Econ 4690 Final Review Note

8/12/2019 Econ 4690 Final Review Note

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ECON 4690 FINAL REVIEW NOTE

4-15-10

Examine Models of Reform

- Examining reform with respect to state-owned enterpriseso The idea of autonomy during the bird in a cage period is very narrowly definedo During the bird in the cage period, it was all about giving the enterprise a small

amount of moneyo Characterize reform as a profit-making scheme that seems to worko Profit retention schemes: very good instance of experimentalism, trying reform bit

by bit, like blindly crossing stones through rivero In old system, if profit was made, gave it to the state

There is no retention of profit, other than petty casho First experiment with profit retention is called: fixed comparison

Enterprise manager got to keep profit for specific uses Fixed comparison: get to keep a share of profit

o Circular comparison: There would be two profit retention rate

Get to keep small percentage of total profit, and, above other levelof profit from last year, you get to keep much more

Gives managers incentives to increase profit year over yearo Problems: profit was a bad way to reward enterprise due to numerous pricing

flukes Did not indicate mangers ability Also, less government revenue, more money staying with firm

o Third system, Profit Contract: Rather than a share, government will take a fixedcut off the top

o Fourth System: Tax for profit Forget about remitting profit, remove that vocabularly, You will get a tax bill based on certain tax schedule, and, after taxes,

enterprise gets to keep all after-tax profit Adjustment tax: recognizes that prices are not a good basis for rewarding

performance

Prices are still arbitrarily being assigned by planners The point is to give each eneprrise a specific tax to attempt to

adjust for pricing

Last stage is an attempt to implement a profit-based system toimplement pricing

- Autonomy is identified by profit retention, which feeds enteprirse funds- Another piece of bird-in cage model is open market

o If you have excess capacity above plan, you can enter the market and sell goods,and retain profit

o The departure is that there is no above planned market when we get to aboveplanned levels

o Where will you sell this extra stuff?


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State had to institute new markets in which managers could change Material supply bureaus were told to start markets for means of production

Wholesale markets run by government Enterprises were also allowed to open stores, and put their surplus in store

to sell to consumers directly

o

This increased fairly quickly, 15-20% of total output was above plan andmarketed above enterpriseo Bird in the cage does not fundamentally change soviet planning system

Plan is still there, still primary means of allocating resources- Enteprirse in New Economic Model, 1984

o In new economic model, attempt to change planning itselfo In new economic model, enterprise autonomy no longer means profit retention, it

changes to mean operational autonomy Leadership makes a list of decisions that enterprise managers can make Operational autonomy means a specific list of rights The action is mainly in the sphere of planning reform

Guidance planning is going to take up 50%, with mandatory planning andfree market as 25% eacho On the ground: growing out of the plan

Government reduced size of plan and freezes it Industrial output is outside the mandatory plan Grow out of mandatory planning

o Lower Level government subverted the growing out Local government would add on more mandatory planning So, 25% production commanded by national would be matched by 25%

from local governmento Free market was growing much higher than expectedo

Guidance was being subverted Guidence: Manipulating parameters to make prices How can you enforce people to buy at a specific price?

o Recall: free market was only supposed to be about 25%, its at 37%, gudienceplanning, which was supposed to be about 50% is at about 17%

o Guidance was just unworkable Guidance planning got squeezed out by mandatory and free-market Tax-for-profit

Tax for profit experiments carry over into new economic model Profit remission is gone, and the new notion of paying a set

schedule of taxes and paying all after taxes is in

Profit retention and profit sharing is now taxes

o Taxes: Corporate income tax Adjustment tax Other taxes (lump sum, sales, profit) NO tax on fixed assets, enterprises are getting a free

ride on capital counrtesy of the state


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Enterprise expansion: Grants are our and loans are in, you go to the bankand borrow

Expansions, incriments to the fixed assets, should be bankfinanced, is a revolutionary idea

o Government of china split off three banks, sciphons offenterprise lending done by three small banks

o Much of the lending during the 1980s is still not being donein commercial terms,

o However, the direction is clear, enterprises will becomeprofit oriented

o 1986: Bankruptcy law Idea that enterprises will be profit oriented, they will be motivated to

increase profit to increase earnings Aside from the carrot, there is now the stick: bankruptcy Bankruptcy was not widely used until 1990s

Many firms were not taken into bankruptcy until years after theyshould have been considered insolvent

This is the direction of change for state enterprises This unravels with guidance planning

Theres a temporary interlude, but before that, the central governmentplanning does not see results

o Contract responsibility system Enterprises were roughly speaking, leased out to the managers of the

enteprirses Manager signed out contract from supervisory bureau This is a half-way house, since the guidance planning system did not

work, and there was not a new model yet, A means of backing away from guidanceo New economic model failed

- Socialist market economyo Name indicates direction of change

In 1992, a new model is worked out and is worked into a centralcommittee decision by 1993

China will phase out planning completely, soviet type and guidanceplanning

Socialist market economy will accomidate a diversity of forms, plethora ofentites, public ownership companies, (that includes shareholdingcompanies)

All forms of ownership will compete on level playing field, no preference

Tremendous liberalization compared to previous thinking of what chinaseconomy should look like

You can see that state owned enterprises, by 2002, are only 41% Other forms of ownership are growing rapidly

o What happens in 1993, is that new ownership of form takes hold State says that they will unload much of the state sector Town and village enteprirses becoming larger


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o Year by year, state is dramatically reducing state owned enterprises Dramatic change in ownership Why do this?

Everyone else is increasingly productivity faster than state ownedenterprises

State enterprises are being out-performed and out competed Going back to 1978, this changes with planning system They work better to some extent

o State-owned enterprises are clearly one of the economiclaggards

By this time, china is much more deeply engaged in internationaltrade

o In 1993, no state owned enterprise will be an internationalleader like SONY or Hyundai or Samsung

Why is it in 1993 that the Chinese government waits to do this?o Welfare concernso If you put state enterprises out of business, you will put 10sof thousands of people out in the streets, the cities rely on

state enterprises as welfare institutionso Huge reluctance to cut into sector

Why now?o The Chinese government is entering a period of financial

crisis Gross value of china enterprises is about 15%

Look down to 1993, they are making lessthan 2% profit

Many enteprirses are losing year over year Looking at small and medium enterprises,

they are collectively losing money by 1990s

This matters, because state ownedenterprises are a main source of governmentrevenue

You cannot have a state-owned enterprisesector

1993, new economic model is called thesocialist market economy

Includes ownership reformo Ownership reform

Centerpiece: Company law of 1994 Essence of law remains in place, company law and later revisions

provide framework that will provide ownership reforms

It is a vehicle to get rid of state-owned enterprises State owned entpeirses can get rid of its ownership It could convert completely to non-state ownership Also possible for state owned enterprise to become a corporation


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What are the options available for an enterprise? Several different forms

o Limited liability companies that are intended to be closelyheld, up to 50 owners

Typically, an LLC would not have tradable shareso

Corporation

Corporations look very much like those in US underthe company law

Limited liability, independent legal persons,structure of corporation includes shareholdersmeeting, which installs a board of directors, whichhires a management team

Chinese corporation has a board of supervisorswhich has a lot of directors and manager

Relevant government agencies/specialists have rightto evaluate enterprise and monitor performance

It is an outside entity that can financially andoperationally audit a company

Once a company is formed, it operates under theprinciple of one share-one vote

When a state-owned enterprise converts tocorporation, two types of shares

Non-tradable: owned by government andlegal persons, (bureau, local municipality,etc)

o Value of fixed assets is the value ofnon-tradable shares awarded to state,

it captures past investments the statemade in the enterprises

Tradable shares: if you have a tradableshare, you are free to sell that. Went toemployees with some restrictions. Alsowent to general public

Among shareholding corporations, somewere listed among stock exchanges, it meantcertain requirements

Listed among the two stock exchanges inchina

As an enterprise converts to shareholdingcoproation, it could be that it is no longerstate controlled

There are corporations controlled by the state, butwhich the state does not have total control over

o Public ownerships hallmark is that the state does notmicromanage ever enterprise

