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Can Eastern Europe learn from Asia?
-Introduction1
During the 1980s economists studying the process o f economic reform in China did so in a vacuum. There was little reference either to the literature on economic development or to reforms in other centrally planned economies. The reason for this lack o f comparative analysis appears to have been a belief that the Chinese case was sui generis: too different from the market-oriented economy assumed in the non- Marxist development literature and from the feeble reforms occurring in the USSR or other communist countries - except Hungary, which highly influenced Chinese reforms with its 1968 reform - before 1989. Partly reflecting this inward-oriented intellectual approach students and policy-makers elsewhere paid little attention to the Chinese experience.
In the early 1990s this splendid isolation started to change. Influential policy- makers at international institutions began to argue publicly that other countries in transition from centrally planned to more market-oriented economies can leam from the Chinese experience. Meanwhile, researchers on the Chinese economy since 1979 are starting to relate that experience to the wider economic development literature.
Nevertheless, there still appear to be substantial walls separating subdisciplines.3 This paper addresses the question o f whether China’s experience w ith economic reform is helpful in understanding and providing lessons for the European economies in transition.
1 An earlier version of this paper was presented as the invited lecture at the Chinese Economic Associa- tion o f Australia 1992 Annual Conference, “Chinese Economy in Transition”, held in Adelaide on 12-13 November 1992, and a summary appeared in Access China. The paper was completely rewritten while I was on leave in Bangkok as Regional Adviser on Macroeconomic Management and Economic Reform at the United Nations Economic and Social Commission for Asia and the Pacific. The views ex- pressed are my own and are in no way endorsed by the United Nations.
2 Two articles which stimulated discussion were ,‘Is there Schizophrenia about Socialist Reform Theory ?"
in Transition. The World Bank. July 1991, by Inderjit Singh o f the World Bank and “East Europe should leam from Asia” in the Financial Times. 24 April 1991, by Stanley Katz, a former Vice President o f the Asian Development Bank and at the time a consultant to the European Bank for Reconstruction and Development.
3 Such unwillingness to learn also extends to policymakers. A caricature which recurs frequently is that Chinese policymakers point to their high growth rates and abundant consumer goods in contrast to the economic stagnation and chaos of the former USSR and Central and Eastern Europe, while European policymakers after recognizing China’s rapid economic growth point to the continuing poverty and authoritarianism o f China. One does not leam much from a society which one looks down upon.
The central features o f the Chinese model o f economic reform have been an initial emphasis on agriculture, combined with gradualism in other areas. Advocates o f applying the Chinese model elsewhere see it as having provided rapid economic growth and political stability
Agricultural reform was in practice sudden rather than gradual, because the introduc- tion o f the contract responsibility system in 1978-9 immediately changed incentives.
Although land ownership was unchanged, farmers now had claim to any additional out- put over and above that contracted to be supplied to the state marketing agencies at the official price. The supply response was immediate and large; agricultural production grew rapidly between 1980 and 1984, despite the diminishing area o f land under culti- vation.4
Because China was overwhelmingly a rural economy, this translated into a large increase in GNP and in demand for consumer goods. Lack o f available goods (and o f savings opportunities) led to a substantial part o f the agricultural surplus being chan- nelled into small-scale industrial activities (township and village enterprises), which have been the dynamic part o f the manufacturing sector for the past decade.5 The non- agricultural labor force in rural areas increased by 6% per annum between 1978-83 and then by 20% per annum during 1983-87, creating over thirty m illion jobs. Nominal out- put increased at an annual rate o f 20% from 1978 to 1983 and then by an incredible 55%
in 1984 and 46% in 1985 before dropping to a mere 32% in the recession year 1986.6 The dramatic beneficial effect o f agricultural reform reflects the size o f the agricul- turai sector (Table 2) and the particular unsuitability o f Chinese agriculture to collec- tivization. As the Chinese communist regime pursued an extreme strategy o f public ownership, total factor productivity in agriculture fell over the three decades after the 1949 revolution. The huge post-reform gains in disposable income for a large part o f the population could not be matched in more industrialized economies with less repressed agricultural sectors, such as Poland where private plots and off-farm em- ployment were already common before 1989. Moreover, rice-farming is much less- suited to collectivization than is farming o f wheat or other grains where scale econo- mies from using indivisible machinery are significant. Thus, the agriculture-first strategy may yield sim ilar benefits in Vietnam, but would be far less dramatic in effect in Central and Eastern Europe or the former USSR.
