China - Socialist economic development (Vol. 1 of 9) : Main report

Report No. 3391-CHA F ILm, C 0 p y China: Socialist Economic Development (In Nine Volumes) The Main Report 3391 June 1, 1981 (reprinted March 10, 1982) Vol. 1 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: 1977 $1.00 = Y 1.828 1978 $1.00 = Y 1.661 1979 $1.00 = Y 1.541 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 Preface This report is based on the findings of an economic mission compris- ing several teams, which visited China for periods of 4-5 weeks between October and December, 1980. The mission was led by Parvez Hasan (mission chief) and Edwin R. Lim (deputy mission chief), and also consisted of Ramesh Chander (statistics), Mats G. Hultin (education), Dean Jamison (population, health and nutrition), Adrian Wood (principal economist), Shu-Chin Yang (foreign trade), S. Josephine Woo (research assistant), Helen Kung (mission secretary), and the following teams: Agriculture: David J. Turnham (team leader), Theodore J. Goering (agricultural economist), Wen-poh Ting (agriculturalist), and Henri Boumendil (irrigation engineer - consultant); Energy: Bernard Chadenet (team leader - consultant), Darrel G. Fallen-Bailey (energy resources and technology), David P. Hughart (energy economist), Kuo-Chang Ling (power engineer), and Vatsal P. Thakor (power engineer); Industry: Donald B. Keesing (team leader), Magdi Iskander (industrial economist), and H. Geoffrey Hilton (industrial engineer); Transport: Vincent W. Hogg (team leader), Jacques Yenny (transport economist), Ernst G. Frankel (port specialist - consultant), Paul Banner (railway specialist - consultant), and Clell G. Harral (highway specialist). In addition to the mission members, the following also participated in the preparation of the report: Nancy Birdsall was the co-author of Annex B (Population, Health and Nutrition); Sulekha Patel, Suan Ying, and Janson Chang assisted the mission members in research; Linda Mitchell edited the report; and Dianne Esson was responsible for its processing. Hollis B. Chenery (Vice President, Development Policy) and Caio Koch-Weser (Chief, China Division) participated in the final two weeks of the mission. During its stay, the mission was hosted by the following organiza- tions in the Chinese Government: the Ministry of Finance, which coordinated the mission's overall activities; the State Planning Commission and the State Statistical Bureau, which worked mostly with the general economic team; the Ministry of Agriculture, with the agriculture team; the Ministries of Communi- cations and Railways, with the transport team; the Ministry of Education, with the education team; the State Economic Commission, with the industry team; and the Ministries of Electric Power and Coal, with the energy team. In addition to the many officials of these ministries who worked closely with the mission during the two months, the following Chinese economists worked with the various teams: Zhu Rongji (State Economic Commission), Xing Guang (Ministry of Finance), Zheng Li (State Planning Commission), Zhao Renwei (Economic Institute, Academy of Social Sciences), Zhu Fulin (Ministry of Finance), Chen Lian (Agriculture Institute, Academy of Social Sciences), Hong Huiru (Industry Institute, Academy of Social Sciences), Gong Shaowen (Ministry of Agriculture), 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.  He Enlin (Ministry of Railways), Luo Yunqin (Ministry of Communications), Cao Weigong (Ministry of Electric Power), and Gao Huan (Ministry of Education). Xing Guang, Zhao Renwei, Zheng Li and Zhu Fulin also prepared brief background papers for the general economic team. This list is far from exhaustive; the mission teams were also assisted by many others who are not mentioned above, including officials at the government agencies and institutions that the teams visited on field trips. The mission teams travelled extensively outside Beijing. During the two months, the various teams visited two other municipalities, Shanghai and Tianjin, and seventeen provinces - Fujian, Gansu, Guangdong, Guizhou, Hebei, Heilongjiang, Henan, Hubei, Hunan, Jiangsu, Liaoning, Shaanxi, Shandong, Shanxi, Sichuan, Xinjiang, and Zhejiang. To prepare for its work in the field, the mission commissioned a number of background papers on China's economy to be written by foreign scholars, including: Randolph Barker, Cornell University (agricultural development); Wlodzimierz Brus, Oxford University (socialist planning); P.C. Chen, Wayne State University (population and health); Mark Elvin, Oxford University (historical background); Shigeru Ishikawa, Hitotsubashi University (macroeconomic issues); Nicholas