1

China’s Opening-up and Reform

Yan ZHANG （张晏）

China Center for Economic Studies School of Economics Fudan University

Part I. China’s Economic, Political and Social Foundations

Lecture 1. Introduction: Understanding China’s Miracle

Introduction: Understanding China’s Miracle

• China’s Economic Progress: 1978-present

1.1 Brief History: Before & after 1978

v For centuries China stood as a leading civilization, outpacing the rest of the world in the arts and sciences.

v But in the 19th and early 20th centuries, the country was beset by civil unrest, major famines, military defeats, and foreign occupation.

The Last Emperor Chiang and His Wife

The first lady, Meiling Soong, spent ten years in the States and graduated from the Wellesley College, MA. With excellent spoken English and diplomacy skills , she helped China get some supports from the American government and public during World War II. . On February 18, 1943, she became the first Chinese national and second woman to address both houses of the U.S. Congress.

2

1.1.1 China in 1949

v After World War II, the Communist Party under Mao Zedong established a socialist system that, while ensuring China's sovereignty, imposed a closed and centrally planned economy.

Help you to understand what a planned economy is and how difficult it is to form a consensus on economic transition

Mao Took Over

Mao and His Son

His son died of the Korean War, which ended China’s 4000-year history of hereditary system.

Mao and His Colleagues

Mao and Stalin Chronology of Centrally Planed Economy

v 1949-1952: Recovery from Wars v 1952-1957: 1st Five Year Plan v 1957-1958: Great Leap Forward

Movement v 1959-1961: Hunger and Starvation v 1962-1965: Retrenchment from GLFM v 1966-1976: Cultural Revolution v 1976-1978: Transitional government

3

Development Strategy and Social Structure: 1949-1978

v Strategy of Import Substitution and Heavy Industry;

v Agriculture as Source of Financing Industry;

v Urban-Rural Division; v Collectivizing Farmers and Workers;

Economics of Comparative Advantage

v Initial endowments and comparative advantage；

v Trade pattern: export promotion or export-oriented growth strategy

CPE1: Import Substitution Strategy

v Ignore the initial conditions; v Develop the capital intensive

industry as a substitute for imports;

v Closed economy; v Focus on heavy and chemical

industry;

CPE2: Planning Mechanics

v Allocation of resources through planning apparatus;

v Prices are fixed below market levels including inputs prices such as interests rate, wage rate, and etc.

v State-owned enterprises as production units in manufactures and team production in agriculture

v Government procurement system to hand the distribution of products.

Coupons CPE3: Rural-Urban Division

v Immobility of population and Hukou System;

v Collectivization and agricultural production;

v Work point system and problem of efficiency: Costs of monitoring and productivity.

4

Maoist Legacy

v Large rural population; v Rural-urban division; v Infrastructure Build-up; v Rural Social Security; v Multiple Property Rights (M-Form); v Homogenous Society;

The Cultural Revolution

People’s Commune System

Justin Lin?

People’s Commune System

“To Live”

v Actor: Ge You v Actress: Gong, Li v Director: Zhang, Yimou v Cannes Film Fest.1994

Best Actor Award v banned in mainland China due to its critical

portrayal of various policies and campaigns of the Communist government. Zhang Yimou was also banned from filmmaking for two years.

1.1.2 China in 1978

v New era of China v DENG Xiaoping’s era: 1978-1994

� Time, Person of the Year 1978, 1986

5

A Tale of Two Theories

v For economic growth, political liberalization must be put ahead of economic reforms;

v Political or social stability is maintained by continuous economic growth;

Jeffrey D. Sachs Professor of Economics and Director of the

Earth Institute at Columbia University. He is also a Special Advisor to United Nations ex-

Secretary-General Kofi Annan on the Millennium Development Goals.

The Beijing Consensus- Joshua Cooper Ramo

v The former Foreign Editor of Time magazine argues that there is a new “Beijing Consensus” emerging with distinct attitudes to politics, development and the global balance of power.

Post-Washington Consensus

v De-politicalization; v Liberalization; v Privatization; v Macro-stablization; v The quicker, the better;

1.2 China’s Development Strategies: What Has China Done?

v Putting Economic Reform Ahead of Political Reform;

v Micro-Reform First; v Incremental Reform (Growing Out of

the Planning); v Bottom Up Reform; v Trial and Error;

Post-Reform Era(1978-)

v Liberalization of markets of production and partially opening of factor markets.

v Gradually removal of planning system; v Opening-up; v Allowing new economic sectors to

emerge and expand; v Decentralization of decision-making

power and delegation to local governments

6

Evolutionary Nature of Reform （1）: Dual track pricing

v Dual track pricing: prices are decontrolled for above-quota production and sales; two prices coexist for the same production and sale. The merit of dual pricing is that it avoids the collapse of state sector due to sudden breakage of government delivery. The government, however, reduces the quota over time, and there will be a tendency for convergence on market prices.

