China - Recent economic trends and policy developments

Report No. 4072-CHA FIECCp China: Recent Economic Trends and Policy Developments March 31, 1983 East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties Its contents may not otherwise be disclosed without World Bank authorization  CURRENCY EQUIVALENTS The Chinese currency is called Renminbi (RMB). It is denominated in yuan (Y). Each yuan is subdivided: 1 yuan = 10 jiao = 100 fen Exchange rates used in this report are as follows: 1979 $1.00 = Y 1.55 1980 $1.00 = Y 1.50 1981 $1.00 = Y 1.71 1982 $1.00 = Y 1.89 WEIGHTS AND MEASURES Chinese statistics are usually in metric units; in addition, mu and jin are often used: 1 mu = 0.1647 acres = 0.0667 hectares (ha) 1 jin = 0.5 kg FISCAL YEAR January 1 - December 31 TRANSLITERATION The Pinyin system is used in this report.  FOR OFFICIAL USE ONLY CHINA COUNTRY ECONOMIC MEMORANDUM Table of Contents Page No. SUMMARY AND CONCLUSIONS i-ix 1. INTRODUCTION ........................ . 1 A. Economic Setting .1.. . . . . . . . . . . . . . . . . . . I B. Overview of Reform, Adjustment and Stabilization. 3 2. MANAGEMENT OF GROWTH AND ADJUSTMENT . . . . . . . . . . . . . . 5 A. Planning and Management ... . . . . . . . . . . . . . . . 5 B. Growth and Structure of the Economy . . . . . . . . . . . . 8 C. Incomes and Employment ... . . . . . . . . . . . . . . . 11 Urban Incomes and Employment . . . . . . . . . . . . . . 12 Rural Incomes . . . . . . . . . . . . . . . . . . . . . . 14 D. Investment . . . . . . . . . . . . . . . . . . . . . . . . 15 Size and Composition of the Investment Program . . . . . 16 Investment Process . . . . . . . . . . . . . . . . . . . 18 3. FINANCIAL AND BALANCE OF PAYMENTS MANAGEMENT . . . . . . . . . 20 A. Inflation and Prices . . . . . . . . . . . . . . . . . . . 20 Inflation . . . . . . . . . . . . . . . . . . . . . . . . 20 Price Structure . . . . . . . . . . . . . . . . . . . . . 22 Price Reform .23 B. Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . 24 Budgetary Deficits and their Impact . . . . . . . . . . . 24 Trends in Expenditures .26 Revenue Developments .26 Fiscal Decentralization .29 C. Monetary Policy .30 Money and Credit in Stabilization . . . . . . . . . . . . 30 Interest Rates and Banking Reform . . . . . . . . . . . . 33 This report was prepared by Ian Porter, Bill Byrd and Gene Tidrick. Mr. Porter and Mr. Byrd visited China in March/April 1982 as members of an IMF Article IV consultation mission and the report is based largely on the information provided to the IMF mission. A draft of the report was discussed with the Government in January 1983 by a mission led by Mr. Parvez Hasan and including Mr. Porter and Mr. Byrd, and was revised to take account of comments received as well as developments since April 1982. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -2- Page No. D. The Balance of Payments . . . . . . . . . . . . . . . . . . 34 Exports and Imports . 35 External Borrowing and Creditworthiness . . . . . . . . . 39 Institutional and Policy Changes in the External Sector . 40 4. SECTORAL POLICIES AND REFORMS . . . . . . . . . . . . . . . . . 44 A. Agriculture . . . . . . . . . . . . . . . . . . . . . . . . 44 Agricultural Growth and Adjustment . . . . . . . . . . . 44 Production Responsibility Systems . . . . . . . . . . . . 48 B. Industry . . . . . . . . . . . . . . . . . . . . . . . . . 51 Adjustment in Industry . . . . . . . . . . . . . . 52 Institutional and Policy Changes . . . . . . . . . . . . 56 C. Energy . . 59 Energy Consumption . . . . . . . . . . . . . . . . . . . 60 Incentives for Energy Conservation, Substitution and Production . . . . . . . . . . . . . . . . . . . . 61 Short- and Long-term Energy Planning . . . . . . . . . . 62 D. Transport and Commerce .62 Transport . . . . . . . . . . . . . . . . . . . . . . . . 63 Commercial Sales and Inventories . . . . . . . . . . . . 64 Commercial Reforms .66 5. ECONOMIC PROSPECTS ... . . . . . . . . . . . . . . . . . . . 68 A. Constraints and Options ... . . . . . . . . . . . . . . . 68 Human Resources ... . . . . . . . . . . . . . . . . . . 68 Agriculture .... . . . . . . . . . . . . . . . . . . . 69 Energy . . . . ... . . . . . . . . . . . . . . . . . . . 70 Industry . . . . . . . . . . . . . . . . . . . . . . . . 72 Infrastructure . . . . . . . . . . . . . . . . . . . . . 72 Financial Resources ... . . . . . . . . . . . . . . . . 73 B. Macroeconomic Prospects ... . . . . . . . . . . . . . . . 73 The Sixth Five Year Plan (1981-85) . . . . . . . . . . . 73 Scenarios for the 1980s . . . . . . . . . . . . . . . . . 76 C. Prospects for Economic Reform . . . . . . . . . . . . . . . 80 D. Concluding Remarks . . . . . . . . . . . . . . . . . . . . 83 TABLES IN TEXT 2.1 Agricultural and Industrial Growth, 1970-82 . . . . . . . . . 8 2.2 Growth of NMP at Current and Constant Prices, 1970-81 . . . 9 2.3 Structure of NMP at Current Prices, 1970-81 . . . . . . . . . 11  - 3- Page No. 2.4 Consumption and Ownership of Specific Commodities, 1977-81 12 2.5 Urban Incomes, 1978-81 . . . . . . . . . . . . . . . . . . . . 13 2.6 Survey of Rural Incomes, 1978-81 . . . . . . . . . . . . . . . 14 2.7 Gross Fixed Investment, 1977-82 . . . . . . . . . . . . . . . 16 2.8 State Capital Construction Investment, 1977-82 . . . . . . . . 17 3.1 Inflation, 1970-81 .21 3.2 Growth Rates of Sales and Incomes at Current Prices, 1979-81 . 22 3.3 Budget Deficits, 1977-82 . . . . . . . . . . . . . . . . . . . 25 3.4 Budgetary Expenditures and Subsidies, 1977-82 .27 3.5 Domestic Revenues, 1977-82 .28 3.6 Developments in Money and Credit, 1978-82 .32 3.7 Current Account, 1978-82 .35 3.8 Value, Price and Volume Indices of Exports and Imports, 1978-82 . . . . . . . . . . . . . . . . . . . . . . . . . . 36 3.9 Composition and Growth of Exports, 1978-81 . . . . . . . . . . 37 3.10 Composition of Imports, 1978-81 . . . . . . . . . . . . . . . 38 3.11 Direction of Trade, 1978-81 .39 4.1 Gross Agricultural Output, 1970-82 .45 4.2 Foodgrain Balance, 1977-81 . . . . . . . . . . . . . . . . . . 46 4.3 Use of Manufactured Inputs in Agriculture, 1977-81 . . . . . . 47 4.4 Industrial Growth: Percentage Change Per Year in Gross Output, 1970-82 . . . . . . . . . . . . . . . . . . . 53 4.5 Growth of Manufactured Exports, 1978-81 .55 4.6 Imports of Machinery and Equipment, 1978-81 .56 4.7 Changes in Main Transportation Indicators, 1978-81 . . . . . . 63 5.1 Selected Sixth Five Year Plan Targets ... . . . . . . .. 74 5.2 State Capital Construction Investment by Sector . . .. . . . . 75 5.3 Effects of Low Growth and Moderate Energy Savings,1978-90 . 77 5.4 Effects of Moderate Growth and Moderate Energy Savings, 1978-90 .79 5.5 Effects of High Growth and High Energy Savings, 1978-90 . . . 80 ANNEXES 1. Restructuring of the Commissions and Ministries of the State Council 2. Conversion of Macroeconomic Statistics STATISTICAL APPENDIX MAP   - i - SUMMARY AND CONCLUSIONS 1. The first World Bank report on China entitled "China: Socialist Economic Development" was distributed to the Executive Directors in June 1981. The report was designed to be as comprehensive as possible and included an analysis of China-s economic system, a review of development efforts over the past three decades, a comparison of the economic situation and level of development of China with those of other countries and an assessment of China's development prospects. This Country Economic Memorandum focusses primarily on economic developments since 1978 and on the implications of these developments for China's future economic prospects. Background 2. Following a period of major institutional changes in the 1950s, which included land reform and the eventual establishment of communes in rural areas and the extension of public ownership to cover almost all of the modern sector, development efforts in China have been directed toward the major objectives of industrialization and poverty reduction. Substantial progress has been made: China now produces a far greater variety of industrial goods than most developing countries, and in terms of basic education, nutrition and health the Chinese population is much better off than most of its counterparts in other developing countries. Despite these achievements, however, China remains a very poor country with a GNP per capita of only $300 in 1981 /1 and about 200 million people or 20% of the population with unacceptably low incomes. The economy is also inefficient: past growth has come mainly from massive mobilization of resources and fundamental institutional changes; relatively little attention has been paid to issues of efficiency. For a country that faces significant domestic resource constraints this is a particularly serious problem. 