Chinese Economists on Economic Reform - Collected Works of Zhou Xiaochuan

Xiaochuan Zhou, China Development Research Foundation

• Publisher: Routledge
• Year: 2016
• Topic: Economics
• eBook ISBN:
  9781317209492
• Subtopic: Economic History
• Index: Economics

This book is part of a series which makes available to English-speaking audiences the work of the individual Chinese economists who were the architects of China's economic reform. The series provides an inside view of China's economic reform, revealing the thinking of the reformers themselves, unlike many other books on China's economic reform which are written by outside observers.

Zhou Xiaochuan (1948-) has been Governor of the People's Bank of China since 2002 and is one of the most influential economists in the world. He holds numerous other important positions, including Governor of the International Monetary Fund for China and Vice-Chairman of the National Committee of the Chinese People's Political Consultative Conference. Before his important work as a banker, he was in the 1980s a major contributor to the process of analysing policies to do with the structural reform of the Chinese economy.

The book is published in association with China Development Research Foundation, one of the leading economic and social think tanks in China, where many of the theoretical foundations and policy details of economic reform were formulated.

1 Reform of central planning

Orientation, methods, and limits¹
(1991)

The essence of economic structural reform involves creating a more effective system. In the final analysis, the idea is to realize a more effective structure through the actual results of economic development.

If one posits that the primary focus of reform is to improve the centrally-planned economy, then the question becomes how to do that: through what means and in what direction? Under predetermined orientations and methods, how large is the potential for any improvement (or will there be a limit to improvement)? In comparing the theoretical models of an improved system with models of other systems, what will the “nature” of the systems be? What can we derive from the process that will contribute to how we approach the subject?

Strictly speaking, this work should be highly mathematical and quantified in order to ensure the validity of hypotheses and subsequent comparisons. In this article, I approach the subject in layman’s terms. I avoid the use of any mathematical expressions although I will use a few mathematical terms.

Moving a step further, since the subject is already too large for an article, I reduce its scope by putting in some assumptions. Specifically, this article focuses on how centrally-planned economies seek to arrive at equilibrium through “the plan,” and how they seek to arrive at the desired proportionate relationships of everything in the plan. Among all the proportionate relationships that are to be realized by the plan, how do we arrive at the optimum proportions and optimum growth? Can we, and indeed how do we, arrive at the desired end-result “nature” of a socialist economy? That is, to the greatest degree possible, how do we satisfy the material and cultural needs of the people? Finally, as compared to other systems, what are the results of such a system after reforming and improving it?

I mainly adopt the following three assumptions:

1 I assume that the work of central planning can receive timely and effective information as needed to execute planning decisions. This is based on the assumption that we have sufficient modern telecommunications and computer technology.

2 I assume that the behavior and motivations of our cadres stay aligned with those of the central government. That is, I assume that our hierarchical form of organization, Party cadres who are organized in hierarchical teams, will stay aligned with the central government.

3 I assume that we may employ some primary theoretical concepts when we make comparisons to market-economy systems. For example, those would include Pareto optimality, the first theorem of welfare economics, the Turnpike theorem, and so on. I assume this even though some of these concepts might be disputed.

Given the above, this article focuses on a subject that has not received much attention within China. That is, it looks at how a planned-economy system can improve the functioning of the system apart from using the standard methods of information transfer and motivating cadre teams.

Moving from a non-equilibrium type of plan to an equilibrium-type plan

Given the experience of centrally-planned economies, and particularly the experience of China’s own planning work, it is not such an easy thing to arrive at equilibrium when trying to organize a plan for the many things that need to be incorporated. We always say that the superiority of a “planned system” can be found precisely in the way in which it is “done according to the proper proportions by operating through a plan.” Nevertheless, one still must answer the question about what the proper proportions might actually be. One must answer this with respect to proportionate relationships among all different industries, as well as the goods each industry produces.

