Chapter

Chapter 10 China’s Agricultural Policy Choices

Editor(s):
Manuel Guitián, and Robert Mundell
Published Date:
June 1996
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Author(s)
Yiping Huang

The rapid growth of China’s agricultural production in the first half of the 1980s was widely regarded as a successful achievement of its reform policies (McMillan, Whalley, and Zhu, 1990; Lin, 1992). In 1985, however, the agricultural sector began to present problems to the macroeconomy. The slow growth of agricultural production and, especially, the stagnation of grain production during 1985–88 resulted in a widespread shortage of agricultural supply. More recently, insufficient agricultural supply caused a dramatic increase in agricultural prices, which, in turn, were blamed for the high inflation. According to China’s State Statistical Bureau, food prices rose by 32 percent in 1994, contributing about 12.1 percentage points (or 55.8 percent) to overall inflation; grain prices increased by 51 percent, contributing about 2.6 percentage points (or 12.4 percent) to overall inflation.

Such an unsatisfactory agricultural performance since the second half of the 1980s has spurred continuous debate on agricultural policies. Two mainstream groups of arguments dominate the policy discussion. The first group criticizes certain policy reforms, such as the rural marketization policy implemented from 1985 and the liberalization of grain prices from 1992, as incautious. It is argued that declines or insufficient increases in agricultural supplies bottlenecked overall economic growth and, therefore, that a certain degree of state intervention in agricultural production and prices is necessary. Such an argument often leads to calls to reverse agricultural reforms. The second group attributes unsatisfactory agricultural supplies to decreases in government investment in agriculture and insufficient incentives for agricultural production. Farmers have already been exploited for forty years. The aim of economic reform is to eliminate price discrimination and establish a market system. Imbalances in domestic markets, therefore, should be solved only through market mechanisms, such as further increases in agricultural prices in the case of agricultural shortages.

This paper reviews the process of agricultural reform in the past 16 years and asks what the major differences are between policy reforms before and after 1985. It is argued that many of the agricultural problems that began to emerge in the second half of the 1980s did not result from the introduction of policy reforms but occurred because of the incompleteness of these reforms. More specifically, the domestic agricultural markets remain to be segmented from international markets. It is a common phenomenon that price changes, resulting from fluctuations in production and consumption, are magnified dramatically in a closed agricultural market. As China’s domestic prices for many important agricultural products are very close to or already above international prices, China’s agricultural policy is facing a critical turning point. Three possible policy options for the Chinese Government are discussed at the end of the paper.

Review of China’s Agricultural Reform

Before embarking on reform, China pursued a development strategy oriented toward heavy industry. A set of agricultural institutions were developed logically to facilitate its overambitious industrialization program. Low agricultural prices were designed as one major instrument to tap agricultural resources for industrialization. Agricultural prices lower than market equilibrium secured a lower subsistence cost for industrial workers and also lowered wages and the prices of raw materials. Lower production costs, in turn, enabled the industrial sectors to generate high profits from production, which can be reinvested for industrial development—either by enterprises themselves or through the state government.

To implement lower agricultural prices, the Government needed a central planning system and various government bodies to make and enforce these plans. But then it was almost necessary to sever the link between the domestic economy and the international market. It would be extremely difficult to enforce such comprehensive economic plans when the economy was exposed to the international market. This notion of domestic insulation was further supported by the fact that at the time China had virtually no trade relationship with the world’s major market economies. But then the Government found that, with all the domestic agricultural markets in place (even at the margin), the transaction costs of fulfilling purchase plans for agricultural products were very high becuse agricultural products can easily be diverted from the planning system to free markets. Hence, free markets for agricultural products had to be restricted or totally abolished. The state agencies monopolized the purchase and marketing of agricultural products.

Because households were the basic units of agricultural production and income allocation, their objective was to maximize households’ total income instead of fulfilling state plans. Fulfillment of the state plan was important to farmers only when its enforcement was effective and efficient and when the penalty for not doing so was high. It happened so often that farm households failed to produce and deliver what the Government required that the household production unit was abolished and the commune system was introduced. A commune was usually organized at three levels: commune, brigade, and production team. The production team consisted of about thirty households, which served as the basic unit of production and accounting. Land and other production means were pooled together, and all production activities, such as land allocation, the application of inputs, and labor use, were decided by the team leader. Distinguished from household heads, team leaders always had a political motive in their objective functions, and the connection between the team leaders’ (or their families’) own welfare and the teams’ total income was less direct.

