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Reform and Growth in China: New challenges for policymakers in the wake of earlier successes

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1988
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shahid Javed Burki

In 1978 China began a process of economic reforms that has brought about dramatic economic and social change in just over ten years. In 1980, Chinese planners set a target of quadrupling the country’s industrial and agricultural output by the close of the century. Since 1976, China has achieved a GNP growth rate of over 8 percent a year and if this trend can be maintained the country will comfortably meet the target set for 2000. Between 1949 and 1976, China’s output increased mostly through increased capital formation, made possible by a very high level of domestic savings; productivity increased slowly, if at all. But in more recent years, half or more of China’s growth can be explained by rising total factor productivity. This signals a change from the past.

Will China be able to maintain the rate of growth of recent years? The answer depends in part on the country’s ability to address a number of problems that have surfaced recently. Inflation has been increasing: it was estimated at 7.9 percent for 1987, but it increased to an annualized rate of 11 percent in the first quarter of 1988; more recently, estimates suggest a rate of close to 20 percent. Increases in prices have been much higher in major cities and for such commodities of daily use as pork, eggs, and vegetables. Reform inevitably tends to be inflationary in all circumstances, since it requires adjustments in relative prices, which in practice means that average prices are certain to rise. China’s situation differs little from those of countries that have attempted deep restructuring of their economies. But what complicates matters in China is the country’s size and the rapid move from a centrally controlled system to one in which the market has an increasing role to play. Future success will depend on whether China can do four things simultaneously: let growth result from productivity improvements rather than simply from capital formation; introduce fiscal discipline at all levels of government; control monetary expansion; and integrate quasi-autonomous provinces into a national market. In other words, reform has entered a new and critical phase.

Decentralization

The process of reform begun in 1978 needs to be seen in the context of China’s earlier attempts to decentralize economic decision making. The reforms associated with the Great Leap Forward of 1958 had increased the authority of local governments over the supply of raw materials and over certain types of investment, and had given them responsibility for the great majority of enterprises formerly managed by central government ministries. The 1958 reforms also transferred responsibility for “unified balance” in the economy away from the State Planning Commission; the new system sought to achieve balance by aggregating decisions taken by individual production units. Later, when the failure of the Great Leap Forward led to some recentralization of economic management and controls, the central government did not completely reestablish its authority over local governments.

Another series of decentralization measures was adopted in 1970 under the slogan of “delegating power to lower levels is a revolution.” However, this attempt to relocate economic decision making away from the center did not proceed very far, since the country at that time was in the throes of the Cultural Revolution.

Nature of current reforms

The reforms undertaken since 1978 differ in two important ways from the earlier ones alluded to above. First, the approach adopted in December 1978 used the slogan fangquan rangli, or “delegate power and relinquish revenues.” This way of thinking has had a profound economic and social impact over the years, particularly since it has allowed economic decision making to be influenced by the market. Decision making under this approach has thus meant more than shifting authority over economic decisions from central ministries to provincial bureaus. It has meant introducing producers and managers to some of the discipline of the market place.

Second, the post-1978 reforms have left a much larger share of revenue in the hands of producers and managers. Within limits not very strictly defined, these revenues can be used for investment, social development, and increases in wages and therefore in consumption. The state expects to control economic activity by regulating the market, not by directly controlling individual units of production.

The current reforms began, and have progressed farthest, in rural areas, but there is hardly a part of the economy left untouched by the new policies.

Agriculture. Agriculture supplies 30 percent of China’s GDP and employs more than two thirds of the labor force. China’s is the oldest surviving agricultural system in the world. Agriculture in China has always been more intensive than in other parts of the world. This has been made possible by the development of a sophisticated network of irrigation and by the adoption of new technologies. It is for these reasons that while China has less than 8 percent of the world’s arable land, it provides food for about 22 percent of the world’s population.

