Re­flec­tions on China’s re­forms

China Daily (Latin America Weekly) - - Views - The au­thor is the World Bank’s coun­try di­rec­tor for China.

Forty years ago in De­cem­ber, Deng Xiaop­ing de­liv­ered his his­toric speech: “Eman­ci­pate the mind, seek truth from facts and unite as one to face the fu­ture.” This trig­gered four decades of re­form and open­ing-up that have trans­formed China into the world’s sec­ond-largest econ­omy. By some time in the next decade, China will be among the few coun­tries in the world that will have tran­si­tioned from low­in­come to high-in­come sta­tus since World War II.

Un­der­stand­ing the path China has trav­eled, the cir­cum­stances un­der which his­tor­i­cal de­ci­sions were made, and their ef­fects on the course of China’s econ­omy will in­form fu­ture de­ci­sion mak­ers. In­creas­ingly, this re­flec­tion is im­por­tant to the rest of the world as more and more coun­tries see China as an ex­am­ple to em­u­late. At the 19th Na­tional Congress of the Com­mu­nist Party of China in Oc­to­ber 2017, China ac­cepted this man­tle for the first time since the on­set of re­form and open­ing-up.

In some ways, China’s re­forms were fairly main­stream. The coun­try opened up for trade and for­eign in­vest­ment, lib­er­al­ized prices, di­ver­si­fied own­er­ship, strength­ened prop­erty rights, kept in­fla­tion un­der con­trol, and main­tained high sav­ings and in­vest­ment.

But this view is sim­pli­fy­ing the re­form and open­ing-up and ob­fus­cates their essence: the unique steps China has taken to re­form its sys­tem are what make its ex­pe­ri­ence of in­ter­est. Its grad­ual ap­proach to re­form was in sharp con­trast to Eastern Europe and the Soviet Union. Although often com­pared, China and other tran­si­tion coun­tries were sim­ply too dif­fer­ent in terms of ini­tial eco­nomic con­di­tions, po­lit­i­cal de­vel­op­ment, and ex­ter­nal en­vi­ron­ment.

Pre­dom­i­nantly ru­ral and among the poor­est coun­tries on Earth, China was marred by the dis­rup­tions of the “great leap for­ward” and the “cul­tural rev­o­lu­tion (1966-76)”. In­te­gra­tion into the global econ­omy was min­i­mal. In­dus­try was in­ef­fi­cient, but also far less con­cen­trated than in Eastern Europe and the Soviet Union. Per­haps most im­por­tantly, be­cause China re­tained po­lit­i­cal con­ti­nu­ity, it could fo­cus on an eco­nomic and so­cial tran­si­tion in­stead of a po­lit­i­cal one.

Com­par­i­son with much of the Latin Amer­i­can re­forms also seems out of place. Brazil, Mex­ico and Ar­gentina were far closer to a mar­ket-based sys­tem than China, and their re­forms — lib­er­al­iza­tion and macroe­co­nomic sta­bil­ity — were fo­cused on macroe­co­nomic sta­bi­liza­tion, whereas China’s re­forms aimed for a trans­for­ma­tion of the eco­nomic sys­tem as a whole. So there is no need to jux­ta­pose the “Wash­ing­ton Con­sen­sus” with a “Beijing Con­sen­sus”: the ap­proaches taken served very dif­fer­ent pur­poses in­deed. often start­ing in a few re­gions, and ex­pand­ing them upon proven suc­cess. A broader strat­egy emerged only in 1993, with the De­ci­sions of the Third Plenum of the 14th CPC Cen­tral Com­mit­tee, but this too was im­ple­mented grad­u­ally.

In ad­di­tion to be­ing a means to find so­lu­tions suit­able to China, ex­per­i­men­ta­tion and grad­u­al­ism was a means to cir­cum­vent po­lit­i­cal re­sis­tance against re­form. Many in the CPC re­tained a sus­pi­cion of the mar­ket. Grad­ual ex­per­i­men­tal re­form was also a prag­matic ap­proach in a heav­ily dis­torted en­vi­ron­ment in which “first best” so­lu­tions were un­likely to ap­ply. Ex­per­i­men­tal re­forms, con­fined to spe­cific re­gions or sec­tors, al­lowed the au­thor­i­ties to gather in­for­ma­tion on the unan­tic­i­pated ef­fects of re­form. They were also able to de­velop and test the ad­min­is­tra­tive pro­ce­dures and com­ple­men­tary poli­cies needed to im­ple­ment the re­form. Suc­cess meant the ex­per­i­ment could be ex­panded to other re­gions and sec­tors.

