The extraordinary emergence of China during the past three decades has been a hallmark of the global economy, heralding a 21st century world that looks quite different from the previous one. This book serves as an introduction to the economy of China during its reform period since
1979. The aim is to explain China’s remarkable transformation from a centrally planned to a more market-oriented economy through the insti- tutional reforms utilised to support such marketisation and eventually global integration. This is a challenging process, as China is not only in transition but is also a developing economy with many of the problems associated with being a primarily rural, poor country.
The theme is that China’s marketisation process is one that entails a gradual introduction of market forces into areas of the economy, which also requires both dismantling the structure of the centrally planned economy and developing market-oriented incentives. The creation of various types of institutions to support this process of establishing markets will be examined closely. For instance, these include corporate laws to establish private firms, reforms to the wage structure to incentivise labour productivity, and industrial policies designed to attract foreign investment. China under- took much dismantling of institutions from the centrally planned period, but it also must now build the additional institutional foundations to support a more market-oriented economy. This book seeks to explore the interplay between growth and institutions in China, a topic which is of relevance to China and also to the economic development and growth literature.
The structure of the book covers the transformation of the major sectors in the Chinese economy and the reforms associated with the main economic growth factors, such as labour, capital, and technological innovation. The second chapter analyses China’s growth model in terms of transition from central planning, economic development challenges, and eventual integration with the global economy. Institutional reforms have underpinned the gradual marketisation process, and legal reforms look to be increasingly important as China becomes a global player. The next four chapters focus on the reform of the factors that drive economic growth, namely, enterprises, labour, entrepreneurship and capital markets (banking and financial sectors). The latter chapter also touches on China’s indirect role in the 2008 global financial crisis as a pointer to future
reform. In each of these chapters, institutional reforms are highlighted. For enterprises, the mixture of ‘institutional innovations’ such as the Contract Responsibility System (CRS) and corporate laws accompany the process of reforming state and collectively owned firms as well as helping to establish privately owned ones and attract foreign investors. In terms of labour and entrepreneurship, reforming the wage structure and disman- tling the lifetime employment system fed into the development of a labour market that was driven by supply and demand, and allowed entrepreneurs to operate. Governance of capital markets and the restructuring of the banking system constitute a good illustration of the importance of institu- tional reforms of markets. The global financial crisis of 2008 provides an unmistakable impetus for further cross-border regulation of international capital markets that involves China as a major economy.
A detailed exploration of the interplay between legal and economic reforms follows in a chapter dedicated to this central quest on as to how laws and markets evolve in China. The subsequent chapter explores the key issue for long-run growth – innovation and patents – covering the domestic and some of the international aspects of the intellectual property rights system. The penultimate chapter turns to the social foundations of growth, including education, pensions, the health system and lingering inequality, as well as poverty. It points to the ongoing institutional reforms in progress to support China’s marketising economy in those areas. The final chapter concludes the book with an examination of China’s external sector develop- ment, namely, policies concerning trade, investment, and exchange rates. An assessment of the impact of China’s re-emergence in the global economy is also included. The legal and institutional backdrop was most apparent in the ways that China treated foreign investors early on in its reform period, and the chapter concludes with an assessment of how China will fare in an increasingly rules-based international economic system. Therefore, the book assesses China’s marketisation process in terms of how major sectors of the economy have been transformed and the areas in need of continuing reform to sustain its transition and continued development. The gradual injection of market-oriented incentives coupled with institutional reform is the approach highlighted throughout the book.
China’s reform path can be roughly divided into three parts: rural reforms in the late 1970s, urban reforms in the mid 1980s and opening up to the global economy, which took off in the early 1990s and culminated in accession to the World Trade Organization (WTO) in 2001. The fol- lowing provides a brief overview of these pillars of China’s transforma- tion as an introduction to the volume and begins first with an analysis of the centrally planned period (1949–78) that provided the backdrop to market-oriented reforms which started at the end of 1978.
1. THE IMPETUS FOR REFORM
The impetus for introducing market-oriented reforms in China stemmed from the structural imbalances that favoured industry over consumption, deriving from the centrally planned economy from 1949 to 1978. Despite the high levels of investment and rapid growth (estimated to be 12.3% in real annual gross domestic product (GDP) growth) in 1978, the Chinese economy by the end of the 1970s had standards of living that were not much better than in the 1950s. In the indicative category of grain con- sumption, average per capita food grain availability in 1977 was similar to the 1955 level. Average grain consumption of the rural population for
1978–80 was actually lower than that for 1955–57, whereas it was slightly higher in urban areas (Riskin 1987).