3. To address the underlying weaknesses and imbalances in the economy and ensure rapid growth and improvements in living standards, the Government initiated a program of adjustment and reform in 1979. Structural adjustment is aimed at speeding improvements in living standards. It has involved readjusting the relative shares of consumption and investment in national income, some sectoral and subsectoral readjustments and an emphasis on foreign trade. Economic reform is aimed at improving the overall efficiency of the economic system and involves: (a) restoring and improving the quality of central planning and policy coordination; (b) devolving more decision-making authority to lower level units in the economic system; (c) establishing more /1 Calculated according to the World Bank Atlas Methodology.  - ii - direct links between incomes and the performance of economic units and individuals; and (d) placing more reliance on market mechanisms and economic instruments, less on administrative directives, to influence economic activity. In 1981 problems of inflation and large budgetary and current account deficits resulted in short-term stabilization temporarily receiving the highest priority, but by 1982 the Government was again pushing ahead rapidly with adjustment and reform. Economic Reform 4. Reforms in the system of economic management have now affected all sectors of the economy and institutions from the central government down to production teams and rural households. A major reorganization of the central government has strengthened the core planning and management agencies (especially the State Planning Commission and the State Economic Commission) and reduced the total number of commissions, ministries and agencies under the State Council from 98 to 52. A reorganization of departments and divisions within ministries and of provincial and local governments is underway. Economic management has also been decentralized: provincial and local planning commissions and banks have been given more autonomy in investment decision-making and there has been an increased use of credit to finance investments; provincial and local governments have been granted greater budgetary flexibility and more incentives to expand revenues and/or economize on expenditures; and the powers of ministries, new territorially based trading companies and, in some cases, enterprises to engage directly in foreign trade have been substantially increased. 5. Reforms of the economic system have been greatest in rural areas. The most important and fundamental change has been the introduction of various types of "production responsibility system" which give lower level collective units, groups and households more autonomy in production and investment decisions and link incomes directly with output. By the end of 1982, 92% of production teams in China had implemented some form of production responsibility system; 78% of teams had implemented some form of household responsibility system, which involves retaining collective ownership of farm land and major equipment but contracting out plots of land to individual households. In many cases households can farm the land as they wish and retain whatever they produce beyond their obligations to the state (in the form of taxes and compulsory deliveries at fixed prices) and to the collective (for welfare and other expenses). These obligations now account on average for about one third of a household's production. In recent years there has also been an increase in the number and types of rural markets at which households can freely trade commodities. 6. Economic reform has not proceeded as far or as fast in urban areas, but significant systemic changes have still taken place. Management of state  - iii - enterprises has been affected by a number of changes and experiments aimed at improving incentives, including the introduction of profit retention schemes and more flexible payment and employment practices. There has been experimen- tation with different types of state enterprise organization, a greater variety of marketing channels, some price flexibility and adjustment of rela- tive prices, and greater autonomy for state enterprises in production decisions. The scope for collective and individual economic activities has also been enlarged. 7. Many economic reforms, especially those in rural areas, have already had a positive impact on efficiency, while others will take longer to have a significant effect. There are also some emerging issues with economic reform that the Government will need to address. In rural areas for example there is the issue of the potential conflict between enhanced economic incentives and equity in income distribution as well as preservation of some of the strengths of the commune system in terms of provision of basic needs and other services and mobilization of labor for construction and maintenance of community infrastructure. In the state enterprise sector, many units still do not have to take full responsibility for their decisions (commercial units buy whatever they produce and there is no risk of being closed down) and are therefore still inclined to overinvest and overproduce. Substantial decentralization of decision making without reforms in the pricing system has also caused lower level units to make some inappropriate investment and production decisions. More use is being made of the market, but information and transport systems are still weak, markets are fragmented and competition is limited. It has also been difficult to develop effective indirect fiscal and monetary policy instruments. During 1982 the Government reviewed such issues and concluded that weaknesses and inconsistencies in reform should be overcome not by backtracking on reform but by carrying out more careful studies and experiments and speeding up the reform process. Adjustment, Stabilization and Growth 8. During the past four years the Government has followed a strategy of setting relatively modest targets while pushing ahead with economic and administrative measures that would contribute to adjustment and stabilization as well as to economic growth. The various measures have included: major increases in agricultural procurement prices; strict controls on many other prices; rationing and other administrative measures to improve efficiency of resource use; changes in the amount and composition of state capital construction; various fiscal measures designed to limit the budget deficit; increases in and a rationalization of interest rates; moderation of currency and credit expansion; and the introduction of an internal settlement rate for foreign exchange transactions and other measures to encourage exports and economize on imports. 9. These economic and administrative measures have combined with systemic changes to play an important role in the impressive performance of  - iv - the Chinese economy in recent years. They have contributed to structural adjustment by helping to reduce the share of investment in net material product (NMP) from 36% in 1978 to 28% in 1981, by stimulating agricultural production and by shifting the emphasis from heavy to light industry. In several ways they have also been critical in restoring economic stability in 1981 and 1982. First they helped to lower the rate of inflation (prices of nonstaple foodstuffs and some other goods have been increasing quite rapidly but the overall level of retail prices rose by only 2.4% in 1981 and an estimated 2% in 1982 compared with 6% in 1981). Second they helped to reduce the budget deficit (adjusted to eliminate financing items) from 7% of NMP in 1979 and 5% in 1980 to less than 2% in 1981 and 1982. Finally they helped to convert the $2.4 billion current account deficit of 1980 into a $2.0 bil- lion surplus in 1981 and an estimated $4.4 billion surplus in 1982. Through- out the period the various policy measures and reforms have also been important in ensuring a satisfactory overall rate of economic growth: gross agricultural and industrial output at constant prices has grown by 6.9% per year between 1978 and 1982 and NMP at constant prices by an estimated 5.3%. In the period 1978-81 net investment appears to have stagnated or even declined in real terms while