Lardy, Yale University (agricultural planning); Dwight Perkins, Harvard University (rural development); Thomas G. Rawski, Toronto University (industrial development); Ashwani Saith, Oxford University (brigade enterprises); Peter Schran, University of Illinois (agricultural statistics and prices); and Christine Wong, Mount Holyoke College (small-scale industries). These papers were generally completed during the summer of 1980 and were discussed with the authors prior to the mission's departure for China. * * * * * * * This report was first issued on June 1, 1981. It was reprinted on March 10, 1982, at which time changes were made in a few places, mainly to correct factual and statistical information.  CHINA: SOCIALIST ECONOMIC DEVELOPMENT MAIN REPORT Table of Contents Page No. SUMMARY AND CONCLUSIONS ....................... . i-xxi 1. THE CHINESE INHERITANCE. 1 A. Introduction. 1 B. The Physical Setting. 2 C. Historical Development. 6 D. Implications of China's Economic Heritage . . . . . . . . . . . 9 Constraints of Prior Achievements . . . . . . . . . . . . . . 9 Comparison with Pre-industrial Europe and Japan . . . . . . . 10 E. Economic Situation Before 1949 .11 2. THE ECONOMIC SYSTEM . . . . . . . . . . . . . . . . . . . . . . . . 16 A. Evolution of the System . . . . . . . . . . . . . . . . . . . . 16 B. Instruments of Management and Control . . . . . . . . . . . . . 17 Annual Plan and Flows of Goods . . . . . . . . . . . . . . . 18 The Budget and Flows of Money ... . . . . . . . . . . . . . 20 The Price System .... . . . . . . . . . . . . . . . . . . 23 C. The Commune Economy ..25 Organization and Management ... . . . . . . . . . . . . . . 25 Income Distribution and Support . . . . . . . . . . . . . . . 26 Planning and Control .28 D. The State Economy .29 Production .29 Labor and Wages .30 Income Support .32 E. Education and Health Services . . . . . . . . . . . . . . . . . 33 Education System .33 Health Care System .34 Family Planning .35 Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 3. GROWTH AND POVERTY REDUCTION . . . . . . . . . . . . . . . . . . . 37 A. Development Strategy .37 B. Population . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Causes of Fertility Decline .39 Population Distribution .40 C. Macroeconomic Perspective .41 Structure . . . . . . . . . . . . . . . . . . . . . . . . . . 41 Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 Investment .48 Consumption .52 D. Income Distribution .53 Regional Inequality .53 Rural-Urban Inequality .55 Urban Inequality ...................... 58  -2- Page No. Rural Inequality .. . . . . . . . . . . . . . . . . 60 Overall Income Distribution . . . . . . . . . . . . . . . . . 62 E. Human Development . . . . . . . . . . . . . . . . . . . . . . . 65 Basic Education . . . . . . . . . . . . . . . . . . . . . . . 65 Health . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Nutrition . . . . . . . . . . . . . . . . . . . . . . . . . . 71 4. SECTORAL PROGRESS AND PROBLEMS . . . . . . . . . .. . . 75 A. Agricultural Development . . . ..... ....... . .. . 75 Growth and Development . . . . . . . . . . . . . . . . . . . 75 Per Capita Supplies . . ..77 Productivity and Income Growth . . . . . . . . . . . . 78 Technological Change .9*.* ... 81 Policy and Problems . . . . . . . . . . . . . . . . . . . . . 84 B. Industry . . . . ........ ... ......... . .86 Growth .... . . . . . . . . . . . . . . . ... . . . 87 Structure . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Problems .... . . . . . . . . . . . . . ....... . . 92 C. Energy .. ..... . . . . . . . . . . . . . . . . . . . . . 94 Production . . . .. ........ . . . . . ... . . . 95 Consumption .... . . . . . . . . . . . . . ...... . . 97 D. Transport . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Development Strategy . . . . . . . . . . . . . . . . . . . 99 Growth of Traffic ..100 Modal Development and Problems ..102 E. Advanced Education and Training ... . . . . . ..... . . . 105 Skilled Manpower Availability ... . . . . . ..... . . . 106 Universities . . . . . . . . . . . . . . . . . . . . . . . . 107 Technical and Vocational Schools . . . . . . . . . . . . . . 108 Nonformal and Continuing Education . . . . . . . . . . . . . 108 F. Foreign Trade .... . . . . . . . . . .. ..... . . . . . 109 Role of Trade .... . . . . . . . . . ...... . . . . . 109 Trends and Composition ... . . . . . . . . . . . . . ... 111 Recent Developments .... . . . . . . . . . . . . . . . . . 113 5. ADJUSTMENT AND REFORM . . . . . . . . . . . . . . . . . . . . . . . 116 A. Strengths and Weaknesses of the Economic System . . . . . . . . 