Scientific enteprirse management


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Laws were revised in 2005 Liberalized original laws Capital requirements for starting company lower Can form LLC with one owner, LLC can invest in other companies Rights of shareholders are increased in 2005, shareholders can

demand access to shareholders 1994 is a crucial change in the nature of ownership in Chinese enteprirse

o Another aspect of changes came along in 1997: grasping the large and letting goof the small

Grasping the large: corporatizing the large, state-owned enterprises Letting go of the small: the vast majority of state owned enterprises will

be gone, they will unload their interest

Central government told local governments to get rid of them This went by general restructuring, get rid of Management was able to get rid of state owned entprises

o As firms privatized, many companies went bankrupt In some cities, there would be no more state owned enterprises, Dramatic decline in numbers is this divesting of small and medium state-

owned enterpriseso Statistical problem following this process in 1998

Beginning in 1998, this only includes state enterprises and enterprises thathave sales of greater than 5 million yuan

You can still see the decline in state-owned enterpriseo By 2006, there is a proliferation of types of ownership of corporationso Problem: share of state ownership

State owned enterprises, state owns 86% of state owned enterprises,foreigners own percentage

Private, wholey owned enterprises, state has ownership There is problem with definitions

4-20-10

State-owned enterprise Reform

- Bird in a cageo No fumdamental change to planning system

- New economic modelo Change from mandatory to guidance

- Socialist market economyo Phasing out of all sorts of planningo By year 2000, share of aggregate output as subject to plan is trivialo Plan is gone by beginning of 21stcentury

- State Owned enterpriseso Government has different degrees of control of enterpriseso 1997: Grasp the large, let go of the small

Get rid of the majority of state-owned enterprises Sold off to private investors, often the management team


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Sold to foreignerso State sector from 1993 looks dramatically differento State-owned enterprises are down to less than 10% of industrial outputo State owned enterprises plus all enterprises where state has controlling share,

Additional enterprises that have been corporatized plus state ownedentperises are about 30%, above scale industrial output

Above Scale? 1998: new accounting system was introduced, accountingsystem only included enterprises that sold above 5 million yuan,everything above this line was above scale

o Layoffs In four years, approximiately 30 million people were laid off from state

enteprirses

Chinese state got serious about fixing the state-owned sector, makethe sector small compared to other industry

- How is the state going to exercise its rights in these corporations?o How will state exercise control in privatized sectoro

Ownership rights question was not answered until 2003 Document called: regulations and supervision of state owned assets in

enterprises

Not state owned enterprises, but shares in state enterprises Set up new beuracracy: SASEC

o Oversees enterprises where it owns shareso Enumerated responsibilities, provides guidance to

enterprises in which government owns shares, and goesbeyond guidance of regular shareholders

o Representative of state, delegated responsibilityo There are some exclusions: SASEC does not have any

financial institution rightso State council delegate to SASEC

There is a central to regional SASEC, governmenthas shares

Enterprise is not to interfere with other activitieso You are not to be meddling these companies, you are just a

representative of the government

SASEC was established at central levels in 2003 and subsequentlevels in 2004-5

o Originally supervised 2.6 trillion yuan of assets andhundreds of large enterprises

o These are clearly the largest enterprises by sector Now down to 150o Few sectors account for 2/3 of direct control

Peterolum and refining Metulurgy Industries directly related to military

o Government has focused on what sorts of enterprises andhow many it controls


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SASEC acts in the governments interest as shareholder,o What about control

Ministries have been retasked as corporations or trade organizations State planning commission is gone China has regulatory commissions

Financial Regulatory Comission

Enviromental Protection Agency Electricity regulatory agency

These are not charged with micromanagement, but to set the environment The state is not the planner of the enteprirses, it is shareholder, and only in

a small amount of cases is it shareholder

It is also regulator developing the contours of how enterprises willcompete

o Bankruptcy law came into wide use in the 1990s Firms were not generally allowed to go belly up until 1990s, with rare

excpeion Labor reform: the iron rice bowl was gradually phased out in 1986, whennew employees were given contracts instead of lifetime guarantees

1990s, state became very serious about shedding surplus labor,many people unemployed after contract expired

Firms were able to hire/fireo Separate out of enteprirses all of the functions that are not directly related to

productive purpose of entperise Pension system moved out and put to regional and now national level Health insurance: privatized Housing: privatized

1985: rent at low rate, 1986: housing went condominium forheavily subsidized price

Almost all activities have been moved away from enterprises Older enterprises that had all the burdens of pensions, housing, etc,

could not compete with new entperiseso This was changed as this was moved out

o State rights of minority shareholders Found that as state owned more, performance goes down Corporate laws protecting minority shareholders

- Urban Private Sector Reformo Private sector: This entire sector was formed by entry and not by state-owned

firms

In 1990s, Private sector also arose through privatization of state ownershipo Focusing on people starting their own private firmso 1978: one form of urban business in china: peddler

Small retail/service sector in urban area Nominally, 150k people as private businessmen, They cannot hire new people, outsiders

o 1978: change in policy to encourage development of small-scale sector


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Change came primarily from urban unemployment, there were simply notenough jobs in state owned enterprises and collectives

There are several million people leaving school every year There are also millions of people who return to city after cultural

revolution

There are a lot of people entering the labor force having been temporarilyexiled Policy: let them fend for themselves

Self-employment: urban individual business sectoro 1981: state council issued set of regulations on urban self-employment

Concerned with creating jobs for unemployed Want people to create work in following areas:

Handicrafts Trade Food services Other services Repairs Transport Building maintenance

Private businesses have register and get a license, and are limited to sevenworkers

Could have up to seven hired workers, turned a blind eye toprevious prohibition

o Still a legal cap on seven workers on urban/individual businesso Little businesses run by family with minimal outside helpo Some businessmen turn blind eye to cap and hire and grow like crazy

Does government shut these businesses down or turn a blind eye Government turns a blind eye, until 1988

o 1988: Government introduces private enterprise Urban private enterprise, assets are in private ownership, it is a profit-

seeking business and it has seven workers Traditional self-employment introduced in 1988

o Rules for implementation of new stance, came along in 1989 Stance provide a framework for business/payment of taxes, survelence by

administration, commerce, etc Private business is firmly established & recognized by 1989

o In 1980s, business obsticles occur Low status

Private business jobs are viewed as below state and collectivesector

o State sector =job security and benefits People start enterprises because they do not have state jobs Often run on the side, like private plots in rural sectors

Restrictions Need a liscence to get into private business legally


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o You can be refused a license if you submit a business planthey do not like

Supply issues Utilities are provided by local govenrmnet, and you somehow have

to deal with government to get these inpus

Local governments has input control and a lot of power Government has to choose to provide them to you

Government Taxation Thriving private business is a cash cow government were extremely imaganitive in collecting taxes

o ex: hanging sign chargeo trade association fees

Difficulty with Private Funding Official credit cooperatives and banks would turn down loan

applications

It was difficult to find money Informal financial sector

o Essentially zero employment in 1980 to several million people How? Terrible state of urban services and retailing in china

State retail establishments were grimo Service was terribleo Staff was unattentiveo System was inefficient

Niche for a firm to market and source products that people wanted,easy to compete against stat

Many small businesses were not going to grow past 7 people, theywould live in the niche past the 1980s, they did not have thoseproblems

Ambitious entrepreneurs cultivated relationships with localgovernment

Many entrepenerus registered as collective businesses with localgovernment,

o How do you do that? Bribe local official Numerous private businesses entered niche of finances to private

firms

Private businessmen would also purchase state owned property inthe 1990s and strip out profitable components

Large number of entrepreneurs who are outsmarting stateo This changes dramatically in the 1990s

Company law makes available LLCs to businessmen Socialist market economy commits to level playing field Socialist market economy is more or less rectified in the post period One of the key indications is the admission of private businessmen to

Chinese communist party


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Private entrenepurs were allowed to join communist party in 2001 Private enterprise in china that are registered as one sort or another are

private businesses

If you adjust for excluded entprise, private business is above thescale enterprises

- Open Dooro Domestic changes have second-order impacto Numerous domestic changes in contract law impinge on foreignerso 1970s, Chinese economy was very closed