The combination of the age of the system and the intensity of cultivation created a unique set of problems that demanded action by the government, especially after the disruption caused first by the Great Leap Forward in 1958 and then by the Cultural Revolution which began in 1966. These left many unhappy legacies, among them the virtual elimination of the market for surplus agricultural output; dispersal of industrial capital all over the country, including those units critical for providing agriculture with inputs; and destruction of the educational system, including the closing down of agricultural research institutions. The Great Leap Forward and the Cultural Revolution encouraged provinces to become self-sufficient in food and to depend on indigenous agricultural technology.

In the late 1970s the Government responded to this situation by recreating markets for agricultural output, reestablishing agricultural research institutions, and importing modern technologies. Prices for farm products procured by the state have been raised sharply, while a much larger share of output may now be sold in the market, rather than handed over to the state. At the same time, the system of people’s communes has been dismantled. (This highly structured system had been built up over the two decades since 1958, when land was collectivized and management of the production system was made the responsibility of a hierarchy of supervisors located at four different levels—counties, communes, production brigades, and production teams.)

Under the household responsibility system that has replaced the people’s communes, land is leased to fanning households; farmers are encouraged to manage cropping patterns according to their perception of market opportunities. Villages are also permitted to start nonagricultural activities as well as farming; some 80 million villagers have left farming altogether and entered the “town and village enterprise” sector of the economy.

Collective enterprises have been encouraged to grow rapidly and some private entrepreneurs have been allowed to set up their own businesses. Rural and urban private sector employment grew from insignificant levels to 3.4 million in the five years between 1979 and 1984. The share of the collective and private sector in industrial output increased from 14 percent in 1979 to 40 percent in 1987.

This growth signifies a massive restructuring in the industrial sector, not only in terms of ownership and management but also in the mix of products produced and the geographic location of industries. For example, the province of Guangdong overtook Shanghai in its contributions to national industrial output since it was able to invest large amounts in light and consumer goods industries that were in demand at home and abroad.

State enterprises had not performed well before the current series of reforms, and thus the Government began to loosen control over them. In 1981, an immense number of “economic responsibility systems,” or jingji zerenzhi, were introduced, to provide managers within the state enterprises with incentives similar to those enjoyed by managers and owners of collective and private enterprises.

A new financial relationship between state enterprises and the government has been shaped by reforms introduced between 1983 and 1985. Its centerpiece is a 55 percent tax on gross profits, with enterprises allowed to retain after-tax profits. Retained profits can be used for new investments and worker bonuses. Enterprises are now being permitted to buy equity in other enterprises, and this has led to the creation of “social joint stock companies.” The highly centralized budgetary system has been replaced by a contractual revenue-sharing arrangement which fixes central government appropriations for a period of five years, leaving surpluses to be used by local governments or individual enterprise owners at their discretion.

Response of output, exports. The economy has responded vigorously to the reforms. Between 1980 and 1986, GDP increased at 10.5 percent a year, or almost twice as fast as in 1973–80 (Table 1). Agricultural production has expanded at a rate unprecedented in Chinese history, and at nearly three times the rate of 1973–80. In 1985, China produced 407 million tons of foodgrain, an amount that not only met domestic demand but also allowed significant exports. The output of the industrial sector grew by 12.5 percent a year.

Table 1China: growth and change, 1965–87(In percent)
Shares of gross domestic product

(from current price data)
Annual growth rates

(from constant price data)
1965198019861965–731973–801980–8619861987
Agriculture39.132.030.72.82.87.93.44.7
Industry37.548.046.212.18.612.511.416.5
of which
manufacturing29.635.333.711.88.412.69.6
Services23.320.023.111.73.49.45.4-3.4
GDP100.0100.0100.07.85.410.57.99.4
Exports4.27.110.92.13.613.310.815.3
Imports3.78.413.71.611.317.1-13.2-7.9
Source: World Bank

denotes data not available.

Source: World Bank

denotes data not available.

