China's Development Challenges

Economic Vulnerability and Public Sector Reform

Richard Schiere

• Publisher: Routledge
• Year: 2009
• ISBN:
  9781135171650
• Edition: 1
• Topic: Economics
• Subtopic: Sustainable Development
• Index: Economics

This book argues that a major potential source of social tension in transition and developing countries is not poverty as such, but vulnerability: that is, the risk of becoming poor. It demonstrates how in China many of the recent reforms to the public sector, such as decentralisation from central to local government, especially fiscal decentralisation; the reduction in public services provided by the state; the increasing practice of local government of charging fees for basic services which were previously free; de-collectivisation of the rural commune system and market sector experimentation in Economic Processing Zones have made many households extremely vulnerable to poverty. Having to find funds to pay for health and education leaves the households exposed should macro-economic fluctuations related to factors – such as trade, resource imports, and financial volatility – have an adverse impact on the Chinese economy overall. The book argues that to become less vulnerable to macroeconomic shocks China would need to shift from an export-oriented development strategy to a domestic consumer-demand driven development strategy, and this would need to be supported by public sector reforms: strengthening of public service provisions in the health and the education sectors as well as expanding social security programs. The book discusses these problems, relates them to the economic literature and outlines the likely consequences.

Part I
General introduction on the developmental challenges of China

Introduction

In the last three decades, China has made remarkable progress in overcoming transitional challenges (i.e. domination of state sector, political economy of state-owned enterprises, lack of institution for “pricing”, etc.) as well as developmental challenges (i.e. largely an agricultural based production sector, lack of physical infrastructure, overpopulation, high rate of migration and urbanization, low education level, etc.). As part of the transition process, China’s international trade has grown exponentially and the country acceded to the World Trade Organization (WTO) in December 2000. The rapid economic growth also gave the country more political influence in global affairs, in particular with resource-rich developing countries in Africa, Latin America and Asia. Moreover, the 2008 financial and economic crisis could accelerate the debate on China’s re-alignment of economic weight with political influence, in particular as the economies of the United States of America and Europe shrink, China’s growth is continuing albeit at a lower rate. This trend will also result in a stronger voice for the country in the global financial architecture, most notably the IMF and World Bank.

China’s rapid growth and poverty reduction can be attributed to incremental reform process as well as “a learning state”. This refers to a public sector which learns from previous mistakes and implements development policies that are successful, through experimentation of policies at local level. This started with the introduction of the household responsibility system at the beginning of the 1980s that led to massive rural poverty reduction. During this period, vulnerability did increase as social safety-net provisions were abolished or privatized. In essence, previously free social services became “commodities” for which citizens had to pay. In addition, Township Village Enterprises (TVE) were created. These public– private owned companies were highly successful in creating employment and producing consumer products that were often not manufactured by state-owned enterprises (SOEs). In the 1990s the reform process spread to the urban areas with the privatization of SOEs. Unlike rural areas, reform in cities was accompanied with social security programs (as urban industrial workers are more inclined to cause civil unrest) although in practice these safety-nets were often under-funded. Another adverse effect of the rapid economic growth was the rise in multidimensional inequality, which accelerated creating wealth in the eastern regions through the “coastal development” strategy. These inequalities created a large floating population of 130 million migrant workers and led to unequal distribution of human capital and reinforced the “twin-peak” poverty–growth path, in which inequality and economic growth increase simultaneously.

The first part of the book is organized as follows. The first chapter, “China’s reforms in transition and development perspective”, emphasizes that the development success was the result of policy experimentation and how this contributed to economic growth and poverty reduction. It further highlights the importance of WTO accession and the impact of China on the international global financial architecture. Finally, this chapter compares China’s development experience with other transition and Asian countries. The second chapter, “The evolution of poverty and inequality since the opening-up period”, focuses on the link between the various reform initiatives and the poverty impact. It further highlights the impact of reforms on public service provisions in the health and education sectors, in particular the effect of user fees on vulnerable segments of the population such as the poor and migrants. Some of these issues are being addressed through the “new socialist countryside” in the Eleventh Five-Year Plan (2006–10).

1
China’s reforms in transition and development perspective

Introduction

China is often viewed with admiration for its remarkable developmental successes, not only because of its massive reduction of poverty and high level of economic growth, but also as this country is steadily increasing its global influence. However, successful outcomes of the reforms were by no means clear cut and predictable. At the beginning of the reform in 1978, China was still in the aftermath of the Cultural Revolution which severely distorted social and economic structures. What sets China’s development apart from the reform of many other transition and developing countries, was its cautious and slow pace as well as its decentralized policy experimentation. This meant that policies were first tried out at provincial level. If successful, they were subsequently adopted at national level. Moreover, the slow pace of reform created a political economy in which the vested interest groups such as the communist party elite, the bureaucracy, as well as society at large could support the liberal reform agenda. The final step in transition was the accession into the World Trade Organization (WTO), which required both deepening of the market based allocation system as well as internationalization of the economy. Moreover, this international treaty effectively “locked” China “in” a market based economic system. The emergence of China as an economic and financial power was further enhanced in the wake of the 2009 G-20 summit in London, which highlighted China’s important role in the global financial architecture. The success of China is more striking when considered in the perspective of its overall transitional and developmental challenges.

