By Jason Meade
MA in International Political Economy
21 May 2001
3,300 words
I. History
A. The Dual Economy
B. Agriculture
C. Industry
D. The Reform Period
II. Policies
A. Reactive Policymaking
1. Advantages
2. Disadvantages
B. The Promotional FDI Regime
1. Background
2. Analysis
3. Implications
III. Conclusions
This essay will examine two particularly interesting policy practices of reform-era China. It will begin by reviewing some of the history of Chinese economic management since the 1949 revolution. It will then go on the examine the center's reactive policy making. This will be followed by a look China's promotional FDI regime. Finally, some conclusions will be presented.
I. History
A. The Dual Economy
China's current period
of economic liberalization began in 1979 following the Third Plenum of
the Eleventh Congress of the Chinese Communist Party in December of 1978.
By 1978 China was well in need of economic restructuring. The pre-reform
era was characterized by a Stalinist dual economy with a sharp divide between
agricultural activity and industrial activity. The industrial sector was
created and financed through the seizure of nearly all agricultural surpluses.
At the same time, access to industrial employment was limited to the urban
working class, which formed a privileged minority with "benefits, status,
and security which elevated them above both peasants and intellectuals."
(Li, 1999, pg. 214) Peasants on the other hand were so forcefully restricted
to the countryside that one observer has written that "one is almost tempted
to say the land owned the people." (Selden, 1993, pg. 190)
B. Agriculture
This created a situation
where the agricultural sector was beset by a high, and rising, labor input
while the industrial sector was similarly saddled with a high, and rising,
capital input (Pei, 1998, pp. 91-2). As Pei points out there could be very
little interaction between the main economic sectors for two reasons:
1. farmers saw virtually the entire
product of their labor seized by the state and consequently they had no
money with which to purchase the goods produced by industry, and
2. since rural citizens were confined
almost exclusively to rural areas for several decades, natural population
increase obviated the need for any industrially produced labor saving devices.
C. Industry
On the industrial side,
the Chinese government pursuit of an import substituting industrialization
strategy led to a continually increasing demand for capital as the government
entered ever more capital intensive areas of industrial production. (Lardy,
1998, pg. 32) And as this capital was mainly being squeezed from the rural
population, the longer the ISI strategy was pursued the greater the gulf
between agriculture and industry became. By the late 1970's poverty, stagnant
labor productivity, and the growing labor surplus had all reached near
crisis proportions. The Chinese government was no longer able to guarantee
employment even to the children of privileged urban workers. (Seldon, 1993,
pp. 25, 215) A disaster seemed imminent.
D. The Reform Period
Under Deng Xiaoping,
China began a program of domestic economic restructuring and opening to
foreign investment. Deng called on China to pursue "the four modernizations":
modernization of industry, agriculture, national defence, and science and
technology. In a series of speeches Deng pushed the idea of economic restructuring
and liberalization. Beginning in the late 1970's China opened up to foreign
investment, mainly in the form of joint ventures via what was called the
"Open Door policy". The government also pursued a strategy of domestic
economic decentralization.
The state's economic
relationship with the rural population was made fairer and more predictable.
The "household responsibility system" allowed Chinese farmers to negotiate
a fixed payment to the government, leaving households with a marketable
agricultural surplus for the first time in many years. At the same time,
decentralization allowed local officials to experiment with new forms of
economic organization with the result that vibrant market economies were
quickly able to grow throughout the country.
The combination of
domestic economic liberalization and infusions of foreign capital, technology,
and managerial know-how formed a beneficial feedback loop which has sustained
high rates of economic growth over the past two decades. In the earlier
period of the reforms, roughly up to 1989, the rural domestic economy was
the prime beneficiary. The new policy environment allowed township and
village enterprises (TVEs) to grow and prosper in the countryside as one
of the main types of firm in the new market environment. Farmers were also
able to accumulate savings and buy vital consumer goods which had previously
been unavailable. In the period since 1989, China has moved from a permissive
foreign direct investment regime to a promotional regime. This has led
to a rapid increase in FDI and shifted the emphasis from rural reconstruction
to urban industrialization. In fact, of the US$220B in paid-in FDI over
the entire reform period of 1979-1999, US$196.8B, or 89% of the total,
has been invested since 1 992 (Huang, 1999). The looming threats of poverty
and economic collapse have been largely overcome, although the urban/rural
divide is still generally maintained through discriminatory residence policies.
The next section will look at two interesting policy practices which China
has followed over the course of this reform period.