To summarize, the Government made mistakes in three major areas related to agriculture in the prereform period: the commune system, the central planning system, and the closed-door policy. This undesirable institutional arrangement created difficulties for agricultural development and industrialization. In the second half of the 1970s, not only was it extremely hard for agriculture to provide sufficient food to feed the rapidly increasing population, but it also became a bottleneck to overall economic growth. Some adjustments or reforms to the old institutional system therefore became necessary. Agricultural reform, in my view, is a process to correct these three major institutional distortions—to rebuild the household-based production system, to establish a unified domestic agricultural market, and to integrate China’s agriculture into the world economy.

The Government, at the beginning of the reform program, intended to encourage agricultural production only by raising state purchase prices, increasing state investment in agriculture, and improving management of the commune system. Initiatives that disrupted collective production were strictly prohibited. Farmers in poor regions, however, secretly experimented with household-based production responsibility systems. Good harvests by teams that adopted the experiment attracted others to experiment the next year. In 1979, only 1 percent of all production teams adopted the household responsibility system. The acceptance rate grew to 14 percent in 1980 and to 45 percent in 1981. Finally, it was officially recognized at the beginning of the 1980s, when the household responsibility system was implemented as a national policy. Nearly 98 percent of production teams had adopted the household responsibility system by the end of 1983 (Huang, 1993).

The household responsibility system reform, together with increases in state prices, greatly stimulated agricultural production (Table 1). Grain output grew remarkably in the first half of the 1980s and caused the so-called nationwide temporary grain surplus. The temporary surpluses and the price falls in markets for major agricultural products, especially grains, during 1982–84 placed a limit on the growth potential of agricultural outputs and farmers’ income. Introducing market mechanisms and establishing a unified domestic market became necessary and possible, at least in the rural areas. At the beginning of 1985, a package of reform policies was implemented to introduce free markets in place of the previous unified purchase and marketing system for agricultural products.1 The Government, at the same time, designed a set of related policy adjustments in an effort to diversify the rural economic structure and to promote the role of market mechanisms.2

Table 1.Economic Growth and Agricultural Prices
GNP

Growth
Agricultural

Growth
Grain

Output

(million

tonnes)
GNP Per

Capita

(in yuan;

1985 prices)
Agricultural

Purchase

Price1
Food

Market Price2
Year(percent)(1985 = 100)
197812.33.9304.839859.981.4
19797.06.4332.142073.283.4
19806.4−1.8320.644278.488.4
19814.97.1325.045783.090.0
19828.211.8354.548784.891.5
198310.08.5387.352988.591.9
198413.612.9407.359392.192.9
198513.52.7379.1663100.0100.0
19867.73.0391.5703106.4106.1
198710.24.5403.0762119.2112.6
198811.32.3394.1835146.6132.1
19893.73.2407.6853168.6156.7
19905.17.5446.2881164.2160.9
19917.72.3435.3936160.9163.7
199212.85.0442.71047166.4170.2
199313.44.0456.41174182.5182.1
199411.84.0444.51297255.3240.3
Sources: State Statistical Bureau (1993, 1995).

Agricultural purchase prices are weighted-average prices of both state and market purchases.

Food prices are those in rural markets.

Sources: State Statistical Bureau (1993, 1995).

Agricultural purchase prices are weighted-average prices of both state and market purchases.

Food prices are those in rural markets.

This reform fundamentally changed the mechanisms through which the economy operated and marked an important step toward elimination of the state planning system. The elimination of the unified purchase and marketing system was a historical event for Chinese farmers, who, for the first time in more than thirty years, were allowed to make their own production decisions as to what and how much to produce, given price signals in the markets. Some of the policies, however, did not last long. Government purchase contracts for grains and cotton, for instance, were quickly made mandatory in 1985 and 1986 after significant decreases in production. One reason for the drops in production was that, when the Government tried to liberalize grain purchase through a designated contract system, it did not at the same time liberalize the marketing of grain to urban residents. The widening gap between the rising purchase prices and the stagnant retail prices, which had to be financed by the Government, placed increasingly heavy pressure on the state budget.

