Economic Reforms and Social Change in China

          Economics Analysis and Application

                                      An Essay on

                                                Economic Reforms and Social Change in China          

Name: Stewart Miles

Submitted Date: 12 March 2020

Capital Normal University(Beijing)china

                                                                             Abstract

This essay applies a systems-oriented, “holistic” approach to China’s radical economic reforms during the last quarter of a century. It characterizes China’s economic reforms in terms of a multidimensional classification of economic systems. When looking at the economic consequences of China’s change of economic system, I deal with both the impressive growth performance and its economic costs. I also study the consequences of the economic reforms for the previous social arrangements in the country, which were tied to individual work units: agriculture communes, collective firms and state-owned enterprises. I continue with the social development during the reform period, reflecting a complex mix of social advances, mainly in terms of poverty reduction, and regress for large population groups in terms of income security and human services, such as education and, in particular, health care. I discuss little bit about China future policy options in the social field, whereby I draw heavily on relevant experiences in developed countries over the years. The future options are classified into three broad categories, policies influencing the level and distribution of factor income, income transfers including social insurance, and the provision of human services. 

 Introduction  

The fascination with the economic development in China during the last quarter of a century (approximately 1978-2006) largely depends on two circumstances. One is the radical shift of the economic system in a country encompassing a fifth of the population of the world. The other is the country’s successful economic performance in connection with this shift. The most obvious illustrations of the latter are the officially recorded aggregate GDP growth rate of about 10 percent per year, the eightfold increase in per capita household income, and the drastic fall in the number of individuals living in “absolute poverty”. However, equally interesting are the social problems that have accompanied this transformation – manifest, for instance, in the fields of income security, the overall distribution of income, and the provision of various types of human services, such as education and health care. To highlight these issues, this essay applies a systems-oriented, “holistic” approach to china's radical economic reforms. It deals with both the nature of the reforms and their economic and social consequences. More specifically, the essay focuses on the interaction between economic and social forces during the reform period. I also consider China’s options for continued economic and social reforms, whereby I draw heavily on relevant experiences over the years in developed countries. Although I concentrate on the economic and social developments of the country as a whole, the huge differences across geographical areas within China remain an important aspect of these developments. Since the focus of the essay is on long-term structural issues, the design of short-term macroeconomic stabilization policy will not be discussed, although the importance of such policies for income stability will be stressed. The essay starts with a characterization of China’s economic reforms in terms of a Multidimensional classification of economic systems, where today’s China is described as a special type of “mixed economy”. When looking at the economic consequences of the reforms, I deal with both the impressive growth performance and various types of economic costs. The next step is to study the consequences of the economic reforms for the previous social arrangements, which were tied to individual work units – agriculture communes, collective firms, and state-owned enterprises. I continue with various social developments, which reflect a complex mix of social advances in some respects and regress in others. China’s future policy options in the social field are also classified into three broad categories: those influencing the level and distribution of factor income (i. e., incomes from labor and capital), income transfers (in particular, social insurance), and the provision of human services. Few steps contain brief concluding remarks about China’s achievements and unsolved problems in the economic and social fields. It is unavoidable that the analysis shoots at a moving target – both because the reform process moves on and because of ongoing revisions of the national accounts. 1 I make no attempt to explain the internal political processes among the Chinese leadership behind the economic reforms. Although Deng Xiaoping stands out as the dominant political leader in the initial stages of the reforms, the views interests and actions of political leaders at all levels must also have been crucial for the process.

