Preliminary Economic Concepts and Principles:



China’s Transition from a Centrally Planned Economy to a Market Economy:

(“Global Economics” – Chapter #18 and “The Commanding Heights” – Chapter #7)

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Present state of People’s Republic of China:

• Population = 1,330,141,295 (roughly 20% of World population; over 4.25 times the population of the U.S.)

• Life Expectancy at Birth: 74.51 years

• Geographic Area = 3,705,407.36 square miles (U.S. has a geographic area of 3,794,100.43 square miles)

• Per Capita GDP (PPP) = $6,546.30

• GDP Growth Rate = 9.65%

• Inflation Rate = –0.7%

• Unemployment Rate = 4.3%

• Gini-Coefficient = .47 (just above U.S. value of .45)

• International trade in 2009: exports valued at $1.204 trillion and imports valued at $954.3 billion (ranked 1st in exports and 3rd in imports)

Tremendous economic growth began in 1978, when economic reforms were first put in place to move China back toward the market

• Annual GDP growth rate of 9.6% is highest in the world over past two decades => Per Capita Incomes doubled between 1978 and 1987 and doubled again between 1987 and 1996

• Much of this growth was in the “Pearl River Delta” region of the “Guangdong Province” (in the southeast part of China along the South China Sea) => “Pearl River Delta” grew at a rate of 17.3% per year from 1978 to 1993

The person responsible for much of the economic reform and growth in China since 1978 is Deng Xiaoping – before discussing the influence of Deng, it is helpful to have some historical background…

Civil War in China immediately following the end of WW-II (actually, an “on-again-off-again conflict” from 1927-1950), ended with the triumph of Communists over Nationalists

• Nationalists had control of Taiwan; Communists had control of mainland China (i.e., the “People’s Republic of China”)

1952-1959: Communists implemented “Soviet Style Command Planning”

• industry and commerce nationalized; investment in heavy industry; land seized from landlords and wealthy farmers

• greater difficulties of coordinating economic activity in china than in USSR: population of China was 4 times greater than USSR; communications and transportation infrastructure much less developed

• historically China had much more “regional self-sufficiency” => potential gains from centralizing the economy are difficult to grasp

1958-1961: The “Great Leap Forward”

• Mao Zedong’s (leader of China from 1945-1976) plan to “harness the ideological fervor of the Chinese population to the task of raising industrial output.”

• Communes established throughout China (each averaged 5,000 households) as the new form of economic organization – money replaced with “work points”

• Agricultural production “collectivized” – decisions about crops and techniques were made centrally, without regard to local conditions; total output “shared among workers,” not based upon worker productivity (absence of incentives and a “free rider” problem)

• Focus on “rural industry” – attempt to increase steel output through increased production in “backyard steel furnaces” (output of these small-scale furnaces was inferior to large-scale furnaces)

• Proved to be a “great leap into disaster” and “did nothing to advance China’s economy”

1966-1970: The Cultural Revolution

• Movement launched by Mao Zedong to rid China of “liberal bourgeoisie elements” and to continue “revolutionary class struggle.”

• Chinese society turned upside down – bureaucrats, planners, and technocrats were “stripped of their authority and sent off to the countryside for ‘political reeducation’…”

• Many argue that the true intent was to solidify Mao’s political control after the disastrous effects of the failed “Great Leap Forward”

1978-1993: The First Phase of Reform

• Following Mao Zedong’s death in 1976, Deng Xiaoping emerged as the de facto leader of the Communist Party and China (Deng would essentially be in power from 1978 through the early 1990’s)

• In December 1978 he “launched the modern period of reform, moving China away from a planned economy and toward a market one.”

Agriculture Reform:

• Reforms began in 1979 to alter the “collectivized system” instituted in the 1950’s and 1960’s

• Central argument: productivity could be increased by simply providing “economic incentives” for households

• Created the Household Responsibility System (HRS):

▪ large plots of collectively owned land leased to individual households for a fixed period of time (15-40 years, depending upon type of crop)

▪ quota or target level of output established for each plot – production above the target could be kept by the household, either consumed or sold in the marketplace (either at “free prices” or state controlled prices)

▪ by 1984: 93% of China’s cultivated land was managed under the HRS

• output increased by more than 50% in next 16 years

• by 1993 price controls in grain markets were eliminated in about 80% of the country => prices now determined by Supply and Demand

Reforming State-Owned Enterprise:

• The large “State Owned Enterprises” (SOE’s) that existed in China before economic reform were very inefficient

• Iron Rice Bowl – jobs within SOE’s were often referred to as an “iron rice bowl,” because of their security, steady income, and steady benefits

▪ metaphor: if a clay or porcelain rice bowl were dropped it would shatter – in contrast, an iron rice bowl can be abused without becoming damaged (e.g. – an employee with an “iron rice bowl job” could make many mistakes without being fired)