A first attempt was made to reform the marketing policy for food (excluding grains and edible oils) in 1988.3 In May 1988 in all cities, retail food prices were raised to levels similar to market prices, and urban residents were given a fixed lump-sum subsidy ranging from 5 yuan to 10 yuan a month. In so doing, the Government attempted to de-link the price changes and government subsidy, creating, in the process, a need for further reform of agricultural prices.4

Despite the rapid expansion of the rural economy and the sharp increase in farmers’ real income, declines in agricultural outputs placed the Government under heavy pressure. In 1989, an austerity program was introduced to cool down the overheated economy.5 The importance of maintaining stable growth of agricultural production, especially grain production, was reinforced by the government policy. Not only were grain purchase prices raised significantly in 1989, but the Government also increased its other agriculture-related efforts, such as raising budget spending on agriculture and input price subsidies. The contract purchase of grain was termed “the state purchase quota” to avoid the confusion caused by the form of contract.6 The more important impact of the policy adjustment in 1989 came from the effects of the austerity program on the development of township, village, and private enterprises (Huang, 1993). Because the policy adjustment aimed particularly at restricting bank loans to the rural industry, the township, village, and private sectors contracted significantly in 1989 and 1990. Part of the resources flowed back to agricultural production, which, as expected, started to recover.7 Grain output in particular, for the first time in the past five years, reached the 1984 record level. This good harvest continued in the following four years, helped by favorable weather conditions. But farmers’ real income fell continuously in 1989 and 1990. Agricultural policy changes associated with the austerity program were an important setback in the process of introducing free markets to Chinese agriculture (Huang, 1993).

Good harvests in grain production, however, did not solve the more fundamental problem: the rising demand for grain owing to rapid increases in income and decreasing resources for grain production because of competition from other (high-return) production activities. One important constraint on agricultural reform was still the increasing gap between the rising purchase prices and the fixed marketing prices in urban areas.8 In an effort to eventually introduce a market mechanism for grain, the Government first raised marketing prices significantly at the beginning of 1991 and then unified them with purchase prices in April 1992.9 By the end of 1993, only 25 counties out of 2,000 had not organized their grain marketing system on market principles.10

This last step to reform the grain marketing policy was particularly important because it removed constraints on the movement of purchase prices, reflecting changes in the markets for the most important agricultural product. The Government finally walked out of the long-lasting policy dilemma: on the one hand, it wanted to organize the rural economy on market principles so that prices would reflect the true relationship between demand and supply; on the other hand, it always found it difficult to fund a sufficient increase in purchase prices because marketing prices remained the same. After the 1992 reform, increases and decreases in grain prices would be absorbed by producers and consumers in the markets and would have no further implication for the government budget.11 Over time, farmers tend to gain more in the expectation that prices will rise faster than they would have under the previous system. Farmers therefore regarded the 1992 reform as the “third revolution” (Garnaut, Cai, and Huang, forthcoming).

The sharp rise in grain market prices at the end of 1993 and in 1994 led to several policy changes in 1994 and 1995. First, grain purchase prices under the state contract were raised further, on average by 20 percent, to encourage grain production. Second, the Government has recently reiterated the importance for all regions, especially the relatively developed ones, of maintaining self-sufficiency in grain.12 And finally, some administrative measures regulating grain markets were reintroduced. Private grain traders, for instance, are banned from transacting grain sales with farmers in villages before the state purchase contract is fulfilled. At the end of 1994, grain coupons were reintroduced, in some areas, to employees of large-scale state enterprises owing to the rapidly rising food prices.13

Growth and Inflation: An Agricultural Story

It is clear that 1985 represents an important year for China’s agricultural reform and growth in the past 16 years. During 1979–84, agricultural reform, mainly implementation of the household responsibility system and increases in agricultural purchase prices, greatly stimulated agricultural production. Agricultural output grew by 7.4 percent a year, while grain output rose at an annual rate of 5 percent. Because at that time the other sectors of the economy were still stagnant, agricultural production was a driving force behind overall economic growth. The agricultural sector, however, has been a persistent burden on overall economic development since 1985. Complaints about insufficient agricultural supply or rapidly rising agricultural prices were frequently heard after 1985. At times, changes to agricultural reform policies were recommended. In the presence of grain shortages in 1985–88, for instance, some economists criticized the rural marketization reform in 1985 and called for state intervention. Recollectivization of agricultural production was also discussed and, in some cases, recommended on the argument of scale economy. Again in 1994 and 1995, after the dramatic rise of domestic agricultural prices, the early liberalization of grain prices was attacked. The resumption of grain price control and the approach of basic self-sufficiency in grain were recommended and eventually implemented in 1995.

It is interesting to ask why the outcomes of agricultural reforms are so different in the two periods before and after 1985. In retrospect, we may find that the specific aims of the reforms were different in the two periods, although the overall objective was to correct the three-dimensional institutional distortions. Before 1985, reforms aimed mainly at solving the incentive problems at the micro level through the introduction of the household responsibility system. The household responsibility system improved farmers’ production incentive significantly. Measured by increases in agricultural output, the reform was very effective because, at that time, farmers did not have many production opportunities other than planting a number of agricultural crops, mainly grain crops. Energies released by the policy reform were directly channeled to agricultural production and resulted in sharp agricultural growth.

