After Japan and South Korea, China is
arguably Asia's next giant. Starting from a relatively egalitarian base,
in terms of asset and income distribution, created during the years of
central planning, it has over the last two-and-a-half decades grown at
a remarkable pace within the framework of an increasingly market-friendly
regime. Per capita income has increased more than four-fold from $168
in 1980 at 1995 prices to $727 in 1998. Growth over time was indeed uneven
with the annualised rate of growth of three-year-average GDP figures rising
from a little less than 7 per cent in 1982 to a peak of close to 14 per
cent in 1985, then falling continuously to less than 6 per cent by 1991,
rising again to the above 13 per cent level in 1994 and then falling to
less than 8 per cent in 2000. However, the average rate of growth has
indeed been high.
This increase in per person incomes has occurred in a period when China
has witnessed major reform of its economic policies, starting with reform
in the agricultural sector in 1978. Later, beginning in the mid-1980s,
China opened its economy to inflows of goods and investment. Though a
range of non-tariff barriers still remain in place, the average tariff
rate on imports has fallen from 40 per cent in the early 1990s to 15 per
cent in 2001. Foreign investment flows, which increased from around $1
billion a year to $3.5 billion during the 1980s, mainly as a result of
investment in special economic zones, jumped to $37.5 billion in 1995
and $40.3 billion in 1999. As a result, during the second half of the
1990s, FDI inflows amounted to over 5 per cent of GDP and accounted for
well over 10 per cent of gross capital formation. There does seem to be
evidence of a virtuous link between such FDI flows and China's export
performance. In the event, China's exposure to trade has grown substantially,
with the ratio of imports plus exports to GDP rising from 12 per cent
in 1980 to 42 per cent in 2000.
This and other evidence has been collated in a recently released 800 plus-page
study titled "China in the World Economy: The Domestic Policy Challenges".
As is to be expected the study uses the link between reform, growing trade
dependence and high growth as the basis for two generalisations. First,
that if appropriately carried out, a shift from an interventionist to
a market-friendly regime, which facilitates international integration,
is the best route to high growth. Second, that to overcome the deceleration
in growth that China has been recently experiencing, the best strategy
would be intensify the reform effort. Thus, China's commitments as part
of its accession to the WTO, which go far beyond what many other middle
income countries have adopted, is seen as a positive step forward.
However, while declaring that China's progress during the economic reform
era is one the great success stories of the post-war era, the study points
to a number of emerging areas of concern in recent performance. These
include the evidence of a loss of dynamism in industry and agriculture,
of growing unemployment and of substantial and rising regional disparity.
Grain production has stagnated in the early- and late 1990s fell in 2000
to its mid-1990s level. Industrial growth has fallen quite sharply after
1993. The town and village enterprises (TVEs), which were a much-noted
source of dynamism in the Chinese economy, are faced with difficulties.
This is of significance, since the TVEs were the largest contributor to
growth in aggregate GDP and employment from the mid-1980s through the
early 1990s, and by 1996 employed 131 million workers, or 28 per cent
of the rural workforce. The development of rural enterprises in turn has
transformed rural income generation, with more than 40 per cent of rural
incomes now coming from non-agricultural activities. Unemployment has
been on the rise, which in its starkest form is reflected in the phenomenon
of "floating" migrant workers in search of underpaid informal
sector employment, estimated at around 100 million. Finally, China's growth
during the 1990s has been accompanied by growing inequality among its
regions. Growth has been most rapid in the coastal provinces, followed
by provinces in the central region, and least rapid in the western regions.
These trends have generated some degree of scepticism regarding the evidence
of rapid growth over long periods in China as well as a degree of disillusionment
with the reform itself. Surprisingly, it is precisely at this time that
China has decided to accept extremely tough conditions in terms of trade,
foreign investment and financial sector reform as commitments made in
return for WTO access. This, many argue, would not merely ensure a qualitative
shift in the nature of the economic regime in China, but would accentuate
the tendency towards sluggish growth and weakening welfare.
It is that argument that the OECD study seeks to challenge. While admitting
that the evidence is growing that "the important engines that have
driven China's growth in the past have lost their dynamism", the
study advances two theses. First, it holds that although China is even
now as open as many WTO members and though the depth and breadth of its
WTO accession commitments to increase access to its domestic economy are
far greater than those agreed to by previous adherents to the WTO, China's
accession is merely an important and much-needed milestone in its reform
path rather than a change in direction. Second, to reverse the tendency
towards loss of dynamism and maximize the benefits of the imminent increase
in the openness of its economy, China would have to go further than its
WTO commitments and undertake a set of complementary and far-reaching
reforms. The intent of the study is clearly to remake China in the image
of the developed capitalist world, if that is possible at all, ostensibly
because "to reap the full benefits of further integration in the
world economy, the Chinese economy must undergo fundamental adjustments."