1978: foreign investment was essentially zero in china Foreign export was trivial

o 1978: China opens up Concrete measures:

Very conspicuiouso China haqd previously been wary of dealing with first-

world powers

o Dimensions of opening Commodity trade was very small in 1978: 9 billion US dollars in 1978 By 1993, 100 billion dollars 2007: 1 trillion dollars Nobody in 1978 would have predicted this sustained growth

1978: China was an autonomus economy with no prospects of growth to 1trillion in exports within 30 years

o Resource intensity of exports Between 1987 and 1993, skew towards labor intensive goods

o US is largest trading partner with china, Japan is largest exporter to chinao Trade is a very small part of GDP in 1970s, 1/3 of GDP by 1005

1/5 of world trade originates in china- Absorpiton of foreign capital

o Foreign direct investment is zero up to 1978 Legalized in Dec 1978

o FDI very small in 1980s, and does not exceed 5 billion US dollars until 1992o Boom of FDI into china was recent, 1990s and thereafter, approaching 100

billion/year by 2005 and thereaftero 1983, FDI is 100 contracts per year, size of individual contracts is increasing

Timepath: utilized FDI Bit of a stumble, quite low

o Equity Joint Venture New firm owned by foreigners and local Foreign partner must find local firm Foreign partner needs to take at least 25% share and has no cap Both partners need to add something to company

o Foreign invested firm, foreigners owned 100% of firmo Foreign Shareholding Limited Companies

Catch All


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Foreigner can take equity stake in currently established firm Flexibility in apportioning shares in pre-existing firm

o At beginning, most foreign firms equity joint ventures due to fear of navigatingChinese market alone

Foreign firms wholly ownedo

Looking at countires of origin: Cayman Islands and Virgin Islands Shell corporations that funnel money through these islands

Taiwan has a large investment through shells Round-Tripping: Chinese investors route money through hong kong shell

corporation Japan large investment, US number 5 Hong kong companies moving operations to china Since 1990s, flood of mulit-nationals who have been moving into china This is partly a reflection of Chinese policy

Initially, china wanted foreign invested firms to export China changed policy: markets for technology

o China would trade domestic market for advancedtechnologyo Prior to 1986, most vehicles produced by foreign

manufacturers were sent as kitso Auto Companies were granted access to foreign markets by

introducing technology FDI is a source of technology and management/marketing experience Quality goods

People want to buy foreign goods due to precieved quality boost,domestic comapneis need to compete

Foreign companies need to source locally produced goodsdomestically, local goods need to improve in quality

Source of capital, upgrading economy Tourism: much of the tourism is work related

4/22/10

Now there are labor service projects (sending bunch of workers) but also there arecontracted projects

o Chinese firms undertake all aspect of projecto Now also design consultation projects no labor but provides technology

2008, China signed 168,000 of these contracts. Over $100 billion. Much in Asia andAfrica

Another dimension of Chinas opening is outbound foreign direct investmento Took off only quite recently (2004)o In 2008, this reached $50 billion


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o In 2007, China accounted for 1.1% of all FDI worldwide (outbound) from 0 six orseven years earlier

U.S. is 16%o Much of that outbound FDI has been concentrated in natural resources

How did China manage to generate phenomenanal growth rates starting with a systemthat wasnt really friendly to trade or FDI

Foreign Trade in 1978o In 1978, this was a puzzle. Foreign trade system was not intended to go out and

solicit business. It was a residual activity and entirely planned

Foreigners could not deal directly with industrial enterprises All foreign trade until 1978 went through companies controlled by

ministry of trade. At 1978, there were 12

o When material balance had a surplus, planners tell ministry of trade to sell it atworld market price. Domestic supplier sells it to ministry at set price and thenministry sell it on world market (might be higher or lower from the ministry price)

Imports were the exact same exact in an opposite manner This system was called an airlock system. The ministry completely

insulated domestic supplier or purchaser from world price

o The activities of the 12 companies controlled by trade had to balance because ithad to have enough foreign capital to import (import has to equal export). But forindividual companies, it didnt matter

This system worked when trade is residual. Trade is a very small part ofChinas economy

If you want to trade in a big way, you have a huge problem. This system isnot designed for large amount of trade

Trade Reformo Key questions: Whos going to trade? How much autonomy are traders going to

have? How are planners going to control this sphere?

In many aspects, Chinese government wanted to maintain control ofoverall control

Buzzword of trade well into 1980s is decentralization Meant giving many other entities in the central government foreign

trade rights


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o In addition, foreign trade rights were dissolved to provinces and cities Provinces could have their own foreign trade company Foreign trade rights were also given to large enterprises allow them to

market their products directly

Only given to certain enterprises, not every one Mid 1980s, 500 enterprises had trade rights. By early 1990s, over 5,000.

Why will companies pursue exports?o You have to give companies incentive to exercise this foreign trade rightso Enterprises that have foreign trade rights have a right to keep a portion of their

foreign exchange profits

You have to sell all foreign exchange to bank (get RMB in exchange) butyou get certificate that says youre entitled to buy back a certainpercentage of foreign exchange.

You cant use the foreign exchange for yourself but you can use it forapproved purposes:

Did include collective welfare. Many times it led to purchase of carfor company

o In 1980s, there was contract system implemented Sign contract with government and in contract it says this was total value

of exports. Then they were allowed to make their own deals. Theconstraint was they have to produce that set amount for the gov.

Adjusting of the planning systemo Its making room for these decentralized decisionso Planning system completely controlled trade as of 1978. In the 1980s, the

planning system is reduced and by 1988, there are only 112 exports still subject tomandatory planning

45% of total exports. As of 1992, mandatory planning cover 15% of total exports

o Created a regulatory system to regulate trade. (MOFERT ministry of foreigneconomics and trade)

Also legal innovations Instruments available to MOFERT


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o Granting of trading rights individually given to specific enterprises Very powerful instrument of control over foreign trade

o Restricted to particular commodity lines A foreign trade company might have foreign trade rights, it doesnt haverights over all commodities.

o It also licensed certain commodities qualitify restriction that apply to supplynumber of commodities

In 1993, there were 53 commodities subject to import licensing. Eventhough you have foreign trade rights, and you have right to trade thiscommodity, you still need to get a license

In essence, this was a quota. Licenses were valuable and in manycases companies got import license when they didnt need it. They

just import it and then make a great deal of profit from it

Some exports required license tooo Tariffs

On import side, average tariff rate was very high, but many goods wereexempted

If you import good for use in export production, the import tariff isrebated.

Average effective tariff rate is much lower Also have export tariffs

In 1993, this applies to 40 productso Many non-tariff barriers. Many of these ended with WTOo If you look down on list of instruments, many of these were not market

instruments. Instead, they were case by case interventions.

o One thing that does not appear on list is manipulation of foreign exchange rate(relatively recent occurring)

The Socialist Market Economy started to undo everything it did before (1993 is a hugeturning point)

o It began for example decreasing and removing non-tariff barriers Removed some and converted some to tariffs


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o In 1994, China began reducing its nominal tariff rate. Very large reduction in1997 in particular

o China in 1993-1997 is looking forward to WTO and already reducing tariffs withexpectation that it will be joining the WTO and subject to mandatory tariffreductions

o In 2001, China joins WTO. 2002 is first year of membership and it commits todramatic change in its tariff structure and many other aspects of its opening to therest of the world

If you look at the tariff rates, they are remarkably low as of 2002. Vastmajority of tariff rates are bound (upper limits) and most of its tariffs arebelow it now

o In 1993, China has already made the decision to join WTO. It began to convert toa market driven system for trade and got rid of many qualitative, subject barriersto trade

Foreign Direct Investmento In 1978, FDI was prohibited but after, it was actively seekedo In July 1979, there was a law passed to legalize FDI

Covers joint ventures and wholly owned foreign companieso In 1982, constitution of thepeoples republic is revised to include language that

protects foreign owned companies in China

o Unsurprisingly, a great variety of laws and regulations require revision For example, you need tax law (1980) Laws concerning accounting requirements, laws require use of land, etc. Everything needed new laws because its brand new

o FDI got off to a gradual start but it did start off nonethelesso Chinese gov. did its best to accommodate foreign investors