After 1985, the Government attempted repeatedly to establish a unified domestic market and allowed prices to be determined by domestic demand and supply conditions. This involved increasing state purchase prices to meet market prices—a process started in 1979—and eliminating state intervention, including production planning and mandatory procurement, in the domestic market. The important difference of the reform in this period compared with that in early years was the potential structural adjustment consequences. When controls over production were gradually removed, resource reallocation and changes in output composition became inevitable.

We can use a production possibility frontier framework to illustrate the different reform consequences in the two periods. Figure 1 presents possible output combinations given factor endowment. The horizontal axis represents the quantity of agricultural output, and the vertical axis measures the quantity of nonagricultural output. Curve AB, the production frontier, contains all the efficient production possibilities. It is reasonable to assume that the actual production point (C) before economic reform was within the frontier. Reforms before 1985 moved actual production toward the frontier (moving from C to D), through the elimination of inefficiencies that resulted from the commune system. After 1985, however, farmers were gradually granted autonomy in resource allocation and production decisions. Structural changes occurred through the movement of production along the frontier (from D to E or F). But market liberalization after 1985 was carried out within a closed domestic market environment. The removal of state controls can usually result in two different outcomes.

Figure 1.Different Consequences of Agricultural Reform Before and After 1985

In one case, the Government may liberalize the rural market while controlling the prices of some key agricultural products, thereby opening up a wider range of production opportunities to farmers. For instance, farmers are now allowed to engage in industrial production, which was not possible before the reform. The higher returns in the nonagricultural sector would attract resources moving away from agricultural production. In the production possibility frontier diagram, this process is represented by the movement of the production point from D to E. Agricultural production would decline, in a comparatively static framework, as it did during 1985–88, which was why changes in the production structure during that period were not a failure of reform policies but an absolutely normal outcome (Huang, 1993). Although agricultural production stagnated, overall economic growth accelerated (Table 1).

In another case, the Government may liberalize agricultural prices at the same time. In a densely populated country with a limited per capita agricultural resource endowment, like China, the natural outcome is for domestic prices to rise dramatically if free trade in agriculture is not allowed. Agricultural production may have to increase to meet domestic demand (such as from E or D to F), but prices would be pushed up significantly. A rapid rise in income would further exaggerate such rises in agricultural prices. This was the case in 1993 and 1994. After 1985, the growth rate of agricultural production as a whole dropped to 3.8 percent a year, while that of grain output dropped to 0.9 percent a year. However, the annual growth rate of the whole economy increased from 8.3 percent in the pre-1985 period to 9.7 percent in the post-1985 period.

Recently, heated discussions have arisen in China about how agriculture was related to the high inflation in 1994. The dominant viewpoint is that increases in agricultural prices were the major source of the inflation (according to the State Statistical Bureau). The practical way to control the high inflation was to keep agricultural prices from rising. Because low prices may again result in agricultural shortages, it is then necessary to reinforce the compulsory procurement of grain. Because grain prices are directly associated with the local governments’ budget, a new policy was adopted in early 1995 whereby every province should be responsible for its own grain supply.

Other economists, mainly agricultural economists, argue strongly against the above policy movements. Because the aim of the reform is to establish a socialist market economy in China, it is unjustifiable for the Government to reintroduce discriminatory policies against farmers. The only way to solve the domestic agricultural problem is to correct the previous price distortion and to provide farmers with sufficient production incentives. Further, they consider unfounded the argument that agriculture was a major source of inflation. An increase of 51 percent in grain prices cannot be convincingly explained by a reduction of grain production by merely 2.6 percent in 1994 (Johnson 1994; Han, 1995). Both of the above viewpoints have merit. It is true that the root of the high inflation rate was the expansionary monetary policy. Price liberalization was also a contributing, though temporary, factor. But to what extent and in what way did agriculture contribute to this inflation and what further measures should be applied? If we look back at the institutional distortions in the prereform period and the subsequent reform efforts, we can easily find that one key element missing from the various reform attempts was the linkage between domestic and international markets. The Chinese Government has so far adopted a basic self-sufficiency strategy for grain. A closed market can easily magnify changes in food prices as a result of production fluctuation. It has happened in Japan and happened in China in 1994. An expectation of a small output drop can cause significant price changes because producers may sell less while consumers want to buy more. The situation can be further exaggerated by the existence of regional obstacles to trade.14 Increases in grain or food prices contributed to the high inflation through other mechanisms, such as the soft budget for the state enterprises and salary increases for government officials. Rises in food prices placed heavy burdens on consumers, especially low-income groups—because of the high proportion of food in their total expenditure—and many enterprises—because of increases in their production costs. The Government therefore had to subsidize state enterprises and government employees (including school teachers and university lecturers), which finally fueled monetary expansion.

