From: "D-P Deng (O-516-282-2197,~{5K6,F=~})" <deng@BUNNY.RHIC.BNL.GOV>
Subject:      Capitalism with Chinese characteristics
Reply-To: "D-P Deng (O-516-282-2197,~{5K6,F=~})" <deng@BUNNY.RHIC.BNL.GOV>
Organization: Indiana University
Date: Tue, 15 Dec 1992 02:17:03 GMT
Comments: To: china-nt@uga.cc.uga.edu

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Capitalism with Chinese characteristics
(second article in a China Survey)
The Economist, November 28 -- December 4, 1992
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Competition has the key to China's success
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The Chinese reforms have succeeded thus far because they introduced a great
deal of competition into the economy, albeit sometimes in forms that are
hard to recognize. This has created an economy that at its grassroots works
surprisingly well -- since it increasingly resembles and is integrated with
the economies of its East Asian neighbours -- but which in its half-reformed
state is full of contradictions and strains, especially in the role of the
government.  Begin with the happier part of the story.

The first of China's three waves of reform was directed by Mr Deng himself
in the late 1970s and early 1980s. He did two main things. One was to create
a market economy in food, initially by freeing prices for most food except
grain and eventually by abolishing the agricultural communes as the unit
of production and replacing them with what were basically family farms.

His two moves were a spectacular success. Output rose sharply. More
significantly so did productivity. Farming output perhead in China did not
go up at all between the mid-1950s and 1978. In the first half of the 1980s,
real value-added in agriculture went up by 7% a year while the number of
people working the land went down. This made everyone in China, either as
food producer or food consumer, quickly and palpably better off. It laid
the goundwork for substantial growth of agriculture output, and generated
the surplus of rural savings needed to finance the industrialisation of
China. The political genius of the reforms was that they captured this
surplus not by milding the countryside, as mistaken third-world or
Stalinist industrialisation-drivens always did, but by making farmers
richer. Mr Deng created a committed reform constituency three-quarters of
China's population.

The second element of the early Deng reforms was less spectacular, but is
proving to be just significant. The "open-door policy" began by eliminating
the central government's monopoly over foreign trade. Four experimental
"special economic zones" were also set up, three in Guangdong province next
door to Hong Kong, the other in Fujian province across the strait from
Taiwan. These were intended to draw in foreign capital, companies and
expertise -- mainly, as their locations show, from the ethnic Chinese
businessmen of Hong Kong and Taiwan. The open-door policy has transformed
the economy, bringing it the same benefits that the export-led growth of
the East Asian tigers delivered to them.  A later article will explain just
how.

INDUSTRY'S TURN

The agricultural reforms worked so well that attention of China's policy-
makers quiickly shifted away from them (as will the rest of this survey).
The next two rounds of reform, in 1984 and 1987, dealt instead with
industry. More was accomplished than people usually assume, though the
central difficulty with state-owned industry has still not been tackled.

To see how much has been done, it is useful to refer to a checklist drawn
up by Mr Perkins, the Harvard economist. He notes that four conditions must
be met for a market system to work well in a reforming centrally planned
economy. They are: (1) Goods must be made available through the market
rather than through administrative allocation. (2) Prices must reflect
long-run relative scarcities rather than the dictates of the plan. (3)
competition must exist; no monopolists otherwise no productivity gains.
(4) Managers must behave according to the rules of the market, rather than
those of the state bureaucracy. In China, numbers (1) and (2) are being
taken care of by reforms begun in the mid-1980s and nearing their end now.
Number (3) is also being taken care of, though mostly inadverntly. That
leaves still number (4).

(1) Ever fewer goods are flowing through the hands of the planners. In
1978 around 700 kinds of producer goods were allocated by the plan; by
last year the number was below 20. In the rapidly growing non-state sector,
almost no inputs or outputs are covered by the plan. But even in the case
of state-owned firms.  If an industrial survey by the Chinese Academy of
Social Sciences can be believed, as long ago as 1989 around 56% of inputs
were bought outside the plan and almost 40% of output sold outside the
plan. Today the market rather than distributes almost 60% of coal, 55% of
steel and 90% of cement.