Passed 22 articles address many issues of forieng investors For example, in 1996 access to foreign exchange were allowed. Access to

labor benefits (didnt have to follow same restrictions as domestic

companies), etc

o Locales throughout China began to compete for FDI throughout China. Itspossible to get a great bargain. Get a huge break from central gov (3 year taxbreak) and then get local benefits as well


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o Probably most important exemption and benefit was exemption from past foreigntrade rules

DIdnt have to deal with quotas or anything. They came underexportprocess regime It means all of their export stuff were completelyexempt from normal rules and regulations

Tariffs were completely rebatedo By early 1990s, there were 2 foreing trade regime. Ordinary trade

regime(domestic traders) and export process regime for foreign

o Chinese government recognized that there will be a fair upfront cost to attractforeign investment need transport, storage and factory etc. (capital costs)

One strategy they used it to channel foreign investment in certainlocations: focused the investment on transport, storage and factory sitesthat will be needed for foreign companies on certain places

Designed special economic zones and then a variety of open areas.Encourage foreign investors to go to those places (with better benefits)

Initial investments from the Chinese POV (roads, structures,facilities) were in these areas

o In late 1980s, there was retrenchment. Fair amount of discontent by foreigninvestors. 1992 was turning point: Dengs southern tour pronouncing all is well

Then a lot of laws passed (lull in late 80s but started again in1990s) trademark, copyright, patents

The preferences for investing in certain places were gradually faded in the1990s.

Chinese government also takes new approach in 1990s. It institutesprovisions on guiding FDI. Provisions are a catalogue of FDI projects

Each project is classified as encouraged, permitted, restricted orprohibited.

In 1stcatalogue, there were 315 categories, 31 were prohibited, 32were allowed but only when Chinese side has majority share and

so on

With emergence of many more legal protections and this catalogue, thenature of FDI started to change

In 1990s, there were larger projects. Form of ownership shifts fromjoin ventures to wholly foreign owned. Also, multinationals startedto invest


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Used to me mostly HK companies but now much morefortune 500

Foreign Exchange Regimeo Very constraint in beginning and completely different latero Before 1981, China had multiple exchange rate regime.

They had official rate but also many internal settlement rates Ex: when foreign trade company deals with bank in china, didnt

deal with it at the official rate. Instead, it deals with it in an internalsettlement rate.

There were multiple internal settlement rateso In 1981, all of these internal settlement rates were unified

After this, there were just 2 rates: internal settlement rate and official rateo Government controls foreign exchange rate can make up whatever number it

wants. No reason it has to make up just one price for everyone

o In 1984, the two rates are unified. Now there is one foreign exchange rateo In 1986, back to two official rates

One is you see in news paper. The other is swap market rate. In 1986, Chinese government in response to complaints from

foreign investors, liberalized its foreign exchange provisions. Itallowed foreign investors to trade foreign exchange among eachother

Prior to this, these companies had to balance individually(if it wants to import, it had to have at least as much export)

Ex: if youre a tourist company that gets a lot of dollars,then you can sell it to another foreign invested enterprise atthe swap market rate

Originally only foreign invested enterprises and designed domesticfirms could use the swap market

Due to these two rates, there was also a black market. They might buyfrom government at one rate and sell to foreign investor at another rate

Arbitrage between the two legal markets Overtime, requirements to get in swap market was liberalized. More and

more people were given tickets to operate in swap market


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For example: if you were travelling abroad for official purposes,you can enter swap market

o In 1994, two rates are unified Moved official rates towards the swap market rate until they were the

same

Resulted in 50% devaluation of Chinese currency Official exchange rate in 1993 is 5.76 yuan per dollar. 1994, its 8.62.

o In 1996, the Chinese currency is made fully convertible on current account. Intent at that time is to institute a managed float. RMB will move around

with respect to other currencies not totally freely but the government willimplement selectively

Never implemented. Exchange rate was closely pegged to USdollar

o In 2005, said wont peg to dollar anymore. Instead, peg to basket of currencies Rescinded during recent economic crisis

Special Economic Zones and Open Areaso SEZs were places designed at beginning of opening up as places where gov hopes

to concentrate foreign investment

China in these places build all these places physical plants that foreigncompanies need

Original 4 zones with Shenzhen being most well known. Only 1 moreadded later (Hainan)

o Idea was these places could be fenced off. Shenzhen had a fence originally but byfencing off these areas, these places could be extremely liberalized.

What happened here, stayed here. Doesntaffect rest of China. Ifexperimenting went terribly wrong, you only screwed up these areas andnot the entire China

In fact, initial results were not promising: lots of investment by Chinesegov. to build infrastructure with minimal foreign investors

But it eventually took off. Chinas export processing boomed andChina became genuine competitor with other potential destinationsof FDI.


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o SEZs in retrospect are viewed successfully as Chinas windows on the rest of theworld

Idea was not to open up a door but to open a few windows When its proven to work, then open it up everywhere

o Once SEZs worked, it was opened up to everywhere Other places allowed to offer provisions and benefits to foreign

companies. First to 14 coastal cities, then to three delta areas, then to morecostal areas, then to provincial capitals, then to everywhere.

Every city in China has Economic and Technology Zones placeswhere foreign investors are concentrated and given specialprivileges

o WTO was a turning point because it said in essence you cant do this. Investorseverywhere in China has to be treated the same

As WTO is fully implemented (suppose to implement over 5 years, but notall of it implemented yet), special zone will be gone because foreigninvestors would have same rights everywhere

Problems of Chinas opening upo Its been a great success but there are still problemso Naturally, some places are better suited to foreign investment and export

production than are other places

Most of FDI was initially concentrated in a few places in Guangdongprovince. Even today, vast bulk of FDI is in coastal cities

Aggravated the inherent disparities. Coastal cities were alreadymore developed; now they are even more developed than inland

Recognized in 1990s and now theres a western development plano Climb of product ladder just hasnt been as rapid as what could have been

Many of Chinas exports are classified as high technologyfor example, itexports a huge number of computers.

But the computers are not designed, companies not head quartered,parts are not made. Instead, China just provides assembly.

Chinese value added is very small In fact, a large share of Chinese exports is from this export processing

regime. What China is providing is just final assembly labor and factory


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This is being changed overtime but many people in China and fromoutside have said that, when you round out this net tripping, theres not

much left

Whats classified as high-tech is just final assembly Fiscal Reform centers on the government budget and the sources of government revenue

and distribution of revenue between different levels of government

o We already seen pieces: tax for profit in SOEs, conversion of budget grants tobank loans and many other reforms that affects government budget (i.e. increasein procurement prices)

o Key thing is referred to fiscal erosion in 1980s (handout: the two ratios) Both ratios in has been declining into early 1990s Ratios are: Government is controlling less and less of total GDP and from

central governments POV, they are getting asmaller and smaller chunk ofit

These trends forced a fiscal reformo 1994 is a key turning point: by that time, the shares have fallen to a point that are

unsustainable

From handout: government revenue is increasing but its increasing slowlyas compared to increase in GDP

Why is the share of the government in GDP falling?o Many of the reforms dissolved profit retention from government to enterprise:

previously government was taking all of the profit from enterprises but withreform, allow enterprise to retain profit

This got out of hand. The reforms was such that revenue wasnot buoyantin respect to GDP. (government revenue does not keep pace)

o Old system: government gets 100% of profit. Profit doubles, revenue doubles New system, government gets less and less of profit. Thus, profit doubles,

revenue doesnt double

o If you look at balance of revenue to expenditure, the balance is surprising. There are deficits almost throughout. The deficits are not very

worrying relatively small

The Chinese government was very sensitive to governmentdeficits. When deficits got to what it thought was significant, itbecame really worried


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They covered the deficit by printing money (until 1994).Aftrer 1994, they are no longer allowed to do that anddeficits are covered by sale of government bonds.