Thus, although high inflation was the end result of China’s monetary policy, the agricultural sector did contribute to the high inflation because of the special link between food prices and the government budget and because of the interdependence between fiscal policy and monetary policy. Agriculture contributed to high inflation not because of reform policy but because of the incompleteness of the reform.

Turning Point for China’s Agricultural Policy

The more important question is whether the current agricultural problem or inflationary problem can be solved through either reintroduction of interventionist policies or further increases in agricultural prices. A resumption of government intervention will no doubt lead to another round of supply shortages. Furthermore, the Government is unlikely to be able to control domestic food prices. As the Government now controls only a limited proportion of the total grain and food supply, market prices continued to rise significantly in the early months of 1995. Rises in domestic prices may be desirable, because China’s agricultural products were significantly underpriced before reforms were initiated. Price increases in the early stage of reform indicated a reduction in distortion against agriculture. For instance, China had large negative nominal protection rates for most agricultural products in the prereform period. These negative numbers decreased during the process of economic reform (Guo and others, 1993; Ke, 1993). Guo and others suggest that by 1988 the nominal protection rate had been raised to −48 percent for rice, −26 percent for maize, −4 percent for wheat, −16 percent for soybeans, and between −30 percent and −50 percent for pork, beef, and lamb. The gap between domestic and international prices narrowed more quickly after 1989, with some agricultural products enjoying positive protection in 1989 and 1990 (Guo and others, 1993).

But in 1994, domestic prices for many agricultural products already approached or exceeded the international prices (Figure 2). Domestic distortions relative to free trade have been reduced almost to zero. This is further illustrated by changes in estimates of the producer subsidy equivalent (PSE) for Chinese agriculture (Table 2). In the mid-1980s, PSEs were between −40 percent and −60 percent but increased rapidly after that. In 1994, PSEs were estimated at around zero. If domestic prices continue to rise, they will far exceed the international prices and reintroduce price distortions in the opposite direction.

Figure 2.International and Chinese Market Prices, January 1993-September 1994

(In U.S. dollars per tonne)

Sources: International Monetary Fund; China, State Planning Commission.

Note: Chinese prices are market prices in rural and urban fairs converted using the swap exchange rate. International prices for wheat are f.o.b. Gulf for No. 1 hard red winter (ordinary protein); for rice, f.o.b. Bangkok for white milled 5 percent broken; and, for maize, f.o.b. Gulf for No. 2 yellow.

Table 2.Producer Subsidy Equivalent (PSE) for Agriculture(Billion yuan, unless otherwise noted)
198619881990199219931994
Producer value4015877669091,0301,280
Income transfer due to border policy−190.6−414.6−245.2−209.9−251.4−96.5
Exchange rate (yuan-U.S. dollar)5.06.35.86.58.68.7
Agricultural taxes4.57.48.89.09.69.6
Budget on agriculture18.421.430.837.944.144.1
Disaster subsidy1.11.11.31.61.61.6
Welfare subsidy0.30.30.30.30.40.4
Input subsidy1.01.21.41.41.51.5
Interest difference7.911.314.920.824.724.7
Agricultural loans28.340.453.174.087.887.8
PSE value−162−379−197−148−179−24
Share−40−65−26−16−17−2
Source: Garnaut, Cai, and Huang (forthcoming).Note: International agricultural price is an aggregate of international prices weighted by value shares in total world trade. The commodities included in the calculation are beef, lamb, pork, eggs, wheat, rice, maize, oranges, apples, and tea. Domestic price is the rural market food price. The numbers for 1994 are estimates based on available information.
Source: Garnaut, Cai, and Huang (forthcoming).Note: International agricultural price is an aggregate of international prices weighted by value shares in total world trade. The commodities included in the calculation are beef, lamb, pork, eggs, wheat, rice, maize, oranges, apples, and tea. Domestic price is the rural market food price. The numbers for 1994 are estimates based on available information.

Was the convergence of domestic and international prices and the substantial reduction in producer subsidy equivalents for agricultural production through the first half of the 1990s a historical turning point or a temporary fluctuation in China’s agricultural development? While there were some short-term factors behind the speed of price adjustments in late 1993 and through 1994, the underlying pressures associated with rising domestic demand and constraints on growth in supply will continue and strengthen over time. They will tend eventually to push domestic prices much higher in the absence of trade liberalization.

