investment in China The largest sources of investment in China come from Hong Kong Taiwan Macau and free ports or tax havens Hong Kong is indisputably the biggest investor in China accounting for 42 of the cumulative total in 19852005 In 2005 123 billion in incoming FDI was from companies domiciled in the British Virgin Islands Bermuda the Cayman Islands and other tax havens In the entire 19852005 period Hong Kong Taiwan Macau and all tax havens accounted for 60 of total FDI in China The developedcountry triad of the United States and Canada Japan and the European Union EU accounted for 25 of the cumulative FDI in China in 1985 2005 175 The China Circle INR 4707 Chapter 18 Notes Macroeconomic Trends and Cycles There are three basic features of the macroeconomics within China s transition 1 Decisionmakers in the household business and government sectors were able to adjust their saving and investment decisions gradually 2 The government budget is an important actor in the longrun shifts in saving and investment behavior and the agent of fiscal policy 3 Credit and monetary policy have been the main drivers in shaping the macroeconomic policy in recent years 181 Trends in National Saving In China national saving was high under the planned economy and it remained high during and since the reform process Under the planned economy governmentrun businesses SOES did nearly all the saving Household incomes were low and household saving was also low Thus the most important transfers of saving along with the overall balance of saving and investment took place Within the state sector The tax system and the banking system were not important After 1978 household saving quickly began to increase from the very low levels that characterized the planned economy As of 1995 households were generating 70 of domestic saving over 25 of GDP What explains the dramatic increase in household saving 1 Income growth accelerated 2 Workingage households had less security in old age given the decline in the number of offspring following the onechild policy 3 Household investment opportunities exploded Households placed their financial surpluses in the banks which lent the funds to enterprises including but not limited to SOES which became heavily indebted or leveraged and to the government which began to run deficits for the first time As a result the banking system through its lending decisions increasingly held the key to macroeconomic stability 182 The Fiscal System and Fiscal Reform Before 1978 the government had raised revenue through profit remittances from SOES there were no personal or enterprise income taxes and indeed no real tax policy at all After 1979 the government introduced a variety of profitretention systems in order to give SOES stronger and better incentives Each SOE negotiated tax rates on a casebycase basis with its own supervising agency Central and local governments were also negotiated on a case by case basis In the early 1990s about 40 of GNP was contributed by the state sector but almost 80 of tax revenues were derived from SOES From 1978 onward fiscal revenues declined steadily Budget revenues reached a minimum at 108 of GDP in 1995 given a budget deficit equal to 1 of GDP expenditures were 118 of GDP at all levels of government The 1994 fiscal reform replaced the traditional revenue remittance system with a tax system that resembles the Western system in many ways it allowed enterprises to compete on a more equal footing reduced the scope of government involvement in the productive sector and allowed the government to focus more on the delivery of public goods and services The 1994 fiscal reform had three crucial elements 1 New taxes 2 A tax assignment and sharing system 3 And a new central government taxation agency The most important of the new taxes was the VAT levied on most manufactured goods at the uniform rate of 17 Very small private enterprises without regular bookkeeping systems were to pay a tax of 6 of gross sales in lieu of VAT In addition a 33 profit tax was introduced with uniform rates for state collective and private enterprises The system of personal income taxes was unified and made slightly more rigorous A consumption tax was also introduced for cigarettes alcohol and a few other luxuries The central government had complete claim on the consumption tax customs duties and most direct and indirect taxes on central governmentcontrolled sectors railroads financial institutions for example Provincial governments had direct control over direct taxes on local enterprises as well as a number of relatively modest taxes including real estate and property taxes and pollution and resource fees The key provision was the designation of most VAT revenues as shared income with 75 going to the central government and 25 to the local government To manage such a system a central government tax agency was created and given substantial authority 1821 Reversing Fiscal Erosion From 1996 through 2005 budgetary revenues increased as a share of GDP every year a remarkably strong showing By 2005 budgetary revenues were 175 of GDP Expenditures were 186 of GDP Since 1995 most of the increase in budgetary expenditures has come in the form of current expenditures for the civilian economy Outlays for administration education and pensions and social security have all increased rapidly 1822 Broadening the Tax Base Horizontal Equity The tax reform succeeded in eliminating sources of horizontal inequity it lowered taxes and made them more uniform thus creating a more level playing field These changes make the tax system more transparent