Download IV. Market Transition: Processes and Strategy

IV. Market Transition:
Processes and Strategy
Overall approach to the ReformPeriod Chinese Economy
Introduction
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China’s economy has been transformed by
successive wave of reforms over the past 30 years.
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Distinctive Chinese approach on market transition.
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Distinguished from other transition economies.
Initial reform began with rural sector.
Two main phases, showing different characteristics.
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It has moved remarkably toward a market economy
(unimaginable when reform started).
Not complete yet.
First phase (-1992)
Second phase (1993-present) * Third phase?
Contemporary challenges.
1. Chinese Approach to Transition
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Different from the East European approach.
The goal of East European approach was to
move to market economy as rapidly as possible.
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Model of neighboring Western Europe close at hand.
Attempt rapid & profound institutional transformation.
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Price liberalization, resource allocation responding to
prices, privatization of SOEs, etc.
Smash the entire system, eliminating many distortions
and privileges working against the market function.
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Related with their political changes.
Short-term loss of output (growth) accepted, as
costs for laying the foundation for long-term growth.
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The costs were much larger than anticipated.
Chinese Approach (cont’d)
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China: Imperative of economic development.
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Not conceivable to postpone economic growth for system
transformation (as a poor country).
Individual reform measures judged whether they contribute to
economic growth (rather than to transition per se).
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Reflecting initial absence of long-term blueprint (of reform).
Different understanding of the best way to handle the
distortions of the pre-reform system.
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Try to resolve the immediate problems, namely, satisfy the
immediately recognized needs (‘shortages’).
Lower entry barriers for entrepreneurial individuals (groups).
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Give them opportunity to satisfy the unsatisfied market
demands as driving force for both development and reform.
Incremental reform
Chinese Approach (cont’d)
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Early reforms created unregulated and lightly taxed
activities (‘pockets’) within the system.
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Rural community businesses or foreign-invested businesses
were allowed outside of the state plan.
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Not fair competition, with many exemptions from regulations
and taxes.
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Entered light industry and service (‘niches’) for high return.
Contributed to growth, while not threatening the whole system.
Distortions continued or new distortion arose, while just
loosening control over resources.
Dual track system (双軌制) appeared.
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Coexistence of plan & market.
Discuss later in detail.
Chinese Approach (cont’d)
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Under dual track system, balance between plan &
market shifted over time, ultimately market
prevailing.
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More entrants to the “pockets” and more resources
moving to the “pockets” via market.
The compulsory plan and dual-track plan phased out
over time (‘growing out of the plan’- discussed later).
(Sum up) Gradualist approach of market transition.
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“Cross the river by groping for stepping stones”
In the process of reform, growth achieved without
serious disruptions & ultimate goal of reform evolved.
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<cf: Eastern Europe and Russia
2. How Reform Started? The Initial
Breakthrough in the Countryside
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Experimental reforms widely attempted in many
sectors of the economy in late 1970s.
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Rural reforms were most important & successful,
clearing the way for further reforms.
Rural reforms began with simple policy decision.
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Urgency for rural restructuring recognized.
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Correction for the previous neglect (distortion).
Major policy shift, entailing substantial opportunity cost.
Substantial price increases for agricultural products.
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Initially, collective farms maintained, allowing just more
autonomy on payment (distribution) system, etc.
The Initial Breakthrough in the
Countryside (cont’d)
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Radical organizational change followed soon.
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Contracting out individual pieces of land to farm
households (de facto de-collectivization).
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Overall reallocation of resources followed.
Reduce labor (& land) to grain.
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No formal approval at first, but soon recognized.
Household contracting system prevailed by 1983, with
remarkable increase in agricultural productions.
Discuss in detail in Ch 10.
But more output produced with productivity increase.
Non-grain, non-agricultural productions increased.
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Rapid growth of TVEs, with strong impact on economy.
The Initial Breakthrough in the
Countryside (cont’d)
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The success of the early rural reform worked
as a basis for further reform in urban sector.
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Income increase of rural people provide political
support for overall reform policy.
The successful rural reform provided the idea of
“dual track” approach.
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Household contract system has dual elements.
Household farm system maintained mandatory sales
for government procurement at low price & tax.