It has been suggested that world prices for agricultural products, especially grains, will rise following the implementation of the Uruguay Round settlement (Brandão and Martin, 1993; Huang, 1994). One simulation based on the Dunkel proposal, by Brandão and Martin using the RUNS model, predicts increases in international prices—by 6 percent for wheat and meat, 4 percent for rice and coarse grain, and 10 percent for sugar during the implementation period. This will tend to reverse the long-term declining trend of agricultural prices of the past several decades (Tyers and Anderson, 1992). Upward movement of world agricultural prices may precede the implementation period and may exceed the expected Uruguay Round effects because of supply developments in important agricultural producing countries. Much will depend on policy and institutional developments in Russia and India, economies with the capacity to expand output under favorable economic conditions.

Agricultural prices in China are likely to increase faster than international prices if domestic agricultural markets remain largely isolated from international markets. Because China is a rapidly growing agricultural resource-scarce (per capita) economy, domestic agricultural prices will have to rise rapidly because of rising marginal costs of production and the increasing demand for consumption.

China’s population density, at 121 persons per square kilometer, is not high compared with that of many countries in Western Europe and East Asia, although it is much higher than the world average (Table 3). China’s agricultural area, including arable land, forest, and pastoral areas, however, is very small on a per capita basis. China has about 22 percent of the world’s total population, but only 7 percent of the world’s arable land area. At the margin, China cannot be expected to have a comparative advantage in agricultural production as incomes rise toward those in industrial countries.

Table 3.Population and Agricultural Resources in Selected Countries and Areas
Total

Population

(millions)
Population

(persons per

square

kilometer)
Arable

Land
ForestPastoral

Areas
(hectares per person)
China1,158.21210.080.110.19
United States252.7270.741.160.96
Canada27.031.7013.281.04
Australia17.322.816.1124.09
Germany80.32260.150.130.07
United Kingdom57.42350.120.040.19
France57.11030.320.260.20
Japan123.93280.030.200.01
Korea43.3437
Taiwan Province of China20.45650.04
Indonesia187.8990.090.600.06
India841.72830.200.080.01
Philippines62.92100.070.160.02
Thailand56.91110.330.250.01
Malaysia18.3560.061.05
Pakistan115.51450.180.030.04
Bangladesh118.78250.070.020.01
Mexico87.8450.260.480.85
Argentina32.7120.761.814.35
Brazil153.3180.333.221.20
World5,389.2400.250.750.63
Sources: State Statistical Bureau (1993); and United Nations (1993).
Sources: State Statistical Bureau (1993); and United Nations (1993).

The Chinese economy has now reached a stage of development similar to that in Japan, Korea, and Taiwan Province of China when these countries turned from taxing to subsidizing agriculture. China’s GNP per capita in 1993, adjusted to allow for international comparison, was about $1,300 (1987 prices). This is close to income levels of Korea and Taiwan Province of China in the 1960s and 1970s and similar to Japan’s income levels in the pre- and postwar years. These figures suggest, at least, that China may now be facing pressures to turn from taxing to subsidizing agriculture.

Options for Agricultural Policy Choices

Agricultural policy has reached a juncture in China when some important decisions have to be made. What are China’s options? Generally speaking, there are two broad directions for China’s future agricultural policy. China may follow other East Asian economies, such as Japan, Korea, and Taiwan Province of China, in protecting its agricultural sector, and it may also continue the general reform trend of marketization and internationalization. Yet another proposition in the policy discussion is that China’s grain consumption should rely on its domestic production. The Government should therefore aim to improve agricultural productivity by increasing investment in agricultural public goods, such as scientific research and large agricultural infrastructure. International markets can be used, to a limited degree, to balance the domestic market. These three options are discussed in turn.

Option 1: Adopting Agricultural Protection

It is argued that, in the course of industrialization, most economies shift from taxing the agricultural sector to subsidizing it. China is now at a stage of economic development that is similar to that of Japan, Korea, and Taiwan Province of China when these countries started to protect the agricultural sector. China’s own experience during the prereform period also demonstrated that, under policies that discriminate against agriculture, China would not be able to achieve rapid economic growth. China should start to adopt agricultural protection policies if it is to achieve the successful economic growth of other East Asian economies and if it is to learn some lessons from its own experience. Demand for such policies is further supported by the food security argument.