less costly to administer and easier for the public to understand Thre Changes 1 Enterprise profits which had been treated differently depending on their ownership SOES collectives and private firms and on the profit contract were unified into a basically uniform profit tax regime 2 Multiple similar taxes with different tax bases and tax rates including the product tax and business tax were merged into the VAT 3 The movement of the VAT to the central government level improved the uniformity of application of tax and improves geographic equity 1823 Restructuring CentralLocal Relations The 1994 reform dramatically boosted the center s share of revenue collected Since reforms began China has had three different systems linking central and local budgets 1 19791984 At first the central government was dependent on revenues transferred from local governments making more than 50 of expenditures but collecting less than 20 of revenues 2 19851993 The central government spent about the same share of outlays 30 or more as the share of revenues it took in 3 Since the 1994 tax reform the central government has been largely in control of initial tax collections taking in a little over 50 of all revenues The central government spends directly about 30 of all expenditures Local governments are now dependent on central government transfers that pass on about 20 of total revenues to them This arrangement enhances the central government s overall position and gives it a stronger bargaining position visavis local governments 183 The Fiscal System Today The reforms of 1994 largely resolved the central government s fiscal dilemmas However the same cannot be said for the fiscal system at the local level particularly in the countryside 1831 Intergovernmental Fiscal Relations Principles Centralization in revenue collection While having decentralized budgetary expenditures 1832 Inadequacy of Local Government The Chinese system remains highly centralized No local government has the right to levy new taxes or change rates on existing taxes In practice rural local governments are highly constrained in the types of taxes to which they have access Responses to the Weak rural fiscal system have come both from localities in the form of extrabudgetary funds EBF 1833 Extrabudgetary Funds Levies and Charges Extrabudgetary funds come under decentralized management and allocation by different agencies and organizations and they are earmarked for specific uses Negative elements of EBF 1 Reliance on extrabudgetary funds creates further funds inequities across regions and across government agencies 2 Tax avoidance by the local governments against the center 3 There is an uncontrollable proliferation of fees and levies which in turn leads to social discontent 1834 Abolishing Local Taxes and Stepping Up Transfers In the first decade of the 2000s a relatively consistent approach to the problem of rural finance has on the increased transfers from higher levels of government and reduced local taxation of the farm economy This approach first became evident during the Western Development Program WDP As part of the WDP higherlevel budgetary authorities began providing direct subsidies for administrative personnel and education to poor counties in the western regions Central money is used to cover deficits in local social security funds bring government personnel wages up to national standards and pay relief to unemployed workers On January 1 2006 China abolished agricultural taxes Ending the agricultural tax substantially reduces the tax burden on farmers and also significantly shrinks the tax base of local governments The agricultural tax at around 60 billion yuan only accounts for 22 of budgetary revenues 1835 Arbitrary Nature of Transfers In 2000 487 of transfers are discretionary ad hoc payments from the center Many of the discretionary payments are earmarked for good purposes western development education social security and government wages in poor areas are all prominent justifications Disadvantages of arbitrary centrallocal transfers 1 Since the transfers are not guided by an overall developmental framework they are not very effective in transferring income to lower income regions 2 Local government officials have strong incentives to be seen as needy by upper levels of government They do not have the confidence that they will continue to receive budgetary support if they improve the governance and living conditions of their populations 184 Fiscal Deficits and Fiscal Policy Chinese fiscal policy has tended to adapt to macroeconomic conditions rather than shape them Chinese budgetary deficits have generally been modest Between the 1980s and early 1990s deficits were at 1 of GDP After 1998 fiscal policy shifted gears as China was faced with the rising unemployment resulting from state sector downsizing and the external effects of the Asian financial crisis The Chinese government began to implement expansionary fiscal policies between 2002 to 2002 the government increased its deficit to well over 2 of GDP In 2005 deficits were cut back to 11 of GDP China faces a challenging set of future spending demands including the restoration of capital to debtridden state banks and welfare payments to pensioners and the unemployed A recent attempt by the Chinese Ministry of Finance to account for all types of government obligation came up with a figure of 55 of GDP To meet the needs of funding future debt levels China needs both to push through reforms to its tax system and create more vibrant capital markets which would allow it to raise more money through taxation