After fulfilling the requirement, all remaining income
belong to the household (“residual claimant”)
3. Two Phases of Economic Reform
(Overview)
The first phase(1978-92)
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Zhao Ziyang
Cautious decisionmaking
Introduce market where
feasible
Dual-track approach
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The second phase(1992-)
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Zhu Rongji
Rapid decision-making
Strengthen institutions
for market economy
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(details discussed below)
(details discussed below)
Inflationary economy
with shortages
Reform without losers
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Price stability, with
goods in surplus
Reform with losers
4. Elements of the First-stage of
China’s transition (1979-1992)
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Nine key features.
(1) Dual track system (雙軌制).
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Coexistence of plan and market, as resource allocation
mechanism (coordination mechanism).
Maintained the plan for stability and attainment of some
key government priorities (energy, infrastructure).
Dual track system (in narrow sense) applied to SOEs,
with two-tier prices.
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SOEs maintained plan production at state-set prices.
Once fulfilling the plan quota, SOEs produced for market,
having diverse transactions with non-state firms.
Non-state enterprisess were not included in the dual track.
The First Phase (cont’d).
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(2) Growing Out of the Plan
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Clear commitment to keep the size of the state
(i.e. ‘plan’) allocation of material fixed.
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As economy grows, share of the plan shrinks relatively.
Ultimately, “grow out of the plan”. (Fig. 4.1, p. 93)
Dual-track system altered the incentives of the
individual (state-owned) enterprises.
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Enterprises face “market price on the margin”.
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The production decisions are based on the market price.
The plan worked as a kind of lump-sum (fixed) tax.
Problem: “rent-seeking” opportunity widely available.
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Two different prices for the same good were exploited.
The First Phase Reform (cont’d).
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(3) Particularistic Contracts
 Gov’t signed individual contracts with every
SOEs, specifying tax payment and plan
production.
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No regular tax system, with de facto tax rate varied across
the individual enterprises.
Each contract tend to be drawn based on the
firm’s past performances.
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Existing firms grandfathered, with unfair & inefficient
outcome. (room for negotiation- arbitrary).
The First Phase Reform (cont’d).
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(4) Entry
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Monopoly of state relaxed, with entry barriers lowered.
Many start-up firms (especially, rural industries) entered
market to take advantage of profit opportunities.
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Many collective-owned, some private- & foreignowned.
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Consumer-good manufacturing & services in short supply.
Soon, market competition sharply increased.
Many private firms registered as collective (假集體眞私營)
Variety of activities between SOEs and non-state ones.
(eg) joint venture, subcontracting, etc for profit seeking.
The huge size, diversity, already strong role of the local
government facilitated this process
The First Phase Reform (Cont’d).
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(5) Prices equating demand & supply (flexible).
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Significant proportion of transactions began to
occur at market prices in early 1980s.
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Legal sanction given for outside-plan transaction of SOEs.
Gradual decontrol of consumer goods prices.
(6) Incremental managerial reform of SOEs.
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Instead of large-scale privatization (not an option
then).
Experiments to improve incentives & autonomy.
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SOEs becoming more profit-oriented <cf. plan fulfillment.
Improved performances of SOEs due to improved
incentives, competition, and better monitoring, etc.
The First Phase Reform. (Cont’d)
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(7) Disarticulation
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Push more radical reforms in less tightly
integrated sectors, while the planned ‘core’
economy remain intact.
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Some sectors of the economy more separated
from the planned core.
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SEZ, countryside, poorer areas, etc.
Partially unintentional outcome (result of
attempting not to disrupt the core economy).
The First Phase Reform. (Cont’d)
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(8) Initial macroeconomic stabilization achieved
thru the plan.
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Reoriented development strategy under the plan system.
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Plan used to shift resources towards household sector to
resolve shortage & inflationary pressure in 1979-1981.
Temporary use of the plan useful for shift from big push
strategy toward labor-intensive development strategy.
 To preserve stability & secure support for reform by
maintaining low level of unemployment.
Favorable for gradual development of market.
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The “shortage” problem solved during the period, so that
demand for planning itself reduced.
The First Phase Reform. (Cont’d)
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(9) Continued high saving and investment
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National saving remained high, allowing high
investment.
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Gov’t reduced its share of GDP to allow households more
resources and better incentives.
Gov’t saving gradually replaced by (voluntary) household
saving, as household income increased.
Due to stable macroeconomic conditions (& vice versa).