Policies to protect agriculture are always firmly grounded in political considerations. They permit China to avoid the painful experience of not being able to buy enough food imports for domestic consumption when it is in conflict with Western countries. They also increase grain farmers’ income and temporarily reduce the pressure on agricultural structural adjustment. However, a protection policy will also rapidly raise domestic food prices. Inevitably, economic development will not only lead to higher demand for agricultural products, but will also increase competition for agricultural resources. It is almost certain that domestic prices will continue to rise rapidly and will reach levels far above international prices if agricultural protection is adopted. This would result in a substantial welfare loss to consumers, given the relatively high proportion of food in total expenditure. In Figure 1, this scenario represents a downward movement of the indifference curve from II to I’I’, which is associated with lower domestic agricultural consumption and higher relative prices of agricultural goods. It would continue to produce significant pressure on inflation under the current fiscal and monetary systems. Overall economic growth can further be adversely affected because agricultural protection is a constant source of international trade conflict. Domestic adjustment may be delayed because of agricultural protection; it is, nonetheless, unavoidable in the end because, with the settlement of the Uruguay Round, agricultural trade liberalization has become a worldwide trend. Agricultural adjustment can be difficult and costly when domestic prices are significantly higher than international prices. Japan, Korea, and Taiwan Province of China have had very successful experiences in achieving rapid economic growth, but their agricultural policies have already become a heavy burden on their governments.

Option 2: Liberalizing Agricultural Trade

To avoid the negative consequences of agricultural protection, some other economists propose trade liberalization. By integrating itself into the world economy, China is able to better exercise its comparative advantage and maximize its national welfare. The pressure generated by a rapid rise in food prices can be eliminated because prices are determined only in international markets, which will not only help overall economic growth but also improve consumer welfare. One important argument is that, because at the moment most domestic agricultural prices are very close to international prices, adjustment problems resulting from agricultural trade liberalization are minimal.

There are, however, many concerns among Chinese economists over free trade in agriculture. Will it increase the instability of domestic food markets? Can China earn sufficient foreign exchange for grain imports? Will the supply of grain imports be secure even when there are political conflicts? The first two questions are often easily answered. Opening up to the world market will increase domestic instability only when the world market is a residual market, such as world grain markets in the 1980s. It is always easier for an integrated world market than for a national market to accommodate production and consumption fluctuations. In this sense, a unified domestic agricultural market is always superior to many segmented provincial markets. Given the Uruguay Round settlement and the general worldwide trend of trade liberalization, it is reasonable to believe that China will be able to earn sufficient foreign exchange through the continued expansion of its manufactured exports. Trade liberalization by other major trading partners, especially the removal of the Multifiber Arrangement, will of course help China’s export performance.

The last question, however, can be answered satisfactorily only with the cooperation of the international community. This is why the Chinese Government and economists regard free trade in agriculture as dangerous. An effective and reliable scheme or arrangement between China and the international community in regard to food security in China is necessary if China is to acquire the confidence it needs to liberalize agricultural trade.

Option 3: Raising Agricultural Productivity with Limited Involvement in Trade

This third option overlaps in many aspects with the first two. The basic idea is to increase domestic supply up to its limit and to use the international market as a measure to balance domestic demand and supply. Various studies indicate that China still has great potential to increase its agricultural yield further. Areas of arable land are believed to be underreported. Productivity can be increased significantly through an appropriate reordering of agricultural research priorities. Government investment in agricultural infrastructure has declined proportionately in the last several years, resulting in the decay of large-scale agricultural infrastructure. As a large and densely populated country, China should indeed make significant efforts to improve agricultural productivity by addressing these areas. An important question is whether China can achieve basic self-sufficiency in grain cost-effectively. While some economists may give different answers for the short run, self-sufficiency is unlikely over the longer term. Technically speaking, of course, China can achieve self-sufficiency in grain at any time, depending on the costs it is willing to incur.

The involvement of international trade in raising agricultural productivity is therefore inevitable. But there are two ways to be involved in the international market. The first is to buy and sell in the international market but to cut the linkage between domestic and international prices. If only small quantities of agricultural trade are allowed, this case is likely to evolve into a protection scenario because the domestic lobby for protection as well as the cost of agricultural production will rise over time. The second is to link domestic and international prices directly. International prices will therefore serve as “caps” in the domestic market. If domestic production cannot increase at the same rate as consumption at a competitive cost, imports will have to increase to balance the market. This case then is likely to evolve into a free trade scenario. Ultimately, therefore, the Chinese Government must still choose between trade protection and free trade.