（2）Incremental Reform

v  Incremental reform: liberalization is only allowed and designed for expanding or creating a new economy (sector) rather than making the whole economy (or sector) out of government control; new part of economy is growing out of the plan;

（3） Experimental Reform

v  Experimental reform: reform programs are not generally designed by the central government, in many cases they are even not implemented universally. Reform is carried out in trail-and-error mode. Some guiding principles are set by the central government, but the central government will encourage the local governments to find their better way to customize and implement the reforms.

（4）Local Specifications

v Reform programs are often modified and adapted to local specifications. The ways of privatizing local SOEs in China, for example, were so divergent, and when there was resistance from local, the central government would allow for change in the program.

（5）Micro vs. Macro Reform

v  Micro reform is ahead of macro reform: the reform programs initially focus on getting incentive right in production and product markets, rather than getting prices rights in factor markets. Though China is gradually liberalizing some prices in product market via dual-track pricing strategy, most factor prices are not liberalized radically compared to Russia in order to maintain a smooth transition. Micro reforms are generating continuous dynamics of output growth.

（6）Economic vs. Political Reform

v  Economic reform is ahead of political reform: economic reforms are carried out within the political system. Though China experienced fiscal decentralization, the Party/Central Government remains the control over local officials and the political control makes macro-stability easier. Social and political stability is required for a better result of economic liberalization, and Chinese leaderships are managing the stability for economic development.

7

1.3 Dual Track Approach Cases: China’s Important Reforms after 1978

v The top 3 reforms which had largely changed China: � Household Production Responsibility System (HPRS)

in 1980s----Rural productivity � Housing market reform----Urban lands � Joining the WTO----Technology, management, etc.

v Other reforms � SOE reforms; price reforms; fiscal reforms; financial

reforms; v What’s the next reform that will totally change

China?------Rural land reform?

What is Dual-track Approach

v Dual Track Approach: the plan and the market coexist. � Track 1: planned � Track 2: market

v Price dual track: � Planned track: to meet the price and output quota � Market track: to sell the above-plan output to the

emerging product market

Dual Track: Lau, Qian & Roland (2000)

v The basic principle of the dual-track approach is as follows. � Under the plan track, economic agents are assigned rights to and

obligations for fixed quantities of goods at fixed plan prices as specified in the pre-existing plan.

� In addition, a market track is introduced under which economic agents participate in the market at free market prices, provided that they fulfill their obligations under the pre-existing plan.

v under such “limited market liberalization”, planned suppliers must physically produce all plan-mandated output deliveries and physically use all plan allocated inputs themselves even though it might have been cheaper to sell the inputs on the market track and purchase the same output from the market track for redelivery.

Several cases of the dual track approach

v Agricultural Goods v Industrial Goods v Labor market v Others

Case 1 The Dual Track Reform in Agriculture: Lau, Qian & Roland (2000)

v Agricultural reform: the first successful application of the dual-track approach

v In the agricultural reform, the dual-track approach was introduced simultaneously with the household responsibility system, which essentially made farm households residual claimants (Lin, 1992).

The Dual Tracks in Grain: Lau, Qian & Roland (2000)

8

The Dual Tracks in Agricultural Goods: Lau, Qian & Roland (2000)

Between 1978 and 1990, the agricultural output of China doubled. Table 2, therefore, provides evidence of the huge supply response to the introduction of the market track in agriculture.

Case 2 The Dual Track Reform in Industry: Lau, Qian & Roland (2000)

v Industrial goods: The most noticeable and often cited application of the dual track approach

v As for consumer goods, urban residents continued to have the right to purchase grain, meat, electricity and housing at the same pre-reform prices and within the limits of the pre-reform rationed quantities. But at the same time, they were also free to buy the consumer goods from the free market at generally higher prices.