116 The State Economy ..117 Commune Economy ..120 B. Progress of Reform ..121 Budgetary Devolution ..122 Reform of the State Economy ..122 Urban Collective and Individual Sector . . . . . . . . . . . 126 The Commune Sector .... . . . . ..... . . . . . . . . 126 C. Issues of Future Reform .... . . . . . . . . . . . ... . . . 127 D. Progress of Adjustment .... . . . ..... . . . . . . . . 133 Short-Term Measures .... . . . . ..... . . . . . . . . 133 Short- and Medium-Term Choices . . . . . . . . . . . . . . . 135  -3- Page No. E. Adjustment, Reform and Planning . . . . . . . . . . . . . . . 136 Adjustment Versus Reform . 136 Planning and Management . 138 6. PROSPECTS AND OPTIONS IN THE 1980s. .142 A. Introduction . 142 B. Population and Human Resources . . . . . . . . . . . . . . . . 143 Population . 143 Employment . 144 Health and Nutrition . 145 Education ... . . . 146 C. Agricultural Constraints and Perspectives. . . . . . 147 Food Supply . . . . . . . . . . . . . . . . . . . . . . . . . 148 Nongrain Agriculture . 150 Rural Incomes . . . . . . . . . . . . . . . . . . . . . . . . 151 Rural Poverty . . . . . 154 D. Energy Outlook and Consequences . 155 Domestic Energy Production . 155 Energy Saving and Switching . 158 Energy Conservation and Growth . . . . . . . . . . . . . . . 159 E. Industrial Issues and Challenges . . . . . . . . . . . . . . . 166 Industrial Energy Conservation . . . . . . . . . . . . . . . 167 Raw Materials . 168 Manufactured Exports . 168 Modernization and Restructuring . . . . . . . . . . . . . . . 170 F. Foreign Borrowing Options . 171 Foreign Exchange Earnings . 171 Foreign Capital Inflows . 174 Debt Management Issues . 177 G. Overview . 182 TABLES IN TEXT 1.1 Cultivated Area Per Capita of the Agricultural Population, 1978 . 6 1.2 International Comparison of China's Level of Development in 1952 . 13 2.1 Budget Revenues . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.2 Budgetary Expenditures .. . . . . .22 2.3 Rural Institutions . . . . . . . . . . . . . . . . . . . . . . . . 25 3.1 Population Totals, Births, Deaths and Rates of Natural Increase, 1949-80. .38 3.2 International Comparison of Birth and Death Rates (1978) . .39 3.3 Production Structure at Current Prices, 1952-79 . 42 3.4 Sectoral Net Output Growth at Constant 1970 Prices .42 3.5 International Comparison of Production Structure, 1979. .43 3.6 Sectoral Employment . . . . . . . . . . . . . . . . . . . . . . . 44  -3- Page No. E. Adjustment, Reform and Planning . . . . . . . . . . . . . . . 136 Adjustment Versus Reform . 136 Planning and Management . 138 6. PROSPECTS AND OPTIONS IN THE 1980s. .142 A. Introduction . 142 B. Population and Human Resources . . . . . . . . . . . . . . . . 143 Population . 143 Employment . 144 Health and Nutrition . 145 Education ... . . . 146 C. Agricultural Constraints and Perspectives. . . . . . 147 Food Supply . . . . . . . . . . . . . . . . . . . . . . . . . 148 Nongrain Agriculture . 150 Rural Incomes . . . . . . . . . . . . . . . . . . . . . . . . 151 Rural Poverty . . . . . 154 D. Energy Outlook and Consequences . 155 Domestic Energy Production . 155 Energy Saving and Switching . 158 Energy Conservation and Growth . . . . . . . . . . . . . . . 159 E. Industrial Issues and Challenges . . . . . . . . . . . . . . . 166 Industrial Energy Conservation . . . . . . . . . . . . . . . 167 Raw Materials . 168 Manufactured Exports . 168 Modernization and Restructuring . . . . . . . . . . . . . . . 170 F. Foreign Borrowing Options . 171 Foreign Exchange Earnings . 171 Foreign Capital Inflows . 174 Debt Management Issues . 177 G. Overview . 182 TABLES IN TEXT 1.1 Cultivated Area Per Capita of the Agricultural Population, 1978 . 6 1.2 International Comparison of China's Level of Development in 1952 . 13 2.1 Budget Revenues . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.2 Budgetary Expenditures .. . . . . .22 2.3 Rural Institutions . . . . . . . . . . . . . . . . . . . . . . . . 25 3.1 Population Totals, Births, Deaths and Rates of Natural Increase, 1949-80. .38 3.2 International Comparison of Birth and Death Rates (1978) . .39 3.3 Production Structure at Current Prices, 1952-79 . 42 3.4 Sectoral Net Output Growth at Constant 1970 Prices .42 3.5 International Comparison of Production Structure, 1979. .43 3.6 Sectoral Employment . . . . . . . . . . . . . . . . . . . . . . . 44  -5- Page No. 6.7 Import Capacity with Moderate Capital Inflows and High Energy Savings .... . . . . . . . . . . . . . . . . . . . . . 176 6.8 Import Capacity with High Capital Inflows . . . . . . . . . . . . 178 6.9 Illustrative Debt Projections . . . . . . . . . . . . . . . . . . 180 6.10 Illustrative Macroeconomic Projections . . . . . . . . . . . . . . 