(2) It is therefore no surprise that prices are coming closer to
reflecting true scarcities. The two-track pricing policy that the
government introduced in the mid-1980s gave rise to some predictable
corruption, as middlemen bought cheap at state-set prices and sold dear
at market prices, but at least the policy introduced market pricing into
the system. More important, it made market prices the relevant ones for
non-corrupt marginal decisions by most factory managers (because, provided
the state quota accounts for less than all the inputs and output, the cost
of an extra unit of input and price of an extra unit of output is fixed
by the market). And market pricing is spreading. In September the
government cut the number of raw-material inputs subject to price controls
to 89, meaning that the prices of 75% of these items, by value of sales,
are now market-set. Moreover, since mid-1991 the government has taken
advantage of a period of price stability to raise state prices like those
for grain and coal much closer to market levels.

(3) competition has spread through the economy from many sources. One
source is foreign trade and investment. A bigger source is the
interprovincial rivalry released by the decentralisation of economy power.
Every Chinese province has been transfixzed by the success of Guangdong,
whose real GNP has grown by an amazing 13% a year for the past 14 years.
All realize that Guangdong has had the incomparable advantage of being
next to Hong Kong. But most now realize as well that Hong Kong would not
have knocked on Guangdong's door had it not been for the province's pro-
business government and the small share of state-owned firms there. The
result is that provinces are striving to out do each other not just in
attracting foreign investment but in designing and carrying out models
of reform. It is strikingly like the social and economic experimenting
that America's federial system was intended to achieve.

The biggest spur of all to competition, however, has been the luxuriant
growth of industries, mainly in the countryside, that are not owned by
the central government but are not exactly private either. These usual
creatures deserve an article of their own, which comes later in this
survey. It is enough for now to note that the "collectives" have spread
thoughout China, competing vigorously with each other and with the state
firms too.

These developments have created an economy that looks like less socialist
all the time. China's industrial structure resembles that of its East
Asian neighbours far more than that of its former ideological friends in
Russia and Eatern Europe: Chinese industrial output is dominated by a huge
number of small firms rather than vice versa.

It is the smaller firms that are growing. In 1978, just before the
reforms began, state-owned firms accounted for 78% of China's industrial
output. The state share has fallen by more than two percentage each year
ever since, and is now just over half (see chart). The Chinese government
guesses that figure will hit 25% by 2000. If agriculture and services are
taken into account, the state's share of Chinese output is already no
more than 25%: some West European countries should be so lucky.

The most significant change in reformist China is how much more efficient
the economy has become. Between the mid-1950s and the mid-1970s, a
horrifying era that included the Great Leap Forward and the Cultural
Revolution, China's real GNP grew by a respectable 5-6% a year. But it
seems that, in the two decades before the reforms started, China's "total
productivity" did not increase much, if at all. This mouthful represents
the best measure economists have for how efficiently an economy is
combining inputs or capital and labour to produce a given amount of output.
Practically all of China's pre-reform growth came from adding more inputs,
especially capital, not from using them more efficiently.  With savings
and investment rates as high as China's -- both run at around 35% of GNP
- -- economic growth can be bought for a long time this way, but not for
ever. Without productivity growth, an economy sooner or later stops
growing.

Things changed in China after 1978. By one recent calculation, the factor
productivity of China's state firms rose by almost 2.5% percent a year
during the 1980s, up from zero in the pre-reform years. The same figure
for non-state firms in the 1980s was 5%. In both cases, productivity
growth picked up speed as the decade went along.

There are other signs that the Chinese economy is becoming more competitive
and efficient. Profitability in the state and non-state industries is
declining at the same time as their productivity is going up. Returns in
the state and non-state sectors are begining to converge. And the range
of profit rates across industries is also narrowing -- from 7-98% in 1980
to 8-23% in 1989. All this suggests an overall reduction in monopoly power
and profits and an equalization of returns across regions, industries and
companies. In gathering political support for his reforms in the early
1980s, Mr Deng said he was aiming to build "socialism with Chinese
characteristics". It is now obvious that he has been building capitalism
with Chinese characteristics.
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^:G.Jefferson, T. Rawshi and Y. Zheng, "Growth, Efficiency and Convergency in
  China's state and collective industries", Economic development and Cultural
  Change, 1992
^^:B. Naughton, "Implications of the State Monopoly over Industry and its
   Relaxation", Modern China, January 1992.
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PS: this is the second  article in a CHINA survey in THE ECONOMIST 1992.11.28
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