4-27-10

NEED 4-22 NOTES, READING: SKIP SECTION 5H

Fiscal Reform in China

- The Two ratioso Share of government revenue in GDPo Share of central government revenue in total revenue

- Both of these ratios were falling prior to 1990so Got to alarmingly low levels by 1993

- Why is thiso Looking at government revenue by item, coming out of the maoist period, the

bulk of government revenue comes from enterpriseso As the governments enterprises get to keep more and more, governments share

of revenue begins to decline Government loses control of enterprise revenue

o That is the decline at the heart of the GDP fall- Why does Central government revenue fall?

o Central government previously got much of the revenue and parceled it outo In the reform era, central government signed fiscal contracts that would explain

how revenue would be divided Central Government would get a share of provence revenue or fixed fee ,

central government would often pay off subsidy This was to reduce the centers share of total revenue, slippery slope that

spiraled out of control

When they begin to share, local government comes up withinventive ways to withhold revenue and shares of money fromcentral government

Central governments share of GDP has fallen to about 22% Something has to be done by the 1990s to fix the slippage

The key changes were implemented in 1994, and maintained to the present Over and over, we see the period in the mid 1990s as a period of

fundamental reforms

State owned enterprises and fiscal systems are defined to thepresent,

- Reforms in 1990so Previously, the central government did not collect revenue, municipalities

collected revenue and was remitted to central governmento By 1994, this had changed to a tax assignment system

Its no longer a tax farm, its considered fiscal federalism Set of taxes that are for provences Set of taxes that are for central government

Its called fiscal federalism because it is similar to that of the USs system


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There are different types of taxes that are assigned to differenttypes of government

The Chinese system, at least in the fiscal sphere, is much like theAmerican system

o There are constraints to which government can exercise tax autonomy

The menu of taxes is created by central government, local governmentscould not come up with taxes

This is widely violated, local governments make new taxe Law states that central government will set taxation

o Main tax: VAT (Value added tax) Intent is: china will join the many countries that rely on the VAT Applies to manufacturing enterprises, as well as retailing, but not service

sector enterprises, they get a business tax

Whenever a VAT can be assessed, it is Was first fixed rate

o Consumption tax Small excise tax on small group of consumer goods

o Income tax Corporate income tax: 33% Personal income tax with very high exemption

o 1994: Key changes Tax assignment Revamp the menu of taxes to shift to VAT

o Who gets the VAT? The central government But: to make the system palatable, the central government will go out and

get the VAT

To get the central government into the tax collection and not taxfarming business, a certain part was kicked back to the provenceso The distribution of spending catagories is unsuprisingo Spending burden on lower levels of government

Chinese government will be tasked with providing education to everychild up to 9thgrade

Central government will provide grants to local governments With these grants, they can fund their mandated expenditures Grants are quite large

Much of the grants go to things that the government wants to get done Public works, poverty alleviation programs Central government will pump money into desired areas with

earmarked grantso There is also a fairly large chunk of government revenue that does not show up on

the budget Extra-budgetary

Budgetary spending that is pooled and collected by localgovernments

That is extra-budgetary expenditure, local bureaus


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They dont enter the budget, they enter a period of extra-budgetaryrevenue

o Off budget items Reached ridiculous proportions:

o 1982: Extra budgetary revenue is 2/3 as large as entirebudget

Government is collecting 66 dollars for non-budgetfor every 100 collects

o 1992: government collects more extra-budgetary revenuethan total revenue

1994: with fiscal reform, government outlawed sources of extra-budgetary revenue, made it illegal in some cases or incorpated itinto the budget otherwise

o Goes down to 33% of budget 1996: local government figures ways around it and moves to 56%

of budgetary revenue

Central government cracks down again to the point where in 2007,extra-budgetary revenue is 13% Final pool of money: Off-budget

Small hordes of money that more provential governments haveaway in rainy day slush funds

No way to estimate how much is usedFinancial Reform

- By the 1980s, government shifted t bank loans- By 1980s, government spins off components of china central banks- Bird in a Cage Reforms:

o During bird in a cage, there are some reforms, but none significanto Peoples bank of china would begin to take control of the financial system, itwould operate as a central banko There is not much leeway for the people bank to do mucho Early 1980s New banks established

Finances are passive in a soviet type system You cannot use instruments of central banking if you are telling the bank

to implement a mandatory plano Creation of trust companies, first time these appear,

Some move towards liberalizing the financial sectoro Shift from granting government grants from fixed capital purposes to borrowing

from banks With this reform, enterprises increasingly borrow from banks Enterprise that needs a loan would get it from the construction bank Over time, firms will go to banks rather than government for its

investment needso Mandated government securities: government is told that it needs to buy treasury

bonds All of this is tightly constrained by central planning system

- New economic model


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o Enterprise autonomy and Guidance planningo If firms are allowed to pursue profit, it will be difficult to persue it if there is no

comprehensive banking systemo Transforming peoples bank into a central bank

Commercial banks subordinate to peoples bank that will do lending toenterprises

1984: with new economic economic model, the peoples bank wasconsidered a central bank, and partitioned off all lending activities

1986: the bank formalized this division, commercial banks moved to beingtruly commercial, and that the central bank deals with monetary policy

o 1986: Central bank was caught with contradictory obligations Bank needed to deal with monetary policy but also policy lending

Policy lending: mandatory loanso Financial instutions post 1984:

urban credit cooperatives start trust companies explode

trust makes loans from deposits made by people

deposits: interest yielding deposits designated deposits: depositors could say where money would go

trusts were a way to get around the banking laws national banks would start trust arms to get around banking

systems as well securities companies leasing companies

o entry into financial sector was liberated substantiallyo interbank market

excess reserves: peoples banks would transfer excess reserves to otherbanks in form of loans

boomed in 1987o government securities industry

more than just treasury bonds construction bonds, bonds from other state agencies when inflation exploded in late 1980s, Chinese government started issuing

tips, securities that were adjusted for inflation non-governmental secutuies begin to take off in 1980s

these are entperise shares these were the shares that were given to workers in enterprise, they

carried no voting rights

beginning of notion that non-governmental securities would existo secondary securities market

transfer of securities were illegal until 1986 if you have an employee share of government, you cannot sell it 1986: government begins with experimental markets in small areas 1988: government expands these securities markets 1990: government opens national securities market

o Numerous types of secruties:


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Subset of markets Variety of numerous types of shares Belongs to numerous legal persons Non-tradable employee shares, tradable shares that are held within

china

Tradable shares that are held outside of china Large variety of different shares

o A shares: tradable domestic shareso B Shares: tradable foreign shares

Other shares, legal shares, did not enter market atall

Only the tradable A &B shares would work, this entered into a bigmess

o A vs B, and there were non-tradable shares, shares carrieddifferent prices

o It was embarrassing to have such a large and fragmentedequities market

At the end of the new economic model period, china has differentmarkets and securities

One other financial market in 1980s: swap market for foreign exchange Entry is restricted, but entities are allowed to trade foreign

currencies with themselveso Mandatory plan

Weight of mandatory plan shrinks Parts of plan that are not subject to mandatory planning not subject

o Indirect instruments of monetary policy:o Divided into two bunches of instruments

Usual policies and monetary policy: Open market operations

o Direct instruments: Quotas

o Indirect instruments Monetary policies

Trend is that more classical indirect instruments would be usedmore

However, central bank is still responsible for implementation ofmandates

o 1989-1992: pause of reforms However, financial reforms continue during retrenchment

During the retrenchment period, markets openo 1993: socialist market economy

Notes that they need financial reform Need

o Capital and money marketso Effective central banking that can stabilize money supplyo We need to free central bank of this set of requirements


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We need genuie commercial bankingo We need banks that will evaluate loan applications and

decide on best usage of funds We will move to genuinely unencumbered central banks It is the persistence of mandatory planning that will lead to central reform

Root of problem of commercial and central banking is mandateso Policy Lending: mandatory lending Make a loan to state enterprise X Loans that the banks are told to make are policy

loans Beginning in 1994, these are directed to three policy

banks They will stay with peoples bank of china and

commercial banks Government can order around As of 1994, government is phasing out its control

over the central bank and commercial banks Policy lending:

o Infrastructure projectso Poor reliefo Disaster reliefo Loans to state enterprises

Law on peoples bank in china 1994: government cannot borrow money from peoples bank,

needs to issue bonds

Mandatory credit planning was phased out by 1998o Banks do not have credit quotas

1995: Peoples bank of china reform Peoples bank is autonomous

o Operates under leadership of state council, but it is anindependent central bank

o Independent is a serious qualificationo Bank is autonomous but under the leadership of the state

councilo Has right to trump independently nominal decissioso What does central bank decide?