The Dual Tracks in Retail Sales Dual Pricing in Industrial Goods

v The first incidence of use of dual pricing in industry was for crude oil in 1981, when the government allowed the export of above-quota crude oil at a higher price.

v  In 1984 the government permitted the market track for all industrial goods but with a restriction of market price range to be within 20% of planned prices, and such a restriction was removed in early 1985 (Wu and Zhao, 1987).

v As a result, the share of transactions at plan prices, in terms of output value, fell from 100% before the reform to 64% in 1985 and further to 45% in 1990 (China Reform and Development Report (1992-93), p.54, and Xu, 1988, p.292). This provides evidence of the decline of the plan track relative to the market track but also of the relatively effective enforcement by the state of the plan delivery obligations (otherwise the share would have declined to zero).

Dual Pricing in Industrial Goods

v Next Table 3 presents the cases of coal and steel, two of the most important industrial commodities which were also the most tightly controlled under central planning.

v For coal, China's principal energy source, the planned delivery had some slight increases in absolute terms during the 1980s, but the market track increased much more. The increments came mainly from small rural non-state coal mines run by individuals and township and village enterprises. As a result, the share of the plan allocation declined from 53% in 1981 to 42% in 1990.

Dual Pricing in Coal

v Outside the planned delivery, some local state-owned mines might be subject to local plan. However, according to Byrd (1991), of the total incremental output between 1978 and 1984, 21.2% were from "unified allocation coal mines" (most of them were under central plan), 8.4% from local state-owned mines, and 70.4% from non-state mines which were under the market track.

v Similarly, Naughton (1995) figured that of the total increment between 1983 and 1987, the central government mines accounted for 27%, local state-owned mines contributed for 1%, and the non-state mines contributed for 72%. Therefore, the picture will not change even if we don't know exactly how local state-owned mines allocated coal.

9

Dual Pricing in Steel

v For steel, the plan track in absolute terms was quite stable ( with a slight decline after 1987), but the share of plan allocation fell from 52% in 1981 to 30% in 1990.

v Unlike coal, the supply response in steel came mainly from large SOEs rather than small non-state firms (Byrd, 1991). In both the cases of coal and steel, because the plan track is essentially frozen, the economy is able to "grow out of the plan" on the basis of the market track expansion by state or non-state firms (Naughton, 1995).

The Dual Tracks in Industrial Goods

Case 3 The Dual Track Reform in Labor Market: Lau, Qian & Roland (2000)

v China's labor market reform started with limited market liberalization. China's high saving (investment) rate provides the potential for the rapid creation of new jobs in the market track without privatization of the SOEs.13 Table 5 shows that between 1978 and 1994, employment in the non-state sector increased by 318.8% (with the urban non-state sector increasing by 171.4% and the rural non-state sector by 426.4%), while employment in the state sector (including civil servants in government agencies and non-profit organizations) increased by only 50.5%.

v But within the state sector, there are two tracks.

The Dual Track Reform in Labor Market: Lau, Qian & Roland (2000)

v But within the state sector, there are two tracks. � Beginning in 1980, while pre-existing employees

maintained their permanent employment status, most new hires in the state sector were made under the more flexible contract system and often at lower wage rates.

� Table 5 shows that employment in the plan track has been virtually stationary -- it went from 87.14 million in 1983, the eve of the introduction of economic reform in industry, to 83.61 million in 1994.

The Dual Tracks in Non-agricultural Employment The Dual Tracks in govt. Bureaucrats

v A similar dual-track scheme is applied to senior government bureaucrats. � In the early 1980s, the old revolutionaries who joined the

government in 1949 were allowed to keep their benefits and ranks and were not forced to retire.

�  But for all new appointments in the government, there have been strict age limits--65 for ministers or provincial governors, 60 for vice ministers or vice provincial governors, and 55 for bureau directors. There are also term limits as well--two 3- or 5-year terms. Mandatory retirement has also been imposed.

10

The Dual Track Reform in Labor Market: Lau, Qian & Roland (2000)

v  limited labor market liberalization had led to over employment as compared with the full market liberalization outcome. Mass labor furloughing and reallocation by SOEs have become a major nationwide phenomenon since 1994. In 1996, approximately 10 million factory workers lost their jobs (China Daily, April 5, 1997), but these furloughed workers are compensated.

v Two schemes used for protecting workers' pre-existing rents are xiagang ("stepping down from one's post") and zaijiuye ("reemployment"). Xiagang workers continue to receive a partial salary, housing, health care, and other benefits from their enterprises. Many furloughed workers were retrained through zaijiuye projects and later found jobs in the non-state sector.