material consumption grew in real terms by over 8% p.a. 10. The combination of structural adjustment, rapid overall economic growth and a low population growth rate (1.3% p.a. between 1978 and 1981) has led to rapid increases in per capita incomes in recent years. In urban areas, general wage increases and higher bonuses have more than offset the increase in the cost of living index, and real per capita incomes increased by 4.8% p.a. between 1978 and 1981. The number of urban unemployed has been reduced dramatically and, with government encouragement, urban self-employment has grown rapidly. Even more impressive, however, has been the increase in rural incomes. After a long period of stagnation, rural per capita incomes increased in money terms by 16-18% p.a. between 1978 and 1981; the real increase in incomes was 10-12% p.a. About 60% of this dramatic increase is due to increased production and the remainder to shifts in the terms of trade in favor of rural producers. While areas and households that were already relatively well off may have benefited the most and income differentials at a local level may have increased, many poor areas and households have apparently enjoyed substantial income improvements. During 1982 there were further increases in real per capita incomes, with rural incomes continuing to grow more rapidly than urban incomes. 11. The high rate of investment in 1978 and the low returns to much of this investment made a cutback in the investment rate a priority for the adjustment program. But achieving such a cutback has proved to be a difficult task. Decentralization of investment decision making and financial resources without accompanying reforms in prices and enterprise responsibility has resulted in a rapid expansion in investment financed from retained earnings or local resources. Some of this investment has gone to priority areas including housing but other investment appears to have been in projects that from a national perspective are of a relatively low priority. The central government has found it difficult to control such investment, even through administrative  regulations. Meanwhile state budget investment has been constrained by the need to restore fiscal stability. As a result most of the cutbacks in investment have had to be in large centrally financed projects and in 1981 even the priority sectors of energy and transportation were affected. Some of these high priority projects were revived later in 1981 and during 1982, but appropriate planning techniques and incentive systems still need to be developed that will ensure a more optimal level and composition of investment. 12. The introduction of "production responsibility systems" in rural areas, the major improvement in the terms of trade for rural producers and reductions in the quantity of grain and other products farmers are obliged to provide to the state at fixed prices have all contributed to a very strong performance of agriculture. Gross agricultural output at constant prices increased by 6.0% p.a. between 1978 and 1982; however real value added in agriculture has not been growing as rapidly. There has been a substantial diversification of the sector, with production of cash crops including oilseeds, cotton and sugar expanding rapidly and large increases in livestock and sideline production (including brigade and team industry). Grain produc- tion has also done well, increasing by about 2.8% p.a. during 1978-82 as a result of significant yield improvements (the area planted to grain has actually fallen). However, domestic grain consumption appears to have increased more rapidly, and net imports of grain have risen to about 15 million tons (4% of total domestic consumption). Emphasis is now being placed on providing the incentives (including price incentives) and other assistance that will further stimulate agricultural production and ensure an appropriate balance between grain and nongrain agriculture. 13. The industrial sector has also performed well in recent years: gross output at constant prices has increased by 7.2% p.a. during 1978-82 (heavy industry by 3.3% p.a. and light industry by 11.8% p.a.). Both the overall growth rate and the pattern of industrial production have been affected by the energy situation. Due to the stagnation of energy production and continued exports of energy products, domestic consumption of energy has grown by less than 2% p.a. during 1979-82, while NMP has risen by nearly 5% p.a. This has been possible largely because of the changing structure of industry: heavy industry consumes about four times as much energy per unit of output as light industry and heavy industry grew very slowly in 1980 and actually declined in 1981 before picking up again in 1982. The Government has been stressing the importance of improved efficiency and energy savings within sectors and has been pursuing energy conservation through rationing and other administrative measures as well as a few selected price and tax changes. It is recognized that as economic reforms proceed further, the role of pricing in energy conservation will become more important. 14. The restoration of fiscal stability in 1981 and 1982 has been achieved more through expenditure restraints than through revenue growth. Total domestic revenues have been increasing but at only half the rate of growth of NMP, in part due to the introduction of profit retention schemes and the shift in the composition of industrial output from heavy to light  - vi - industry. Among expenditure items, spending on capital construction has fallen in every year since 1978 while subsidies (mainly on daily living necessities) have increased dramatically from 6.6% of total expenditures in 1978 to 26.0% in 1982. However, the issue of subsidies is more a pricing and income distribution issue than a fiscal issue. Because of the Government's concern about open inflation, many of the increases in agricultural procure- ment prices have been financed by subsidies rather than being passed on to urban consumers, but without such subsidies the Government would probably have been obliged to permit larger wage increases and hence lower profit remittances (which are a major source of government revenue), leaving the fiscal situation largely unaffected. 15. The improvement in the balance of payments in 1981 and 1982 has been much greater than anticipated. The performance of merchandise exports has been very impressive with real growth averaging over 15% p.a. during 1978-82, mainly because of a rapid growth in manufactured exports which has been encouraged by the decentralization of foreign trade and the introduction of the internal settlement rate. However, some of the growth appears to have resulted from excessive competition among provinces and organizations and from exports of basic consumer and producer goods that are in short supply domestically. To address such problems the Government introduced various export quotas and export duties during 1982. The real growth rate of exports has been declining steadily since 1978, reaching an estimated 8% in 1982. Export prices have also declined and the nominal value of exports in 1982 increased by only 3%. Meanwhile the volume of imports declined in both 1981 and 1982, due in part to the lagged effect of contract cancellations and suspensions (which resulted in a 50% drop in the value of imports of complete plants and sets of equipment in 1982), but also to delays in delivery of equipment already ordered and to problems in obtaining high technology goods. A substantial increase in imports is expected in 1983 and 1984 as China endeavors to take advantage of its strong balance of payments position to import more machinery and equipment and expand its investment program, especially in the priority sectors of energy and transport. 