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Chinas Economy

Global and Political Economic Environment

Global and Political Economic Environment

Chinas Economy

Answer: China has been one of the worlds most dynamic economies in recent decades,

but the industrial revolution occurred in Europe rather than China because European entrepreneurs were eager to adopt machines to cut down on high labor costs. One of the big debates in economics is about the causes of the arguably most dramatic change in development trajectory in (recent) world history, the industrial revolution. Before about 1800, growth did occur, but it was mainly extensive, leading to more people but almost no growth in income per capita. After about 1800 this changed, and growth became (increasingly) intensive, focused on an almost continuous growth of GDP per head. There is consensus about the fact that this change in growth pattern started in northwestern Europe, and gradually spread to large parts of the western and, after a lag, eastern and southern world.

The Great Divergence debate


Recent literature, most famously Kenneth Pomeranzs The Great Divergence (2000), has suggested that Chinas level of economic performance was more or less at par with that of Western Europe. Moreover, the lower Yangzi delta formed a core of economic prosperity comparable with the North Sea area, the most developed part of Western Europe. Pomerantz argues that even in the eighteenth century, China was not inferior to Europe in terms of technology, social structures that could support technological innovation, large pools of accumulated capital, etc. According to him, the reason that Europe succeeded and China did not was largely determined by pure chancea lack of large deposits of coal and iron ore close to each other and the absence of large outward migration (after Zheng He, the greatest world traveler before Columbus, discovered Madagascar, the African Horn, and Saudi Arabia in the early fifteenth century, the emperors of the Ming Dynasty prohibited the construction of big ships and the Middle Kingdom experienced selfimposed isolation for four centuries). Pomeranzs argument is that mass emigration from Europe played a crucial role in the transition to the modern growth regime from a Malthusian regime.2 When technological progress accelerated in the nineteenth century but the population growth rates still remained high and growing (0.6 percent in 1820-70) because the demographic transition had not yet occurred, mass migration to North America helped to alleviate pressure on a scarce resource, land, and to avoid diminishing returns. In a similar vein, land scarcity is seen as a factor that stimulates urbanization and industrialization. It is argued that during the Song Dynasty, despite the fact that China lost a significant amount of arable land to invading nomads as its population peaked, China witnessed a higher urbanization level, more prosperous commerce and international trade, and an explosion of technical inventions and institutional innovations. However, after China significantly improved its man-to-land ratio in the period after the Song only to find itself induced deeper into the agrarian trap, resulting in reduced urbanization, withering foreign trade, a declining division of labor, and stagnation in technology

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Lis The Early Industrialization in Jiangnan is particularly noteworthy for its systematic narrative of the growth of industries in cotton textile, food processing, apparel, tobacco, papermaking, printing, tool making, construction and shipbuilding in the Lower Yangzi during 1550-1850. His depiction of the rise of a dynamic, diverse and commercialized printing industry reveals the existence of a mass reading public in the Lower Yangzi.4 Overall his work attests to industrial progress throughout these three centuries, not only in the scale and technology of production, but also in its organization and the extent of the division of labor. Rea Wages Asian living standards, at least in the Lower Yangzi, were on par with that of Northwestern Europe is built on rather fragile evidential base. They relied on indirect comparison based on scattered output, consumption or demographic data. This on relatively rigorous comparison of the purchasing power of real wages of unskilled laborers in Asia and Europe reconstructed based on the systematic price and wage data. The Yangzi Delta is reputed to have the most advanced economy of any Chinese province, but the real wage there was not noticeably higher than the real wage in Beijing or Canton. Overall, the Chinese cities were in a tie for last place with the Italian cities, which had the lowest standard of living in Europe. And they were far behind that in London or Amsterdam about 30-40% of that of earning levels there in terms of purchasing power measured by our reconstructed subsistence basket during the 1819th centuries. This makes any optimistic assessment of Chinas performance is difficult. Trade, Market Efficiency and Legal Regime Institutions have figured relatively little in revisionist literature on Chinese economic history. In fact, Pomeranz views the property rights or the freedom to contract in traditional China as no less secure or flexible than in Western Europe. This naturally leads the revisionist school to an explanation of the Great Divergence based on resource endowments. The efficiency of market institution seems to find some strong empirical confirmation from market integration studies based on statistical correlation of regional grain prices. Measures of Integration Although foreign trade in the 18th century was not significant, Chinas expansive empire meant that even domestic trade involved large distances. Trade between the fertile agricultural areas in the upper reaches of the Yangzi River of Sichuan Province and the urban regions of Shanghai at the Yangzi Delta involved covering distances of at least 1700 kilometers. This is approximately the distance of the trade route between Antwerp and Lisbon. There are also comparable historical accounts of how grain was paid and transported along routes that connected the Yangzi Delta with Sichuan and Hunan, or, Amsterdam with Spain and France. We may know about large specific transactions of grain, but trade volume statistics are spotty at best. In Europe, rough calculations suggest that 1 % of total consumption of the Mediterranean area was traded in the 16th century, and the situation may have remained much the same in the 17th century.11 Much depends on whether one includes only the urban area importing the grain, or the entire population of