There have been four elements to the reform in China adopted so far. The
process began with reform in the agricultural sector, which displaced
the pre-reform commune economy. This was replaced with a household-based
system in which individual households that leased land from the collectives
were provided autonomy in production decisions. Further, market forces
were given a greater role and government intervention in the production,
pricing and marketing of most crops, excepting grains, was substantially
reduced. Second, the government permitted and sought to encourage investments
outside the state-owned industrial sector, initially in the town and village
and other collectively owned enterprises, then in foreign funded enterprises
and more recently in domestic private enterprises. Third, the government
began to liberalise the import and export trade, by reducing tariffs and
easing non-tariff barriers on a range of exports. Finally, the government
has sought to encourage foreign investment in special economic zones and
elsewhere.
Each of these the report argues contributed significantly to increasing
productivity and stimulating income growth. The problem is that more recently
their role as stimuli has substantially waned. The waning of the effects
of these stimuli is attributed in large part to the fact that the specific
form which reform took in each area had positive effects in particular
segments of the concerned sector. But once the slack in those segments
had been taken up, the persistence of dynamism required not just the intensification
of reform in the affected segments, but the extension of reform to other
segments and to economy-wide policies. While China's WTO access commitments
partly do involve such an extension, they would be inadequate if the benefits
from opening up are to be maximized.
In agriculture, the loss of dynamism is attributed to the fact that there
are now binding barriers to increases in agricultural productivity. Fertiliser
use is already exceptionally high, pesticide application cannot be increased
because of environmental problems, and there is a growing shortage of
water in many areas. This, according to the study, implies that agricultural
production must diversify away from land-intensive to labour-intensive
products like horticulture. But such diversification is constrained by
the grain procurement system maintained for food security reasons, which
has ostensibly contributed to growing surpluses, falling prices, reduced
rural incomes and constrained rural consumption.
This focus on the physical barriers to productivity increase and the policy-induced
constraints to diversification because of the emphasis on grain production
is not just overstated. It also tends to underplay some of the consequences
of agricultural reform for welfare and growth. Thus, according to some
observers the phenomenon of "floating" migrant workers is in
large measure the result of a loss of the institutional ability to mobilize
and utilize labour resources, which was characteristics of the commune
system of production. An example of such utilization was the pooling of
off-season labour resources in building rural infrastructure. The collapse
of the latter not only affected employment adversely, it also resulted
in the neglect of the maintenance and strengthening of communal infrastructural
facilities, with adverse consequences for productivity. But a perspective
which has as its prior the view that Chinese reform was positive but inadequate
inevitably ignores such questions.
Consider also the puzzle as to why rural unemployment has increased despite
the success of the TVEs. The growth of such enterprises in the rural as
opposed to the urban areas was partly because of the opportunity for sustaining
ancillary activity and contract work at extremely low labour costs that
excess labour resources in rural areas provided. Temporarily, at least,
the government's decision to encourage TVEs as a part of the process of
"growing out of the plan" worked because it facilitated the
rural outsourcing of such activities, to sustain low cost production,
including for export markets. As a result, the new system appeared to
be a better way of absorbing rural surplus labour. However, evidence to
the contrary is growing. The demand for such outsourcing was inadequate
to absorb the growing rural labour surplus in full. Further, such employment
tended to be unevenly distributed. Such industries have developed mostly
in coastal provinces and are reportedly much less visible in the interior
provinces, especially in the west of the country. More recently, there
are signs of stagnation and decline in the TVE sector, with employment
in rural enterprises falling by close to 2.5 million since 1996.
Glossing over all this the OECD study asserts that worsening TVE performance
is due to fundamental structural problems. These include financial problems,
operating inefficiencies, loss f competitiveness due to distance from
infrastructure. Hence, "even under optimistic assumptions about how
much their performance can be improved, REs (rural enterprises) are unlikely
to be able to take up more than a fraction of the rural workers who will
need to find jobs outside the agricultural sector."
What then is the answer? Urban industry does not offer much of an alternative.
The OECD's study points out that: "As in agriculture, the dynamism
to industry imparted by structural shifts seems to be weakening. Industry
financial performance has deteriorated sharply since the early 1990s.