Importance of banking (financial) sector increased.
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As intermediary channeling household saving to
investment of the enterprise sector.
Conclusion of First-Phase Reform
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Succeed in both growth and market transition.
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‘Growing out of the plan’ achieved (key
summary given in the first paragraph in p. 97).
The progress of reform not always smooth.
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“two steps forward, one step back”
Fluctuation of business cycle related with
policy (political) cycle.
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Bold reform- high growth with inflation- austerity
policy (reform retarding)- low growth
Side benefits: planners unable to keep up with
rapidly changing cycles (ultimately giving up to mkt).
But, substantial costs on the economy.
5. Crisis of the First Phase of
Reform: Tiananmen Interlude
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Macroeconomic imbalances with expected price
decontrol led to high inflation in 1988-89.
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Followed by political crisis in 1989.
Combined with rampant corruption (partially due to two
track system) and high expectation of political reform.
However, overall reform in 1980s successful, with
market transition resumed only after 2 years.
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The ‘conservatives’ ascendancy was short-lived.
Political support for reform- “Reform without losers”.
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Both rural and urban people better off (not worsen).
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Urban people either exploit new opportunities or enjoyed
protection for the existing economic position.
6. Second Phase of Reform: 1993
Deng Xiaoping rekindle reform initiative
with Southern Tour (南巡講話) in Feb. 1992.
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The last decisive personal intervention by the
‘architect of the Chinese reform’.
New leaders (Jiang Zemin, Zhu Rongji) managed the
new reform initiatives (until 2003).
New model of China’s reform, “socialist market
economy” adopted in the Party Congress in 1992.
Key features of the second phase reform can be
conceptualized in the following three aspects.
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Prerequisites, Contents: regulatory & admin restructuring,
Outcomes
Key Features of the Second-phase
Reform : (1) Prerequisites
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(1-1) Market Reunification
Compulsory planning was abolished by 1993.
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“grown out of the plan”- (dual track merged, 倂軌).
(1-2) Recentralization
Readjust division of responsibility (& power)
between central and local gov’t for further reform.
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Central gov’t needed to strengthen regulatory &
macroeconomic management functions.
Recentralization of fiscal revenue necessary.
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In the context of decentralization and fiscal decline (of
previous period).
Key Features of the Second-phase
Reform (1) Prerequisites (Cont’d).
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(1-3) Macroeconomic Stability
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Needed to cool down the overheated economy.
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Investment boom following Deng’s Southern Tour.
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Zhu led the strong austerity policy begun in mid-1993.
New macroeconomic policy regime settled by 1997,
with macroeconomic stability emphasized.
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Credit surge and highest inflation of PRC history in 1993.
No easy credit to SOEs & slower growth of money supply.
Prerequisite to make SOEs responsible for their
performances (for ‘hard budget constraint’).
The recurrent debate in China.
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Growth oriented (locals) vs stability oriented (center).
Second-phase Reform (Cont’d).
(2) Regulatory Approach & Admin Restructuring
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A new, regulatory approach to economic reform
introduced (led by Zhu Rongji).
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New rules, based on the new (market) prices, applied
equally to all economic actors (in principle).
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Less direct government actions in managing enterprises,
but creating & regulating competition in the market.
Improve the legal and regulatory environment, reduce
distortions, create “level playing field.”
Gov’t : not player, but referee. .
Regulatory & administrative reforms in the four
important sectors.
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Fiscal, financial, corporate, and foreign trade.
Second-phase Reform (Cont’d).
(2) Regulatory Approach & Admin Restructuring
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(2-1) Fiscal and Tax System
Fiscal reforms in 1994 had the following three
goals (detailed discussion in Ch 18).
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Stop the slide of budgetary revenues (Fig. 4.2).
Broaden tax base by introducing value-added tax (&
other business tax).
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Uniform 17% rate applied, lower and simpler than before,
to all economic activities.
Make central-local gov’t fiscal relations sound & stable.
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Increased the share of taxes collected by the center.
Established the rules for sharing revenues between central
and provincial gov’ts.
Second-phase Reform (Cont’d).
(2) Regulatory Approach & Admin Restructuring
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(2-2) Banking and Financial System
Banking system fundamentally restructured in the
second half of 1990s upto early 2000s.
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Discuss later in more detail (Ch 19).