The remainder of this chapter is organized as follows. The first section, “Reasons for reforms”, highlights the difficulties as well as the political economic effects of the disastrous great leap forward and the Cultural Revolution. The second section, “Overview of social-economic developments during transition”, provides an overview of the transition and development challenges of China. The third section, “WTO accession as the end of transition”, emphasizes that the transition from a planned economy towards a market-driven allocation system will likely come to an end as this accession “locked-in” the market based allocation system and private ownership. The fourth section, “The emerging role in the global financial governance architecture”, highlights the important role of China in the world, in particular in the wake of the 2008 financial crash, which triggered an unprecedented economic crisis with massive repercussions. The fifth section, “China as a transition country”, highlights the different reform paths in comparison with Eastern Europe and the former Soviet Union. The sixth section, “China as an Eastern Asian developing country”, compares China’s developmental process with that of other countries in the region, notably Japan, South Korea and Chinese Taiwan. Finally, “Main observations of chapter” considers various political economy arguments underpinning the Chinese reform process.

1.1 Reasons for reforms

Although China’s reforms are considered a success in terms of poverty reduction and economic growth, its outcome could not have been predicted. The reform and opening-up period was officially launched in December 1978 at the Third Plenum of the 11th Central Committee. At this event, Deng Xiaoping officially launched “Four Modernizations” in the areas of agriculture, industry, national defense, and science and technology. The goal of the “Four Modernizations” was to accelerate development by stepping up the volume of foreign trade and opening up its markets, especially for the purchase of machinery, from advanced developed countries like Japan, the United States and Europe. Later this was complemented with a variety of reforms aimed at decentralizing the economy.

The “Four Modernizations” were operationalized by a 10 year plan, which was severely hampered by a shortage of capital, as was the case with many transition and developing countries. International trade and foreign direct investment (FDI) were meant to alleviate the shortage of capital by attracting foreign currency to finance capital imports. These were the first signs that indicated China’s leaders were taking a pragmatic approach to the transition process. At the same time, these initial reforms were a departure from the original dogmatic political approach which shunned both capitalist motivation and foreign economic intervention in the domestic affairs of the country. Moreover, it was a fundamental change from a strict command economy whereby the state controlled almost all output from the service sector: 94.4 percent of agricultural production and 97.5 percent of industrial production was sold at state-fixed prices (UNDP, 1999). There was no notion of an independent financial sector as there was a monobank system, which meant that the bank sector was simply the state’s cashier that channeled financial resources to state-directed development projects.

The radical policy shift from a planned autocracy to a system that permitted foreign economic influence was made more politically acceptable by the social and economic disaster caused by the Cultural Revolution and the Great Leap Forward. This was referred to as the “decades of chaos” as there was social turmoil that severely affected the economy as well as society at large. An example of this chaos was that during the Cultural Revolution, all primary schools in urban areas in China were closed for two to three years. Secondary and tertiary level institutions were closed for much of that period as well. Universities were closed from 1966 to 1970– 71, although those students who had entered university before the Cultural Revolution, and had not completed their degrees, were allowed to stay there without formal teaching until 1970–71 (Zhang et al., 2007). With these kinds of social turmoil still fresh in the memory of everybody, from the party leadership to the people in the street, Deng Xiaoping could gain political support for his reform program as it meant a radical departure from the policies that underpinned the chaos of the Cultural Revolution.

China also saw the rising economic power of South Korea, Chinese Taiwan and especially of their long term rival, Japan, as a geo-political threat. For China to keep its dominant position in Asia would require additional economic development, which was held back by lack of industrialization as 71 percent of the labor was allocated to agriculture, which has a low marginal productivity. This was not only linked to the fact that China was mainly an agricultural society, but also because in the late 1950s nearly all Chinese agriculture had been organized into people’s communes and people’s production teams of some fifty people. Therefore industrialization of China was low and the limited industrial production of the SOEs, generally speaking, was inefficient. This was one of the reasons why Township Village Enterprises (TVEs) could fill the gap as there was a lack of any consumer goods production, which SOEs were not able to fill (Kai-sing Kung and Lin 2007).

