The economics of institutional reform and development in China

Gérard Roland

UC Berkeley

Lecture 1. The Chinese Miracle. Stylized facts and puzzles.

1. Introduction

• Chinese growth since the beginning of the reform process in 1978 has been very impressive. Three decades of very high growth in a country of over a billion inhabitants is akin to an economic “miracle” and is one of the most important economic events since England’s industrialization.

• Real GDP grew at an average rate of more than 9% during 30 years.

• Real GDP per capita at more than 8%.

• Consumption at nearly 8%.

• Foreign trade as a % of GDP from less than 10% to more than 60%...

Fixed telephone (million)

Mobile telephone (million)

Auto production

(million)

Passenger cars per

1000 pop

Urban housing per person (m2)

Super highway

length (km)

1978 - - 0.15 - 6.7 -

1985 3.12 - 0.44 - 10.0 -

1990 6.85 0.018 0.51 - 13.7 500

1995 40.71 3.63 1.45 1.33 16.3 2,100

2000 171.53 84.53 2.07 2.93 20.3 15,300

2003 271.60 269.95 4.44 5.41 23.7 29,700

2005 July 337.44 363.17 5.07

(2004)

6.96

(2004)

- -

Table 2. Growth of various indicators.

Source: Qian-Wu (2005)

Non-agricultural employment (million)

Total Industry Service

1978 118.35 69.45 48.90

1985 159.16 103.84 55.32

1990 222.15 138.56 83.59

1995 276.34 156.55 119.79

2000 330.99 162.19 168.80

2003 359.00 160.77 198.23

Source: Qian-Wu (2005).

Table 3. Evolution of employment.

Chinese national standard World Bank standard ($1/day)

Poverty population

(million)

% of rural population

Poverty population

(million)

% of rural population

1978 250 30.7% - -

1990 85 9.5% 280 31.3%

1993 75 8.2% 266 29.1%

1996 58 6.3% 138 15.0%

1998 42 4.6% 106 11.5%

2002 28 - 88 -

Source: Qian-Wu (2005).

Table 4. Rural poverty reduction.

• While the growth is impressive, not everything is rose.

• Income inequality has increased and many social problems, environmental problems.

Figure 3China: SO2 Levels in Major Urban Areas, 1980-2004

with international comparisons

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Am

bien

t SO

2 m

illi

gram

s p

er c

ubm

ic m

eter

Major City Average

Major City Maximum

Tokyo City Center 1965

Seoul 1990

New York City 1972

Figure 4 Trend of Primary Labor Force Share vs. Urban TSP Concentration

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0102030405060

Primary sector labor force share (percent, with strong downward time trend)

Am

bie

nt

TS

P m

illi

gram

s p

er c

ub

ic m

eter

China Annual Average for 30+ Cities 1986-2003

Tokyo 1966-1997

Seoul 1984-1998

Kitakyushu City 1959-2003

Gini coefficients Consumption inequality

1988 1995 2003 1991 2003

National 0.39

 

0.44 0.45 Richest 20% to poorest 20%

2.02 3.95

Rural 0.32 0.38 0.37 Richest 10% to poorest 10%

2.42 5.66

Urban 0.23 0.28 0.32

Table. Income and consumption inequality.

Source: Qian-Wu (2005).

Puzzle 1. China’s transition success.

• This impressive high growth period is the result of the transition process from socialism to capitalism. China’s performance during the transition period is much better than that of other transition countries. Why did China do so much better than other transition countries?

China has high growth. Other transition countries had output fall and decline!

R e a l G D P tr e n d s i n t r a n si t i o n e c o n o m i e s a f te r l i b e r a l i z a t i o n

0

2 0

4 0

6 0

8 0

1 0 0

1 2 0

1 4 0

1 6 0

1 8 0

1 2 3 4 5 6 7 8 9

n u m b e r o f y e a r s a f t e r l ib e r a l i z a t io n

GD

P i

nd

ex

C h in a 1 9 8 3 = 1 0 0

Po la n d 1 9 8 9 = 1 0 0

R o m a n ia 1 9 8 9 = 1 0 0

L a tv ia 1 9 9 0 = 1 0 0

R u s s ia 1 9 9 1 = 1 0 0

Differences between China and other transition countries.