This article argues that, at the very least, three different levels of requirements must be met in answering this question. At the lowest level, the system must be able to achieve basic balance in proportions. That is, it must not lead to waste of resources, or a situation in which the objectives of the plan cannot be achieved. The next level up is that the system must be able to satisfy ultimate demand (which includes both consumer and investment demand), while still maintaining a stable balance in the proportionate relationships. That is, it requires that the system minimize the use of mandatory arrangements to allocate final products. Instead, the autonomy of the consumer to make decisions himself determines final allocation of goods, or the enterprise itself makes decisions on how to upgrade technology and so on. The third and highest level requirement is that the system must benefit long-term growth. It must be able to accommodate the proper proportionate relationships of the international division of labor.

In our actual experience, the way we achieve a balanced-type plan, or aim for it, is through the use of “industry-linked equilibrium tables,” and the use of “work meetings of upper levels of cadres and lower levels of cadres.” The first is a primitive kind of input–output matrix that is highly incomplete. Meanwhile, the latter seeks to resolve equilibrium through a computing process that involves “work” among government levels. In China, that usually means that the budgeting process for the plan “goes up and down twice.” It is transmitted from the government level of the central government with its departments to provincial and municipal levels, and then back up, two times. This is a process that involves an initial trial resolution and ultimately moves toward an equilibrium resolution. At the same time, it involves negotiating among upper and lower levels of government.

In terms of substance, this planning process seeks to move toward quantified sets of equations in order to satisfy an equation such as “domestic production + imports = intermediate goods consumption + ultimate demand + exports.” In this equation, ultimate demand is divided further into consumers and end-users, and ultimate users into investment in basic infrastructure (capital construction), and investment in technological reform.

In point of fact, our traditional planning methods are fundamentally defective. First, the technology required for “industry-linked equilibrium tables” is backwards and unscientific from start to finish. That includes the whole process, from information gathering and processing, pooling of data, checking and collating, down to how complete the statistics are, so various input–output matrix techniques must be substituted for the data. In addition to needing to set up an input–output matrix for A, however, you also need one for B. On the basis of consolidated or pooled balancing techniques for the A matrix, you should use social accounting matrix (SAM) technology. This in turn requires that you reevaluate the usefulness of the statistical systems of actual production. What’s more, you also need to put the supply and demand for tertiary industries into the mix, including their statistics and planning systems.

Second, since the “planning work method” (budget formulation) by which annual plans are submitted and approved is a process that goes through at least “two ups and two downs,” that is, two iterations or more, it is fundamentally impossible to come up with a balanced result. All one can do is attempt to move a few steps in the direction of equilibrium. At the same time, this primitive sort of “work method” wastes an inordinate amount of time and effort.

In the meanwhile, there is a great deal of ad hoc “glossing over” of discrepancies. As a result, the process of going from a primitive plan to a plan that is in equilibrium must be changed to a process that uses linear matrix equations. There is no other way to ensure equilibrium if we want to use a plan.

Both of the above two methods for improving our planning work, however, require that those doing the work have sound knowledge of input–output models, and that they have a grounding in linear algebra and applied computer technologies. Some people may argue that a plan does not need to be absolutely seamless. Indeed, they say that we generally should “leave a little room for improvement” in our plan. We should let it be a little flexible for when we need flexibility. This is called “an active approach to balancing the plan.”

In fact, however, if we cannot even get to the lowest requirements for a balanced plan, we cannot remotely hope to maintain the authoritative nature of the central plan. We cannot explain why our proportionate relationships should be considered reasonable. We cannot maintain any rationale for the way we set plan prices. Ultimately, we have no way to explain the superiority of the planned economy.

It is precisely these “loopholes in the plan” and our so-called “proactive balancing act” that are leading to the inevitable demise of the entire planned economy.

In the course of reform, one thing has already become a thorny issue, namely how to handle the way in which people decide how to use end-products. How do we maintain the autonomy of the final end-users’ decision-making, whether that is the consumer or the enterprise? How do we estimate that end-use demand? At present, work of this kind is done using the lowest level of technology and is highly unsatisfactory. One of the most difficult problems is that we still have mandatory arrangements while also allowing for autonomy in decision-making. Given that the market is still not able to play its complete role, yet the end-user is not given full autonomy, it is hard to estimate what choices there might be if end-users were in fact given full autonomy. This relates to the issue of whether or not end-use demand systems can be predicted at all. Second, highly complex non-equilibrium quantitative economic techniques must be used to estimate all the variables.