Profits fell to nearly zero in 1998, with more than one-third of enterprises
making losses, and despite noticeable improvement during 1999-2001, financial
performance remains weak in many sectors. Growth in industry employment
and capital spending has declined markedly. The deterioration has been
pervasive and not simply confined to SOEs. The performance of collective
enterprises has worsened nearly as much as that of SOEs; and the SME sector
generally is in particularly dire straits."
With foreign investment flows into China already far in excess of other
developing countries, and with a predominant share coming from Hong Kong,
Taiwan province of China and other Asian countries with ethnic Chinese populations, it is
unlikely that this sector can even sustain its growth, let along help
employ the unemployed. In the event, we are likely to see a worsening
of unemployment, because even the high growth associated with the unusual
combination of more than two decades of rapid expansion accompanied by
persisting and even growing unemployment in the Chinese economy is no
more a reality.
Given all this it should be obvious that this is hardly the point in time
when Chinese producers should be subjected to increasing competition from
imports and state-owned enterprises should be restructured through downsizing
or outright closure. But these are inevitable consequences of China's
WTO accession commitments, rendering the argument that this wide-ranging
commitment is an appropriate deepening of reform questionable. But the
study advances that argument by attributing poor industry performance
to inefficiency resulting from wrong investment decisions and protection
and cost ineffectiveness because of social burdens imposed on them. Even
if this were true, reform in a period when international competition is
expected to increase would only result in closure. And given the dependence
of many local industries on the SOEs, the process is likely to be cumulative.
Yet, in the OECD's view, more reform is the answer. "Trade and investment
liberalisation should help to improve some of the mechanisms needed to
accomplish the necessary restructuring, by increasing competition, expanding
opportunities for alliances between foreign and domestic firms, and spurring
government officials to take measures to improve the business environment.
However, key obstacles that now exist to improvement in industry performance,
such as continued government interference in enterprise management, poor
financial discipline, and restrictions on exit and other modalities for
re-deploying resources, need to be addressed if the potential benefits
of trade and investment liberalisation are to be realised."
The difficulty is that the OECD's economists are not even satisfied with
the extent of reform implied by WTO commitments. The study argues: "In
China's present situation, the outcomes of particular reforms depend increasingly
on the interaction among measures taken by the economy's key actors -
government, enterprises, workers, and the financial system - acting in
markets whose functioning is shaped by key framework conditions such as
competition, property rights, and corporate governance. Rather than emphasising
particular sectors, reforms now need to focus more on economy-wide policies
to promote more efficient allocation of resources and to bolster the effectiveness
of markets."
Two areas into which the extension of reform is emphasized is the financial
sector and macroeconomic policy. Lamenting that the financial sector is
still dominantly state-owned, the report argues that credit is inefficiently
allocated, with state-owned enterprises obtaining the bulk of funding,
to ensure that they operate with soft budget constraints. This is indeed
true since the role of credit in the Chinese system, hitherto, was a means
to realize targeted production as per plan. If in the name of bank restructuring
SOEs are to be now starved of funds, leading to the collapse of such enterprises,
the banks themselves would not be able to survive unless they are recapitalised
by the State. As the study itself notes: "In a proximate sense, the
ongoing problems of financial institutions reflect the poor condition
of their enterprise customers. A severe vicious circle has developed.
Poor enterprise performance contributes to bank non-performing loans and
lowers bank profits by eliminating much of their core market."
Banks after all cannot restore the health of real economy enterprises.
That has to be the result of appropriate corporate restructuring and counter
cyclical macroeconomic policies. But with the customs duty reductions
and the tax rationalisation associated with reform having reduced the
revenues of the State substantially, the manoeuvrability of the State
is already substantially circumscribed. Though "official figures
suggest that China's fiscal position is healthy and that there is ample
scope for fiscal expansion," this picture is misleading because it
is widely acknowledged that the government will need to take on debt obligations
not yet explicitly recognised. The main obligation, the funds needed to
restore solvency to financial system, could more than double the government
debt ratio initially."
Given these factors the challenge in China is to restore the room for
manoeuvre of the state so that it can restore some dynamism to the system.
This would require reducing rather than increasing China's integration
into the world system. But though its own analysis points in that direction,
the OECD given the predilections of its member governments to obtaining
a foothold in the large, even if stagnating, Chinese market, is forced
to argue to the contrary.
For more details click on the below link:
China
in the World Economy: the Domestic Policy Challenge