From: mte152s@vaxc.cc.monash.edu.au
Newsgroups: soc.culture.china,soc.culture.hongkong,soc.culture.taiwan
Subject: NEWS: China Survey Article (3)
Date: 17 Dec 92 18:12:04 +1100
Organization: Computer Centre, Monash University, Australia

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The faltering state
(third article in a China Survey)
The Economist, November 28 -- December 4, 1992
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An inflationary crisis within two years will test the government's reformist
mettle
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The 14th Communist Party Congress, held in October, set the official seal on
China's fourth wave of reform. The coming reforms will have to deal with the
awkwadness that, for all China's progress in creating a market economy at the
level of the firm, it has been bad at improving the government's economic
performance. More awkward still, China is starting to tackle the government's
role at the same time as inflation is building to a peak.

The new agenda of reform is daunting:

*Market splintering. Goods and capital can move relatively freely around China,
but not labour. There has been some relaxation, but for the most part people
still need formal permission to move from place to place.

Even in the case of goods, an unhappy by-product of the generally welcome
decentralisation of economic power is that local governments feel freer to
protect local industries. Extrotion also takes its toll. Machinery cannot be
shipped from one part of China to another without running the risk of policemen
or soldiers demanding bribes to let it through or simply helping themselves to
a motor or other parts for resale elsewhere.

*Infrastructure. Transport has suffered decades of neglect, with investment in
railways running at about half the level (as a share of GNP) invested by
countries like South Korea, India and Brazil. China has one of the world's
smallest networks in relation to population and arable land, and one of the
highest utilisation rates for freight traffic. This fragments the national
market and raises costs substantially.

Energy prices have been kept extremely low, so energy is used inefficiently and
is in short supply. Human capital too is being neglected. China has one of the
world's lowest rates of students-age people in higher education.

*Admininstrative spacity. The burden of arbitrary government decision-making
is heavy. Why a decision is made and even who makes it are often hidden. At best
this slows down projects, at worst it increases corruption. At a higher level,
the lack of a rule of law increases the arbitrary nature of government power,
jeopardises the predictability and security of contract and property rights and
oppens opportunities for waste and corruption.

*Government finance. The chart shows the collapse of government revenues since
the reforms began, from more than 34% of GNP in 1978 to under 20% now. Both
central and local governments have suffered, though for reasons that will be
explained later the decline in local-government revenue does not mean a decline
in local-government power. The central government has lost its power to
commandeer the profits of state-owned firms and to direct their investments. its
Revenue come from increasingly inadequate tax collections that are not fixed but
instead negotiated with lower-tier authorities. This adds to the distrotions of
the administrative system. Both problems could be relieved by swtiching to a
simple low-rate value-added tax as the main source of revenue, but the governmen
shows no sign that it is about to follow technocratic advice to do this.

If revenues cannot rise to cover the persistent budget deficit of 2-3% of GDP,
perhaps spending can fall ? There is an obvious place to cut. If the government
could stop making up for the losses of state-owned firms, and stop paying price
subsidies to these firms and to consumers, the budget gap would be more than
closed.

*Financial system and monetary policy. China has come some way from the command
system of financial management used in pre-reform days. Savings and investment
decisions are more and more by individuals and firms and less by government
fiat. Household financial assests as a share of GNP are already 51%, compared
with 54% in Japan in 1954.

Even so, banks are still directed to make loans for reasons of government policy
rather than on commercial grounds; as a result, their balance sheets are
thought to be frighteningly weak. The central bank's tools of monetary control
remain primitive. It can move short-term interest rates and reserve requirements
but when it really wants to crack the monetary whip it must still rely on
quantitative credit controls.

The government's fiscal and monetary policies are about to be placed under
further strain. Ever since the reforms began, China's economy has been plagued
by sharp stop-go cycles. The sharpest turn in these cycles came in 1988, when
big rises in urban prices--they reached 80% at an annualized rate -- led to a
drain of private savings from the banking system and a run on the shops. China's
revolutionary elders have crystal-clear memories of what inflation and shortages
did to their Nationalist foes in the late 1940s, and in September 1988
conservatives wrested control of economic policy from the reformist secretary-
general, Zhao Ziyang, and imposed austerity. The clampdown, which lasted for two
years, succeeded in getting inflation down but did nothing to further the
conservative aim of bringing more of the economy back under administrative
control.

Once credit was relaxed in 1991, the boom resumed. For two years the supply of
broad money (M2) has been growing an annual rate of almost 30%. Credit expansion
in the first half of 1992 was twice what the government had planned. By early
autumn, price rises in the 35 biggest cities were running at double-digit anual
rates. Stocks of raw materials were dwindling because of rising industrial
demand.

Optimists claim that, this time, China can negotiate a gradual switch to non-
inflationary growth rather than crashing the conomy to slow inflation down. They
point to the great flexibility of supply compared with 1988 (much more output
comes from non-state firms), rising personal bank deposits (which suggest
inflationary expectations are not getting out of hand) and the increasing
monetarisation of the economy (which, rather than excess demand, explains the
rapid monetary growth). The optimists ignore the structural pressure for
overheating, of which the biggest is the interest of local governments in
pushing credit expansion, output and investment to the hilt, whatever the
central government says about it.

The optimists are unconvincing, but the next macroeconomic crunch will
nonetheless contain an opportunity. It should show just how far China's
rulers are prepared to go in correcting the one in-efficiency in which all the
others are bound up: the running of state-owned firms.
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PS: this is the third  article in a CHINA survey in THE ECONOMIST 1992.11.28
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