The Dual Track Reform in Labor Market: Lau, Qian & Roland (2000)

v By the end of 1996, out of the 8.91 million xiagang workers, 3.57 million had found jobs, 2.34 million had decided to stay home, and 3 million were still looking for jobs (Cao, Qian, and Weingast, 1999). Although the interests of furloughed workers in the SOEs are protected, workers outside the state sector, say, some migrant workers from rural areas will suffer as a result of full market liberalization because both the market equilibrium employment and wage rate are lowered. This is precisely the result of sequential dual-track liberalization of the market.

Case 4 Other Dual Tracks in China

v Housing marketization reform � Employees who had not joined in SOEs or public

sectors before the year 2000 have to accept a lower housing subsidy.

v Hiring “turtle” professors in a new track � Discussion

v Others?

Benefits of the Dual Track Approach

v More Outputs, then lower prices � E.g. TV Sets: profits/output/competition/price

v Establishment of market economy � Reduce the allocation distortions and managerial

slacking v No losers

� Pareto-improving dual track approach

v Less political oppositions v Model of incremental reforms v ……

Dual Track vs. Big Bang: L-Q-R (2000)

v While the “single-track” (or “big bang”) full market liberalization will lead to efficiency under the usual conditions such as profit maximization and perfect competition, Pareto-improvement cannot in general be assured.

v In contrast, the dual-track full market liberalization provides a useful way to implement a reform without creating losers while simultaneously achieving efficiency under the same conditions.

No loser: the dual track in agriculture reform

v The agricultural market liberalization illustrates that the dual-track approach can be both Pareto-improving and efficient. The commune (and later the households) is assigned the responsibility to sell a fixed quantity of output to the state procurement agency as previously mandated under the plan at predetermined plan prices and to pay a fixed tax (often in kind) to the Government.

v It also has the right (and obligation) to receive a fixed quantity of inputs, principally chemical fertilizers, from state-owned suppliers at predetermined plan prices. Subject to fulfilling these conditions, the commune is free to produce and sell whatever it considers profitable, and retain any profit.

v Moreover, the commune can purchase from the market grain (or other) output for resale to the state in fulfillment of its responsibility. There is thus full market liberalization.

11

1.4 Economic Centralization & Political Decentralization

v Definition: � Centralization

•  All resources are controlled by the government instead of the market, or by the higher level government instead of the local governments.

� Decentralization •  Devolution

–  Govt. vs. individuals –  Central vs. local

Economic decentralization in China

v Economic decentralization: � Govt. vs. individuals � Central vs. local

v Incentives � Work harder � Hide wealth? � Local competition

Political Centralization in China

v Political centralization � official promotion systems in China � Election & Democracy

v Incentives � Yardstick competition for growth

Federalism Chinese Style

v Economic decentralization & political centralization � official promotion systems in China � Election & Democracy

Social Structure in China

v Relationship-based vs. contract-based v Relatives vs. strangers

v Decreasing role?

Political Institutions

v National People's Congress (NPC) v Chinese People's Political Consultative

Conference (CPPCC) v CPC (Communist Party of China)

� The Third Plenary Session of the18th CPC Central Committee: Nov. 9-12, 2013

12

2014/5 NPC & CPPCC SESSIONS

v Give up the 8% goal: � China sets its GDP growth target at 7.5(7%)

percent this year, down from 8 percent in 2011, according to a government work report to be delivered by Premier Wen Jiabao at the parliament's annual session Monday.

� This is the first time for the Chinese government to lower its economic growth target after keeping it around 8 percent for seven consecutive years.

China and the World

v China's economic transformation matters: � Slower growth, better quality � Lower pressure on the commodities � Lower interest � Negative effect to resource-related countries � ….

References

v Blanchard, Oliver and Andrei Shleifer, 2001, “Federalism with and without Political Centralization: China versus Russia,” IMF Staff Papers, 48, 171-179.

v Wang, Yongqin, Yan Zhang, Yuan Zhang, Zhao Chen, and Ming Lu, 2007, On China’s Development Model: Costs and Benefits of China’s Decentralization Approach to Transition, Economic Research Journal (Jingji Yanjiu), Vol. 42, 4-16.

v Wang, Yongqin, Yan Zhang, Yuan Zhang, Zhao Chen, and Ming Lu, 2006, China at the Crossroad: A Review, World Economy (Shijie Jingji), 3-20.

v Zhang Jun, 2006, “Triggering the economic growth in post-reform China”, Working paper.