Within the state-owned sector which encompassed nearly all of indus- trial output during the command or administered economy, the general freeze on wages after 1957 and the entry of new workers into the lowest rungs of the wage ladder caused the average wage in real terms to fall
17% between 1957 and 1977. Only a large increase in the labour force participation rate – from 30% of the urban population in 1957 to 55% in 1980 – enabled the average per capita income of wage and salary earners to increase by 62% in real terms within that period. Neglect of
‘non-productive’ investment caused the small housing space of 4.3 square metres per urban resident in 1952 to decline to 3.6 square metres in 1977 (World Bank 1983).
However, China did achieve numerous economic and technologi- cal triumphs, including industrialisation, which had eluded so many developing countries. On the innovation front, these included a large machine-building industry, satellites, nuclear weapons, large ships and giant hydraulic presses, and synthesis of insulin. However, these achieve- ments did not translate into an improvement in the real standard of living, technological advances or improved productive efficiency (Chow 1994; Borensztein and Ostry 1996).
Most of China’s industrial growth had come from increases in factors, especially fixed capital, rather than an increase in the efficiency of use of inputs. Even the growth in labour productivity was achieved mainly by increases in the amounts of physical capital per worker. For instance, estimates of the capital-labour index indicate an increase from 100 in 1952 to 373 in 1978 (Riskin 1987). This was due to the structural shifts towards more capital-intensive heavy industries following the Soviet model which were later reversed.
This was the crux of the problem of ‘structural imbalance’ that required reform. Another part is due to systematic reasons familiar to centrally
planned economies, stemming from the deficiencies in the system of eco- nomic organisation, planning and management. This tension became a principal theme of the new economic strategy announced at the Third Plenum of the 11th Central Committee in December 1978, which marked the start of the reform period in China (Chang 1988).
Finally, there was also a problem of high urban unemployment which reappeared in 1978. In 1979, the urban unemployed were thought to number upwards of 10 million or about 9.5% of the estimated non- agricultural labour force of 104 million (China’s National Bureau of Statistics (NBS) 1999). Before 1976, unemployment was largely avoided, by such means as some 20 million urban residents being sent to the coun- tryside after the Great Leap Forward of the late 1950s and early 1960s. Their return likely contributed to the subsequent rise in unemployment figures. The estimated 17 million youth who were sent out to the coun- tryside from 1966 to 1976 were urban residents (Chang 1988). Moreover, during this period, job placement was handled by the state labour bureaux, which were responsible for placing school-leavers, demobilised soldiers, returned youth from the countryside, and released convicts. The burden on the already disorganised state apparatus resulted in many job-seekers spending long periods of time ‘waiting for work’. Enterprises were forbidden to recruit workers and individuals could not seek jobs in compliance with the state’s goal of providing full employment. This com- mitment resulted in general overstaffing (a form of ‘disguised unemploy- ment’) (Knight and Song 2005). This problem was perhaps exacerbated by a continuing gap between urban and rural incomes which resulted in an oversupply of labour at existing wages. The numbers were dependent to some extent on administrative suppression of the movement of labour through a prohibition on rural-urban migration. Other contributing forces include the favoured sector in China’s development strategy being heavy industry, which is capital-intensive.
Therefore, high urban unemployment, stagnating levels of food con- sumption, deteriorating urban housing conditions, falling real wages, widespread rural poverty resulting from the emphasis on industrialisation in urban areas and sluggish productivity growth – all despite rapid eco- nomic growth conventionally measured – could be viewed in the context of the deficiencies of central planning. A reassessment of the structural imbalances and systematic flaws – flaws in the planning, management, and incentive systems under the planned economy – pointed to a number of problems in the economy. These included high levels of capital accu- mulation, coupled with a lack of efficiency and low levels of consumption. There was a neglect of agriculture and light industry as well as of main- taining living standards. The struggle to overcome these structural and
systematic imbalances led to the introduction of market-oriented reforms, whilst retaining a planned portion of the economy consistent with a high degree of governmental control, since unlike other transition economies, China did not embrace marketisation alongside political reform. This became known as the ‘dual track’ transition path of the Chinese economy, in which a planned segment was maintained alongside the market sector.