Central bank has responsibility for formulating andimplementing policy, the central bank makes these

decisions, not the councilo Central bank will decide how to manipulate policy using

indirect instruments Open market operations Reserve requirement operations Interest rate determination for inter-bank lending

o How these instruments will be used is a central bankdecision


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o Under the leadership, reserves are trumped Banks have to have a certain amount of capital for international

standardso Day to day supervision

Another change in 1995 law, branches of peoples bank wereloosely controlled by head office

o Provential government had a branch of peoples banko Had a lot of sway over government

Regional branches, federal reserve districts Peoples bank in china is much like the federal reserve system

o Other functions previously vested in central bank are gone, Old loans to state owned enterprises were non-perfoming, the state

owned enterprise system was destroying and bankrupting entirebanking system, banks would need bailout by late 1990s

Interest rates are lending at market rate, sets interest rate bands for othersorts of banking

Bank has reserve account at central bank Rates at financial institutions that are set to customers

Open market operations began central banking law Began in 1993, and were used since then

1993: Interbank market revised 1996: unified and placed under central supervision

o New interbank market was hub and spoke design Central bank acts as hub

o Small banks operate on the spokes Very large national interbank network Essentially a money market

o Long term loans are no longer permittedo Maximum loan term is one montho There is also a small market for commercial paper

o Corresponding law in 1995: pertains to commercial banks New three tiered system

Central banks Policy banks True commercial banks

In addition to banks, there are numerous banks outside of regulations, suchas trust companies,

Reigned in the trust companieso Secondary security market

When they are started in 1990, 10 companies are listed By 1995, 323 companies 2000, listings crossed 1000, 2008 2008: 1625 listings

Participants Individuals who have accounts, 100 million accountholders


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People who invest in stock exchanges are investing in a crap shoot No one has any idea what these prices mean, they have no

indication of true value Listing is a privilege in china, once you satisfy the listing requrimenets,

you must get in line to get listed

Only small share of corporations are listed Vast majority are not listed, but there are companies that would

like to listo Central banking is still a work in progress

There is still residual interference Independence of central bank would be tested/overrun if there was a crisis This will take time for central bank to get out of grasp

- Overall structure of system at beginning of 21sto Peoples bank on its way to becoming true central banko Four large commercial bankso Smaller commercial bankso Whole host of small non-bankso Major problem: non-performing loans

In 1990s, 40% of loan portfolio was non-performing Resolution trust companies, asset management companies were offloaded

onto separate institutions

They were asked to do what they could with these assets The commercial banks were free to loan again Who paid for this?

o Foreign exchange reserves Non-performing loans were a major problem and were fixed by looking at

experiences of other countries

Segmentation of country with tradable and non-tradable shareso Approval of stock holding enterprises

Could convert into trading shares into G company that would have alltradable shares, three year period

Did it work? Apparently not, there are lots of non-tradable shares

4-29-10- Loans and markets

o First, the emergence of primary of security markets Where government sells to bondholders

o 1986: secondary markets in various securities were allowedo Short term lending amongst banks was nationalizedo Emergence of secondary markets

- Takes off in early 1990s with the opening of two national stock exchangeso Most corporations were not allowed to list their securitieso In recent years, there have been 1600+ firms listed on the exchanges

Chinas performance and reform- Chinas pre reform was beset with different economic regimes- Chinese model of development


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o Different elements are not always weighted equally, but tend to pop up numeroustimes prior to 1978

o Heavy industry, smokestacks preference of planningo Preference for mobilizing more resources instead of allocating a bundle of

resources more efficientlyo

Preference for regional self-relianceo Basic needs acknowledged but not built upon

China does well with basic health care and primary schoolingo Wealth equity issues

Nationwide, there is a dichtomomy of wealth between the rural and urbansector

These are keys of the china sector- 1978: things change

o Mao is gone Mao tipped the government strategy towards china model

o Ability of information was suppressed during Maos lifetime

For the first time, the Chinese leadership is aware of chronic povertyrhoughout the country They are aware of inefficiency and low levels of labor productivity, lots of

materials not being used

Feeling that china is falling behind measure Continuing concern with food insecurity

o Chinese leadership is free now to consider a new package of policies Shifts into a new panic mode

Obvious changes with development policy Technology acquisition with the failed great leap outward

o Attempt to acquire technology with foreign directinvestment

o Transfer from rich to poor provences wither awayo There is a chorus of concern with economic inefficiency

Jao Ziong always spoke about efficiency and productivity in 1978, thisbecame an obsession

o These changes moves to the top of the agenda Its not just another policy shift Prior to 1978, policy shifts had terrible economic consequences

Great leap forward was disaster Cultural revolution was also disaster Mild policy adjustments: nothing you would characterize as a

major shift in policy- Policy making mode changes in 1978

o New policies mean there is a new set of toolso Indirect monetary instruments

Can use new tools that were not available in planned economyo New change with nature of plan itself

First mandatory planning, then guidnece planning, but in the 1990s, itbecomes development programming


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Comes to reflect change in the nature of the plan,o previously a device for extracting commandso Now it is a set of guidelines

These are supposed to be taken into account for all governmentdecissionmakers

China moves to long term development programming 15 year long term plan instead of only five year plan

o Has three smaller five year plans There would be annual tasks that would be developed to

accomidate unforeseen difficulitieso Annual task provides backtrack

These plans are programmatic statements and not concrete planso Government action: direct government activity

Central governemnt collects lots of government revenue, and uses a lot toinvest in government construction

Government is concerned with human capital Second set of guidelines concerns manipulation of policy instruments

o Government plans are vague Long term plan

Rural development Macrostability Intensifying growth No specific notes

Five year plans Intensifying growth: connected with science and technology

o Regional policy Seventh five year plan mentions regional policy Partions china into three pieces

Eastern, central and rural Talks about costal china racing ahead

Trickle down Let coast get rich first, and growth will trickle down to the new

regionso By 1990s, trickle down is not working

No word if china is getting wealth accululating on coast, explodingdisparities between inland and coastal

Necessitates a regional balanceo New regional policy: western development that was approved by central

leadership Trickle down doesnt work and the only way we are going to make the

west reasonably well off, Intensifying growth, Explicit statements: 1989

State council isues a decision about industrial policyo China began to identify pillar industries

This is just a handful of a short list


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Machinery, electronics, chemical processing, construction Those are industries in which china thinks it can build up international

compeittiveness This idea of competitiveness is also something discusses in industrial

policy

National champions: these are the industries that will discuss championso You will have to create parts of the frontier , you need to create industrial

organizationo China;s current policy: developing global Chinese brands

Picking and nurturing national championsChinas Economic Performance

- Refer to the handouts from todayo Graphs/table

- We think of 2% as the threshold of modern economic growtho China: growth remains heavily upon using more capital and more laboro

Furthermore, chinas growth was volatileo Prior to 1978: chinas gdp bounced all over the placeo Growth is negative/catastropohic

If you move down to the reform periodo Growth: 7% year

The vast bulk of this growth is a remarkable growth performace The average growth is very high

In no single year, there not a time where growth has becomenegative

Growth is a fairly narrow band, generally speaking, growth hasbeen consistent

Structural change: agriculture (primary sector) is less and less amajor force in GDP

o Services (tertiary sector) growtho (Secondary sectors) Construction is the fastest growing

industry, followed by industryo Growth of services is characteristic of advanced stages with modern economic

growtho Chinas productivity soars

Even without increasing output, increase in productivity alone counts forchinas growth

o Productivity

Urban industry is five times more productive than agriculture If productivity does not change, but if you move resources from

agriculture to industry, total producitivty goes up

There would be no change in agriculture or industry Moving resources from activites where they dont produce much to

activities where they are major producerso 1978 is a turning point: not just in the growth rate or sources of growth

China begins to look modern with its sources of growth


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Thats whats been happening in china since 1978 Why might it be that productivity exploded in the post 1978 period and

then taper off?