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potential exporters as well, but some kind of per capita weighting is essential. In China, the Yangzi Delta alone with an area of 43,000 square kilometers and a population of approximately 20-36 million inhabitants in the 18th century may have imported as much as one-quarter of its total grain consumption, but adding in the potential number of exporters supplying this grain, the relevant per capita trade statistic must be much smaller indeed.12 Available estimates on disaggregated trade flows are also vague on considerations such as the date of purchase and delivery or the point of origin and destination of each shipment. Even if we had more detailed information on the volume of trade, however, this would not be enough to establish the efficiency of markets. In China in the 18th century, as in Europe, the labor force was predominately engaged in agriculture. The majority of the population was engaged in small-scale, producer-cum-consumer farming, and available estimates suggest that agricultural output made up at least 60 % of GNP in re-industrial economies.13 Grain was an important commodity, not only in overall output, but in consumption as well. Monotony in foodstuffs, with a large share of consumption being in cereals, was common in the lives of both European and Chinese. The share of cereals in the diet of urban dwelling northern Europeans, who it is said ate more meat and fish than their southern neighbors, was still nearly 60%, a figure also likely to be significantly lower than for the average farmer. Fig 1: PPP GDP per capita in major countries at Appendix A Conclusion 1. Chinese family structure, although differing from that in Europe, produced neither unlimited fertility nor unusually large or rapid population growth. 2. Chinese and Indian domestic economic activity in such areas as textile production and food processing was quite sophisticated with regard to large-scale mass production and trade. 3. Chinese and Indian merchants operated with substantial autonomy, and had far larger commercial fortunes than most European merchants well into the late eighteenth century. 4. Chinese international economic activity was vigorous and dynamic through the entire Ming and Qing periods. 5. Chinese agricultural productivity and standards of living were comparable to those in the leading regions of Europe as late as the eighteenth century. 6. China's eighteenth and nineteenth centuries were marked by substantial geographical expansion and economic integration of new regions. 7. It was not European eagerness for trade, but China's desire to obtain silver bullion via trade, that was the motive force in the global trading system of the sixteenth through early nineteenth centuries. 8. Chinese and Ottoman political dynamics were not wholly different in nature from those of European monarchies, for the major political crises in seventeenth century China and the Middle East had similar fiscal, social, and material causes, and often greater institutional consequences, than European revolutions and rebellions of the same era. After the establishment of the People's Republic of China in 1949, the economy began to recover after years of wars. In 1953, the government adopted the Soviet-style central planning in the form of the first Assignment No: 1 Page |3

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Five-Year Plan of 1953-1957. Private enterprises and enterprises formally controlled by the government of the Republic of China were reorganized into state enterprises. In agriculture, the farmers were first given land after the land-owners as a class was brutally destroyed. They were then organized into cooperatives, more advanced form of cooperatives and into Communes in 1958 as a part of Chairman Mao's Great Leap Forward Movement. The Great Leap led to the death of over 25 million people from 1959 to 1962, as can be calculated by officially published death rates. The death rate was about 11 per thousand in 1957 and 1963, but went up to 17 per thousand in 1962. China had the most severe famine in its history. Chinese Economy Prior to Reforms Prior to 1979, China, under the leadership of Chairman Mao Zedong, maintained a centrally planned, or command, economy. A large share of the countrys economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy. During the 1950s, all of Chinas individual household farms were collectivized into large communes. To support rapid industrialization, the central government undertook large-scale investments in physical and human capital during the 1960s and 1970s. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled, state-owned enterprises (SOEs), according to centrally planned output targets. Private enterprises and foreign-invested firms were generally barred. A central goal of the Chinese government was to make Chinas economy relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China. Government policies kept the Chinese economy relatively stagnant and inefficient, mainly because most aspects of the economy were managed and run by the central government (and thus there were few profit incentives for firms, workers, and farmers), competition was virtually nonexistent, foreign trade and investment flows were mainly limited to Soviet bloc countries, and price and production controls caused widespread distortions in the economy. Chinese living standards were substantially lower than those of many other developing countries. The Chinese government in 1978 (shortly after the death of Chairman Mao in 1976) decided to break with its Soviet-style economic policies by gradually reforming the economy according to free market principles and opening up trade and investment with the West, in the hope that this would significantly increase economic growth and raise living standards Economic Reforms Beginning in 1979, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones along the coast for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms, which followed in stages, sought to decentralize economic policymaking in several sectors, especially trade. Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. In addition, citizens were encouraged to start their own businesses. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment. In addition, state price controls on a wide range of Assignment No: 1 Page |4