• 1) China started off poorer. • Sachs-Woo, 1992: Being an agricultural economy, China

was facing the classical problem of development (transfer of rural labor force to urban industry) whereas other transition countries were facing issue of transfer of labor from SOEs to private sector. BUT …

• .. Other countries have been facing classical problem of development and have not had success.

• …While some “convergence à la Solow argument” may apply, it does not explain why East European countries had an output fall and long decline in the nineties. Still leaves open issue of why China did better than other transition countries.

China started off poorer.

• Blanchard- Kremer, 1997. China had less complex economy. More complex economies with institutional weaknesses should have larger output fall.

• China did not have any output fall. Does not explain either lack of any output fall or high growth.

Differences between China and other transition countries.

• 2) China did not introduce democratization• Little academic work on this but much journalism. Issue

nevertheless quite crucial.• Main argument is that absence of democracy gave the

Chinese government more freedom of maneuver to introduce painful reforms.

• Ironically, reforms were less painful in China compared to countries that democratized.

• Moreover, countries that democratized less or had anti-democratic backlash have tended to do less well (former CIS countries had longer output fall).

• TO SUMMARIZE: China’s transition success not clear in view of the overall transition experience.

Puzzle 2. High growth despite relatively low quality of institutions. • China represents a puzzle for the new

mainstream view in economics according to which quality of institutions is a main factor explaining high growth and differences in development. (Hall and Jones, 1999; Acemoglu, Johnson and Robinson, 2001). China does not rank highly in terms of institutional comparison.

1990 2000 2003

PR CL Status PR CL Status PR CL StatusChina 7 7 N Free 7 6 N Free 7 6 N FreeCzech - - - 1 2 Free 1 2 FreeHungary 2 2 Free 1 2 Free 1 2 FreeIndia 2 3 Free 2 3 Free 2 3 FreeMexico 4 4 P Free 2 3 Free 2 2 FreePeru 3 4 P Free 3 3 P Free 2 3 FreeRomania 6 5 N Free 2 2 Free 2 2 FreeRussia - - - 5 5 P Free 5 5 P FreeSingapore 4 4 P Free 5 5 P Free 5 4 P FreeUkraine - - - 4 4 P Free 4 4 P Free

Table. Freedom house index of political freedom and civil liberties.

Source: Qian-Wu (2005).

Country/Region 2004 2002 2000 1998 1996

Singapore 95.7 92.3 98.9 99.5 99.4

Hong Kong 90.3 84.7 90.4 90.8 90.4

Japan 89.9 88.3 90.9 90.3 88.0

Hungary 78.7 77.6 78.6 76.2 75.3

South Korea 68.6 76.5 73.8 76.8 81.9

Malaysia 64.7 67.9 71.1 76.8 82.5

Turkey 54.6 53.1 59.9 65.9 58.4

Thailand 51.7 60.2 69.0 69.2 71.1

India 50.7 55.6 62.0 67.0 56.6

Romania 48.3 52.0 51.9 49.7 44.0

Brazil 46.9 45.9 53.5 56.8 46.4

Mexico 45.9 47.4 46.0 40.0 54.2

China 40.6 48.5 48.7 52.4 37.3

Peru 31.9 36.7 38.5 37.3 40.4

Russia 29.5 21.4 18.7 22.7 19.9

Ukraine 23.2 21.4 26.2 23.2 28.3

Source: Kaufmann et al. (2005). From Qian (2005).

Table. Rule of Law Index.

Country/Region Ranking

Singapore 2

Hong Kong 7

Japan 10

Thailand 20

Malaysia 21

South Korea 27

Hungary 52

Peru 71

Mexico 73

Romania 78

Russia 79

China 91

Turkey 93

India 116

Brazil 119

Ukraine 124

Source: World Bank 2006, Doing Business report. From Qian (2005).

Table. Ease of Doing Business.

