The Market Mechanism and Economic Reforms in China

William Byrd

• Publisher: Routledge
• Year: 2019
• eBook ISBN: 9781315489797
• Topic: Business
• Subtopic: Economic Theory
• Index: Business

This theoretical and empirical study of market-oriented reforms in Chinese industry since the late 1970s focuses on the expansion of the market mechanism in the allocation of industrial products and the concurrent decline of directive planning - a strategy that is a crucial component of the ambitious overall reform "package" that Chinese reformers are trying to implement. The expanding role of Chinese industrial goods has had major implications for the functioning and importance of planning which, the author argues, has become largely irrelevant in terms of direct control over short-term allocation.

The
MARKET
MECHANISM
and
ECONOMIC
REFORMS
in CHINA

1. Introduction

THIS IS a study of China’s attempt since the late 1970s to reintroduce markets into its urban industrial sector. Development of markets for industrial goods is only part of China’s wide-ranging economic reforms designed to improve economic efficiency and promote rapid growth, development, and modernization. Yet it is a crucial part, without which the reform package as a whole cannot get off the ground. Market-oriented reforms have been moving China away from the pattern of administrative control over short-term resource allocation, which is found in traditional centrally planned economies along Soviet lines. This makes theoretical and empirical research on the development of the market mechanism all the more important. But neoclassical and other Western modes of economic analysis cannot be applied to the evolving Chinese situation in a simpleminded manner, since economic institutions in China sharply depart from those in a capitalist market economy.

Scope of the Study

This study is organized around the general theme of the expansion of the role of the market mechanism in the distribution of Chinese industrial goods. This choice of focus is related to the stage and accomplishments of reforms so far, which have made considerable progress in this area. It would not necessarily be as appropriate in looking at other sectors of the economy, where the constellation of reforms may be somewhat different, or at a later time, when goods markets may no longer be a major issue in reform. But in terms of the situation in Chinese urban industry (primarily state-owned industry) through the mid-1980s and into the late 1980s, the emergence, expansion, functioning, and impact of goods markets has perhaps been the most crucial development.¹

The selection of markets for industrial goods as the central topic means that other aspects of reform are approached from the perspective of their effect on and relation to this aspect. The market mechanism is examined in depth from a number of different perspectives, while other reforms are looked at in a more subsidiary light, primarily trying to ascertain whether and to what degree they are prerequisites for the success of market-oriented reforms. Since the latter do require at least a certain degree of progress in reform implementation in other spheres, the study will necessarily touch on such areas as greater autonomy for enterprise decision makers, profit retention for state enterprises, bonuses for workers and managers, price reform, tax reform, changes in internal enterprise organization, and so on.

The study will not, however, give significant attention to some key areas of reform and certain critical parts of the reform process. In the first place, it is a study of economic reform and hence will not cover political, social, and cultural developments, even though these are important and in certain respects critical for the success of economic reforms. Within the sphere of economic reforms, certain specific topics are almost completely excluded: agricultural reforms; development of nonagricultural activities in rural areas, particularly township and village industries; reforms in the ownership system and internal structure and management arrangements for both state and nonstate industrial enterprises; reform and change in the factor allocation system (land, labor, and capital); reforms in the banking system; and reforms in public finance and taxation.

Historical Background

The historical context has had an important influence on Chinese industrial reforms.² Chinese industry was dominated in the prereform period by state-owned enterprises of various types. The state sector accounted for about 78 percent of gross industrial output value in 1978 (State Statistical Bureau 1983, 215; 1985a, 239). There was a substantial nonstate sector of collective enterprises, which grew rapidly in the 1970s with the expansion of rural commune- and brigade-run enterprises. Nonstate enterprises in the prereform period were under the jurisdiction of government supervisory agencies or rural communes and brigades and probably were not controlled and managed in a way greatly different from small state-owned enterprises. They had to rely much more on obtaining inputs and selling outputs outside the state plan, however.

