China's Economy

Lecture for Ed Ghymn's International Marketing Class
Thursday, February 22, 2001, 5:30 PM, AB 107
Elliott Parker

China - The Middle Kingdom: Past, Present and Future

China has the oldest continuous culture in the world, with at least 4000 years of historical records.

Yangshao (5000-3000 BC) and Longshan (2500-2200) Pottery Cultures

Pre-Imperial China: The Three Dynasties of Xia (est. 2033-1562 BC), Shang (est. 1562-1066 BC), and Zhou (1066-221 BC)

Imperial China: Qin/Han (221-207 BC-220 AD), Sui/Tang (589-617-906), Song/Yuan (960-1275-1367), and Ming/Qing (1368-1644-1911)

China experienced a cultural and philosophical flowering during the middle Zhou (Spring and Autumn period, 722-481 BC), around the time the Buddha lived in India and Socrates lived in Athens. Meanwhile, the Romans had yet to have an impact on the Italian peninsula, Europeans were organized as barbaric tribes, and the Israelites had been taken away to Babylon.

In size, scope, and stability, the Chinese Empire dwarfed the Roman empire. Alexander's empire rivaled it in size, but only briefly.

China was once the most technologically advanced, most populous, and (from their point of view, anyway) the most civilized country in the world. The Chinese are a very proud people, and often very nationalistic.

Imperial China's political history is one of long periods of stable, autocratic, and socially conservative dynasties, with a dynastic cycle that leads to collapse of the state and periods of terrible chaos. The Chinese have no history of democracy, and a great fear of political disorder.

Prior to the Song, China fought outside threats from the Xiong-Nü (Turkic) and the Xia (Tibetan) tribes, but the primary threat to dynastic stability was internal. After the Song, the primary threat to dynastic stability was external: the Mongols, the Manchus, the Europeans, and (in the Twentieth Century) the Japanese. The century from the 1840s to the 1940s is sometimes called the century of humilation and broken treaties. The Chinese still have great sensitivity to the perception of foreign domination.

Chinese economic history is full of lost chances. As Needham documented, many of our most important technologies (printing, paper, clocks, gunpowder, and paper money are just a few examples) were first invented in China but not really put to economic use. Chinese fleets traveled to India and Africa before the Europeans but these voyages were halted. The expansion of trade and markets was repeatedly halted by government intervention.

China did not make the technological leap. While Europe was undergoing the Great Transformation, China was in a period of decline. China did not respond to the European challenge, unlike the Japanese who modernized their economy rapidly during the Meiji Restoration.

In the Twentieth Century, China began its revolutionary period. A revolution in 1911 toppled the last Qing emperor, a second and third revolution helped to prevent the creation of a new imperial dynasty in 1916, and the Northern Expedition in 1927 under Chiang Kai-shek (Jiang Jieshi) and the Nationalist Party brought the country back under one government, albeit a weak, incompetent, and corrupt one.

Finally, the Communist Revolution in 1949 put Mao Zedong in power. On one hand, he created a strong central government, ended China's foreign domination, and began a process of determined Soviet-style industrialization. On the other hand, his revolutionary vision led to the death of millions (the two worst periods were the Great Leap Forward of 1958-1961 and the Great Proletarian Cultural Revolution of 1966-1969), the destruction of traditional Chinese culture, and a new political culture of fear and extreme conformity.

By Chairman Mao's death in 1976, the Chinese economy was isolationist and stagnant, and Chinese material living standards had failed to improve (though extreme poverty and outright starvation was reduced, and average life expectancy had increased dramatically). Most Chinese lived on inefficient farming communes. Industrialization had mostly affected the cities, and the state held a virtual monopoly. Inefficient state-owned factories relied on direct state funding and produced shoddy products, and turned over all their profits to the state. State banks were created to help finance state expenditures. Private ownership and incentive was virtually nonexistent.

Beginning in 1978, Deng Xiaoping became China's paramount leader (though he left the highest official positions for others, and refrained from creating a personality cult like Mao). Deng began to push for the reform of Mao's socialist economy.

He created the Open Door Policy, and China began to open to the outside world. Tourism was allowed, students began to go overseas, special economic zones were established, and joint ventures with foreign firms were encouraged to bring in foreign technology, investment, managerial know-how, and market access.
He emphasized that state firms and government agencies should be led by those who had some expertise, not just by those who showed the proper revolutionary fervor.
He encouraged the elimination of the rural communes, and land was turned over to the rural household (for production and income, but not for real ownership). Agricultural productivity jumped dramatically, and free markets were created to sell food. A large surplus of rural workers began to pour into other economic activities.
A two-tier pricing scheme was created that encouraged first farmers and then state firms to produce more than their planned quota, and the economy began to "grow out of the plan," in the words of Naughton.
State-owned enterprises were given improved managerial incentives, allowed to keep much of their own profits for reinvestment and worker bonuses, and forced to rely on loans from state banks rather than direct government grants.
Eventually, the planned economy, with its quotas and its fixed prices, would be dismantled, but unlike in the former Soviet Union it did not happen suddenly and did not lead to an economic collapse.
State firms were encouraged to compete with each other, and new types of firms were also allowed to compete in formerly monopolized sectors. Rural firms (called Township and Village Enterprises) were allowed to compete, and by the late 1980s they accounted for most of China's exports. Small family firms were encouraged, and eventually foreign and domestically-owned private firms would be allowed as well.