II. Policies
As Ho (Ho, pg. 20)
has pointed out "the logic of the Open Door is not the logic of trade liberalization"
per se, the door is being opened because the four modernizations require
it. According to Green and Qu (Green, 1997, pg. 48) China's Open Door Policy,
although never officially stated, "consists of two basic components: import
substitution and export promotion." They go on to point out that China
can not follow an export oriented industrialization strategy since China's
output could become too large for the world market to absorb. Instead China
is encouraging foreign direct investment for the purposes of modernizing
industry and restructuring the economy so that it can operate in a more
or less self-sustaining fashion. The foreign exchange earnings which China
reaps from FDI and exports serve to finance these goals, rather than being
ends in themselves. The fact that China has implemented a variety of economic
policies which actually discriminate against domestic firms bears out this
idea.
A. Reactive Policymaking
Consequently, China's policies are directed
towards achieving the above mentioned goal of relative self-sufficiency.
This is an important point since many of China's recent economic policies
have appeared to indicate an acceptance of the ideas of neo-liberalism,
which is not the case. This conceptual gulf between China and West helps
to explain many otherwise puzzling incongruities in China's economic reforms.
There are two particularly perplexing aspects of China's economic reform
program. One is the general method of central policy formulation. Tsai
(Tsai, 1998), quoting Hamrin writes that, "China's reform process has been
a reactive one, whereby central leaders look to lower administrative levels
and various localities for direction." China's central government relies
on the highly compartmentalized nature of the national economy to allow
various economic experiments to take place simultaneously in different
areas. The central government typically chooses broad policy goals and
allows local officials to find their own way to those goals.
1. Advantages
China's brand of reactive
policymaking has a number of advantages from the point of view of the center.
Firstly, many experiments can be conducted simultaneously and generally
without fear of disruption to the wider economy in the event of a failure.
Secondly, successful policies come "pre-packaged" with successful practitioners
from the moment of their national promulgation. Thirdly, the center can
take the time to observe and judge the effects of a particular practice
over a long period of time before making any determination as to its explicit
legality or illegality. Fourthly, since the center is not directly involved
in the formulation or implementation of particular concrete policies, it
faces a much lower level of political risk. A failed policy can be blamed
on lower officials, while successful policies can be claimed by national
leaders. Finally, economic decentralization and reactive policymaking appear
to have allowed China to avoid the political meltdowns faced by the reforming
Communist regimes of the USSR and Eastern Europe.
2. Disadvantages
However, this method
of policy making does have some major drawbacks from the perspective of
outside observers. It can be incredibly opaque since outsiders rarely have
information on what practices are being used informally at the local level
in a nation of more than one billion people. Observers are further handicapped
by the lack of information as to what criteria central officials use to
weigh the relative merits of different practices. Finally, given the degree
of local control over the economy, it is often difficult for even the central
government to implement policies effectively.
Tsai's (Tsai, 1998)
study of the district of Wenzhou in Zhejiang province in the 1980s and
1990s demonstrates the difficulties of exercising central control. She
points out that banks in Wenzhou began experimenting with floating interest
rates as early as 1980 (less than two years after the Third Plenum), but
the People's Bank of China did not even endorse Wenzhou as an experimental
district for interest rate reform until 1989. This can be frustrating for
foreigners, especially foreign businesses (Gelb, 2000) which frequently
find themselves blind-sided by apparently sudden policy changes made without
explanation. But, it is clear that the center is comfortable with its reactive
policymaking since it has continued to use it for twenty years in spite
of the problems it has caused in promotion of FDI.
B. The Promotional FDI Regime
1. Background
Another difficult to
understand a spect of China's Open Door policy is its highly visible promotion
of foreign equity investments in the second decade of reform. As stated
above, this bias can be partly explained by the goal of implementing the
Four Modernizations which require foreign inputs of various kinds. In general,
FDI can offer a host country greater access to capital, access to new technology,
scope for rapid growth of exports, and increased competition in domestic
markets (Li, 1999, pg. 33). Clearly FDI can contribute to the modernization
of industry and science and technology, and can also bring in export revenue
to help finance China's various economic activities. But this can not be
the entire explanation since in 1993, at virtually the same time that the
FDI regime was becoming promotional rather than permissive, China also
launched financial reforms "to unleash US$250 billion in local currency
savings in the banking system and redirect it to finance industrial development."
(Li, 1999, pg. 7)
This US$250 billion
in local currency savings is greater than the entire amount of paid-in
FDI in China over the first twenty years of reform (US$220 billion). The
fact that China stepped up FDI promotion slightly before launching the
above mentioned financial reforms indicates that the desire for FDI must
be at least partially the result of considerations other than those of
investment and modernization.
2. Analysis
The answer appears
to lie in the old division between the city and the countryside. Despite
deriving its early support from rural Chinese citizens, the Chinese government
has consistently favored the urban economy over that of the countryside.