  The Nature and Economic Consequences of the Economic Reforms

 The Reform 

     The sequence of the economic reforms in China is well known by now. The reforms started with spontaneous, mainly local reorganization in agriculture in the late 1970s, resulting in greater autonomy for individual collective farms, as well as for those working there. These arrangements were codified and further developed in accordance with the so-called Household Responsibility System in 1978/79 and the replacement of collective farms with family farms in the early 1980s. In industry, the reforms began in the early 1980s (also rather spontaneously) with an expansion of collective industrial firms in rural areas, so-called Township, and Village Enterprises (TVEs), initiated by local political leaders. Indeed, TVEs became the most vital part of the manufacturing sector in China from the early 1980s to the early 1990s. The economic reform process continued with central policy decisions to increase the autonomy of individual state-owned enterprises, SOEs, in particular as a result of the so-called Contract Responsibility System initiated in the mid-1980s.  These three developments the shift from agricultural collectives to household farms, the expansion of TVEs, and the reorganization of individual SOEs – constitute the starting point for a gradual overhaul of the entire economic system in China. The reform process continued with the privatization of a large number of small and medium-sized SOEs, the entry and expansion of domestic and foreign private firms (the latter, to begin with, in Special Economic Zones, SEZs), a gradually more private character of the originally collective industrial firms and the liberalization of international trade. While the reforms of the SOEs, in the beginning, were limited to reorganizations, from the mid-1990s layoffs of workers and privatization became dominating features of the reform process in this sector. Moreover, today (indeed from the mid-1990s), most TVEs, although still often called “collective”, are basically private firms – partnerships, unincorporated business, or producers’ cooperatives. (The label “collective” is often presumed to make them ideologically more acceptable and better treated by public authorities and credit institutes; see, for instance, IFC, 2000.) Most likely, the internationalization of the Chinese economy, which has been more important in the industry than in agriculture, results not only in traditional static (text-book type) gains from trade and international capital mobility, but also in efficiency-enhancing international competition and greater opportunities to learn from foreign firms. It is also likely that China’s interaction with the rest of the world influences the values and lifestyles of the domestic population. We may expect the emergence of more individualistic (and perhaps also hedonistic) values, in particular among the urban young – a process that already seems to be underway. China’s choice of a strongly outward-oriented development strategy, subsequently codified by its entry into the WTO as of 2001, must have come as a surprise to observers who, a few decades ago, asserted that such a strategy is mainly suitable for modest-sized countries. These observers were clearly wrong. It is unlikely, however, that such a huge country as China will continue to have a similarly high export share in a long-term perspective. In particular, the statistically recorded export share of GDP in current prices is bound to fall when real wages, and hence the relative prices of non-tradables, rise in the future. Moreover, with higher skills and better technology, China is likely to expand its domestic production of components of manufactured goods. We may speculate that this will reduce the country’s dependence on international trade.

In principle, China’s increased presence on world markets would be expected to boost the potential gains from trade also for developed countries, since such gains tend to increase by the difference in factor proportions among trading partners. In other words, Heckscher- Ohlin type of trade, based on different factor proportions, would be expected to increase. Nevertheless, it is an open question to what extent the outside world will allow China to continue its distinctly outward-oriented growth strategy. To a considerable extent, this probably depends on the ability of today’s developed countries to adjust to the new global competitive situation, with an increased presence on the world market of not only a number of large developing countries, including India and Brazil, but also former Soviet republics and previous socialist countries in Eastern Europe – all with abundant labor and low real wages as compared to developed countries. 

China has, of course, already exerted considerable influence on the market for labor-intensive products in developed countries. However, worries are often also expressed in these countries to the effect that China is already becoming an important exporter of high-tech and high-skill products. For instance, many observers point to the fact that China’s export-product mix is more similar to that of the OECD countries than we would expect on the basis of China’s modest per capita GDP…. China is an example of the complexity. In particular, some elements of corruption have speeded up the transition to private entrepreneurship by helping create a class of private capitalists, for instance, when public funds have been diverted to private individuals (asset stripping”), such as in the case of management buyouts. During the course of the reform period, corruption may therefore not have harmed economic growth, perhaps even the opposite. It has, however, contributed to serious social problems. For instance, as emphasized, for instance, by Zhang (2006), transactions in the context of existing networks have in some cases taken place at the expense of weak groups of citizens. An obvious example is the earlier mentioned expropriation of land-tenure contracts when local politicians and administrators (“cadres”) turn over land-lease contracts to developers in the industry, retailing, and housing. Although such interventions have speeded up the reallocation of resources from agriculture to other sectors, this has occurred at the expense of farmers’ economic security. Social concerns have been relinquished for other purposes, such as a fast rate of structural change – and the enrichment of local cadres, who often share the capital gains of such reallocations of land-lease contracts. Such expropriation of agriculture land, without full compensation, is only one example of many of the misuses of powers by local cadres – other important examples being irregular payments of wages in connection with public works programs and an arbitrary imposition of levies of various types (Chow, 2006d). There is no lack of official (in particular verbal) commitments to fight corruption in China. Indeed, China has made considerable progress in improving the legal system since the late 1970s. As a result, the legal system already seems to be more developed in China than in a number of countries outside East Asia on a similar level of economic development.