• Reforms tried to replicate the “Household Responsibility Reforms” used in the agricultural sector in the industrial sector => the Contract Responsibility System (CRS):

▪ a target level of output or quota was established for each enterprise – output above the quota level could be sold by the enterprise in the marketplace

▪ by 1988: 90% of all SOE’s were operating under CRS contracts

▪ CRS did reintroduce “incentives” and did lead to a sharp increase in industrial output

▪ Difficulty: each contract was “individually negotiated,” giving enterprises incentives to waste resources negotiating for “more inputs” and “lower quotas,” so that they could easily exceed the stated goals (i.e., “rent seeking behavior”) => did not work as well as HRS system did in agricultural sector

“Special Economic Zones” (SEZ’s) – a geographical region in which the behavior of enterprises is constrained by fewer restrictions than in the rest of the country.

SEZ’s in China:

• First established in 1979

• Much of the economic growth in Guangdong Province was in SEZ’s

• “Outward looking orientation” – served as “export processing zones,” that acted as “magnets” to draw in foreign investment

• Enterprises in SEZ’s had tremendous freedom regarding investment and trade decisions and faced much lower tax rates (0% or 15%, as opposed to 55%)

General reasons for establishing SEZ’s:

1. If a region is dependent upon a declining industry, then new industries can be attracted by the incentives that result from SEZ status

2. SEZ’s would tend to result in a “density of industrial activity,” which is desirable if there are “economies of scale” (i.e., “declining average costs”) with respect to the provision of supporting infrastructure and services

3. Increase the realization of “economies of agglomeration” (Economies of Agglomeration – benefits that firms obtain when locating near each other) [e.g., justification for technology parks and cities]

4. Government can restrict economic policies/reforms or activities to a limited geographical region for environmental concerns or to try out new policies before generalizing them (the latter was particularly relevant in the case of China – government used SEZ’s as laboratories in which policies could be tested)

** Reason 4 was most important in China; Reasons 2 and 3 were minor rationales; Reason 1 not relevant to China **

Criticism of SEZ’s – such special provisions may not generate new economic activity, but rather may simply move economic activity from one region to another in an inefficient manner (thus, decreasing social welfare)

Unique Characteristics of Chinese Economic Reform:

• Gradualism – reform along a path of “experimentation,” moving slowly forward only in areas where policies had been seen to work.

• Partial Reform – willingness to create situations in which reform is “incomplete” (and does not move entirely “to the market” – e.g., the HRS and CRS), thereby introducing incentives without completely altering the environment in which individuals must make decisions

• Decentralization – weakening of central control over the entire economy, giving provincial authorities the flexibility to make pragmatic decisions within their own jurisdiction

• Economic Liberalization without Political Democratization – in China economic freedom has emerged ahead of political freedom; with less political freedom there was greater social stability and suppression of dissent, providing a solid platform for growth and attracting foreign investment

The Chinese approach to reform during this period led to the emergence of “Socialism with Chinese Characteristics”

• 1984 onward: debate shifted away from Marxism to a discussion of “how to create a market economy”

• Central question (again): what is the proper relationship between government and markets?

• Overall strategy was to “develop a ‘socialist market economy’ in which the assets of much of the industrial sector are owned by the state, but in which the primary functions of coordination are performed by the market” (a model quite similar to that of France or Britain pre-privatization)

Success of economic reform => avoided a sharp contraction in output, surge in inflation, and increased unemployment (which characterized many economies that attempted “shock therapy”). Possible reasons:

• China was much less industrialized (and more agricultural) and less reliant on international trade when economic reform began => so, disruptions caused by “adjustments in prices” and “adjustments in employment” had less substantial macroeconomic consequences

• Chinese approach to reform was much different than the “shock therapy” approach that was tried in many other countries (such as Central and Eastern Europe).

Overall impact of economic reform and Deng Xiaoping:

• Per Capita Incomes doubled between 1978 and 1987 and doubled again between 1987 and 1996 (it took the U.S. 50 years and took U.K. 60 years to double their Per Capita Incomes)

• “In instituting reforms with such effect, Deng did something that no one else in history has accomplished – he lifted 300 million people out of poverty in just two decades.”

Real GDP Annual

Year Per Capita % Increase

1981 $285.16 13.55%

1984 $435.71 17.95%

1987 $621.28 12.93%

1990 $796.11 6.30% [lowest rate of period]

1993 $1,182.95 15.20%

1995 $1,513.68 12.05%

1997 $1,848.99 10.12%

1999 $2,163.00 8.29%

2001 $2,614.88 9.99%

2003 $3,217.46 11.70%

2005 $4,064.34 12.46%

2007 $5,389.22 15.67%

2009 $6,546.30 9.65%

*** “Double Digit” increase in 21 of the 29 years

between 1981 and 2009 ***

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