16. A major consequence of the Government's conservative trade and balance of payments strategy has been a much reduced need for foreign borrowing. In 1930 and 1981 the Government cut back sharply on interbank borrowing and in 1981 and 1982 took advantage of the unexpectedly strong current account position to repay commercial bank and other loans. In 1981 China's debt service ratio was 7.8%, due in part to accelerated loan repay- ments. At the end of 1981 total reserves (excluding gold) were $5.0 billion or 3 months of 1981 f.o.b. imports; by the end of the third quarter of 1982 they had increased to $9.4 billion. Prospects 17. During the remainder of the 1980s the Government's efforts to improve the living standards of the Chinese people should be helped considerably by the continuation of a relatively low population growth rate; by opportunities to make greater and more efficient use of foreign technology  - vii - and capital; and by the possibilities for improving efficiency through economic reform. Rapid and equitable economic development is constrained by a number of factors, however, some of long-standing and others of more recent origin. There are serious shortages of skilled manpower and current enrollment in both universities and technical and vocational schools is one quarter of the average for other developing countries. The performance of agriculture in recent years has been very good; but with no possibilities for expanding the cultivated area and with cropping intensities and yields already quite high, the growth rate for agriculture (excluding brigade and team industry) is unlikely to average more than 3-4% p.a. during the 1980s. Efforts also need to be made to ensure that all areas and regions participate in agricultural growth. Energy availability will continue to constrain indus- trial growth during the remainder of the decade, and there are capacity constraints in the transport and commercial sectors. Large investments will be required in energy and transport at a time when competing demands from other sectors, especially housing, are very great, domestic revenues have not been growing rapidly and decentralization and reform have resulted in the central government having relatively little control over large parts of the investment program. To address some of these problems and maintain relatively rapid growth and improvements in living standards, further reform and adjustment measures will be required including price reform and greater use of foreign imports and capital. 18. In recognition of these problems and issues the Government's Sixth Five Year Plan (published in December 1982 but covering the period January 1981 - December 1985) emphasizes continuation of the program of "adjustment, reform, consolidation and improvement of the national economy." The period 1981-85 is essentially viewed as an interim period during which important readjustments and reforms of the economy will occur. These will lay the foundation for more rapid economic development during subsequent plan periods. Modest targets are set for production and income growth (the target growth rates for gross agricultural and industrial output and for NMP are 4%), con- sumption is expected to grow faster than investment, prices will be kept basically stable, the budget deficit will be kept low and a significant expansion in foreign trade is forecast, with imports growing more rapidly than exports. In all sectors of the economy the priority will be on policy and institutional measures to improve efficiency rather than on maximization of output, but the Government expects that most of the production targets of the Sixth Plan will be surpassed, as they have been in the first two years of the plan. 19. Whatever the exact rate of production and income growth, China's temporary situation of current account surpluses is expected to change quickly to one of moderate current account deficits and its requirements for foreign capital to finance its development and modernization programs are expected to increase greatly during the remainder of the 1980s. However the actual size of the current account deficits and the magnitude of foreign borrowing requirements are very sensitive to assumptions about economic trends and policy developments. Moreover even a slight acceleration of  - viii - economic growth without stgnificant improvements in efficiency, especially energy efficiency, could result in large current account deficits and debt management difficulties by the end of the 1980s. In these circumstances the Government will need to remain cautious in its import and foreign borrowing strategy. Imports of capital and intermediate goods are expected to expand rapidly. By the late 1980s, some imports of energy also appear to be necessary before new production capacity is established. But the overall rate of import expansion and the overall rate of economic growth are crucially dependent on a continued good performance of manufactured exports and on the rate at which efficiency can be improved. The Government will need to monitor developments in these areas closely and adjust its import and foreign borrowing strategy accordingly. A relatively high rate of economic growth (6-7% p.a. during the remainder of the 1980s) will probably only be feasible if major improvements in energy efficiency continue to be achieved. 20. The need for efficiency improvements highlights the importance of economic reform and the Goverrment's decision that reform implementation will be speeded up during the next three years. Rural reforms are to be broadened and strengthened, with production responsibility systems extended to new spheres of activity, new types of organization including joint ventures between rural and urban units encouraged and the administrative functions of communes separated from their economic functions. In state owned industry schemes for replacing profit remittances with taxes will be greatly expanded, the system of industrial administration will be revamped and streamlined and greater efforts will be made to close down inefficient enterprises. Reform of the commercial system will receive special attention during the next three years and the development of collective and individual commerce, particularly in rural areas, will be promoted. In the area of investment planning the Government is emphasizing more effective implementation of existing adminis- trative regulations, but improving the structure and efficiency of investment will be a long and difficult process, dependent very much on progress on other aspects of reform. Of particular importance are measures to introduce formal economic analysis (including use of shadow prices) into investment decisions and to decentralize decision making not just to administrative units but also to producing units which can be made more economically and financially responsible for their decisions through appropriate pricing and incentive schemes. Price reform itself is critical. The Government recognizes this but, in view of the complexities and magnitude of the changes that will be required, has decided that it will not be possible to implement comprehensive price reform until after 1985. However, appropriate upward or downward adjustments in the most distorted prices can and will be made, and the prices of many minor commodities will be allowed to fluctuate according to market conditions. These will be important steps forward in what is likely to be a gradual process of reform that will need to take account of the scope for "unfreezing" of prices and how state determined prices should relate both to domestic costs and to world prices.  - ix - 21. The 1980s is a difficult period of transition for China. But during the past four years the Government's programs of adjustment, reform and stabilization have achieved very significant results. In fact, in terms of production and growth, efficiency improvements and stability (as measured by budgetary and current account deficits) the achievements have been greater than expected. Nonetheless China is still a very poor country and its investment and modernization requirements are enormous. To help meet these needs and ensure continued rapid growth and improvements in living standards, it is important that the Government continue with its program of structural adjustment (including an expansion in foreign trade and borrowing), and with its program of economic reform, that will help improve the overall efficiency of the Chinese economy. Continued effective implementation of these programs should help ensure a reasonable rate of growth during the remainder of the 1980s while setting the stage for more rapid growth and development in the 199 Os.   1. INTRODUCTION 1.01 The first World Bank economic mission to China visited the country between October and December 1980. The mission's findings were presented in a report entitled "China: Socialist Economic Development" (Report No. 3391-CHA), which was distributed to the Executive Directors in June 1981. The report was designed to be as comprehensive as possible and to compare the economic situation and level of development of China with those of other countries. The report included an analysis of China's economic system and development prospects and has provided a basis for planning the World Bank's future activities in China. 