Think back to how reform evolved Individual incentives began to exist, so individuals began to work

as hard as they can because they can profit from the activity, butthese are once-over changes

It takes a number of years to reap the benefits What happened in china is the easy changes

1990s, its getting harder and harder to make changes China is moving away from organizational change The gross inefficiens have been washed out, china needs to invest

in education/infrastructureo China experiences successive bouts of inflations

Very clear cycles Three complete cycles since 1978 Through the first three, the peak inflation level is higher than previously This pattern was regarded with considerable alarm in china 5% is the panic threshold in china

There are numerous explinations why it takes off/crasheso Explinations for cycles

The inflation problem seems to be a result of reform, its not justthat prices were controlled prior to 1978, its that the inflationproblem was accelerated

o Something is making inflation get worse and worse Another possible explination is legacies of the pre-reformed period

Repressed inflationo People get paid but theres nothing to buyo Once stores get something, people go on buying binge

Thats a once-over explination, may explain 1980s Problem: if you look at models in china, it boils down to a story

o What sets off inflationary bouts? Investment bingeso Its enterprise amangers and government officers going on

spending binges, and build like crazyo If you think back to 1980, industry autonomy

You can benefit from increased capacity Industy managers are bidding up demand for

construction materials, prices rise

What happens above the government panic? Sets in motion tools and demands for enterprises to stop building Once its over, the ban is lifted and people begin to ramp up

investment spending, and the same cycle continues

Nothing systemic has changed What stops inflationary surge is the governments policies and

interventions


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Theres one key element: in order for prices to keep going up,money has to keep coming from somewhere

o Friedmans inflation is a monetary phenomenon People are protesting, not only is the inflation rate far above the threshold,

but its slamming on the growth brakes

Growth troph of 4%, part of taming this bout of inflationo Indirect instruments effect on Prices

For the first time, china experiences deflation, inflation rates below zero Indirect instruments worked far too well, overshot the mark and

took several years to get up above inflation

Key difference is the availability of modern policy instruments China is increasingly a market economy and beginning to use

federal reserve instruments

Still mandatory plan5-4-10

Chinas Post Reform Structural Volatility

- There was a major spurt of growtho People may debate the official 9%, but even unofficial 7% is a fantastic growth

rateo Remember, modern economic growth is 2%o Sustained 30 year growth is amazing

- Outlier growth is less than 7%, growth has been rapid and, in terms of year to yearfluctuation, no downturns in negative real growth

- Looking at structural changes, pattern of growth- Shift more and more into services- Sources of growth: post 1978, substaitial amount of growth comes from productivity

improvement

o However, a lot of inputs used too this is a clear failure of the Chinesedevelopment modelo Post 1978, inflation becomes a major problem,

Cases where inflation approached and exceeded 20% Surprising due to the previous price stability Why? Investment cycle. Enterprise maangers invest like

gangbusters, demand for labor and raw materials rise and sets off aboom in the retail price index

o Weakness of Chinese economic system: central bank was not well controlled Accomindated demands of state enterprises by creating more money,

therefore it facilitated these bouts of runaway inflation

- The last cycle seems different: a soft landingo GDP does not come down significantly and prices overshoot, and prices begin to

deflateo This change in the cycle is attributed to a change in the menu of instrumentso Change from quanatitve controls (quotas) to indirect instruments (interest rates,

reserve requirements) Monetary authorities overshot

Growth in Agriculture


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- Primary sector: For reform era as a whole, during that 20 odd year period, china grew 5%year

o Growth in agriculture slid to only 3% per yearo If you look at agricultural structure, there is farming fishing, forestry, livestock

Sidelines (small crafts) has been taken out

Farmings share has diminished as a share of agriculture Dramatic shift away from farming to animal protein (fishing and

livestock)

Farmers have shifted from field agriculture to other forms The shift is still underway

The share of agriculture is less than 50% in 2007 Agriculture is not primarily farming

Farming constitutes less than the agriculture There is a massive shift out of the agricultural sector Those who stay behind in agriculture move from farming into livestock

and fisheries If you look in the farming branch of agriculture, the share of grain infarming is declining 1983: Grain was 69% of farm output. In 2002, it was about down to 40%

o What farmers are doing is shifting into higher value activities Farming in general is low value compared to fisheries and livestock They run and sell what they want, they are optimizing to maximize farm

profit Looking at farming, the bulk of agriculture in 2007: decompose into

increases in yield and increases in sewn area

At an aggregate level: output=yield X sewn areao Yield is per unit of sewn areao Multiple cropping index and cultivation area

Physical size of field per year times how manyoccasions you use it per year

o Where do output increases come from? Increase in yield per sewn area, increasing cultivation

o Cultivated area in china is underreported by Chinese government In the 1996, Chinese conducted census on land

Went from 90 million hectates in 1995 to 130 million in 1996 This screwed up a number of statistics Another problem: are the changes OK?

o Is it true between 1978 and 1995, the cultivated area wentdown, are the trends shown in the old data correct?

o Best guess: yes, levels are off, but changes are correct Why was it underreported?

o Local officials wanted to boost their yield reportso If you look at sewn area, different direction, because MCI changes

During reform period, MCI declines until 1980s, and then reverses andincreases again

There were concerns to increase MCI thereafter


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There have thus been incentives for land use MCI was a key target during maoist area

o Agricultural labor Here, you can see a modest increase between 1978 and 1998 If you look at data, numbers increase to 1990 and then decline

Then, the exact turning point in the 1990s, the statistics increasedabsolutely and then began to decline You may work 20 hours week of labor and 20 hrs week on a farm, so total

share of labor is significantly smaller than the numbers may suggesto Green Revolution

Improved seed varieties Varities prior to reform improved to the point where by the late 1990s,

virtually all the area for crops is imporved varities

In Fujen, Mid 1980s, improved varities was less than 50%o By late 1990s, 97% was planted to improved varities

Improved varities are virtually universal and it doesnt make senseto count improved vs unimproved varities

Better number: turnover timeo Farmers use seed for 3-4 years and then begin to use better

seeds Turnover to new seeds is almost complete as it adopted new varieties

BT cotton, very widely planted in china, modified to be pestresistant

Farmers were putting massive amounts of chemicals on theircotton plants

o People were injuring themselves to the extent of their useof pesticides

o New crops reduced Incidents of poisioning by making thestrain hardier to begin Fertilizer use

Continued to grow in china, no difference from the maoistperformance

1978: if you look at cultivated acerage, china was applying roughly90KG of nutrient per hectare

This is physical land, not sewn area Skip to 1998, china is at about 400kg of nutrient content per unit of

cultivated area In the maoist era, china made a big push for fertilizer production

Much of it was domestically produced China had a number of small factories scattered amongst the

countryside

A large share comes from imports, china was importing about 25%of its total fertilizer supply

Chinas capability to supply the highest quality fertilizer wasseverely limited


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china also revamped domestic fertilizer industry, small plants thatwere grossly inefficnet and polluting industry

china was doing a great deal of environmental dmanageo much of the share of a total supply was moving upscale to

higher quality fertilizer

o you want to have a key concern fertilizer was being applied to key concern: much of the plants

were starved over countrysideo fertilizer factories were supplying local needso some were supplying lots of factories, some were not

supplying anyo this was precision agriculture, identifying what each piece

of land needso composition and amount

this was extremely knowledge intensive, and thiswas the direction of change now

the new idea is figuring out what this land needsand going out to get appropriate fertilizer this is knowledge, but there are many farmers who

havent caught on

some farmers just buy generic fertilizer anddump it

inappropriate and excessive use Irrigation

commune organization was suited to increase and maintainirrigated area

o people can deal with water control because of the communesystem

Irrigation, during reform period, decreased until late 1980s Reform failure

o End of communal farming meant end of communal repairo Much of it fell into disrepair and fell out of useo State was spending less and less on large irrigation projects

Infrastructure and other long term projects slipped Change in government priorities

o This problem goes on for 10 years until the problem isbrought again under control

Irrigation is about 50% by 1990so Share of land under irrigation in china is very higho World average is about 15%