Chinese industry was characterized by a wide range of firm sizes and technological levels in most industries. The former resulted partly from promotion of small-scale industry under local government or rural collective supervision in the 1970s. The latter was partly related to differing plant sizes but also reflected the continued existence of older plants using obsolete technology.³ As in other centrally planned economies, but to a considerably lesser extent due to its lower level of development, China’s industrial structure was “top-heavy,” dominated by some very large plants set up in the 1950s and thereafter, which accounted for a disproportionate share of total industrial output.

Most Chinese industrial enterprises had only a single main plant; multiplant firms were a rarity, and outside the rural collective sector firms with several different main product lines were virtually unheard of. Many ancillary activities were integrated within enterprises, however, and there were strong tendencies toward backward integration, a common pattern in centrally planned economies characterized by chronic shortage. Activities integrated within larger state enterprises typically included machinery repair and manufacturing, production of components, heat treatment, production or mining of raw materials, and a host of services for employees, ranging from workers’ housing and meals to day-care facilities, medical care, commuter transport, pensions (which came to be paid by each firm to its retirees out of current revenues on a completely unfunded basis), and even in some cases public security. Enterprises in the late 1970s also had substantial responsibilities to provide employment for workers’ dependents: a worker’s child had the right to “replace” his or her retiring parent, and in practice many firms had to find some kind of work for all workers’ children. Chinese state-owned industrial enterprises thus had become key social institutions for their employees and dependents.

Both state and nonstate enterprises were under the hierarchical supervision of at least one government supervisory agency—industrial bureaus at provincial, municipal, and county levels; industrial ministries at the central level. Many firms were under “multiheaded leadership” of more than one level of government, while other government agencies often intervened in enterprise affairs and day-to-day management.⁴ In the early 1970s a massive decentralization of the administrative supervision system for state enterprises was instituted. Most enterprises directly under ministries were put under provincial or local control. Combined with the rapid growth of small-scale rural industry (at the county, commune, and brigade levels), this meant that administrative supervision of industrial enterprises became somewhat decentralized and fragmented along territorial lines.

Enterprise autonomy vis-à-vis government supervisory agencies was extremely limited in the 1970s. Administrative decentralization of government supervision did not translate into greater scope for independent enterprise decision making. There was (and continues to be) a symbiotic patron-client relationship between firms and their immediate supervisory agencies. The latter could help the former in dealing with a complex administrative environment but at the same time were to a large extent evaluated bureaucratically on the basis of the performance of the firms under their jurisdiction. This may have enhanced the ability of enterprises to get favorable deals from the bureaucracy.

Though Chinese state-owned industry was governed by administrative fiat, this does not mean that it was thoroughly or comprehensively “planned” in any real sense. Centralized planning was crude and relatively weak, and large parts of industry were not really included in central planning in the 1970s. Local and provincial government agencies played an important role in economic decision making and resource allocation, but they did not do detailed, comprehensive planning within their own domains.

Given administrative control over resource allocation, markets for industrial goods were underdeveloped. The decentralization and fragmentation of control as well as the crude nature of production planning did, however, leave some major gaps that encouraged certain informal resource allocation mechanisms to emerge, some of which were similar to markets. These mechanisms, discussed in chapter 3, were themselves distorted by the existing administrative system and indeed tended to be managed by local authorities rather than enterprises. Nevertheless, they helped create the potential for development of more genuine market mechanisms in the reform period.

Product prices were administratively controlled and remained fixed over long periods of time. The prices of most important industrial producer goods remained constant between 1967, when a price freeze was imposed during the Cultural Revolution, and the late 1970s or early 1980s. In any case, prices did not serve as the primary guide for resource allocation. Prices for the same good in different jurisdictions could vary, primarily due to supply factors (for example, smaller, backward plants needed higher prices to cover their higher costs) and to a lesser extent as a result of cross-subsidization by localities, which sometimes charged higher prices for outside sales and lower prices for local users. The decentralization of planning and industrial administration was accompanied by a lesser degree of administrative decentralization of authority over price setting, but there is no evidence that local and provincial governments were any more flexible in this regard than the central government. Market price determination was not relevant for most industrial products.