1.02 This country economic memorandum focusses mainly on recent develop- ments in the Chinese economy. It reviews the progress and impact of the Government's programs of reform, adjustment and stabilization between 1979 and 1982, and assesses the implications of recent internal and external develop- ments for China's future economic prospects. The remainder of this chapter provides a brief summary of the Chinese economic system and its achievements and problems; It also provides an overview of progress in implementing pro- grams of reform, adjustment and stabilization. The second chapter reviews developments in the planning and management system and macro-economic trends, particularly in consumption and investment. The third chapter discusses financial and balance of payments developments, while the fourth provides a summary of the impact of the various programs on the key sectors of agricul- ture, industry, energy, transport and commerce. The final chapter draws the discussion of macro and sectoral trends together and reviews the Sixth Plan and some of the medium term prospects and issues that are facing the Chinese economy. A. Economic Setting 1.03 China's economic system reflects in large measure the major institu- tional changes that took place in the 1950s, including land reform and the eventual establishment of communes in rural areas and the extension of public ownership to cover almost all of the modern sector. But the system has evolved since then and is continuing to change as a result of the Government's program of economic reform. Basic policy in China is determined by the Communist Party while the state (or the administrative organs of government) manage the economy. Despite recent reforms, the economic management system is still quite hierarchical and subject to administrative controls, with commands constantly flowing downwards and information upwards between levels (the center, the provinces, the municipalities or prefectures, the counties or districts and lower level administrative units). But the extent of central control has varied almost continuously since the 1950s and remains the subject of much debate. 1.04 The rural economy consists in the main of people's communes, /1 about 53,000 of them, each with about 3,500 households. The commune itself /1 State farms only account for about 5% of the cultivated area.  - 2 - is a multi-level management system, with each household being part of a team, each team part of a brigade and each brigade part of a commune. The division of responsibility for economic and social activities among these levels varies with the locality and is now undergoing major change. But everywhere land remains collectively owned. 1.05 Enterprises owned by the state make up much of the rest of the economy. Traditionally such organizations have enjoyed little independence, but this is gradually being changed as a result of recent reforms. Workers are allocated to these organizations by central and local labor bureaus, and they receive both prescribed wages and bonuses. In addition, urban collec- tives employ about one-f ith of the urban labor force, and the self-employed are a small but rapidly growing part of the Chinese economic system. 1.06 During the past three decades, development efforts in China have been directed toward the major objectives of industrialization and poverty reduction. Substantial progress has been made. Between 1952 and 1979, gross industrial output grew at an annual average rate of 11% (13% in heavy industry and 9% in light industry). China now produces a far greater variety of industrial goods than most developing countries and is much less dependent on imported equipment and materials. Almost the entire range of modern industries have been set up, and special efforts have been made to spread manufacturing into poorer regions and into rural areas. 1.07 China's record in terms of poverty reduction has also been impressive. Due to the rapid growth of savings and investment, per capita consumption in real terms grew by only 1.9% per year between 1957 and 1979, compared with a real GNP per capita growth rate of 2.5-3.0%. But substantial progress has been made in meeting the basic needs of the population, partic- ularly basic education, nutrition and health. There is almost universal primary school enrollment, adult literacy is now well ahead of the average for low-income countries, and life expectancy has risen to 68 years. Despite these achievements, however, China remains a very poor country. In 1981 GNP per capita was only $300,/1 and about 200 million people, or 20% of the population, still have unacceptably low incomes./2 1.08 Morever, the Chinese economy remains inefficient. Past growth has come mainly from massive mobilization of resources and fundamental /1 Annex 2 provides information on the assumptions made by the World Bank in converting Chinese data from the system of material production to the UN system of national accounts. Conversion of GNP to US dollars is based on the World Bank Atlas methodology. /2 The poorest fifth of the population had an average annual per capita income of about Y 70 in 1979 which would purchase only about 300 kg of unmilled rice (equivalent to about 2,100 calories per day) even if nothing were spent on other commodities.  - 3 - institutional changes; until recently relatively little attention has been paid to improvement of systems and technologies. The state economy is inefficient in terms of converting inputs into outputs, matching supply with demand and choosing appropriate investment projects; supply bottlenecks frequently occur and there are large inventories of often poor quality goods. The commune economy appears, at least in principle, to be a much more efficient system, but it too has sometimes used inputs inefficiently and failed to produce the most appropriate outputs. Such inefficiencies and problems in both the state and the collective economies appear to have stemmed mainly from inefficient planning and management; from the lack of objective methods for making choices between different activities and techniques; from the failure to use instruments such as prices as incentives to improve efficiency; and from the country's isolation from technological and other developments in the rest of the world. 1.09 In view of the widespread poverty remaining in China and the generally low standard of living, the Government is seeking a rapid improve- ment in living standards. Factors favoring this goal include, most impor- tantly, the low population growth rate. But China faces serious shortages of resources. The scarcity of good agricultural land is a centuries old problem, but the total arable area, as well as the amount of land per worker, may now be declining and the cropping index and yields are already high relative to other developing countries. China is faced with a serious energy constraint: domestic primary energy production actually declined in 1980 and 1981 and only slow growth can be expected for the remainder of the 1980s. Insufficient infrastructural development in key sectors like transport also constrains growth. The labor force continues to expand and substantial underemployment remains in rural areas. On the other hand there are serious shortages of skilled high-level and technical manpower. China could ease some of its domestic resource constraints by opening up its economy more to international trade and by making more use of external borrowing. But to achieve a rapid growth of production and an increase in living standards China must improve the efficiency with which it uses both domestic and external resources (the present low level of efficiency indicates the pos- sible gains from such improvements). B. Overview of Reform, Adjustment and Stabilization 1.10 In China, the period since 1977 has been characterized by much debate concerning development strategies and the strengths and weaknesses of the Chinese economic system. Initially the Government's major concerns were to overcome the disruptions and setbacks caused by the Cultural Revolution (1966-76) and resume a rapid growth path. Emphasis was placed on the modernization of agriculture, industry, national defense, and science and technology; an ambitious investment program was prepared and a comprehensive ten-year economic development plan announced. But by 1979, it was apparent that underlying weaknesses in the economy would make the investment program and the plan unsustainable. Thus, the Government initiated a program of "adjustment, reform, consolidation and improvement of the national economy".  - 4 - 1.11 Economic reform is designed to improve the functioning of the economic system and thereby the overall efficiency of the Chinese economy. Its major objectives have been to: (a) restore and improve the quality of central planning and policy coordination; (b) devolve more decision-making authority to lower level units in the economic system; (c) link incomes and rewards more directly with the work and effort of economic units; and (d) rely more on market mechanisms and on economic instruments and less on administrative directives to influence economic developments. Economic reforms first got under way in 1979, but most of their effects were not apparent until after 1980. The government's planning and management systems and the management of state enterprises and collectives have all been affected. 1.12 Accompanying economic reform has been a major program of structural adjustment designed to speed improvements in living standards, particularly in rural areas. The key feature of this program has been a readjustment in the relative shares of investment and consumption and of different productive sectors in national income. In view of the already relatively high share of investment in national income and the low returns to some of this investment, the Government decided in 1979 to raise the share of consumption and reduce the share of investment in aggregate demand, by cutting capital construction, raising agricultural prices and increasing money wages. The associated need for substantial sectoral and subsectoral readjustments of production and investment was recognized, with more emphasis being placed on agriculture and light industry at the expense of heavy industry. There has also been a continued emphasis on foreign trade. 1.13 Managing the reform and adjustment programs has proved to be a difficult task. In 1979, there was a large budget deficit, a significant deficit in the balance of payments, a sharp increase in the amount of currency in circulation and upward pressure on prices. The Government took some corrective measures in 1980, including a reduction in capital construc- tion expenditures financed by the state budget, but these proved insufficient to restore stability. In 1980 the budget and balance of payments deficits remained large and open inflation increased. At the end of 1980 there was a review of the economic situation and in 1981 the Government instituted a more restrictive stabilization program. At its core were sharp cuts in investment, a restoration of budgetary balance and a moderation of currency and credit expansion. The stabilization program proved to be even more effective than planned: there was a large swing in the current account, a cut in the absolute level of investment and a reduction in the rate of open inflation as well as a sharp reduction in the overall rate of economic growth. In 1982 investment expanded again and the economy resumed a path of more rapid growth. 1.14 Thus the period since 1979 has been characterized by a series of government programs designed to improve efficiency and raise living stand- ards while maintaining domestic stability. The management of these various programs, the conflicts and complementarities between programs and their macro and micro effects are the subject of this memorandum.  2. MANAGEMENT OF GROWTH AND ADJUSTMENT A. Planning and Management 2.01 In recent years the Government has been endeavoring simultaneously to readjust the structure of the economy and to improve the overall effi- ciency of resource use. Many policy changes and reforms of the system have been introduced with potentially wide-ranging effects. Managing this overall process and ensuring that programs and measures are complementary and not conflicting has proved to be a difficult task, particularly for a country with a still relatively weak central planning and management system. In fact it is well recognized in China that readjustment and efficiency im- provements require not only reforms in the management of the collective and state enterprise sectors and more use of the market but also a restoration and strengthening of central planning and policy coordination. 2.02 In an effort to improve the quality, speed and coordination of central decisionmaking, a major reorganization of the central government was initiated in early 1982. This has resulted in a reduction in the number of vice premiers from thirteen to two and in the number of Commissions, Minis- tries and agencies under the State Council from 98 to 52./l The staff of the State Council' and Ministries and Commissions is also being cut by 30% from 49,000 to 32,000. Particular emphasis has been placed on strengthening and improving the core planning and management agencies: the State Planning Commission is being strengthened, and the State Economic Commission has been reorganized (to include the State Capital Construction Commission and several other commissions) and its functions and powers augmented. The State Planning Commission remains responsible for longer term planning while the State Economic Commission is responsible for helping prepare and implement shorter term economic plans. A reorganization of departments and divisions within ministries and of provincial and local governments is under way. 2.03 Other measures to improve the quality of central planning are accompanying this administrative reorganization. Planning methodologies are being improved; more emphasis is being placed on economic criteria in making planning and investment decisions; and the statistical system is being strengthened, with sample surveys supplementing the Government-s previous dependence on comprehensive administrative reporting. The promulgation of a detailed and comprehensive Sixth Five-Year Plan in December 1982 demonstrates the progress that China's planning system has made since the mid 1970s. /1 Details on the restructuring of Commissions and Ministries are contained in Annex 1.  - 6 - 2.04 The Government has recognized, however, that improvements in central planning and policy coordination on their own are unlikely to ensure the efficiency improvements China requires. Accordingly a set of reforms has been introduced designed to improve the management and efficiency of lower-level administrative and economic units by giving them more responsibility and autonomy, by linking incomes and rewards more directly with output and productivity, and by relying less on administrative measures and more on the market and on indirect economic instruments to influence their activities. 2.05 Management of state enterprises has been affected by a number of changes and experiments aimed at improving incentives, including the introduction of profit retention schemes and more flexible payment and employment practices. There has been extensive experimentation with different types of state enterprise organization, the variety of channels through which goods can be marketed has been expanded, some flexibility in prices has beeni introduced, and state enterprises have been given more control over what they produce. At the same time the Government has endeavored to improve the efficiency of state enterprises through indirect measures such as providing loan instead of grant finance and introducing charges on their fixed assets and circulating capital. 2.06 Major changes in the organization and management of the collective sector have taken place. In rural areas more responsibility has been given to lower-level collective units and to households; incomes and rewards have been more directly linked to the work and efforts of groups and households; and new types of rural organizations are being encouraged. There has also been an expansion in the number and types of rural markets at which house- holds can freely trade commodities. Meanwhile in urban areas the scope for collective and individual economic activities has been enlarged. 2.07 Of particular importance for central-local government relations has been the decentralization of fiscal and foreign trade management: a revenue and expenditure sharing system between provinces and the central government was introduced in 1980, and provincial branches of foreign trade corporations, local trading companies and in some cases enterprises can now export and import without having to seek approval from the central government. 