Our traditional planning mainly uses regression techniques for lateral comparisons, and time-sequence projections. (In fact, very few people have a grasp of how to do this.) When it comes to China’s planning for durable goods, the mistakes are staggering. Because of this, people engaged in planning work must be very skilled in solving special econometric problems.

In trying to achieve equilibrium, we attempt to have a balanced import and export structure that then helps satisfy the right proportions. Importing and exporting supposedly can help balance out oversupplies and undersupplies of the plan in general and therefore make the work of planning a great deal easier. International exchange is carried out under a market system, however. An import–export structure that is balanced in terms of actual goods is not the same as being balanced in terms of value. Whether or not a balance in value can be achieved by such an approach carries with it considerable risk. It is also doubtful whether or not this kind of making up of balances as a way to adjust overall structure does indeed arrive at the optimum situation.

Another problem with this kind of planning model is that it is hard to have the system itself provide incentives for upgrading technology and conserving scarce resources. In the actual functioning of our system, we simply have to admit that this problem is rather relevant to the way things stand today.

Going from equilibrium to optimization

Some people view a market economy as being the root cause of an anarchistic process that leads to periodic crises. It is therefore viewed as the root of all evil, whereas a planned economy is far more intelligent. It uses a planned approach and carries things out according to proper proportions. In both theory and practice, however, the actual situation is that the market is not so bad. Classical market economics allows the market to allocate resources in ways that achieve what is called a Pareto optimum. That is, scarce resources are used in the most efficient way because of the way the market itself functions.

As economics developed, the appearance of macroeconomics and game theory have gone further in demonstrating how to ensure a Pareto equilibrium and not allow an economy to stagnate in a condition of what is called a Nash equilibrium. (In simplified terms, a Nash equilibrium arrives at equilibriums that are sub-optimal. I do not present a mathematical treatment in this article.)

This kind of system is a major challenge to a centrally-planned economic system. After all, when we declare that our plan can balance things out according to proper proportions, and that this must necessarily win out over market economies, we must answer the question, “exactly what proportions?” We must demonstrate what kind of equilibrium we achieve. Is it indeed optimum, the best choice of all? Unless our planning work is shifted in the direction of “the optimum equilibrium,” and “the optimum proportions,” we are unable to answer these questions. In theoretical terms, at the very least, we lose the argument to a market economy.

Let us assume that in actual practice we have two State Planning Commissions. They both operate according to traditional planning methods in coming up with the plan. Both of these may be able to come up with “equilibrium,” and to reach what is said to be “proportionate relationships that are in balance,” but the two may be entirely different. With the same logic, now suppose a country “N” has a State Planning Commission that comes up with a whole variety of plans that are all in equilibrium. Country N still must use some criteria or other by which to determine which is best. (One could call this a function that describes the ideal end result or an “object function.”) From a purely methodological viewpoint, it is impossible to ensure that the optimum plan is included within these equilibrium plans, all derived by traditional planning methods.

From traditional methods of planning, as well as the method by which we currently operate, one can see that it is fairly easy to come up with a balance or equilibrium if that is at a low level of growth. We can use China’s 6th Five-Year Plan as an example. During the 6th Five-Year Plan period, China’s gross national product (GNP) actually grew at the high rate of 9.8 percent. By plan indicators, however, it was to grow at a rate that “aimed for 5 percent but tried to stay above 4 percent.” The very real problem we face is that if we make our plan according to a growth rate of 8 to 9 percent, we will find it very hard to achieve any kind of balance by using our current planning methods. It will definitely be necessary to “leave some gaps here and there” so that we can fudge things, and this will incur criticism.