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products were gradually 1978 was the year when Deng Xiaoping took over control of the Communist Party. He was responsible for initiating reform of the planned economy towards a more market-oriented economy. There were four reasons why the time was ripe for reform. Table 1: Chinas Average Annual Real GDP Growth: 1960-210: Annexure B First, the Cultural Revolution was very unpopular and the Party and the government had to distance themselves from the old regime and make changes to get the support of the people. Second, after years of experience in economic planning government officials understood the shortcomings of the planning system and the need to change. Third, successful economic development in other parts of Asia including Taiwan, Hong Kong, Singapore and South Korea, known as the four Tigers, demonstrated to the Chinese government officials and the Chinese people that a market economy works better than a planned economy. This lesson was reinforced by the contrasts between the different rates of economic development in North and South Korea, and in countries in Eastern and Western Europe. Fourth, for the same reasons as stated above, the Chinese people were ready for and would support economic reform. Given the above four reasons was economic reform in 1978 inevitable? The first two reasons alone were sufficient for the government to initiate reform. The Cultural Revolution had made the government so unpopular that both the government and the people wanted to change eagerly. The direction of change was clear because economic planning was recognized to be a failure. Given such a situation there was no other way for China to go. The urgency of the case was such that it had to occur as soon as the political leadership was ready after Chairman Mao's death. Chinese economic reform in 1978 is an example of the possibility of predicting a major social change by examining the prevailing conditions. Such prediction is easy to do by hindsight but more difficult to do before it occurs. In my opinion, Six major components of economic reform beginning with agriculture. The remaining areas are state-owned enterprises, price reform, the banking sector, foreign trade and investment, the non-state sectors and institutional infrastructure. I point out that the reform process has been a combination of the effort of the central government and the natural desire of the Chinese people and lower level government units to improve the economic institutions for their own benefits. For example it was a combination of the efforts of the farmers and the government which changed the Commune System. As far as the role of the central government is concerned, the process has been a gradual and experimental one and has proceeded in steps. Reform of Chinese state-owned enterprises is an example of a gradual approach to economic reform through experimentation. In this case, the following concepts were accepted and carried out step by step. The first was to give state enterprises some autonomy in production decisions rather than simply carrying out the production targets under a system of central planning. The second was to make them financially independent, allowing them to keep the earnings as their own profits after paying taxes to the state, rather than as revenue belonging to the government. The third was to introduce a contract responsibility system, first to selected parts of the enterprise under the important reform decision of October 1984, and later to an enterprise in 1987. Under the contract responsibility system, a part of an Assignment No: 1 Page |5

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enterprise or the entire enterprise was allowed to keep all the gain (such as output produced) or profit after surrendering a fixed amount of it to the enterprise controlling the part, or to the government controlling the enterprise. The fourth was the reform of the price system that gradually allowed prices to be determined by the market forces of demand and supply. In the meantime a two-tear price system was introduced to allocate scarce resources formerly under the control of central planning, including material inputs to state enterprises and foreign exchange. Under such a system, the government continued to distribute the scarce resource to designated users at an official, below market price. At the same time a second market was allowed to trade the scarce resource at market price. The fifth, introduced in 1997, was to restructure the state enterprises into share-holding companies. It will be useful to keep this general picture in mind when studying China's reform process in general or in a particular sector.