The roles of government and public administration were also important to establish domestic-owned policies relevant for China. This was because China had traditionally been a country with a decentralized structure, in which a local government could undertake policy experimentation. If successful, this policy was implemented nationally. This policy formulation and development process is linked to the traditional decentralized system of government in China that had an M-form organization, in which regional governments (be it province, county, township or village) had considerable responsibility for coordination within their jurisdiction (Maskin et al., 2000). An M-form organization (multi-divisional form) is defined as an organization that consists of “self-contained units’ where complementary tasks are grouped together (Qian, Roland and Xu, 2003). Therefore regional governments are less reliant on each other and this would facilitate policy experimentation. In particular, a large number of SOEs, including many in heavy industries, were subordinated to the regional governments even before the economic reforms. Hence, each region was relatively self-sufficient, while the scale of enterprises was small and industries were less concentrated. In this environment, regional policy experiments can be carried out in a less costly way because the disruptive effect to the rest of the economy is minimal (Barrell et al., 2000).

Although the introduction of a market system was undertaken incrementally, the overall objective of reform and opening up was clear: to improve the economic welfare of the people at large. Against this yardstick, the reform measures that worked have been kept and improved; those that did not were discarded. Overall, policies were not imported from foreign countries without adaptation. Rather, policies were geared toward the development of a system that can best deliver the economic welfare outcomes and is most adaptable to the changing social, political and cultural conditions. As such, transition from a planned economy to a market based system was seen from a pragmatic point of view as a means to improve welfare and not an end in itself, nor ideologically driven.

1.2 Overview of social-economic developments during transition

The socio-economic changes in China have been dramatic over the last twenty-five years. While growth rates of GDP have averaged close to 10 percent per year for nearly two decades, average materialistic standards of living have been transformed, pulling about 500 million people out of poverty, more than at any other time in human history. However, the benefits have not been equally divided, with the elites and middle class enjoying an affluent lifestyle, while an estimated 100 million people remained poor (World Bank, 2001). Moreover, 30 million children of school age are not going to school (World Bank, 1999). These poor are predominately located in rural areas of the middle and western regions of China.

The reform process first started in rural areas and subsequently spread to urban regions. One of the first rural reforms was abolition of the commune system in the countryside – where 90 percent of the population used to live – and its replacement with small-scale, de facto privatized family farming. This started at the end of the 1970s and is also referred to as the introduction of the household responsibility system. It was combined with a reduction of top-down autocratic planning and direct control of the economy, while market mechanism was slowly introduced along with fixed supply quota. Moreover, local political leaders were encouraged to engage in economic enterprises, which were later referred to as the Township Village Enterprises (TVEs).

At the same time, China started abandoning its isolationist position in the world and embarked upon the development of international trading relations with other countries. As such, China created four Special Economic Zones (SEZs) (and subsequently “open cities”) to allow foreign enterprises to collaborate in new joint ventures with their Chinese counterparts. There SEZs enjoyed special privileges, including a relaxed regulatory as well as tax holidays, to encourage foreign direct investment. As these areas were located in eastern parts of the country, these cities became China’s “engine of growth” and had the official policy of becoming rich first. Deng Xiaoping promised that the benefits of this strategy would eventually trickle down to the rest of the country. This policy resulted in an increase of regional inequality as well as inequality between social classes (Kanbur and Zhang, 1999). As such, the objective of attracting hard currency necessary to finance capital imports for economic development was deemed more important than having an egalitarian society. This was a major departure from the traditional central credo of the Chinese Communist Party (CCP) which focused on creating an equitable society for everybody, in particular for the peasants upon which the revolution was originally built.

The urban reform process started a decade later than the rural reform, in the beginning of the 1990s, with the privatization of SOEs. The smaller SOEs were first privatized and at a later stage, new forms of enterprises were created, including stockholding as well as foreign (partial) participation in companies. The objective of privatization and changing the ownership structure of companies was to “harden the budget constraints”, by strengthening corporate management. The process of privatization of Chinese SOEs had a major impact on the urban areas, as social provisions and social security disappeared, which were traditionally provided by these companies. Laid-off SOE employers were often not only hit by a sudden loss of income, but more importantly, also by the loss of secondary benefits such as housing, schooling, health care, pensions, etc. To some extent, local and central governments tried to limit the impact of these policies by providing minimal safety-net measures. However, in general it can be stated that the privatization process led to increased vulnerability as primary benefits (such as income), as well as secondary benefits (such as housing, schooling and pensions), were not automatically provided any more by the state, as used to be the case before reforms.

The central government acknowledges social-economic challenges, particularly in rural areas. It is in this context that Premier Wen Jiabao proclaimed the “new socialist countryside”, which had th...

Table of contents

• Routledge Studies on the Chinese Economy Series Editor
• Contents
• Foreword and acknowledgement
• Preface
• Abbreviations
• Part I General introduction on the developmental challenges of China
• Part II Managing vulnerability and increasing livelihood opportunities
• Part III Public sector reforms, fiscal decentralization and social security
• Conclusion
• Notes
• Bibliography
• Index