Partly because of the greater freedom allowed private and collective enterprises, exports from China became competitive; they have risen at more than 13 percent a year in real terms since the beginning of the reform effort (Table 1). In 1987, China earned $39 billion in exports, as against $15 billion in 1979.

Living standards. While the productive sectors of the economy were being reformed, the Government continued its efforts to alleviate poverty. China’s accomplishments here are impressive. One measure of the country’s achievement is the increase in life expectancy at birth. In 1955, life expectancy was estimated at 39 years; in 1985, as Table 2 shows, life expectancy had risen to 69 years, largely because of a sharp drop in infant mortality and in the incidence of communicable diseases.

Table 2China and other developing countries; selected development Indicators
Country/RegionCrude

death

rate

per 1000
Infant

mortality

rate

per 1000

live births
Life

expectancy

at birth

years
GNP

per capita

1985 US$
China: 198573569310
1950–553123634
India: 1985128957270
Brazil: 1985867641,640
1985 Average:
Low-income countries107260270
Middle-income countries1068621,290
Sources: WDR 1987 and China: The Health Sector (World Bank, 1988).

denotes data not available.

Sources: WDR 1987 and China: The Health Sector (World Bank, 1988).

denotes data not available.

Having significantly improved both its health and education standards, China has now begun to address a number of “second tier” problems. These include improving the standard of general education and dealing with health problems associated with urbanization, industrialization, and the aging of the population.

In 1986, the Government passed the “compulsory education law” under which nine-year universal education is to be achieved in stages: in the cities and coastal areas by 1990; in less-developed towns and villages by 1995; and in the more remote areas at a rate commensurate with the development of each area. These are ambitious targets. At present, for example, only 52 percent of children of lower secondary school age are attending school. This is a respectable figure for a developing country but far short of the goal adopted by the Government.

Further progress in health will be equally demanding of government resources and skilled manpower. China’s health problems are those familiar in developed countries, but to address them, China has a level of income only one fortieth of that in the industrial world.

Questions

Even in the productive sectors where progress has been rapid, questions are being asked as to whether growth at such a pace can be sustained. For instance, if China chooses to remain self-sufficient in food, it will need to increase annual grain output per head of the population from the 400kg achieved in the mid-1980s to 500kg by the end of the century. (This is because as incomes rise and people consume more meat in their diets, more grain will be required as animal feed.) This increase will have to come from a sector that already uses land very productively and which is losing valuable agricultural land to urbanization and industrialization.

In the past, China relied more on export earnings than on foreign borrowings to generate the revenues required for investment. A second important question is whether a world in which trade is now expanding at a sluggish rate will be able to absorb large annual increases in Chinese merchandise exports.

A third question, receiving a great deal of attention in China, is whether it can sustain its current high rate of economic growth without addressing the problems that are created by severe transport and communication bottlenecks and by the shortage of electricity. In other words, China will have to reorient its growth strategy: perhaps allowing some food imports, so that land can be released to produce high-value crops for export; placing somewhat greater emphasis on using domestic markets as the engine of growth; and reviving national development programs for improving infrastructure. The groundwork for such an effort began to be laid by the Communist Party and the Government beginning in the last quarter of 1987.

In view of these questions, the leaders of China have defined a new ideological framework within which to pursue “socialism with Chinese characteristics.” Zhao Ziyang, Secretary General of the Communist Party, spelled out the new framework in his opening address to the 13th National Congress of the party. “… Precisely because our socialism has emerged from the works of a semi-colonial, semi-feudal society, with the productive forces lagging far behind those of the developed capitalist countries, we are destined to go through a very long primary stage. During this stage, we shall accomplish industrialization and the commercialization, socialization, and modernization of production which many other countries have achieved under socialist conditions,” he informed the party delegates in their meeting held in October 1987.

The Bank’s program

In organizing its economic, sector, and lending programs in China, the World Bank is also dealing with these issues.