US number is 11% China has a very large share of its numbers

irrigated, and much of its land was in largeirrigation districts that have modern facilities

Farm machinery Farmers are interested in buying trucks not tractors


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They dont want to mechanize field operations but thetransportation of their goods

What use would they have on a tractor for their small family fieldso They want transportation equipment

They also buy rototillers, mini tractors for small plots They have also invested heavily in processing equipment,livestock, processing

Rural electric power consumption This was just getting underway in the maoist period No electricity for household use Total electric consumption increases by a factor of about 8 in 20

years

Its still a low number in any absolute senseo To make this concrete, if you look back at 1978 number,

previous 1978 number is 31.5KW per person All the electricity in rural china would give every

person 13 days of light Very modest supplies The electricity is only for production use

o This continues to the 1990s, very modest use of electricityo First, we see the amount of land has gone down

By official figures, its gone down 6% from 1996 until now Cultivated land has gone down Agricultural labor has gone down from 1998, trend is down Fertilizer use, other current inputs, in the maoist period, is growth

from zero

Irrigated area, its hitting a plateauo Its unlikely the irrigated area will rise above 50%, the

unsuited irrigated area Yield of crops more than doubled, yields have increased dramatically,

labor productivity has increased dramatically

It seems that half of the increases is due to chemicals, andorganizational changes, this is especially relevant during reformperiod

The other half is due to household responsibility system andliberalizing marketing

Farmers work harder due to household responsibility and theyallocate more efficnetly due to the shift to markets

They are careful about what they plant and where they plant it What matters: the increase in inputs and organizational change

o Many people wondered if Chinese agriculture was self distructing Not using land efficiently and the excessive use of chemicals There was a concern after a few years of excessive decline of land output

sustained agricultural catastrophe considered imminent


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however, if you look at the sources of the decline, it came from thedecision to grow less grain, using less area

why?o Farmers looked at grain and found the price was falling

both absolutely and relatively

o

Farmers began to shift resources towards other production China was taking grain out of production

o From grain to green, take grain production where it doesntbelong

WTO is loomingo Liberalization of tradeo Foreign trade will come into china and grain production

will come into china from countires like the US and Canadathat have comparative advantage

A few years down the road, the trend after the downturn returns toprevious trendline

This was a temporary correction, not a major worry- Income distribution and poverty alleviationo Khan and Riskin

What they did is sampled households in 1982, 1988, 1995, and 2002 They did a methodology that was consistent with internaitoanl

standards Calculating rural incomes per capita

Calculate increase between 1988-1995, real incomes increase 3.8%year

1995-2002, 4.7% increase per year Farm and non-farm activity in the household

Those two account for 56% of totalo If you look at next item on list, wages account for 22% of

rural incomeso This is money earned from someone else, not your own

earnings

1988, Its rare that people have someone working outside thehousehold, 1995, about 25% working outside

Looking at net transfers, in both 1988 and 1995, net transfers are anegative contribution to income

Gini concentration ratio Gini coefficient in rural incomes is about .34 Increases quite singicantly by 1995 to .42

o Rural china, by 1995, is a very unequal placeo This is a VERY high Gini coefficient

Urban china, in same period goes from .23 to .33o Urban china was once extrodinarily equal, but, by 1995 is

very unequal5-6-10

EXAM: TUESDAY 5/18, GS 132/HEC 7PM


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OHS: NEXT WEEK T/R 10:15-12:15, TUESDAY 5/18 12:30-4:30

Growth in Chinas Agricultural sector- Where did growth come from (50%)

o Improved inputs

Productivity inputs with fertilizer, green revolution bundleso New structural changes (50%)

Household repsonsiblity system Better marketing tools

Picking bundles that are most efficient- Increased weight in productivity in chinas growth in the post-reform era

o This is a change, because before reform, China had to throw more inputs toincrease outputs

- Income distrubitiono Between 1988-1995, 3.8% growth year, between 1995-2002, 4.7% growtho Farmers can visibly notice their increase in standard of living

Take 18 years to double standard of living

o Farmer standard of living Early 80s, Half of people had bicycles, few had watches and radios,

motorcycles, refrigerators and TVs are unheard of By 2006, state statistical bureau does not count many things in rural china,

everyone has a radio, start counting TVs and Refrigerators

Refrigerators and other heavy appliances are more sparse due tothe lack of availability of electricity

o By 1995, wages are already over 22% of household income This is not wages earned on the farm, but wages on household

unemployment

This is not where the wages are coming from- New idea: concentration ratioo Psuedo-Lorenz Curve

Total income on horizontal axis, vertical, wage income This is not a Gini Coefficient, because there are different numbers The ratio received is the concentration ratio

This will show the inequality of one subset of income on the entireaxis

Can range from -1 to 1 Can go below horizontal axis

o Wage income Concentration ratio in 1992 is .78

Total gini coefficient is .416 If concentration ratio is higher than GINI coefficient, that particular part of

income causes inequality If you were to increase wage income, you would increase Gini coefficient

Increasing that particular part of income, increases inequality, andvisa versa

If you increase farm income, the Gini coefficient will go downo Wage income is concentrated heavily amongst rich people


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If you increase wage income, you are only helping people on the top of thedistribution

Wages can do a lot of damage to the distrubition because the weight islarge, its only 22% of the income

Wages increase inequality because they are only 22% of the total

Looking at the last column, the concentration ratio and share are the sameamount Wages are the most disequalizing component of rural income

Whats driving rural inequaliuty in china is wage incomeo Property income concentration ratio has a negliable effecto Urban and rural households

Look at contributions to rural china People get income inequality by getting job and looking out Household subsidies give the rich urban people more income inequality

While housing housing subsidies are 10% of total income, theycontribute 15% of total income

Part of Urban peoples Iron Ricebowlo Transfers are at a negative level Transfers are, in effect, coming from the poorest to the richest people It can go below the horizontal to drive entire concentration ratio down to

negative Through the government transfer system, poor are essentially giving rich

money In the case of housing, directing to the wealthier urban people

o Most people earn the vast bulk of their income from the agricultural sector in ruralchina

However, as rural Chinese go and find wages, there is income inequalitywithin rural china, high gini coefficient- Urban and Rural together, the overall Gini

o The difference between urban and rural is very large and persistento Overall gini coefficient is higher than the componentso Income distrubition and the extent of poverty in rural china

Count up the poverty striken people in rural china In the 1990s, there was no single consistent definition in china destitute was defined as haiving a less than 50 yen combined income year

after year, for three years

The count, a very crude count, 88 million people in 221 counties,where entire county was destitute

Also destitute people scattered amongst non destitute 170 million people by 50 yen standard

Incidence in rural china was below 33% 150 yen in total income, not just collective income

This was even more shocking than the entire survey This is poverty by an official estimate

1984-1985: povery threshold reset at 200 yuan


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This was done carefully, this was done by assembling aconsumption bundle that was mostly food, but had other items

Instance of poverty 12.2%, rural only Until recently, there were not enough poor people in the city

Threshold keeps changing, new numbers all in current yuan Need a standard poverty bundle that is updated year after year

In years going back to 1990 and abouts, you can track a constant poveryyuan, 630 yuan bundle

1990, poverty around 12% Many Chinese see real incomes fall by this time

In 1995, this instance by the constant threshold, 8%, 30 million peopleescaped from poverty

2002, 3.2% of Chinese were in poverty Some was from changing threshold, but much was from

dramatically better standards of living

People are much better off then they were beforeo World bank poverty statistic

What world bank did is took the international pvoery threshold, 1 dollar aday purchasing power parity, and came up with 850 yuan as the povertystatistic

They did this to be internationally comproable Headcount index: State statistical bureau vs World bank

o Clearly when you increase the poverty threshold, you willincrease the amount of people who are poverty striken

o Uptick in poverty by 1990, and, reduction, by either count avast reduction in poverty

o 10% world bank account, 3% Chinese account New economic model is attributable to models of economic reform

and increases in procurement prices

Huge number of people found their way out of poverty How? They were paid a lot more and they worked a lot harder

o Incentive to work on private farm rather than freeloadingon their own farm

o Chinese economic reform in countrys

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