Fi­nally, ex­per­i­men­tal re­form also saved re­form­ers from “los­ing face”. An ex­per­i­ment that did not work could be aban­doned rather than con­demned as a pol­icy fail­ure. The strat­egy re­in­forced the cred­i­bil­ity of re­form over time. By mak­ing re­form one step at a time, and start­ing with those most likely to de­liver re­sults, the Chi­nese gov­ern­ment built up its rep­u­ta­tion for de­liv­ery. Ev­ery suc­cess­ful re­form helped the next one. This also built up ex­pe­ri­ence and skills for the de­sign and im­ple­men­ta­tion of re­form, help­ing China to build up its “re­form” cap­i­tal.

De­cen­tral­iza­tion of author­ity be­came a pow­er­ful tool. The prov­inces and lo­cal gov­ern­ments re­ceived in­creas­ing author­ity over in­vest­ment ap­provals, fis­cal re­sources, and poli­cies. Prov­inces, mu­nic­i­pal­i­ties and even coun­ties were al­lowed, even en­cour­aged, to ex­per­i­ment with re­forms. Suc­cess­ful ex­per­i­ments be­came of­fi­cial pol­icy and were quickly adopted through­out the coun­try. By de­cen­tral­iz­ing, China turned the coun­try into a lab­o­ra­tory for re­form.

The fis­cal sys­tem and the po­lit­i­cal or­ga­ni­za­tion within the Party were key in align­ing sub-na­tional gov­ern­ment in­cen­tives with that of the cen­ter. The fis­cal re­forms in­tro­duced in 1980 formed a de facto tax con­tract­ing sys­tem, with high rev­enue re­ten­tion rates for lo­cal gov­ern­ments, par­tic­u­larly set for growth. For in­stance, Guang­dong prov­ince paid a lump sum in rev­enues to the cen­tral gov­ern­ment, and re­tained 100 per­cent of the rest. The ben­e­fits of re­forms were dis­trib­uted broadly across the pop­u­la­tion and gov­ern­ments, cre­at­ing strong in­cen­tives to pur­sue growth and pro­mote a mar­ket econ­omy.

Within the Party, achiev­ing growth — by cre­at­ing jobs and at­tract­ing in­vest­ment — quick­ened pro­mo­tions. So­cial achieve­ments also played a role, but suc­cess with GDP growth, es­pe­cially in the re­gions, was para­mount to climb­ing up to higher posts. This re­gional ex­pe­ri­ence en­abled the most tal­ented to demon­strate their ca­pac­ity to re­form.

A dis­ad­van­tage of the ap­proach was im­per­fect macroe­co­nomic con­trol and re­peated bouts of in­fla­tion driven by lo­cal gov­ern­ments’ loos­en­ing their in­vest­ment and credit con­trols. Th­ese con­di­tions gave rise to lo­cal pro­tec­tion­ism, which threat­ened to un­der­mine China’s uni­fied mar­ket. In 1992, re­form re­gained mo­men­tum af­ter Deng Xiaop­ing’s “Tour through the South”, but in­fla­tion re-emerged, and the agenda be­came one of cen­tral­iza­tion of poli­cies. Fis­cal and fi­nan­cial re­forms fol­lowed, aimed at cre­at­ing the tools for macroe­co­nomic man­age­ment in a mar­ket econ­omy.

In the course of re­form, China’s own par­tic­u­lar tran­si­tional in­sti­tu­tions emerged. The “dual track” sys­tem for grow­ing out of the planned econ­omy was the most im­por­tant of all tran­si­tional in­sti­tu­tions. It al­lowed a con­tin­u­a­tion of the plan­ning sys­tem at planned prices, which avoided the col­lapse of pro­duc­tion. But on the mar­gin, the sys­tem al­lowed a non­planned econ­omy to emerge. This also pro­vided the in­for­ma­tion needed to grad­u­ally re­form within-plan prices in such a way that by the time of the abo­li­tion of most ma­te­rial plan­ning in the mid-1990s, plan and out­side-plan prices had been largely aligned.

Sim­i­larly, the de facto fis­cal con­tract­ing sys­tem in­tro­duced af­ter 1980 in­cen­tivized growth to sub-na­tional gov­ern­ments by leav­ing much of the in­cre­men­tal rev­enues in the prov­inces. Able to self-man­age re­sources, lo­cal of­fi­cials pur­sued re­form and at­tracted the in­vest­ments needed to pro­mote growth.

A very ef­fec­tive hy­brid in­sti­tu­tion was the Township and Vil­lage En­ter­prise. This type of en­ter­prise form op­er­ated out­side the plan, but was owned and to some ex­tend man­aged by lo­cal gov­ern­ments. Th­ese en­ter­prises ex­panded pro­duc­tion and cre­ated jobs. As pri­vate prop­erty was frowned upon and hardly pro­tected by law, cre­at­ing an own­er­ship form that aligned the in­ter­ests of the lo­cal gov­ern­ment with that of the en­ter­prise was cru­cial. Once pri­vate prop­erty be­came more acceptable, most of the TVEs were over­taken by pri­vate and for­eign-in­vested com­pa­nies as the main source of growth and job cre­ation.