2.08 The Government has recognized that when an economic system relies less on administrative decisions and commands and more on economic instru- ments, the legal rights and obligations of economic agents need to be better defined. In the last three years major additions have been made to the body of China's laws and regulations - additions aimed at strengthening the socialist legal system domestically as well as facilitating foreign invest- ment. The political, administrative and judicial structure and organization of Chinese society and the rights and responsibilities of individuals have been spelled out legally; laws on domestic economic contracts have been enacted; and laws and regulations concerning joint ventures, income taxes,  - 7 - exchange controls and the development of offshore petroleum reserves have all been introduced. In December 1982 the National Peoples Congress adopted a new constitution as well as endorsing the Sixth Five-Year Plan. 2.09 The array of reforms that lhave been introduced in recent years testifies to the Government's determination to improve planning and manage- ment at the local, enterprise and collective as well as at the central levels. It is likely to be some time, however, before the effects of many of these changes on the overall efficiency of the Chinese economy are apparent, and indeed the effectiveness of many reforms is dependent on reforms taking place elsewhere in the economy. Reforms appear to have been most effective in the area of incentives - most economic units now operate under financial reward systems of one sort or another, and peasants- and workers- incomes are dependent in part on individual or work unit performance. Distortions in the price system have, however, led to some inequities in rewards. 2.10 The reforms have also involved a substantial decentralization of decisionmaking. But again the absence of major price reform has sometimes resulted in inappropriate investment and production decisions by lower-level units. In addition, in the state enterprise sector some units apparently still do not have to take full responsibility for their decisions - state trading corporations tend to buy whatever the units produce and for most units the risk of financial penalties or being closed down as a result of bad management or performance is negligible. In these circumstances there is a built-in tendency for enterprises to overinvest and overproduce. In some cases, it also appears that administrative decentralization has meant that powers supposedly put in the hands of enterprises have actually accrued to local governments. To offset some of these tendencies the central government has been obliged from time to time to resort to administrative interventions and restrictions. 2.11 More use is now being made of the market in determining resource allocation, but information and transport systems are still weak and markets tend to be small and fragmented along territorial lines. Competition is often limited; markets have in some cases been subject to price and trade restrictions. More generally the Government has found it difficult to develop effective indirect fiscal and monetary policy instruments to replace or at least supplement the tight microeconomic supervision inherent in command planning. 2.12 Some of the difficulties with economic reform are an inevitable part of any effort at transformation from one kind of economic system to another, while others stem from inconsistencies in some of the reform measures. These difficulties were analyzed during 1982 as part of an overall review of economic reforms. The Government has now decided to increase the pace of economic reform, but each new measure will be preceded by careful study and, wherever possible, by some initial experiments./l /1 Future reforms are discussed in more detail in paras. 5.26-5.34.  - 8 - B. Growth and Structure of the Economy 2.13 Some reforms, particularly those in rural areas, have contributed greatly to the readjustment and overall growth of the economy. But others have made the process more difficult. For example, greater autonomy and financial resources for lower level units has made it more difficult to reduce and redirect the investment program. Nonetheless significant adjustments in the structure of the economy have taken place. Except in 1981 a high overall rate of economic growth has also been maintained. Some of the structural and growth developments reflect a continued recovery of the economy from the Cultural Revolution period, but adjustment and stabilization policies as well as system reforms have had an important role to play. 2.14 An outstanding feature of recent economic developments has been the high rate of agricultural and industrial growth (see Table 2.1). Gross agricultural output at constant prices has increased by 6.0% per year between 1978 and 1982, much above the growth rate in the first half of the 1970s. Industry by contrast has been able to maintain a high overall growth rate throughout the 1970s and early 1980s, but in recent years there has been a major shift in the structure of industry with light industry growing much faster than heavy industry between 1979 and 1981. The strong performance of both agriculture and industry is reflected in the high overall rate of economic growth. In fact it was only in 1981 that the growth rate of net material product (NMP) at constant prices fell below the average growth rate in the early 1970s when the requirements of stabilization took precedence over economic growth and adjustment (Table 2.2). In 1982 however the pace of development speeded up again and the constant price NMP growth rate is estimated to have been about 6%. Table 2.1: AGRICULTURAL AND INDUSTRIAL GROWTH, 1970-82 (% change in gross output value at constant prices) 1970-77 1978 1979 1980 1981 1982 (prelim) Agriculture 3.4 9.0 8.6 2.7 5.7 7.0 Industry 8.7 13.5 8.5 8.7 4.1 7.4 Heavy 9.3 15.6 7.7 1.4 -4.7 9.3 Light 7.8 10.8 9.6 18.4 14.1 5.6 Total Agriculture plus Industry 7.3 12.3 8.5 7.2 4.5 7.3 Source: Statistical Appendix, Table 2.5.  Table 2.2: GROWTH OF NMP AT CURRENT AND CONSTANT PRICES, 1970-81 (% per annum) 1970-77 1978 1979 1980 1981 Agriculture: current prices 3.1 8.6 23.8 11.2 11.5 constant prices /a 2.3 7.5 7.8 2.0 5.2 Industry: current prices 6.4 18.3 9.1 10.5 1.2 constant prices /a 6.9 17.3 8.7 8.7 1.2 Other material sectors:/b current prices 3.7 13.5 - 7.6 1.4 6.2 constant prices 4.9 9.4 0.1 1.8 4.0 Investment: current prices 4.3 30.6 6.8 0.3 -6.4 constant prices 4.8 30.0 6.3 -1.4 -6.4 Consumption: current prices 4.7 7.6 14.3 14.6 8.8 constant prices 4.6 5.6 7.8 9.3 4.8 Total NMP: current prices 4.6 13.8 11.3 9.5 6.0 constant prices 4.8 12.4 7.0 5.2 3.0 /a In view of the difficulties in deflating NMP data, not much should be read into the differences between these growth rates and the gross output growth rates in Table 2.1. Growth rates are single deflated in keeping with present S.S.B. practice. /b Including construction, transport and commerce. Source: Statistical Appendix, Tables 2.3, 2.4 and 2.5, and Annex 2, Tables 1-4.  - 10 - 2.15 The rapid increase in agricultural and industrial production has been accompanied by and in the case of agriculture was encouraged by major shifts in relative prices. Although information on prices is limited, it is clear that agricultural procurement prices have risen much more rapidly than either industrial prices or retail prices in recent years (see para. 3.05). The comparison of current and constant price NMP growth rates shows the effects of such price changes. Agricultural growth at current prices was much above its growth rate at constant prices; industrial growth was almost the same at current and at constant prices; and the growth rate of other sectors was lower at current than at constant prices due to the profits of the commerciat sector being squeezed. It should also be noted that the constant price growth rates do not take account of the fact that input prices have been rising less rapidly than output prices for agriculture, while the reverse has been true for industry./l Taking these price changes into account would reduce the estimated real growth rate of agriculture between 1978 and 1981 from about 5.0% to about 3.5% per year and increase the estimated average annual industrial growth rate in real terms from 6.1% to over 8%. 