The form of this favoritism has already been described for the pre-reform
period. In the reform period China has placed a number of restrictions
on domestic, especially non-state firms, in terms of access to the banking
system, investment opportunities, and government contracts. (Huang, 1999
and Li, C., 2000, pg. 142) Coincidentally, TVEs happen to control the c
ompose the largest bloc of domestic, non-state firms in China.
A comparison (Pei,
1998, pg. 81 and Li, 1999, pg. 33) of the TVE and FIE sectors in 1994 (and
1995) shows that TVEs employed 120 million people while FIEs employed only
12.6 million. In 1994 TVEs accounted for one third of all China's exports,
while in 1995 FIEs accounted for 31.5% of total exports. Both types of
firm were also responsible for considerable tax payments to the central
government. So in many respects, the two sectors do not appear all that
different. It is true that FIEs frequently have advantages in terms of
technical and managerial skills, but two factors must be kept in mind.
First, as Huang points out, most FIEs in China are formed with small firms
in Hong Kong and Taiwan which have few specialized skills to offer to China.
Second, given the enormous untapped local currency savings China should
be able to obtain most, if not all, of the same equipment and skills it
has obtained via FDI in other ways which rely more on indigenous enterprises.
Huang identifies a
number of motivations for the official policy of favoring FIEs over domestic
enterprises from which I draw the following observations. First, the vast
majority of Chinese partners in FIEs are traditional state owned enterprises
(SOEs). So, most of the immediate benefits of FDI will go these SOEs. Second,
FDI can help to fill the insatiable capital demands of SOEs, demands which
the central government can no longer accommodate. Third, FDI and FIEs can
prop up ailing SOEs in the short term while simultaneously improving their
long term positions through transfer of funds, technology, and managerial
know-how. Fourth, conversion to FIE status provides a convenient means
to operationally privatize SOEs with out major political controversy. In
a way, conversion to FIE status recreates many of the features which contributed
to the success of the TVE form of enterprise. Conversion to FIE status
allows SOEs to immediately gain operational autonomy, including new powers
to hire and fire and choose the level of employment appropriate to the
operation. This is turn insulates them from bureaucratic depredations.
Finally, conversion to FIE status qualifies firms for better tax treatment.
Compare this to some
of the features Pei associates with the commercial success of TVEs (1998,
pg.43). He cites the lower number of managers relative to SOEs and the
ability to choose workers based on merit as important factors. These conditions
were subsequently recreated in the FIE. The autonomous nature of TVEs is
also important. Again this factor was recreated in the FIE. He further
cites the reliance on profit maximization as a primary criteria of success
as a major factor. This may seem obvious, but profit has traditionally
not been a major concern for Chinese Communist enterprises. FIEs also follow
the same criteria of success.
Further, the administrative
identity of TVE directors, that is their dual role as agents of the state
and agents of the enterprise, is seen as an advantage in as much as it
provides the enterprise with a sympathetic ear in the government bureaucracy.
Once again, this role is at least partially reprised by the SOE managers
who move into leading positions in a new foreign invested enterprise. Finally,
as an SOE converts to FIE status, its semi-privatization mimics the semi-private
character of the TVE on a larger scale. That is, whereas a TVE is ostensibly
owned by an entire town or village, but is functionally a private venture,
the SOE portion of an FIE is ostensibly owned by the entire country, but
again it acts as if it were a private venture.
3. Implications
Despite these many
similarities, the Chinese central government continues to favor SOEs and
SOE/foreign hybrids over other forms of indigenous enterprise such as TVEs
and private domestic enterprises. This refocussing on urban and industrial
reform is very problematic. Some of the greatest successes of the current
reform period were the result of rural reforms. As Pei (1998, pg. 31) has
pointed out in regards to the first phase of economic reforms, when the
transaction costs of 82% of the Chinese population declined (that is, the
rural population), China's overall transaction costs declined considerably.
Even today the percentage
of the labor force directly engaged in agricultural production is one half
of the total amount and "50 to 100 million surplus rural workers are adrift
between the villages and the cities." (CIA, 2001) The policy changes that
drove improvements in the rural areas were relatively cheap, simple, and
easy to implement. The magnitude of the positive effect came from the sheer
number of beneficiaries.
A shift to an industrial
and urban-based reform program, which relies in large part on a continued
flow of FDI, will directly affect a much smaller portion of the population
and therefore the benefits of reforms will have to be correspondingly much
larger and more intensive to have the same effect on the country as a whole.