The other salient feature o f the Chinese model o f economic reform has been the process o f gradual and partial reforms.7 Introduction o f the open door policy towards
4 China: Refont! and the Role o f the Plan in the 1990s. The World Bank. Washington DC, 1992, pp. 52-53.
5 Strict control over residency also favoured the growth of rural manufacturing because surplus agri- cultural labor could not migrate to the cities.
6 Figures from World Bank Report, No. 7267-CHA, "China - Rural Industry: Overview, Issues and Prospects", March 1989, pp. 11-13. The report cautions that the official figures used are lower-bound estimates because some o f the TVE expansion was unreported.
7 The agricultural reforms were also introduced on an experimental basis in a few provinces in 1978 and formal rules were only changed gradually over the following years, but the economic impact was sud- den because farmers took the initiative in ensuring the most fundamental change (ie. that after meeting a fixed commitment to supply the state any marginal output could be sold for the farm er's own account) was widespread.
1. The Chinese Model o f Economic Reform
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foreign investment and trade, while apparently a dramatic policy change, was in prac- tice more gradual. The 1979 equity jo in t venture law permitted foreign investment for the first time since 1949, but foreign investment in China was very small before 1984 (Table 3), and most o f the inflow was concentrated in the Shenzhen special economic zone adjacent to Hong Kong. In 1984-5, as wages and land prices rose sharply in the crown colony, entrepreneurs from Hong Kong led a foreign investment boom in China, shifting their labor-intensive manufacturing operations into China. In most cases the domestic partner was a TVE, which were more flexible than state enter- prises. The ability o f Hong Kong entrepreneurs to transfer appropriate technology and export-marketing skills was especially crucial to the development o f neighboring Guangdong province, a previous backwater which led Chinese economic growth during the 1980s (Table 4).8
Restrictions on foreign firm s’ activities and ability to repatriate profits were relaxed gradually during the second half o f the 1980s. The pattern o f direct foreign investment has been cyclical as each boom ran up against obstacles which were subsequently removed, and only in the 1990s has foreign investment in China really taken o ff (Table 3).9 Restrictions on imports and exports have also been relaxed substantially since 1979, but remain severe enough to impede China’s application to jo in the General Agreement on Tariffs and Trade (GATT).
Reform o f the industrial sector has been even more closely controlled.10 Tentative attempts to introduce greater enterprise autonomy had little impact on the state sector in the early and mid 1980s. A fter 1988 a contract responsibility system was generally adopted, by which taxes were separated from profits. This had far less impact than the ostensibly sim ilar agricultural reform o f a decade earlier, in part because the govern- ment recontracted its tax demands i f the enterprise became ore profitable, but mainly because the ownership structure provided no strong incentive to earn profits. The government began to encourage the creation o f conglomerates, which would issue shares (predominantly to their employees) - a strategy which could provide a basis fo r future privatization (see next section), but which had little immediate impact on enterprise behavior. A bankruptcy law was drafted and some state enterprises were
Taiwanese and South Korean investors played a similar role later in the 1980s and especially in the 1990s. The critical contribution o f investors from the East Asian 1T ig ers” was not so much the capital, which often came in the form o f used equipment, but rather in the skills of the entrepreneurs at organi- /in g the production and marketing of labor-intensive goods; both the physical and the human capital had lost economic value as wages increased in the entrepreneurs’ homelands, but were valuable in China with its huge reserves of unskilled labour.
4 The government’s basic dilemma is between creating an environment attractive to capitalist investors while not diluting its own control over the economy. The authorities have tried to maintain control over the capital account o f the balance of payments and have placed strict emphasis on macroeconomic stability, but it is difficult to isolate economic policies. Some relaxation o f exchange controls proved necessary to support the trade reforms and the opening up o f the country to foreign investment. Also, as the economy has become more developed foreign and domestic firms require financial services which could not be provided under the old system, but financial reform is undermining the form er method of direct credit control.