The study and for­mu­la­tion of re­form and new poli­cies was in­sti­tu­tion­al­ized in China. Start­ing with the Chi­nese Academy of So­cial Sciences, a va­ri­ety of think tanks sprang up to study and pro­mote re­form. Among the most in­flu­en­tial were the De­vel­op­ment Re­search Cen­ter of the State Coun­cil, China’s Cab­i­net, and the State Com­mis­sion for the Re­struc­tur­ing of the Eco­nomic Sys­tem. Not bur­dened by bu­reau­cratic in­ter­ests like many tra­di­tional gov­ern­ment de­part­ments, th­ese or­ga­ni­za­tions were in­flu­en­tial in for­mu­lat­ing and di­rect­ing re­form. growth rate in the 1980s bears wit­ness to that. It was a gen­uine search for which el­e­ments of a mar­ket econ­omy would work in China, and which ones would be po­lit­i­cally acceptable at the time — house­hold re­spon­si­bil­ity sys­tem, dual pric­ing, TVEs, and spe­cial eco­nomic zones for for­eign in­vest­ment.

The 1993 De­ci­sions of the Third Plenum of the 14th CPC Cen­tral Com­mit­tee sig­ni­fies the start of the sec­ond phase, as it laid out a com­pre­hen­sive plan to build the in­sti­tu­tions for a mar­ket-driven econ­omy. Th­ese in­cluded a mod­ern tax sys­tem, en­ter­prise re­forms, and a fi­nan­cial sys­tem that sep­a­rated pol­icy banks from com­mer­cial banks. The start of se­ri­ous SOE re­forms in the mid-1990s al­lowed those com­mer­cial banks to be­come truly com­mer­cial, and hous­ing and (ur­ban) so­cial se­cu­rity re­forms fol­lowed. China’s en­try into the World Trade Or­ga­ni­za­tion not only served as a lever for those do­mes­tic re­forms, but also en­sured much greater com­pe­ti­tion in the goods mar­ket. The slash­ing of im­port tar­iffs made China far more com­pet­i­tive in ex­ports, and made the coun­try a vi­able plat­form for fi­nal assem­bly of Asia-based ex­ports hith­erto pro­duced else­where. The in­clu­sion of pri­vate prop­erty in the Con­sti­tu­tion con­cluded the mar­ket-build­ing phase.

This phase can be seen as the years in which the State left in­creas­ing room for the mar­ket. Pri­vate in­vest­ment in the econ­omy ex­ploded and in­creased its share in the econ­omy from less than 2 per­cent in 1992 to some 15 per­cent by 2003. In 1999, the Chi­nese gov­ern­ment also con­sol­i­dated all the in­dus­try-re­lated min­istries into the Min­istry of Com­merce and the Min­istry of In­dus­try and In­for­ma­tion Tech­nol­ogy.

Since then, re­form has fo­cused on what I would call en­hanc­ing the mar­ket. Its two main ingredients? A grad­ual ex­pan­sion of the so­cial safety net (pen­sions, health­care, wel­fare), and a re­turn of in­dus­trial pol­icy. “Techno-in­dus­trial pol­icy” had been on the de­fense af­ter 1978 but re-emerged af­ter for­mer premier Zhu Rongji left of­fice. The State Com­mis­sion for Re­struc­tur­ing the Eco­nomic Sys­tem was merged with the State De­vel­op­ment Plan­ning Com­mis­sion in 2003 to form the Na­tional De­vel­op­ment and Re­form Com­mis­sion. In 2006, the Medium-Term Strat­egy for Sci­ence and Tech­nol­ogy was launched along with 16 mega projects, bring­ing in­dus­trial pol­icy to the fore­front. The global fi­nan­cial cri­sis, which prompted China to an­nounce a large do­mes­tic stim­u­lus, en­cour­aged the pol­icy, and State banks and SOEs were called to help pol­icy im­ple­men­ta­tion.

The 19th Party Congress and Gen­eral Sec­re­tary Xi Jin­ping’s re­port con­firmed th­ese pol­icy di­rec­tions: mar­ket-based al­lo­ca­tion, a dom­i­nant role for pub­lic own­er­ship, and a strong em­pha­sis on in­dus­trial poli­cies, and sci­ence and tech­nol­ogy to achieve the goals of the “first phase of the New Era (2020-2035)” namely so­cial­ist mod­ern­iza­tion. With the new era, China seems to have found its dis­tinct eco­nomic sys­tem, with mar­kets and State own­er­ship liv­ing side by side, and with in­dus­trial poli­cies guid­ing the mar­ket. This sys­tem has its own com­plex­i­ties and is­sues. How­ever, those who thought that “cross­ing the river” would lead to a fa­mil­iar mar­ket econ­omy sim­i­lar to those found in the Or­ga­ni­za­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment mem­ber coun­tries may want to think again.

SONG CHEN / CHINA DAILY

BERT HOFMAN

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