Whether such benefits will be forthcoming remains to be seen. In 1998 Rosen
(1998, pg. 86) was already pointing out that FIEs labor costs had skyrocketed,
the labor pool had shrunk considerably, and that competition for competent
English speaking professionals was fierce. He further identified the problem
of incumbent firms.
"Incumbent firms often have an incentive to counteract the reforming instincts of central authorities and their incumbency usually provides the flow of cash needed to express their preference. While reform might lead to regulations applied uniformly- making administration more efficient and equitable, and expanding competition to enhance aggregate economic welfare- existing firms may prefer the status quo. Perhaps they seek special provisions grand fathering their privileges, or perhaps they seek to block change altogether."
One final problem with reliance on FDI is that foreign investment cannot be taken for granted over the long term. China is explicitly counting on FDI to put into practice the Tenth Five Year Plan, particuarly in the area of modernizing the western regions ("China's Preferential Policies for Foreign Investment", 2000). While China can most likely count on foreign companies to maintain current fixed assets in the country, any number of world events could easily reduce the flow of FDI dramatically. As the importance of FDI increases, this vulnerability of the Chinese economy will also increase.
III. Conclusions
The most important
lesson to be learned from this examination of Chinese policymaking behavior
is that China continues to follow its own unique ideas on economic management.
But prospects for the future are mixed as China seeks to move its reform
initiatives in new directions. The method of reactive policymaking has
managed to serve the interests of both the nation and the central government
up to now, but as new interests emerge and old interests diverge, the value
of reactive policymaking is likely to decline substantially. The complaints
of foreign businesspeople and the possible loss of central control are
two drawbacks which have already manifested themselves. More are likely
to follow as the center continues to persue a policy which is less and
less appropriate to the circumstances.
Likewise, the shift
in emphasis from broad based rural reforms to more targeted reforms with
an increased reliance on FDI may not be an improvement for a variety of
reasons. The implications of the FDI problem demonstrate that the Chinese
government may not continue to be successful in charting an sound course
for the Chinese economy. Taken together, the new course of China's economy
and the method of setting that course demonstrate that twenty years of
past success will not guarantee twenty years of future success.
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(May 26, 2002 Note: One of the main ideas I had in writing this essay was still very imperfectly formulated in my mind by the time I had to hand it in, and therefore it does not show up very clearly there. I have still have not forumlated the idea very well, but it is becoming clearer to me.
Essentially it is this:
Modern Chinese prosperity increased most rapidly and for the greatest number of its citizens when the government abandoned its long-standing bias against the rural population and eased its commitment to the dual economy. However, the structure of the promotional FDI regime in the country has tended to rebuild the divide between rural and urban areas, and to reinvigorate the bias against rural areas since urban economic improvements are:
A. more concentrated and therefore more spectacular and prestigious
and
B. physically closer to national level decisionmakers and therefore are more familiar and more likely to influence the thinking of top decisionmakers.
The less spectacular, less concetrated, and less interesting improvements in the countryside- which are much more vital to the health of the nation- are more easily dismissed when the explicit commitment to the countryside is removed from the equation. Therefore, it seems to me there is a danger that a new reincarnation of the debilitating dual economic structure of the mid-twentieth century could be reproduced in China in the early part of the present century, with effects that may be equally detrimental to the country.
Another danger of a new rural/urban division in the present century is that the urban sector will most likely be backed by powerful international interests outside the control of the Chinese central government. Under such conditions a new policy for the rectification of the divide could be much more difficult to implement. Short of that, it is reasonable to expect that international interests will be much more effective at lobbying the Chinese government in favor of their own interests- which will most likely to continue to be mainly urban interests- than will domestic rural interests.
I think that the center's penchant for reactive policymaking in the area of the domestic economy blinds decisionmakers to the possibility that they could themselves (re)create such a split. In the first place, only successful experiments are even considered for national application by observant reactive policymakers in Beijing. However, experiments are more likely to be successful if they have access to foreign inputs of money and expertise. Foreign inputs of money and expertise, in turn, are concentrated in urban areas as a result of the structure of the Chinese promotional FDI regime. Therefore, there is a structural bias in the system which favors the success of urban experiments over rual experiments. Finally, it is reasonable to expect that urban experiments will generally only be applicable to other urban areas. This means that as long as the reactive policymaking approach is persued, ostensibly "national" reforms and improvements and the government assistance associated with those reforms and improvements, will actually be urban reforms and improvements.
A self-reinforcing cycle could begin, or may have already begun. National economic policy could become heavily biased in favor of the urban economies which contain a minority of the population and are already well ahead of the rural areas.
The reactive policymakers
do not appear to have made any provision for a mechanism to identify the
emergence of such a cycle, or indeed to identify any of the national level
consequences of the various policies they promote from the local to the
national level.)