10 W.A. Byrd, Chinese Industrial Firms Under Reform, Oxford University Press, 1992, pp. 1-32. The author surveys industrial reform and performance up to 1989; this volume contains seven case studies of Chinese industrial performance.
closed down amidst great publicity, but the numbers were small (39 by the end o f October 1991).11
Prices have been substantially liberalized since the late 1970s. Agricultural prices to producers were first raised to encourage output, and then consumer prices were gradually increased to eliminate the subsidies. The prices o f most manufactured con- sumer goods were freed during the second half o f the 1980s. For producer goods, however, a dual pricing system still exists, as a means o f preserving a role for planned allocations and softening the disruption o f immediate price liberalization.12
Despite frequent published “ reforms” the state enterprises continue to face a soft budget constraint. The problem is more fundamental, insofar as with distorted prices profitability would not be a good guide to social desirability. The result has been lack o f incentive and o f entrepreneurial behavior, which combined to make the state enter- prises a drag on overall growth.13 There is a strong correlation between total factor productivity in industry and the share o f the non-state sector in industrial activity,14 with the most dynamic provinces being those in which the township and village enterprises have flourished best (Guangdong, Fujian, Jiangsu and Zhejiang). These five east-coast provinces enjoyed the most rapid growth during the 1980s (Table 4).
China’s agriculture-first plus gradualism strategy led to a “ natural” growth process reminiscent o f that in eighteenth century England or mid-nineteenth century Canada.
Increased demand, generation o f savings and release o f labor from a more efficient agricultural sector, all stimulated the growth o f consumer good industries and services.
(Figure 2) The open door policy helped because the small-scale manufacturing enter- prises set up to meet domestic demand could expand by exporting labor-intensive goods. Rapid growth o f manufactured exports benefitted from the proxim ity o f Hong Kong, but most important was China’s large labor force and low wage which meant that there were huge potential gains from specialization and trade. Other countries can follow this development pattern, but the benefits are likely to be less dramatic.
2. Shortcomings in Chinese Economic Reforms
The apparent smoothness and success o f China’s gradual and partial reform process hides significant shortcomings. Even advocates o f the Chinese model such as Chen, Jefferson and Singh list four shortcomings: weak labor markets; excessive interven
11 By contrast about three million township and village enterprises went bankrupt or were taken over during the economic austerity year o f 1989 (Y. Qian and Ch. Xu, “The M־reform Hierarchy and China's Economic Reform.” European Economic Review, April, 1993, p. 547).
12 K. Chen, G. Jefferson and I. Singh, “Lessons from China’s Economic Reform.” Journal o f Compara- tive Economics. 1992. p. 208. This is made possible by the incomplete liberalization o f international trade. Nicholas Lardy describes the Chinese system as one o f creating an “airlock” between domestic and world prices. (N. Lardy, Foreign Trade and Economic Reform in China 1978-1990. Cambridge University Press, 1992.
13 G. Jefferson, T. Rawski and Y.X. Zheng, “Growth, Efficiency and Convergence in China’s State and Collective Industry.” Economic Development and Cultural Change, January, 1992, pp. 239-66. provide evidence that the industrial enterprise reforms since the m id-1980s have had some impact on efficiency, but there is no doubt that the state enterprises are the poorest performers in the Chinese economy.
14 China: Reform .O p .c it.ff 1992. Figure 1. p. 58.
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tion in enterprises by officials; persistent soft budget constraints; and inhibiting o f competition and interregional trade.
One would add to this list the absence o f real financial reform before the 1990s, which prevented resolution o f the fundamental central planning problem o f efficient mobilization and allocation o f capital. It is unsurprising that enterprise reform, labor market reform, government reform and financial reform feature so prominently; they are the d iffic u lt areas to tackle in the transition from central planning to a more market-oriented economy. Indeed, the word “ shortcoming” may be inappropriate in that a gradual transition inevitably involves sequencing issues, with some reforms progressing faster than others. The practical question is whether gradual reforms w ill become bogged down when they enter the d iffic u lt areas.