Another interesting feature of the immediate prereform situation was the virtually complete absence of financial incentives at the enterprise and individual levels. Enterprises did not retain any of their profits, and workers had no performance- or profit-related bonuses.⁵ Some financial incentive systems were instituted for provincial and local governments and in some cases for agencies supervising enterprises,⁶ but these did not affect firms directly. The bonus system for workers was not restored until 1978. Thus, in the realm of financial incentives, the Chinese system in the immediate prereform period lagged behind the Soviet system, where bonuses for workers and profit retention by enterprises had long been acceptable practice.

Chinese industry was characterized by extreme rigidity of factor allocation and severe problems of factor immobility, aggravated by the “cellularization” of the economy in the 1970s (Donnithorne 1972). Land, labor, and capital in the state sector were subject to allocation by administrative decrees, and given the difficulty of reallocating factors once they were assigned to firms, enterprise factor endowments tended to be highly uneven. The factor allocation system was a major, if not the predominant, source of inefficiency and waste in the system.

Poor product quality was a severe problem, to the point that large amounts of national industrial output had to be discarded as useless. There were periodic massive campaigns to write off substandard, damaged, or nonfunctional inventories of goods and equipment in the hands of industrial and commercial firms. Similarly, lack of technological progress was manifestly evident, both in continued production of obsolete products, without even marginal improvements, and in backward process technologies.

Chinese state-owned industry in the immediate prereform period suffered from tremendous inefficiency and slack. There was great waste of factors of production (including labor as well as land and capital), and inefficiency in the utilization of material inputs and energy as well. Total factor productivity in state industry grew slowly or stagnated between the late 1950s and the late 1970s, a poor record considering the rapid industrial growth that occurred in this period (see Tidrick 1986, 1–5). New estimates of total factor productivity growth by Chen et al. (1988), based on careful adjustments of the data, show an average increase of only about 1 percent per year. Moreover, these estimates are based on exclusion of the three years 1958–60, on the grounds that data for those years are unreliable, and discounting of data for five other years between the late 1950s and late 1970s. Inclusion of these years in calculating average annual productivity growth would almost certainly lower estimates to near-stagnant levels.⁷ Hence China’s impressive industrial growth in the prereform period (9.7 percent per year in real terms from 1957 to 1978) was achieved primarily through increases in factor inputs rather than efficiency improvements.

Various explanations have been advanced for the poor performance of Chinese industry. Naughton (1988) has noted the huge, to a large extent wasted investments that went into the “Third Front” defense industrialization program in China’s interior provinces. He claims that this alone is sufficient to explain poor utilization of capital in China in the prereform period. Others cite the politicization of economic decision making, weaknesses in the planning apparatus, and other related aspects. Decentralization of administrative control over enterprises also had a problematic impact on industrial performance (see Wong 1986). But there is no doubt that systemic features of the Maoist economy as outlined above had a major adverse impact on efficiency. Certainly this was the perception of reformers and policy makers at the outset of the reform process in the late 1970s.

Chinese Industrial Reforms

Pervasive inefficiency and the need to shift from a Soviet-style extensive growth pattern to intensive growth based on improved efficiency of resource allocation were the underlying economic factors giving impetus to economic reforms starting at the end of 1978. Political changes of course played a crucial role particularly in determining the timing of economic reforms. The death of Mao Zedong and downfall of the Gang of Four in 1976 and subsequent political developments had an important impact but will not be discussed here.