183 MAPS IBRD 15528R China: Road Network IBRD 15837 China: Major Crops ANNEXED VOLUMES ANNEX A - Statistical System and Basic Data Annex A provides a review of China's statistical system, including a brief description of the concepts and methodology used, and tables showing economic and social statistics by sector. ANNEX B - Population, Health and Nutrition Annex B describes the policies and achievements in population control and health improvement in the post-liberation years. ANNEX C - Agricultural Development Annex C provides an analysis of developments in agriculture, including progress in output, technology, and rural income, and the evolution of major policies and institutions; it concludes with a discussion of current problems and future prospects. ANNEX D - Challenges and Achievements in Industry Annex D examines China's achievements in industry since the Revolu- tion, outlines the organization and structure of the sector, and discusses current constraints on industrial progress. ANNEX E - The Energy Sector Annex E contains a brief survey of the energy sector, including descriptions of the coal, petroleum and electric power industries, and discussion of possible problem areas. ANNEX F - The Transport Sector Annex F describes progress over the past 30 years in developing the transport sector, including a discussion of trends in traffic growth and past development strategy, and examines issues in the future development of the sector. ANNEX G - Education Annex G describes and analyzes education and training in formal and nonformal institutions, in rural communes and in urban enterprises, and reviews the Government's plans for education in the context of several major issues. ANNEX H - External Trade and Finance Describes the institutional framework of the external sector and examines the past trends and patterns of foreign trade and capital flows, and their future prospects.   SUMMARY AND CONCLUSIONS 1. In recent years, within and outside China, two related questions have been debated: how well has China's economic development since the 1949 revolution served the Chinese people; and what have been the respective roles of (a) factors outside the Government's control, (b) the policies followed, and (c) the system of economic management itself? This first World Bank report on the Chinese economy is primarily an attempt to address these questions in the context of experience in other developing countries, and to discuss some of their fundamental implications for future policy. In view of the scale and difficulty of this task, and the limited time and resources available, the report should be regarded as no more than a preliminary step toward an under- standing of China's economic progress and potential. Retrospective 2. In geographical size and internal diversity, in the age and richness of its civilization, and in its recent political history, China is unique. This should constantly be borne in mind in reading the report, which for the sake of simplicity and brevity deals mainly with the past two or three decades, focuses largely on economic matters, and does not fully analyze interregional differences. System and Strategy 3. China's economic system combines a largely urban state economy, similar to that of other socialist countries, with a rural commune economy of its own invention. The state economy is characterized by public ownership, centraliza- tion of economic decisions, strictly hierarchical control, and little reliance on markets or prices. To a greater degree than in East European countries today, people's jobs and consumption patterns are chosen for them by the state. 4. In the commune economy, land and most capital are owned and used collectively by production teams of 30-40 households, which generally corre- spond to small villages (or neighborhoods of larger villages). Each team is part of a brigade, each brigade part of a commune: these higher-level units organize land improvement projects, run industrial and other enterprises, and deliver education and health services. They also pass down instructions from the planners: but in general, production and investment decisions in the commune economy are less subject to central direction than those in the state economy; and markets and prices play a larger role. Private household activi- ties, moreover, account for about 30% of total agricultural production, and an even larger share of rural cash income. 5. Development efforts have consistently been directed toward two main objectives: first, industrialization, and in particular development of a heavy industrial base; second, elimination of the worst aspects of poverty. Chinese development strategy has also been shaped by two major constraints: first, an extreme shortage of cultivable land in relation to population; second, a high degree of international isolation. 