The central bank (PBC) thoroughly reformed.
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State-owned commercial banks reformed to become
genuine “commercial bank”.
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To implement independent monetary policy (from gov’t).
Access to easy gov’t money reduced.
Began to pass tougher standards to their clients (mainly,
SOEs).
Began to tackle serious existing problems.
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NPL (non-performing loan), supervision, etc.
Second-phase Reform (Cont’d).
(2) Regulatory Approach & Admin Restructuring
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(2-3) Corporate Governance
Major effort to restructure the SOE sector.
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Discuss later in more detail (Ch 13).
Gradually privatize or reorganize as limited-liability
corporations with clarified corporate governance.
Some of them listed in stock market.
(2-4) External Sector: WTO membership (Ch 16).
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Extensive foreign-trade reforms in 1993.
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Unified foreign exchange regime, devalue currency, etc.
Joined the WTO in late 2001 (after long negotiations).
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Accept broad range of market opening and harmonize
regulatory system with international standards.
Second-phase Reform (Cont’d).
(3) Outcomes
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(3-1) From Inflation to Price Stability
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Macroeconomic context moved toward price stability.
 Cycles not completely eliminated, but much stable prices
(low inflation).
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(3-2) SOE Restructuring and Downsizing
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Major restructuring in SOEs sector since 1997.
 Bankruptcy, M&As, sales (privatization), massive lay-offs.
SOE sector began shrinkage since mid-1990s.
 Increased market competition, reduced access to bank credit,
& restructuring.
 * SOE employment decline (Fig. 4-3, p 106).
Reflect the changes in the incentives facing local
governments, the de-facto “owner” of most SOEs.
 Few advantages, but burden for local gov’ts.
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Second-phase Reform (Cont’d).
(3) Outcomes
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(3-3) Privatization (incl. de facto privatization)
Not officially adopted privatization policy.
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Use vague (milder) terms “restructuring” or “corporatization”.
However, privatization of small/medium SOEs quite common.
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Favorable option by local gov’ts to rationalize local economy.
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Reduce burden of ill-performing SOEs.
Decreasing ideological constraints.
Diverse methods, in particular management buyouts.
Private business got gradually increasing recognition and
legitimacy.
(3-4) Reform with Losers.
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Some social groups seriously hurt in the second stage reform.
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(eg) Laid-off SOE workers (previously privileged), rural people,
7. Contemporary Challenges
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China’s approach to transition has become
similar with other transition economies.
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Build regulatory institutions supporting market economy,
maintain stable macroeconomic policies, etc.
China’s experience has many valuable lessons.
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Careful policy-making, firmly grounded in local
conditions, is necessary,
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<cf: pre-packaged policy prescriptions.
Developing social and economic capabilities more
important than just price decontrol or privatization.
Debate on gradualist vs big-bang strategy not
productive.
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Academic debate on determinants of performances of
transition economies continues.
7. Contemporary Challenges
(cont’d)
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Despite the successful record of transition thus
far, no guarantee of continued success.
The new leaders (the 4th generation) took power
by 2003.
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Hu Jintao as General secretary of CCP and Wen Jiabao
as State premier.
No change in fundamental policy direction,
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Policy agenda broadened & style of policy making
changed.
Face dual challenges.
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Advance (complete) the market transition.
Remedy problems (social, economic) created during the
previous (particularly, second-phase) reform.
Contemporary Challenges (cont’d)
(1) Complete transition process
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Institutionalization is the key.
Institutions created so far are not adequate.
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Financial system, fiscal system, corporate governance,
etc not working properly (although nominally exist).
Weak legal accountability & transparency, regulatory
institutions not fully independent of gov’t, etc.
These challenges are more “political”.
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Further progress in institutionalization will touch upon
the ultimate structure of political power
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Contradictory with monopoly of power by the CCP.
True “level playing field” yet to be created.
Contemporary Challenges (cont’d)
(2) Remedies for new problems
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Inequality has increased sharply.
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Economic life has become more uncertain.
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Urban-rural, coast-interior, inter-provincial, within rural,
with urban, etc.
Less secure job, weak social safety net, much mobile
society, etc.
The new leadership (Hu-Wen) began to
introduce remedial works.
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For vulnerable groups in both rural & urban sectors.
Political motive for securing support for reform & CCP.
How much implemented in reality?