and privatesector financing 185 In ation and Macroeconomic Cycles Overall inflation in China has been moderate since the reform era began particularly in comparison with other transitional economies Nevertheless China has been troubled by persistent boombust cycles in which periods of unsustainably rapid in ationary growth have been followed by periods of macroeconomic austerity and slower growth Expansionary phases have generally been accompanied by significant decentralizing reforms and relaxed supervision of the industrial financial systems Contractionary phases have generally been accompanied by macroeconomic austerity measures low inflation and slow economic growth 19881989 Inflation jeopardized the economicreform process and fueled popular discontent thereby contributing to the political crisis that culminated at Tiananmen Square on June 4 1989 19931994 Incomes rose rapidly enough that most residents experienced real improvements in living standards notwithstanding the in ation After the in ationary surge of 19931994 Chinese policy makers declared their intention to achieve a soft landing By the end of 1997 a soft landing had been achieved as inflation was brought down to zero 186 Monetary Policy Under the planned economy the uses of money were circumscribed by the plan while conversely households faced frequent shortages of consumer goods so money did not carry the full range of purchasing options it carries in a market economy In China monetary policy adopted more gradually to the needs of a market economy Why didn t interest rates play a stabilizing role in China 1 Interest rates have never been deregulated and have never been free to play a stabilizing role 2 Adjustments have never been quick enough to fully re ect the range of cyclical factors Thus real interest rates have been significantly negative during times of high in ation and significantly positive during times of minimum inflation Such interest rates are automatic destabilizers INR 4707 Chapter 20 Notes Environmental Quality and the Sustainability of Growth Environmental Kuznets Curve According to this conception pollution and other environmental problems worsen during the early stages of economic growth and then begin to improve as a country reaches middleincome status In terms of technology early stages of industrialization often a involve rapid spread of relatively crude production techniques that produce lots of byproducts and pollution In terms of preferences poor people understandably place priority on economic growth to increase income and consumption Public environmental quality is a luXury good and demand for environmental quality at low income levels is therefore initially limited but it increases rapidly as incomes grow above a certain level Pollution Pollution causes the largest current costs Urban air pollution causes more than 100000 excess deaths annually and millions of dollars in health care costs China s city dwellers are beginning to demand improvements in the air The sustainability of resource use In these cases economic activities result in impairment of the natural system s ability to replenish itself but the costs of this resource depletion are not necessarily apparent in today s economy 201 Pollution Air and water pollution are damaging to human health worker productivity and agricultural output At the same time some efforts to control pollution have begun to have an effect 2011 Air Pollution In China s cities today air quality has been improved by industrial emission controls and by the shift in household fuel use away from coal Household use of coal has dropped off dramatically from its peak in 1988 88 of the urban population now has access to gas for cooking Indoor air quality in many urban households has improved significantly as gas electricity and central heating have spread However in rural areas indoor air pollution is still a severe problem Indoor air pollutants contribute to high rates of respiratory disease the leading cause of death in rural areas and the thirdleading cause in cities The growth of industry and the growth of automobile transport are causing an increase in pollutants The biggest negative impact on air quality has come from the dramatic increase in trucks and automobiles The total number of vehicles in China soared from 55 million in 1990 to 43 million in 2005 2012 Water Pollution Since 1980 the quality of China s surface water and groundwater has deteriorated significantly under the pressure of rapid industrial development brisk population and urban growth and increased use of chemical fertilizers and pesticides Main sources of pollutants include the following 1 Industrial Waste Pulp and paper metallurgical and chemical factories are the worst polluters There has been major progress in cleaning up large scale factories and today 90 of industrial wastewater from regulated large scale industries receives some kind of treatment However smaller factories including township and village enterprises often have no treatment facilities at all 2 Municipal Waste Only a reported 42 of municipal wastewater was treated 2003 3 Agriculture Pesticide use more widespread in recent years has been implicated in species loss birds and has polluted some important water bodies Animal waste from lifestock farms is another major source of pollution Intensively used nitrogen fertilizers and pesticides are a serious source of water pollution As a result of these pollutants water quality is poor especially in the watershort northern regions 2013 Costs of Pollution
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