2.16 In the period since 1978 changes have taken place in the structure of expenditures as well as the structure of production, with the share of consumption in NMP rising from 65% to 71% in 1981 before declining slightly in 1982 (Table 2.3). 1978 was however an exceptional year; in 1977 and for most of the early 1970s the share of consumption in NMP was between 68 and 70%. The recent shift from investment to consumption is also due in part to changes in relative prices because prices of investment goods appear to have been rising less rapidly than consumption goods prices. Nonetheless since 1978 consumption in real terms has been growing more rapidly than investment; in 1981 investment actually fell in both current and constant prices, while consumption continued to grow. There has also been a major change in the structure of investment, with nonproductive investment (mainly housing) growing much more rapidly than productive investment./2 /1 This is because agricultural and industrial growth rates are only single-deflated in keeping with present State Statistical Bureau (SSB) practice. Annex 2 provides further information on the effects of relative price changes. /2 The composition of investment is discussed in more detail in paras. 2.26-2.29.  - 11 - Table 2.3: STRUCTURE OF NMP AT CURRENT PRICES 1970-81 1970 1977 1978 1979 1980 1981 Production (net output) Agriculture 41 37 35.4 39.3 40.0 42.0 Industry 40 45 46.8 45.9 46.3 44.2 Other 19 18 17.8 14.8 13.7 13.8 Total (NMP) 100 100 100.0 100.0 100.0 100.0 Expenditure Investment 32.1 31.5 36.1 34.7 31.8 28.0 Productive 23.4 23.3 25.6 22.6 18.1 14.0 Nonproductive 8.7 8.2 10.5 12.1 13.7 14.0 Consumption 68.0 68.2 64.5 66.2 69.3 71.2 Foreign material trade -0.1 +0.3 -0.6 -0.9 -1.1 +0.8 balance Total (NMP) 100.0 100.0 100.0 100.0 100.0 100.0 Source: Statistical Appendix, Tables 2.3, 2.4 and 3.1. C. Incomes and Employment 2.17 In recent years government policies on consumption and employment have been aimed not only at ensuring a more rapid improvement in living standards, but also at reducing urban unemployment and narrowing the differ- entials between urban and rural incomes. Substantial progress has been made in all these areas. Due to the combination of a high overall rate of economic growth, the low population growth rate and the shift from invest- ment to consumption, a more rapid growth in per capita consumption than in the early 1970s has been possible. At current prices material consumption per capita increased by over 12% p.a. between 1978 and 1981 and stood at Y 280 in 1981; including nonmaterial services would increase per capita consumption to Y 320. When account is taken of estimated price increases, the real level of material consumption per capita increased by more than 6% p.a. between 1978 and 1981, much above the average 1.3% p.a. recorded between 1957 and 1977, and there have been significant increases in consumption and ownership of key commodities (Table 2.4).  - 12 - Table 2.4: CONSUMPTION AND OWNERSHIP OF SPECIFIC COMMODITIES, 1977-81 1977 1978 1979 1980 1981 Annual Per Capita Consumption Grain, milled basis (kg) /a 192 196 207 214 219 Pork (kg) 7.0 7.7 9.7 11.2 11.1 Sugar (kg) 2.8 3.3 3.6 3.8 4.1 Cotton cloth (meters) 7.7 8.0 9.0 10.3 10.6 Ownership of Consumer Durables (per 100 persons) Radios n.a. 7.8 9.4 12.1 14.9 Bicycles n.a. 7.7 8.6 9.7 11.2 Watches n.a. 8.5 10.4 12.9 15.7 /a This is trade grain i.e. milled rice and millet plus other grains on an original weight basis. Source: State Statistical Bureau. 2.18 In recent years personal incomes appear to have been growing even more rapidly than average material consumption. This reflects in part a decline in the share of government consumption in total consumption. But private financial savings (excluding cash) have also increased rapidly from Y 2.7 billion in 1978 to Y 13.2 billion in 1981 and have become more important at the margin (though the government budget and the retention of profits and other funds by enterprises still account for the bulk of total national savings). In 1980 and 1981, private financial savings amounted to about 3.5% of NMP compared with less than 1% in 1978. High marginal savings rates may partly reflect shortages of consumer goods (see para. 3.03), but to a much greater extent are probably the result of interest rate changes and other banking reforms which have made savings more attractive. Urban Incomes and Employment 2.19 Average nominal wages (including bonuses) in urban areas have increased substantially in recent years, reaching Y 772 per worker in 1981 (Table 2.5). The increase in wages has resulted mainly from the three general increases in wage rates introduced by the Government in 1978, 1979 and 1980, but it also reflects the impact of higher bonuses as a result of industrial reform./l In 1981, however, the stabilization program resulted in no general increase in wage rates and efforts were made to link both wages and bonuses much more closely to efficiency criteria. As a result average /1 Industrial reform is described in detail in paras. 4.25-4.31.  - 13 - wages rose by only 1.3%. Participation rates increased, however, and average per capita incomes in urban areas (excluding nonwage incomes) rose by 2.6% in 1981, about as fast as the cost of living index. Overall real per capita incomes in urban areas increased by about 4.8% p.a. between 1978 and 1981. Wages remained under relatively tight control in 1982 but there were increases for certain groups of workers and staff. Participation rates also appear to have risen again and consequently some further increase in urban per capita incomes should have taken place. Table 2.5: URBAN INCOMES, 1978-81 /a Average annual growth 1978-81 (%) Annual level (Y) Money Real 1978 1979 1980 1981 terms terms Average wage 614 668 762 772 7.9 3.8 Participation rate (%) 55.0 55.1 55.8 56.5 Per capita income 338 368 425 436 8.9 4.8 /a Excluding nonwage incomes. Source: Statistical Appendix, Table 1.6, and information on participation rates. 2.20 In recent years substantial progress has been made in addressing the problem of open urban unemployment. At the end of the Cultural Revolution, many young people who had been obliged to work in rural areas returned to their homes in cities and towns and swelled the ranks of those looking for jobs in urban areas. As a result about 20 million people or 15% of the urban population were either unemployed or only in temporary employment. This number has now been substantially reduced: at the end of 1981, urban unemployment had fallen to 3 million, of whom 2 million were recent college and school graduates and 1 million had been waiting for jobs since before 1980. In 1981, the state arranged for the employment of 8.2 million people, of whom 5.3 million had previously been unemployed and the rest were either demobilized soldiers, recent graduates of secondary schools and colleges or people from rural.areas. 5.2 million were given jobs in state enterprises, mainly in urban areas, 2.7 million found employment in urban collectives, and the rest were allowed to work as individual laborers in cities and towns.  - 14 - 2.21 The Government acknowledges that not all of the additional employ- ment has been in very productive activities (labor productivity in state industrial enterprises actually fell by 1.8% in 1981). Since all additions to the labor force cannot be productively employed in state enterprises, the growth of urban collective and self-employment has been actively encouraged. The number of workers in individual enterprises in all sectors rose from 320,000 in 1979 to 810,000 in 1980 and 1.1 million in 1981, when they still accounted for only 2% of total urban employment. Rural Incomes 2.22 Rural incomes in both money and real terms have increased greatly in recent years, much more rapidly than urban incomes. A sample survey of 18,500 households in 568 counties of 28 provinces suggests that average per capita rural incomes in current prices increased by 19% p.a. in both 1979 and 1980 and by a further 17% in 1981 (Table 2.6). When account is taken of estimated price increases, the average increase in real per capita incomes in rural areas between 1978 and 1981 was 10-12% p.a. Rural income growth estimates based on consumption and savings changes and rural production and terms of trade changes also suggest that real per capita income growth rates have been 10-12% p.a./l About 60%