For these reasons, the Chinese economic system is perhaps best characterized as a special type of “mixed economy” – with more private ownership of firms than of assets, frequent political and bureaucratic  interventions in public-sector firms, poorly developed factor markets (in particular financial markets), and business networks that partly replace the “rule of law”, although in many cases at the cost of widespread corruption. Although the previous economic system in China has been overhauled by the economic reforms, there are nevertheless important continuities between the pre- and post-reform periods. Obvious examples are the inheritance of heavy industrial structures (in particular, in northern and western provinces), the collective ownership of land, the TVEs (although they have gradually been turned into private enterprises), the role of informal networks and the combination of political centralization and administrative decentralization in the public sector.

 Economic Consequences                                                                          We do not really know which specific elements of China’s economic reforms during the last quarter of a century best explain the county’s successful growth performance. We can only say that the actual combination of elements in the reform package, schematically illustrated highly conducive to GDP growth. An important component of the reforms has then simply been to remove various institutional obstacles for economic growth, and hence release initiatives that have boosted the accumulation of real and human capital, and stimulated import of foreign technology and organization. It is tempting, and usual, to argue that China’s growth performance has also been enhanced by the gradual and experimental nature of the reform process. To a considerable extent, the process also relied on bottom-up initiatives, rather than top down reforms, although new political signals from central political authorities have, of course, kept up the thrust of the process and influenced its course. However, the reforms do not seem to have been based on a blueprint of a specific “final stage”, although new intermediate goals have been spelled out consecutively in the Five-Year Plans. Often mentioned examples of the gradualism are that agricultural reforms began as local initiatives before they became national policies, that the reforms in manufacturing were initiated only after the success of agricultural reforms, and that the national economy was only gradually opened to international trade and foreign investment. As a consequence, while family farms were the most dynamic force in the Chinese economy during the first years of the reform process, the TVEs generated much of the dynamism during the course of the 1980s, and foreign enterprises were an important growth factor in the 1990s. Another important example of the gradualisms is that firms and households were exposed only step-by step to competitive markets and new price relations. It remains to explain why China chose such a pronouncedly gradualist approach to begin with. One reason might be that the country had recent experiences of a number of unsuccessful “Big Bang” reforms: the radical nationalization and collectivization after the Communist take-over in the late 1940s, the Great Leap Forward 1958 to 1962, and the Cultural Revolution from the mid-1960s to the mid-1970s. Moreover, the reformers in China probably did not regard a Big Bang strategy as necessary to block a subsequent reversal of the economic reforms. Both the authorities themselves and economic agents were probably confident that the new regime would continue to be in political control for a considerable period of time. This point is important since confidence that the reforms would stay, and indeed continue, is crucial for agents contemplating investment in real and human capital. In this sense, political stability contributed to making gradualism feasible. The actual growth performance of the Chinese economy has been impressive regardless of whether we rely on the official figures of about 9.5 percent GDP growth per year since the start of the reforms (8.3 percent per capita), or whether we believe in somewhat more conservative calculations. When evaluating China’s success in terms of GDP growth, it is, however, also important to take into account the resource costs of the chosen growth strategy – i.e., the efficiency of the growth path. There are several reasons to expect that the growth path has not been very efficient.