6. The two constraints have sharpened the conflict between the two objectives. The prospective returns to investment in agriculture (the principal source of income for the poor) have been limited by land scarcity, by the fact that the easiest advances in intensive cultivation had already been made, and by limited opportunities for international trade. Similarly, the inevitable competition for capital and skilled manpower between industrialization and other means of poverty reduction has been aggravated by reliance since 1960 entirely on domestic resources.  - ii - 7. The Chinese response to this dilemma has been to approach the two objectives in two different ways. Following an initial phase of institutional change and prope-ty redistribution, poverty redtiction - mainlv through rural development and the provision of basic social services - has been based largely on local resources and initiative, with a strong emphasis on economy and technical improvisation. Industrialization, by contrast, has been based mainly on a massive infusion of centrally mobilized resources, with less concern for cost effectiveness, and using technology largely descended from Soviet designs of the 1950s. 8. Tension between these two approaches has contributed to sharp policy oscillations, as has a continuing debate on the role of political criteria in economic decisions and on the most appropriate degree of centralization. Up to 1957, economic criteria predominated and centralization increased. *The Great Leap Forward (1958-60), however, was an attempt to accelerate economic advance through political will and local initiative. Its unfortunate effects led to a revival of economic planning and recentralization. But this was soon disrupted by the Cultural Revolution (1966-76), which emphasized egalitarianism and ideology at the expense of economic efficiency. In recent years, economic criteria have again predominated; but efforts to rehabilitate the planning system have been combined with reforms. Growth and Poverty Reduction 9. Notwithstanding these twists and turns, which have engendered some dramatic economic fluctuations, there has been substantial progress toward the two main objectives. Industrialization has been very rapid, largely as the result of an unusually high rate of investment, virtually all of which has been financed by domestic savings. The share of industry in GDP (around 40%) is currently similar to the average for middle-income developing countries. But because the share of services is much smaller than in other countries, agriculture still accounts for 34% of GDP and over 70% of employment - similar to the average for low-income countries. Around 85% of the population, moreover, lives in rural areas. 10. Although a phenomenally successful effort during the past decade to control the birth rate had reduced population growth by 1980 to only 1.2% p.a., over the whole period 1949-79 the population expanded at much the same rate (a little under 2% p.a.) as in other developing countries. But despite this, and despite the large weight of a tightly constrained agricultural sector, rapid expansion of industrial output has caused national income per person to grow fairly fast. With adjustments for international comparability, per capita GNP appears to have grown at an annual rate of 2.0-2.5% in 1957-77 and (because of a spurt in the last two years) 2.5-3.0% in 1957-79. Even the former rate is significantly above the average for other low-income developing countries (1.6% in 1960-78) - though even the latter is well below the average for middle-income developing countries (3.7%), and has not been high enough to pull China out of the low-income group. 11. Because the system has been very effective at mobilizing domestic savings (at 1970 prices, the marginal saving rate in 1957-79 was over 40%), consumption has grown significantly slower than income. In real terms,  - iii - per capita consumption is estimated to have risen at an annual rate of about 1.9% in 1957-79, but (again because of a spurt in the last two years) at only about 1.3% in 1957-77 - barely above the average for other low-income countries (1.2% in 1960-78). 