In order to gloss over or conceal our technical problems, in the past our approach was to “leave a little room” in the plan to make up for things. This “theory of how to operate” was a self-contradiction, however. When the actual rate of economic growth is twice that of planned growth, the actual proportions in the economy will be very considerably different from those that are in the plan. (This goes for disparities among macroeconomic indicators as well as among departments.) Has the planned economy actually been able to achieve what we declare to be its intended results? Have we in any way achieved proper proportions by the use of a plan? Exactly what kind of proportions have we achieved?

I recommend that we admit the truth. Due to the primitive nature of our planning processes, and our inability to make full use of modern scientific methods, our central plan is incapable of allowing our economy to reach its full potential. Nor can it arrive at an optimum equilibrium. Indeed, our planning may be leading us far in the opposite direction. This means that we are either holding back the potential for economic growth, or we are deviating from the planned proportions as set forth by the plan. It means that we are finding it hard to be competitive in a world economy. Instead of relying on specious excuses, we should try to move forward.

Fortunately, modern mathematical tools and computer science now provide us with the ability to improve our planning in the pursuit of an optimum equilibrium. They allow us to arrive at optimum proportions. I refer to linear programming and specifically to the large-scale linear programming that matured as a science in the 1970s. From the perspective of economic planning, these tools can help optimize a given variable under the constraints of other variables such as economic conditions, productivity, proportionate relationships and so on. Any given target (such as economic growth) can be optimized (or minimized). The logic behind linear programming also indicates that many results can come from applying different constraints, but only one is the optimum result.

What kind of “object function” should central planning adopt as its goal? The simplest method would be to try to maximize national income, for example. That is, we would optimize the aggregate value of the ultimate end-products of each department (which have corresponding demand in other departments). If we also take the dynamic results of investment into account, we could convert the future capacity of national income into net present value. We could then add that to current national income in order to achieve a more complete object function. One of the requirements of linear programming is that the object function and the constraining variables must all be linear functions. If we use this kind of scientific approach, our planning work could perhaps not only achieve greater equilibrium relationships but we could seek to optimize the end result. That would then improve the competitiveness of our planned-economy system overall.

What this means, however, is that decision makers engaged in planning must understand linear algebra. They must have an understanding of operations research and econometrics and be able to carry out input–output modeling. The regrettable thing is that some of our planning personnel seem far more adept at finding verbal excuses than at learning anything scientific or new.

Going from an arbitrary way of setting prices to abiding by the law of value

The two sections above discuss equilibrium and an optimum equilibrium, which can be expressed in terms of physical goods. Given a condition in which physical goods are in balance, planning solutions can, in theory, ensure the equilibrium of the aggregate value of such things as finance, credit, and foreign exchange. The implication of this, however, is that we not only accommodate severe distortions in the pricing system but we also arrive at equilibrium only through the use of mandatory controls. We achieve our predetermined “proportionate relationships” in this way. (The real problem is that the “object function” is measured in terms of value.)

However, socialist economic theory quite correctly says that we must respect the law of value. An importan...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of illustrations
• Brief biography of Zhou Xiaochuan
• Foreword
• Preface by the author
• 1 Reform of central planning: orientation, methods, and limits (1991)
• 2 An economic analysis of housing reform (1991)
• 3 Moving toward an open economy (1992)
• 4 Fiscal and tax reform, and an overall economic analysis (1992)
• 5 Different paths toward achieving economic structural reform (1993)
• 6 The role of liberalized foreign trade in creating a more reasonable pricing system (November 1993)
• 7 Social security: economic analysis and systems engineering (1994)
• 8 Microeconomic concepts within the field of economics (March 1999)
• 9 Resolving to deal with the nonperforming loans of banks, and some pitfalls along the way (July 23, 1999)
• 10 Elevating our accounting standards (April 11, 2001)
• 11 Capital adequacy ratios and the need to take corrective action in time (September 12, 2003)
• 12 Several issues to do with reform of State-owned banks (April 16, 2004)
• 13 Promoting further development of capital markets by improving corporate governance (December 1, 2004)
• 14 Improving legal systems and reforming China’s “financial ecosystem” (December 2, 2004)
• 15 China’s corporate bond markets: experiences and lessons learned (October 20, 2005)
• Major works by Zhou Xiaochuan
• Index