     One reason is the previously mentioned malfunctioning of factor markets, in particular credit and capital markets. While the financial markets in China have succeeded in intermediating the large volume of household saving to firms, the allocative efficiency of the process seems to have been poor. Obvious indicators are that the geographical mobility of capital and credit is low, that firms plow back profits rather than return them to the capital market, and that public-sector firms are favored as compared to private firms. There are also indications that the government tends to reallocate funds from regions with high returns to regions with low returns. As a result of the priorities given to state firms in financial markets, large capital-intensive firms have been favored relative to small, medium-sized and labor-intensive firms.  Indeed, according to estimates by the People’s Bank of China (2004), small and medium-sized firms received less than ten percent of the bank loans in the early 21st century, although they produced more than half of GDP…….The modest size of the service sector is often regarded as another indicator of inefficiencies in the allocation of resources across production sectors in China. This point has recently been weakened, although not eliminated, by revisions of the national accounts (in December 2005), whereby the reported GDP share of services was raised from 32 percent to 41 percent – still, however, a fairly modest figure for a country at China’s current stage of development. Naturally, China’s capital-intensive growth strategy has also constrained the ability of non-agricultural sectors to absorb the surplus labor in agriculture. This helps explain why the population share in agriculture is still quite large as compared to that of countries at about the same level of economic development, although the official figure, 50 percent of the population is likely to be exaggerated. Moreover, there is a number of reasons to expect that state-owned firms usually are less efficient than private ones in China, including the political appointment of managers and the direct political intervention in the operations of such firms. On the basis of existing evidence, it is reasonable to conclude that (except mainly for the sector of foreign firms) economic growth in China has largely been resource extensive in the sense of heavily relying on capital accumulation, inputs of raw materials and energy, and the depletion of environmental resources. Naturally, both the public discussion and the scholarly literature have emphasized the huge regional differences in per capita income growth – with the eastern (coastal) provinces as the leaders, and the mountainous provinces in the west, along with the “rustbelt” areas in the north as the laggards; see, for instance, Démurger et al. (2002).  Official statistics suggest that while GDP has grown by about 11.5 percent per year during the reform period in the most successful provinces (Fujian, Guangdong, Jiangsu and Zhejiang), the growth rate has been about half of that in the least successful province (Quinghai); see, for instance, Wei and Liu (2004). However, such extreme comparisons give an exaggerated picture of the overall dispersion of the distribution of growth rates across provinces. The standard deviation of the per capita growth rate across provinces during the period 1980-2002 seems to have been 1.5 percentage point, which, however, is enough to generate large differences in levels of per capita income across provinces. The level of per capita GDP is currently reported to be about seven times higher in the most developed than in the least developed province, even if we exclude the very poorest province (Guizhou).

Indeed, the regional differences among China’s provinces (and large cities) are so large that China looks like a continent with a mixture of emerging industrial countries and some of the poorest “countries” in the world. It is also well known that per capita income differs drastically between urban and rural areas within provinces. For instance, official statistics suggest that the ratio of average income in urban areas is about three times (3.3) as high as in rural areas. However, this is a highly uncertain figure because it may not fully reflect differences in costs of living in rural and urban areas – a measurement defect that is usual

in other countries as well. Although average income and consumption have increased rapidly in nearly all parts of the country during the reform period (Chow, 2006a; Ravalli on and Chen, 2006), these geographical differences are an important background for widespread dissatisfaction with the social situation in the country – an issue to which I now turn.

              Social Advance and Regress

The Chinese authorities have been much less active, and much less successful, in the social field than in the case of growth-promoting economic reforms. This contrasts with the pre-reform period. While aggregate output growth then was modes, and total factor productivity hardly increased at all, there were important achievements in some social fields. The main examples are basic health and elementary education – although the authorities during this period also were responsible for the devastating famine in connection with the “Great Leap Forward” in the late 1950s and early 1960s and the educational regress during the “Cultural Revolution” in the late 1960s and early 1970s. What, then, have been the most important social developments in China during the period of economic reform? And what are the consequences of the economic reforms for the functioning of previously established (“inherited”) social arrangements? I start with the second question.