Country/Region 2004 2002 2000 1998 1996

Hong Kong 99.5 89.3 98.4 98.4 98.9

Singapore 99.0 99.0 100.0 100.0 99.4

Hungary 86.7 84.2 88.2 88.0 74.6

Japan 83.7 78.1 81.8 69.0 82.3

South Korea 71.9 75.5 69.5 58.2 78.5

Mexico 68.0 66.8 76.5 75.5 74.0

Malaysia 64.5 69.4 64.2 70.1 82.9

Brazil 58.1 63.3 64.7 57.1 60.2

Peru 57.1 62.2 73.3 81.5 76.2

Thailand 51.2 64.8 77.5 56.0 69.6

Romania 49.8 55.1 35.8 58.2 30.4

Turkey 48.8 55.6 55.1 80.4 71.3

China 35.0 37.8 36.9 42.9 47.0

Ukraine 33.5 27.0 11.2 17.9 23.8

Russia 30.5 43.4 5.3 31.5 31.5

India 26.6 43.4 38.5 41.8 44.2

Source: Kaufmann et al. (2005). From Qian (2005).

Table . Regulatory quality.

Country/Region 2004 Rank 2004 Score

Finland 1 9.7

Singapore 5 9.3

Hong Kong 16 8.0

Hungary 42 4.8

Mexico 64 3.6

Thailand 64 3.6

Peru 67 3.5

China 71 3.4

Turkey 77 3.2

Romania 87 2.9

Russia 90 2.8

India 90 2.8

Ukraine 122 2.2

Source: transparency International.

Table . Corruption perceptions.

0

3000

6000

9000

12000

15000

18000

- 15 - 10 - 5 0 5 10I nst i t ut i onal Qual i t y I ndex

GDP

per

capi

ta(P

PP$)

TJ K

TKM

UZB

AZE

BLR

GEO

UKR

RUS

KAZ

ARM

KGZ

MDA

ROM

BGR

HRV

LVA

LTU

SVK

EST

CZE

POL

SVN

HUN

CHN

VNM

Qian (2005).

Figure. Institutional quality and GDP per capita.

• China’s institutional quality, corrected for income per capita is not that low.

• There have been significant improvements since the beginning of the reform period on the legal and political front.

• Still, the coexistence of strong growth and weak institutional quality is a puzzle. How to explain high growth despite low quality of institutions in comparison to international norms?

• Possible answers we will investigate:1. Transitional institutions were created at different points during the

transition process that were very imperfect but helped move the reform process forward and thus operate large scale resource reallocation and creation of markets.

2. Meritocratic administration fundamental in explaining sustained growth.• Success in transition and in growth are linked but useful to look at

them separately. High growth presupposes successful transition but successful transition does not automatically imply high growth.

Explaining the growth success

• Lecture 2. We will look at the basic sources of growth over the last decades to understand better the anatomy of growth in China and see what the macro-indicators tell us. Traditional growth analysis will give us anatomy of growth but will not give us detailed causes of the Chinese success and we will need to dig in more deeply in understanding the causes and consequences of the institutional changes associated with China’s transition process.

Explaining the transition success.

• Lecture 3. Chinese gradualism. Experimental approach to reforms and flexibility of administrative organization played a very important role in a) getting reforms started, b) providing flexibility for reversal in case of failure. Chinese M-form organization made experimentation much easier since it could be done at a small scale without disturbing the rest of the economy. Chinese gradualism was criticized in the 1980s but proved more successful than East European “big bang” approach.

Explaining the transition success.

• Lecture 4. The dual-track approach to price liberalization. Price liberalization at the margin helped prevent the output fall, protected existing rents and acted as Pareto-improving reform. Was criticized for some of the rents it generated. Represents a general political economy device for creating reform without losers.

Explaining the transition success.

• Lecture 5. Fiscal decentralization and incentives of bureaucrats. Reform of organization of government and provision of incentives to bureaucrats played important role in creating support for growth. Local and provincial governments became interested in promoting reform and growth.

Explaining the transition success.

• Lecture 6. Meritocracy and yardstick competition. Leaders with more success in growth got faster promotion. Organization of government facilitates yardstick competition. Promotion within government administration a strong incentive for elite members.