China’s Economic Reforms - Background and Rationale


The article will go in brief in describing the well known and oft told story of China's economic development prior to the watershed events of the death of Mao Zedong in 1976, the fall of the "Gang of Four", the rehabilitation and assumption of power by Deng Xiaoping, and finally, the reforms initiated in December 1978 at the 3rd Plenary Session of the 11th National Congress of the Communist Party of China. In keeping with communist ideology, the Chinese State had nationalized industry by 1958 and monopolized foreign trade, even earlier. By 1956, when agricultural collectivization started, almost all rural households were members of a cooperative. Agricultural communes were initiated in 1958. Development strategy was Stalinist in its unbalanced growth of industry (especially heavy 8 industry). Autarkic policies led to a significant fall in the share of world trade from about 1.25% in 1952-1955 to 0.75 percent in 1978 (Sung 1994: Table 4.1). Growth was achieved through higher rates of investment and labour force participation, but with negligible increase in total factor productivity (Sung, 1994:109). The disasters of the Great Leap Forward or GLF (1958-1962), with an estimated decline of two-thirds in grain output and excess mortality of over 30 million are well known. The decade (1966-76) of Cultural Revolution (CR) resulted in a slow down in the growth of output to about 4.5% per year, compared to 12.2% per year during 1949-57 and 15.3% per year during 1962-66. The worst economic performances were during 1958-62, during the GLF followed by the withdrawal Soviet aid when growth in total output declined at the rate of 3% per year, and the first two years of CR (1966-67) when the decline was even faster at 7% per year.
Rationale for Reforms
The turmoil of the Cultural Revolution had severely dislocated the economy and it would have been natural for those who came to power after the death of Mao to focus on economic recovery. But there were no obvious pressures for the institution of radical reforms. Qian and Wu  claim that the “Primary Objective of the Communist Party of China is to maintain power” and that the political will of the leadership for economic reform is based on the central proposition that economic reform is good for economic development, which in turn is good for maintaining the Party’s power. The two authors further claim that the experience of the disastrous consequences for the national economy and living standards of the people because of the central focus of the Party on political movement during the CR, “had an enormous effect on the mind-set of some top leaders. They were convinced that without economic development the Party could not survive, in 9 other words, a necessary condition for maintaining Party’s power and regaining popular support was economic development. To a large extent, the displacement of the dogmatic ideology in favour of pragmatism was due to the backlash of the Cultural Revolution. The proposition of economic development became even more compelling after the 1989 Tianenman Square incident, because it was the only source from which the government would gain its legitimacy. In Deng Xiaoping’s words “[economic] development is the hard rule”…. The authors argue that the commitment of political leaders to economic development for the purpose of maintaining power, led not only to the start of economic reform in 1978, but also to their pushing for more reforms and deepening them through the decision of the 3rd Plenum of the 14th Congress of the Communist Party of China in November 1993 to establish a Socialist Market Structure. The claims of Qian and Wu seem plausible. In the absence of any freedom for political expression in China, there is no reliable way of assessing popular support. Presumably challenges within the party to its leadership could be viewed as reflecting the lack of popular support for the policies of the leadership. In any case Deng Xiaoping, unlike Mao Zedong, had always been pragmatic and in fact, Mao had found himself Deng’s pragmatism useful earlier. As such, with Deng’s rehabilitation after the death of Mao in 1976, and the fall of the Gang of Four, a shift towards pragmatism in Chinese policy was inevitable. On the other hand, Qian and Wu may well be right in that Deng’s rehabilitation itself would not have occurred had other leaders of the Party not drawn the right lesson from the Cultural Revolution about the importance of economic development for staying in power. For the purposes of this chapter, it is not necessary to resolve this issue.
Contents of Reforms
 In important ways integrating the centrally planned Chinese economy into the  world economy that is driven largely by market forces differs from integrating the mixed economy of India. A reasonably well functioning legal system for enforcement of contracts, and a financial system sufficiently well developed to include a range of financial intermediaries including commercial banks, term lending institutions and insurance firms, are the foundations of a market economy. While India had functioning legal and financial institutions, in China they had to be built up from scratch. Much of China’s foreign trade on the eve of reforms was carried out by state trading agencies. In India, except in food, fertilizers, petroleum and minerals, foreign trade were in private hands. Paraphrasing Shangquan (1999), Chinese reforms during 1978-98 were undertaken in three successive stages. Reforms in the first stage (1978-84) consisted of: the introduction of household responsibility system in place of agricultural communes; free sale of output at market determined prices but for a relatively small proportion delivered to the state at fixed prices, formation of township and village enterprises; replacement by taxes of surrender of profits by urban enterprises; and opening to the outside world through the creation of 4 special economic zones and 14 coastal open cities. The second stage reforms (1984-85) were focused on urban areas and on state owned enterprises. These consisted of: introduction of a variety of contracts on enterprise leasing and management responsibility systems; creation of a share-holding system to facilitate mergers, leases, auctions as well as bankruptcy of enterprises: development of markets for production materials capital, labour, information and technology: role of mandatory plans reduced drastically and enterprises were free to 11 make their own investment decisions; contracting of fiscal budgets, strengthening the regulatory role of the central bank; and further opening of the economy through the creation of the Hainan and Pudong special economic zones. In the third stage from 1992 on, reforms concentrated on the establishment of a socialist market economy. They consisted of: replacing the fiscal contract system by the tax-sharing system, with turn-over and value-added taxes at its core; regulation of money supply and supervision of financial systems entrusted to the central bank; transformation of state-owned banks into commercial banks; extension and deepening of the price and foreign trade reforms of earlier stages; legal and regulatory reforms; and reform of government institutions concerned with education science and technology. The first stage reforms, by providing incentives for increasing productivity of land and rationalizing the use of labour, were highly successful in raising the incomes and welfare of the overwhelming majority of the Chinese population, namely, the peasants. This success encouraged the leadership to proceed with subsequent stages of reform with popular support. After two decades of reform, Chinese economy has been radically transformed. Peasants and enterprises are essentially free to decide what and how much to produce in response to market signals, prices for most products are determined by the market, and market forces determine resource allocation, albeit under a regulatory system adapted to a market economy.

Thursday, 06th Aug 2015, 07:29:46 AM

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