             Social Policy Options

             When discussing the possibilities for the Chinese authorities to speed up improvement in social conditions, it is useful to classify policies into three categories:

(I)       Interventions  that boost and stabilize the factor income of citizens, in particular among low-income groups;

(ll)         Tax /transfer arrangements designed to stabilize and redistribute disposable income for given  factor incomes (”income security”); and

(III)      Improved and more evenly distributed provision of various types of human services. Since the social arrangements (the “social system”) in China is undergoing rapid change.

Concluding 

I have described China’s economic reforms since the late 1970s as a gradual transformation of the country’s economic system, expressed in terms of a nine-dimensional vector I have argued that China has much to gain from a continuation of the transformation in the form of further deregulations of product and factor markets, not least the markets for capital and credit. More efficiency-based prices on energy and raw material are also important from that point of view. Deregulations and equilibrating prices would also help reduce corruption, since politicians and public-sector administrators would then have less to “sell”, such as various types of permits, loans, and subsidies. Deregulations, combined with less political interventions in publicly owned firms, would also contribute to further decentralization of production and investment decisions. The decentralization of China’s economic system would be further speeded up by a continuation of privatization and by improvements in the working conditions of private entrepreneurs. Broad experience from developed countries also indicates that private entrepreneurship is highly conducive to innovations; see, for instance, Baumol (2000). Moreover, a large-scale privatization bank would, most likely, reduce the bias in bank lending in favor of state enterprises. (In the case of large state banks, China has so far only sold minority posts.) China has also much to gain from giving up its resistance to private ownership of land which, most likely, is a serious obstacle to faster income growth in agriculture (at least during a period of transition). An important source of corruption would then also be removed by taking away the control of land allocations from local caders. Deregulation and privatization would also boost competition and increase the role of economic incentives in the production system. Although a continuation of a high degree of internationalization of the economic system is also favorable for competition, I have argued that it is not likely that such a large country as China will, in the long run, have a foreign-trade sector of the present size (i.e., about three times as large as in the United States and Japan). If the continued economic reforms follow such lines, it is likely that China’s growth path will be more “intensive” (less resource-demanding) than earlier – with more emphasis on human relative to physical capital, less use of raw materials and energy (per output unit), and a faster introduction of new technology, innovation and organization. Why should such “fine-tuning” of the economic system be important when China has already been exceptionally successful in generating fast economic growth? One answer is that a more intensive growth path would release resources for consumption of both ordinary consumer goods and human services (such as education and health care) – without reducing the GDP growth rate (much). There would also (or alternatively) be more resources available for cleaning up the highly polluted environment. Less capital intensive production would also counteract tendencies to gradually increasing unemployment. A complimentary answer to the question (of the importance of “fine-tuning” of the Chinese economic system) could be that a more intensive growth path will be more decisive in the future when China is likely to be closer to the international technological frontier in a number of fields. Extensive growth (based on the mobilization rather than the effective use of resources) was probably less problematic in the early stages of the transition period. However, experiences in developed countries also show that it is important to make welfare-state arrangements reasonably robust to exogenous shocks – such as unfavorable changes in demography, productivity growth, and unemployment. It is also important to avoid large “undesired” endogenous behavioral adjustments by individuals, for instance, as a result of tax distortions and moral hazard. I have discussed various ways of minimizing such risks. One is, of course, to keep the generosity of the benefits within “reasonable” limits. Another way would be to opt for “quasi-actuarial” social-insurance systems, hence tying benefits tightly to the individual’s own previously paid contributions. Countries in early phases of building up welfare-state arrangements, including China, have particularly strong reasons to be aware of the risks of disincentive effects when entering the route towards more advanced welfare-state arrangements.  And By an appropriate design of future social arrangements, and their financing, China maybe able to avoid serious trade-offs in the near future between social ambitions, on one hand, and efficiency/growth considerations, on the other hand.

 References

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