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Already in 1977, Deng Xiaoping made it clear that performance should be the main consideration in the economic and social advancement of individuals. In other words, professionalism and results should count. Furthermore, he emphasized the importance of academics and scientists for the future of the economic development and the international standing of China. He thought that this should be more widely recognized by the Chinese people. During 1978, Deng Xiaopings reform philosophy gained growing support in the CCP and its desirability was accepted in December 1978 at the Third Plenary Session of the Eleventh Central Committee. This session proved to be a turning point in the direction of Chinas policies for its economic and social development. It was decided at this meeting that the system and methods of economic management in China would be transformed; economic co-operation with other countries would be expanded; special efforts would be made to adopt the worlds advanced technologies and equipment; and that scientific and educational work would be greatly strengthened to meet the needs of modernization. The importance of the four modernizations (modernizing agriculture, industry, national defense, science and technology) was emphasized. Furthermore, it was stated that The general task put forward by our Party for the new period reflects the demands of history and the peoples aspirations and represents their fundamental interests. The CCP now intended to concentrate on rapid growth in production *to+ improve the peoples living standards significantly and strengthen national defense. Several other important decisions about reforms were made at the Third Plenary Session. There was recognition of the need to reduce bureaucratic centralized management of the economy and eliminate bureaucratic and political impediments to achieving economic efficiency and development, particularly at lower leves (such as local levels) of economic activity . This was consistent with Deng Xiaopings emphasis on professionalism and efficient economic management. It was decided that the economic reforms should begin with agriculture because at that time it was the foundation of the national economy. Particular attention was given to the rule of law, decentralization and resource ownership in undertaking the agricultural reforms. These features were applied later to the rest of the economy. The importance for Chinas economic development and its future international standing and welfare of maintaining political stability under the continuing leadership of the CCP was stressed. In mid-1981, the CPC again stressed the importance of striving for the modernization of Chinas economy by acting systematically and in a staged fashion while basing its development policies on the realities of Chinese conditions and the level of available resources in China. Only modest and realistic goals would be sought. This contrasted with the much earlier attempt by China to make massive economic advances during Chinas Great Leap Forward. The issuing by the CCP of the document On Reform of Economic Structures in 1984 marked an important milestone in the strengthening of Chinas economic reforms and their extension. It was agreed that following the success of Chinas rural economic reforms, similar reforms should be extended to the whole economy with the focus now being placed on the urban economy. By continuing and extending reforms, it was hoped to establish a dynamic economy, invigorate enterprises and establish an economic system in which economic activity and production would be responsive to economic values. Several important goals were outlined in the document On Reform of Economic Structures. It was stressed that a rational price system should be established for the whole economy and that this system should make use of economic incentives as Assignment No: 1 Page |7

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levers. This would mean the extension of reliance on market systems for organizing economic production in essence, the development of market socialism with Chinese characteristics. Enterprise functions were to be separated from those of the Government. This was to ensure that investment and production decisions by enterprises were made on economic grounds rather than political ones. Furthermore, it was confirmed that economic responsibility systems should be established for enterprises. This meant that the government no longer intended in the long-run to prop up uneconomic state enterprises with soft loans and other forms of financial support. Notice was also given that it would no longer be the case that state enterprises would have an unassailable position in the economy. A diversity of enterprise forms was to be encouraged. In addition, it was decided to press ahead with payment according to work as an economic incentive even though it was realized that this would result in greater income inequality. A continuing feature of Chinas reforms would (according to this document dealing with economic reforms) be further promotion of economic openness through international economic cooperation, investment, trade and exchange. Great success was subsequently achieved in pursuing this goal. Time Jan 1976 Sept 1977 Dec 1978 Event Premier Zhou Enlai dies. Chairman Mao Zedong dies. Hua Guafeng becomes Chairman of the CCP and subsequently Deng Xiaoping returns from political exile. Increasing CCP support for Deng Xiaopings reformist agenda culminates in its basic acceptance by the 11th Central Committee of the CCP. It was argued that the reforms should begin with agriculture Deng Xiaoping becomes Chairman of the Military Commission. He criticizes dogmatic approaches to policy and favours a pragmatic approach Hua Guofeng steps down as Chairman of CCP Under the influence of Deng Xiaoping, the CPC stresses that Chinas policies for modernization must be realistically based, systematic and staged, and take account of Chinese conditions. The CCP decides that the economic reforms commenced in agriculture should be extended to the whole economy. An end to the privileged position of state enterprises is signaled. Increasing emphasis occurs on greater economic openness as an instrument of development policy. Chairman Jiang Zemin confirms the direction of Chinas development policies, such as extension of the market system and greater economic openness as well as measures to limit population growth. He saw the need for China to improve its science and technology policy because as China catches up with the rest of the worlds technology; it will need to do more to advance its own scientific and technological improvements