The exact amount of grain imported in a particular year is not crucial to the policy choice. More important is that the domestic production potential should be fully realized, whether or not the Government allows domestic prices to be distorted. The price link between domestic and international markets is critical in that no further distortions will be involved. Within an integrated market, the Chinese Government does not have to worry about who will feed the Chinese population. If the Government really regards agricultural production as important, it can continue to make various efforts to improve domestic productivity. Self-sufficiency in grain, at 70–80 percent as is currently targeted, is not impossible even with a link between domestic and international markets. If China can produce cost-effectively, it can feed not only its own population, but also populations elsewhere, such as in Africa, through the international market. However, if the Government continues to aim at achieving basic self-sufficiency in grain and allows domestic prices to rise further and then turns to the international market in the event of a big domestic shortage of grain, it may be impossible to feed the Chinese population within a short period.

References

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Note: I wish to thank Justin Lin, Gao Xiaomeng, Peter Drysdale, Chen Xiwen, and Guo Shutian, who inspired me and helped greatly in my work on China’s agricultural reform. In particular, I learned a lot from Ross Garnaut and Cai Fang in frequent discussions and during collaborative work. Financial support from the International Monetary Fund and the Australian Centre for International Agricultural Research is gratefully acknowledged.

For grain and cotton, mandatory purchase quotas were to be replaced by a combination of contract and market purchases. The state would sign contracts with farmers voluntarily before planting seasons (Sicular, 1988). The contract procurement level was about 70.5 million tonnes for grains in 1985 (Huang, 1993). For other products, such as vegetables, fish, and meat, government regulations were abolished, and the state department would buy and sell in the markets.

First, private commercial agents were allowed to enter the urban markets for meat, poultry, vegetables, and fruits, and prices were allowed to be determined in the markets. Second, within the agricultural sector, livestock production was seen as an important activity to both absorb domestic grain surplus and increase value added in agricultural production. And, third, because the agricultural sector was unable to accommodate all the surplus labor in the rural areas, the Government encouraged the development of the rural township, village, and private enterprises. These rural enterprises, between 1984 and 1985, enjoyed a series of preferential policy treatments, including tax exemptions and subsidized bank loans.

The products covered by the 1988 food policy reform program included consumption rations on meat, egg, and soybean products that were sold by government stores at subsidized prices.

In theory, urban residents would have to face all the changes in market prices for major food products (excluding grains), although they can receive the fixed amount of subsidy each month. But, in many cities, local governments maintained the consumption ration, at higher prices, after the 1988 food policy reform. This set the stage for another round of subsidies when market prices continued to rise while the prices set by the Government were fixed.

The inflation rate was as high as 18.5 percent in 1988 and 17.8 percent in 1989.

During 1985–90, many village and township leaders and the grain departments were often challenged by farmers, who asked why they did not have negotiating power over prices and the right not to sign a contract.

Rural industry started to contract in 1989: the number of township, village, and private enterprises fell from 18.9 million in 1988 to 18.7 million in 1989 and 18.5 million in 1990, and the number of employees decreased from 95.5 million in 1988 to 93.7 million in 1989 and 92.6 million in 1990. In contrast, the agricultural labor force rose significantly in 1989 and 1990. Starting in 1988, more investment was directed to agricultural production, and investment in nonagricultural production dropped in 1989, in particular. Real output of the township, village, and private sector declined in 1989 by 2.9 percent. At the same time, its total profits in nominal terms dropped from Y 25.9 billion in 1988 to Y 24 billion in 1989 and to Y 23.3 billion in 1990.

Free markets existed after 1985 in both urban and rural areas. But the state grain department still purchased more than half of farmers’ total grain sale. In some cases, the Government also had the power to close free markets for grain before it fulfilled the purchase quota.

As in the case of the food policy reform of 1988, a monthly lump-sum subsidy is paid to urban residents as compensation.

Among these 25 counties, 13 are in Yunan Province and 12 are in Qinghai Province.

The Government spends a fixed amount of money on the lump-sum subsidy for each urban resident.

During a tour to Zhejiang Province in early 1994, Vice Premier Zhu Rongji stressed that relatively developed regions (such as Guangdong, Fujian, Jiangsu, and Zhejiang provinces) should not rely on purchases of grain from other regions or on imports to meet demand. More recently, Chen Junshen, who is in charge of agricultural work in the State Council, pointed out that the sustainability of the rapid growth of the whole economy in the developed coastal region depends on its ability to balance grain demand and supply and that the realization of national balance between grain demand and supply depends on the balance in the coastal region (Economic Daily, November 14, 1994).

The grain coupon system was officially abolished in 1993. This partial reintroduction at the end of 1994 reflected partly the pressure of food price increases and partly the failure of the state sector in increasing its employees’ income.

Some economists tried to refute this argument by presenting the case of 1991 when grain output fell more dramatically but prices did not change much. One thing we should keep in mind, however, is that grain prices were still largely controlled by the Government in 1991, and per capita income did not increase as much as in 1994.

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