The economy took off in the 1980s, growing at 8% per year or more, and life improved dramatically for most Chinese. Agricultural production was the first sector to show improvement, and then the production of consumer goods. Private savings rates rose dramatically as incomes rose, as people no longer feared that having money in the bank would open them to political criticism, and as people began to plan for big future purchases. Rising savings made it possible for government to increase the money supply to cover deficits due to a falling share of tax revenue (most of it from the profits of state-owned enterprises) and increased subsidies to offset the difference between official prices and market prices. State-owned enterprises, on the other hand, were not doing very well, and government efforts to subsidize them would eventually cause rising inflation. New market opportunities also provided opportunities for some government officials to grow rich illegally, and many Chinese were upset by this corruption. Soviet political reforms under Gorbachev and improved expectations combined with economic concerns, led to a series of political protests, culminating in the Tian'anmen demonstrations of 1989. Though the government debated about whether to allow political reform, ultimately the decision was made to send in the army to put down the demonstrations, and unfortunately for the government the western press was in Beijing at the time to witness it. The official leadership of Hu Yaobang and Zhao Ziyang in the mid-1980s was replaced by Jiang Zemin, Li Peng, and (a couple of years later) Zhu Rongji.

For a couple of years, the Chinese government stepped back from reform, but the economy went into recession, millions of unemployed peasants began to migrate into the cities, and the collapse of Communist governments in the Soviet Union and Eastern Europe frightened the government. Thus, in 1992 the Communist Party announced a new policy to create a Socialist Market Economy. What this meant exactly was unclear, but their intention was to maintain political control while promoting ever-increasing economic liberalization.

Initial reforms were focused on creating a more stable and uniform international trading system (with current account convertibility but an "airlock" on capital flows), a more market-oriented banking system (with separation of commercial banks from the government's lending preferences), and better managerial incentives through shareholding systems and creation of a stock market.

China's economic transformation accelerated, and the results were staggering, especially in the coastal cities. By 1994, China had become the world's 10^th largest trading nation, and by official measures trade accounted for 40% of China's GDP. In 1995 alone, China received over $100 billion in signed foreign investment contracts. The share of industrial output produced by state-owned enterprises fell 3/4 in 1980 to 1/3 by 1995, while the share of the labor force engaged in agriculture fell from over 70% to less than 50%. China's share of population in urban areas rose from 20% to 40% in the same period, and Shanghai's mayor claimed that more than half of the world's tower cranes were at work in Shanghai's construction boom.

By the time Deng died in 1997, right before China finally took back Hong Kong from the British, Jiang Zemin and Zhu Rongji were trying to force the banking system to deal with its bad debt problem and were pushing more and more for privatizing or simply shutting down the many inefficient state enterprises. China survived the Asian Crisis of 1997 without being forced to devalue the Yuan because it did not allow for free capital flows, but export growth slowed as products from other Asian countries became more competitive. Competition and slowing demand led to deflation, but the economy kept growing primarily as a result of government expansionary fiscal policy.

Last year, China finally came to agreement with the United States over joining the World Trade Organization. Nationalist China had been an original signatory to the General Agreement on Tariffs and Trade (GATT), which became the WTO in 1994, and for the last two decades China has been given the same Most-Favored Nation (MFN) status by the U.S. as it gives to GATT/WTO members. To get this agreement, which ends the humiliating ritual of the U.S. government's annual review of China's human rights record, China made major concessions to allow U.S. firms access to the Chinese market. Because of what this portends, Chinese stock markets have jumped up significantly.

Joining the WTO will require China firms to face more competition, and will likely result in rising bankruptcies and unemployment in some previously protected sectors. Existing subsidies for Chinese farmers may have to be curtailed, resulting in rural hardship and rising urban migration. China's state-owned banks still hold huge shares of bad loans, and allowing foreign banks to compete may force some of them into bankruptcy. Why would the Chinese government do this? A good suggestion is that reformers in the government want to use the WTO as a whip to force the Chinese economy to deal with its problems. The government will likely be forced to accelerate privatization further, and while there are doubts that local governments won't get in the way, the WTO will pressure the central government to pressure local governments for compliance.

What are China's current prospects? Of course, it is hard to say. Economists are skeptical that China can continue its rapid growth performance, and the problems of bankruptcy, bad debt, slowing export growth, slowing consumption, rising deficits, urban migration, and the rural economy are daunting. Still, China's government has proved its ability to recognize and deal with its problems, and it is likely that economic pressures will continue to force China's economy to privatize, become more competitive, and follow policies of market liberalization. Will the government be forced to politically liberalize? This is the realm of pure speculation, but as long as the economy continues to deliver most Chinese appear willing to accept the current government even though they might prefer another one. Times are relatively good now, and history has taught the Chinese how bad things can get when the government is weak.