1979 1980 Mid-1981

1984

1989

A Review of Chinas development strategies

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1. Realigning the economy towards Chinas comparative advantage: Chinas rapid growth since the reform is mainly due to the rebalancing of Chinas developments strategy away from a central focus on heavy industry and in the direction of more labor-intensive sectors 2. Since the economic reforms beginning in the late 1970s, the central government has shifted its development strategies toward more labor intensive sectors, initially agriculture, and then increasingly export-oriented rural industries. In the global context, China possesses an obvious comparative advantage in the labor-intensive manufacturing sector. After introducing the open door policy, massive foreign direct investment flowed in and married with Chinas cheap labor. As a result, both capital and labor resources were more efficiently allocated, which greatly boosted economic efficiency. Chinas development path therefore reemphasizes the importance of adhering to comparative advantage in creating labor]intensive, export]oriented economic growth 3. Experimentation and marginal reform as a solution to risk, uncertainty and opposition: In the economic arena, Chinese reformers used two related strategies to simultaneously promote economic learning and overcome political resistance to reform: (1) reforms at the margin (e.g. dual track pricing in agriculture and housing); and (2) more explicit experimentation.2 The economic role of these policies is selfdiscovery in the face of uncertainty. 4. Economic and Political Expansion: Chinas remarkable economic success: (1) comparative advantage (and conditional convergence); (2) incentives matter (fiscal decentralization and realignment of incentives towards growth-maximizing activities); (3) experimentation (as an economic and political discovery mechanism); and (4) pressure and crisis as inducers of reform. We conclude this section by noting that all these explanations are highly compatible and complimentary with each other, and that together they comprise a compelling and holistic explanation of Chinas economic miracle. After three decades of growth: the challenges of the present and the future After three decades of spectacular economic growth in China, the problem is no longer how to achieve growth but how to manage growth consequences and how to sustain growth. Chinas spectacular growth and poverty reduction has been accompanied by rising inequality, environmental degradation, and increasing social tensions. The institutions that have brought rapid growth so far are now under stress, and there is a need to reform and innovate on this front in order to sustain rapid growth, and to obtain growth with equity. Rising inequality is one of Chinas most serious problems. In particular, the regional dimension of inequality rural/urban and inland/coastal dominates in a country as large as China, and especially with its particular history. Regional inequality has become a key issue for China and a number of interventions have been introduced to address the problem. The pattern of Chinas regional inequality closely follows the history of its development strategies in the past half century. The heavy industry oriented development strategy justified the creation of the household registration system (hukou) which was a major contributor to the large ruralurban divide. Assignment No: 1 Page |9

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The opendoor policy, which granted preferential treatment to coastal areas, has helped the coast to better exploit its comparative advantage in the international markets, but left many interior provinces lagging behind. Similarly, fiscal decentralization policy promoted local government officials to develop their own economies, but differences in initial endowments tends to leave the effective tax rate regressive across Chinese regions (Zhang, 2006b). Regions with better endowments thereby have more revenues left to invest in public goods and improve business environment after turning over a portion of their fiscal revenues to the upper level government and maintaining the daily operation of local government. In contrast, the local governments in poor regions have difficulty in competing with the governments on the coast to attract investment and develop the local nonfarm economy. Their local revenues are sometimes barely sufficient to cover the salaries of civil servants on the public payroll. Consequently, they are more likely to levy heavy taxes on existing enterprises, worsening the business investment environment. In summary, the successful development strategies mentioned in the above section also have some deleterious side effects. The interjuridical competition is a key contributing factor to the increasingly serious environmental problems. In order to attract investment, many local governments loosen their environmental regulations to allow polluters to operate as long as they generate lucrative revenues for the local government. In the rapidly industrializing coastal areas, such as Jiangsu Province and Zhejiang Province, the degree of water pollution and industrial waste hazard is alarming. The cost of cleaning up the environment problem may eat up a large portion of the gains from industrialization. The investmentdriven growth model also induces local officials to collude with investors at the expense of the rights of individuals. In order to attract investment, many local governments provide preferential treatment to investors, such as free land. In the process of procuring farming land for industrial or other commercial use, the compensation to farmers was often far below the market level. Resenting this unfair treatment, many relocated farmers filed petitions to the upper level government for help, and land disputes have become a breeding ground for social unrest all over China (Yu, 2003). How to make local government officials accountable has become an increasingly important issue.

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Appendix A

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Global and Political Economic Environment Annexure B

Chinas Economy

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