Reforms have been haphazard, often seemingly chaotic, and highly ad hoc in their implementation. There has been no overall reform blueprint or plan, and specific reforms in particular spheres of the economic system often do not appear to have been planned or thought out in any detail. Implementation in some areas has sometimes far outrun the expectations of central authorities, whereas in other areas little progress has been made despite strong reform directives from the center. There has been a great deal of local experimentation, which has resulted in significant differences in the pattern and timing of reforms across localities and provinces.

Under these circumstances, economic reform in China has been to some extent a “natural” process, with a kind of “natural selection” at work. Numerous different methods and solutions have been tried out in different places; those that fit in well with the existing, evolving system and did not generate strong opposition have survived, prospered, and become part of the system. On the other hand, reform proposals and experiments that did not fit in as well or led to opposition did not get off the ground, progressed slowly (if they were sponsored by central authorities), or simply disappeared (which may have happened to many local experiments).

In this process the greatest progress has been made where resistance to reforms was weakest; for example, enterprise profit retention and bonuses—firms and their employees clearly benefit from increased flows of financial resources—and the expansion of the role of the market mechanism, which helped fill the vacuum left by weak and fragmented planning. By the same token, however, many reforms have become adapted to the existing system, which may distort their content and impact. For instance, workers’ bonuses to a large extent became more or less fixed-income supplements, with minimal incentive effects. Moreover, by the late 1980s the progress of the reform program as a whole was increasingly being held back by bottlenecks in spheres of the system where change was resisted. Hence, reforms in Chinese urban, primarily state-owned industry have involved a process of evolution and change based on conflicts between old and new elements in the system and a considerable degree of fluidity in institutional arrangements as well as changing formal and informal rules governing behavior of different agents.

Main Elements of Industrial Reforms

Despite the lack of overall guidelines and often haphazard implementation, there is an underlying “package” of industrial reforms, which fits together in terms of both logical interrelationships and actual implementation. The underlying structural coherence of Chinese industrial reforms is only implicit and appears to have emerged from experience rather than from conscious thought at the beginning of the reform process. Nevertheless, the main features of reforms in Chinese state industry can be understood as components of this package.

The set of reforms initially promulgated in the late 1970s included: (1) a degree of enterprise decision-making autonomy in production, and to a lesser extent in investment; (2) reinstitution of financial incentives at the enterprise and individual levels; and (3) expansion of the role of the market mechanism in the allocation of industrial goods and corresponding reductions in the role of planning and administrative allocation (see Byrd 1983b). The components of this initial reform package are closely interrelated and mutually reinforcing. Considerable progress was made in achieving both (2) and (3), initially much less with (1). Since 1984, however, there has been a renewed focus on implementing (1), which is a cornerstone required for other reforms to be meaningful.

Expansion of the role of the market mechanism in resource allocation is the central focus of this study and hence is not incorporated in this introductory discussion. Financial incentive schemes for state enterprises, starting with the reinstatement of the “enterprise fund” scheme and institution of profit retention pilot programs in late 1978, are discussed later in this chapter. Bonuses for employees were reinstated relatively early, but their incentive effect is in question, given that they were subject to ceilings (later a highly progressive bonus tax), treated as income supplements by many if not most workers, and distributed in an egalitarian fashion by most enterprises, at least until the mid-1980s. Enterprise autonomy in business decision making, a key building block of urban economic reforms, was pushed forward gradually and intermittently.

Other reforms can be understood in the light of this initial package. Price reform is needed ...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• Tables
• Preface
• 1. Introduction
• 2. Prerequisites for Effectively Functioning Markets
• 3. Markets in Chinese Industry
• 4. The Impact of Markets on Chinese Industrial Enterprises
• 5. The Redistributional Role of Chinese Economic Planning
• 6. Plan and Market in the Chinese Economy: A Simple General Equilibrium Model
• 7. Assumptions, Limitations, and Extensions of the Model
• 8. Market Price Trends and Market Integration
• 9. The Atrophy of Central Planning in Chinese Industry
• 10. Conclusions
• Notes
• References
• Index