Early operations. China regained its membership in the Bank in May 1980. The Bank’s assistance began in the sectors in which the Government felt it most needed outside technical and financial help: trained manpower in the sciences and engineering, agricultural productivity, and the efficiency of the transport sector.

The Bank’s first operation in China, approved in June 1981, was a $100 million credit from the International Development Association (IDA). The main purpose of this University Development Project was to help rebuild the scientific and technological infrastructure, which had been very seriously affected by the Cultural Revolution. The project aimed to increase the number of graduates and the volume of research work at 26 universities and to improve the management of these institutions.

The Bank’s second operation in China, approved in June 1982, was also financed from IDA. This was a $60 million operation to improve drainage and irrigation facilities in the provinces of Shandong, Anhui, and Henan in China’s northern plains. The project was designed to overcome the main agricultural constraints of soil salinity, waterlogging, and surface flooding. While the area assisted by the project was small compared with the total amount of land under cultivation in China, the problems to be addressed were common to all of China.

The third project, approved in the fall of 1982, was for $124 million of IBRD lending to modernize and expand facilities at the three ports of Huangpu, Shanghai, and Tianjin.

Current program. The Bank’s lending program has steadily broadened in scope. By the end of financial year 1988, the Bank had financed 68 projects for a total commitment of over $7 billion (Table 3).

Table 3World Bank lending to China, fiscal year 1981–88
Amounts

(In millions of

dollars)
Percentage

share
Number

of

operations
Transport1,7712512
Agriculture1,5612218
Energy1,4272012
Industry1,1501610
Education751118
Water supply22532
Health16522
Technical assistance7614
Total7,12610068
Source: World Bank
Source: World Bank

The lending program for fiscal year 1988 marks a new phase in the Bank’s work in China. The program includes the Bank’s first policy-based operation in China—a Rural Sector Adjustment Loan for $300 million, to support the second phase of the Government’s rural reform program. This includes the establishment of markets for agricultural land, to allow leaseholders to trade user rights; reform of the food subsidy system, so that state support will be restricted to a small number of targeted groups; expansion of interregional trade in agricultural output, and efforts to improve the capacity of town and village enterprises to absorb surplus labor from agriculture. These reforms are being introduced by the Government in a number of experimental areas spread over eight provinces in 20 counties, covering a population of 30–35 million. The Bank will help the Chinese authorities implement and monitor the reform efforts and eventually to replicate successful initiatives throughout the country.

In fiscal year 1989, the Bank expects to start lending directly to provinces in China. As was noted above, the reforms begun in 1979 have already transferred much economic decision making to the provinces. The government reorganization that was authorized by the 7th National People’s Congress in April 1988 will keep macroeconomic management in the hands of central government, leaving most other decisions to provincial and county administrations. In this environment it was prudent for the Bank to start working directly with the provinces.

In the lending program for fiscal years 1989–91, the Bank is planning a series of operations in Jiangsu province and in the municipalities of Shanghai and Tianjin. These operations will identify policy and institutional changes necessary in the more important subsectors of the provincial economies, and once these reforms have been instituted, the Bank will finance investments in these sub-sectors.

The Bank also hopes to start work on two sectoral investment operations, one in forestry and the other in irrigation. High priority was attached to both these sectors by Chinese leaders in their discussions with World Bank President Barber Conable when he visited Beijing in March 1988.

The development of new lending initiatives will be supported by an economic and sector work program that encompasses 25 studies to be launched between 1988 and 1992. This program, agreed with the Chinese authorities, will assist Chinese leaders to make decisions in areas critical for the Chinese economy and provide a solid analytical basis for the Bank’s operations in the country.

The Bank’s relations with China have matured since the country resumed its membership in the institution. The Bank is welcomed by the Chinese authorities as a partner in development efforts, while the Bank, for its part, is committed to playing a key supporting role in China’s economic and social development.

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