Despite the difficulties o f reform in these areas, there are two strong pressures for keeping the reform process moving in China. First and most important, there is pressure from below as people become more and more accustomed to growing mate- rial wealth. This could be offset by concerns about jo b security and about growing income inequality, but at present the demand for higher consumption levels appears dominant. Second, the bureaucracy is also a force for reform insofar as all levels below the center now have more influence, and associated with that the opportunities for corruption have mushroomed. The latter is not a good omen for future economic efficiency, but so far the forces o f corruption and rent-seeking have been stimulating rather than inhibiting the reform process.15
The next steps w ill, however, be d ifficu lt. Financial reform is progressing in the 1990s with the arrival o f foreign bank branches and the growth o f the two stock exchanges, but the most fundamental reform, i.e. changing the domestic banks into entrepreneurial financial intermediaries, is still in the future.16 A llow ing inefficient state banks to fail is even more costly than with other state enterprises, so the banks face the softest o f all budget constraints.
Labor market reform w ill also be d ifficu lt, because like banking reform it is not simply a matter o f scrapping existing restrictions but rather involves replacing one set o f rules by another. Not just the work relationship between employee and enterprise must be reformed, but also the social welfare role o f the employer. Under Chinese communism the work unit covered every aspect o f its members’ lives. Mobile labor needs portable social security and the means o f obtaining entitlement to housing, education and so forth for fam ily members. Providing such services w ill be d ifficu lt for a government facing budget crises as existing revenue sources dry up and a new tax system has not yet been put in place.
15 The felicitous outcome seems to be because the opportunities for rent-seeking are greatest in China when a project is operational and officials can command a share of the gross profits through their con- trol over allocation o f goods at plan prices. This is in contrast to India, where the opportunities for cor- ruption are mainly in the approval process, which in consequence is dragged out with harmful econo- mie results. Further price and enterprise reform in China may be opposed by officials fearful of losing their influence or if they go through may shift the outcome from benevolent to malignant corruption.
16 China made an early decision to create a two-tier banking system in 1983, but it proved difficult to change the behaviour o f the specialized banks which still dominate commercial banking. The central bank also plays an allocative role because, when credit is being restricted, its almost three thousand branch managers decide who gets the scarce funds.
W ithin industry, the state sector remains essentially unreformed.17 The dominant current approach to enterprise reform is to create jo in t stock companies whose shares w ill be traded on the two stock markets. There is, however, some confusion about the purpose o f these flotations which are seen as methods o f attracting domestic and foreign capital for restructuring technologically outdated enterprises, but not as a method o f transferring control to shareholders. 8 A ll o f the listed companies on the stock exchanges (including those in which foreigners are allowed to hold shares) have majority state ownership, so it is unlikely that individual shareholders could vote to change the management o f an under-performing company.19
The manufacturing sector in China has been dynamic only because o f the huge scale o f new enterprise formation. The township and village enterprises are the most important part o f this non-state sector, but there is also a growing private sector.
Recent official figures refer to over 150,000 private enterprises in China, employing over ten m illion workers with over RMB 13 billion in capital and accounting for some 6% o f industrial production. Also, there are over fourteen m illion private household businesses.20 These are positive developments which to some extent have been a substitute fo r enterprise reform, but they cannot avoid the long-run need to address the inefficiency o f the old industrial enterprises.21
3. Assessment o f Chinese Economic Performance
When measured by conventional growth criteria, the Chinese economic reforms have been a phenomenal success. During the 1980s China enjoyed one o f the highest rates o f economic growth in the world; GDP grew by 9.5% per annum, slightly less than South Korea, but ahead o f all other Asian countries. The abundance o f consumer goods in Chinese cities by the late 1980s was in stark contrast to the pre-1979
situa-17 This is related to the previous point because the major existing source of government revenue is the financial profits of state enterprises. These profits are declining, but the government is unwilling to take steps which would encourage greater efficiency in the state enterprises at the expense of losing government revenue.
18 There is also a tax incentive. An enterprise switching to a joint stock company will see its tax rate fall from the standard 55% to as low as 27%.
19 There are three types o f shares, owned by the state, by institutions and by individuals, and in principle the markets for each type are segmented. By 1993 there was considerable pressure for loosening this restriction in order to create a larger market in shares of each company, and some institutions had sold shares to individuals who offered a higher price than institutional buyers. The proportion o f state- owned share varies from 51 % to 80% (China Daily. Business Weekly, May 2, 1993, p. 3), so even if the institutional and individual markets were merged takeovers would remain impossible.
20 The difference is that a household business employs less than eight workers. Figures are from the
20 The difference is that a household business employs less than eight workers. Figures are from the