12. Because of the absence of individual income from property, the income share of richer groups in China is small. Moreover, unlike most other developing countries, where extreme poverty and considerable affluence often occur side-by-side, China is composed of communities within which there is comparatively little inequality. The income share of poorer groups, however, is not particularly large: this is partly because urban incomes are on average more than double rural incomes; but mainly because rural incomes, despite collective ownership of land and capital, are themselves quite unequally dis- tributed (the share of the poorest 40% of rural people is below that of the richest 10%). This rural inequality, which may have increased over the past two decades, is primarily due to differences between communities in the quan- tity (per capita), quality and location of land. Poverty thus persists in some areas. 13. Nonetheless, and despite slow growth of the average level of consump- tion, China's most remarkable achievement during the past three decades has been to make low-income groups far better off in terms of basic needs than their counterparts in most other poor countries. They all have work; their food supply is guaranteed through a mixture of state rationing and collective self-insurance; most of their children are not only at school, but being comparatively well taught; and the great majority have access to basic health care and family planning services. Life expectancy - whose dependence on many other economic and social variables makes it probably the best single indicator of the extent of real poverty in a country - is (at 64 years)/1 outstandingly high for a country at China's per capita income level. Agricultural Progress and Problems 14. Gross agricultural output grew in real terms at 2.1% p.a. in 1957-77, but at over 6% in 1977-80 (reflecting good weather in 1978 and 1979, a sharp expansion of fertilizer use, and improved economic incentives). The long-term trend rate thus appears to have been 2.5-3.0% p.a., with net output growing somewhat more slowly. Foodgrain output has grown more slowly than total agricultural output, and even in 1980 was on a per capita basis only 7% higher than in 1957. 15. This slow growth of agricultural production in relation to population nonetheless represents a considerable achievement, given the lack of scope for expanding the cultivated area. Despite the initially high level of develop- ment, the rate of multiple cropping has been increased to an average of 1.5, and the trend growth in yields per cropped hectare has been clearly higher than in other developing countries. This, and increased stability of yields in the face of weather changes, has been obtained by refinement of traditional labor-intensive cultivation techniques; by extensive irrigation (45% of the land is now irrigated), flood control and land improvement, much of which has /1 The official Chinese estimate for 1979 is 68 years. See Table 3.23 (page 68) for an explanation of the adjustment made by the mission.  - iv - been done with commune labor; by improvement of seed varieties; and, more recently, by increased use of machinery and chemical fertilizer. 16. The institutional framework in agriculture is basically sound. But from 1966 to 1976, productivity growth was retarded by misguided application of the "grain first" policy, by excessive higher-level intervention in agricul- tural production decisions, and by political constraints on the cultivation of private plots. Relaxation of these policies has contributed to the agricultural resurgence over the past few years. So have rises in agricultural prices (though, despite a marked improvement over the past three decades, agricultural prices remain lower relative to industrial prices than in most other developing countries). The main remaining problems are technical. Fertilizer supplies are unbalanced in nutrient content, and in some places there is serious erosion, siltation or salinity. Agricultural research capacity has also lagged during the past decade, which is a particularly serious handicap since future progress will depend mainly not on greater supplies of modern inputs but on adaptation and diffusion of new seed varieties, and on more careful and balanced use of other inputs. 17. Partly because rural to urban migration is restricted, the agricul- tural labor force has been increasing by about 2% p.a., and rural per capita incomes have risen relatively slowly. Between 1957 and 1977, net output per worker dropped by 12%: despite improved agricultural terms of trade, reduced agricultural taxes, and expansion of commune and brigade industry, rural per capita incomes must have increased very little. In 1978 and 1979, there was a very rapid increase in agricultural production and rural incomes. Even so, for the whole period 1957-79, the growth rate of rural per capita income (1.6% p.a.) was well below that of urban per capita income (2.9% p.a.). Industrial and Infrastructural Development 18. Industry - including mining and energy - has been the leading sector. Its net output grew in real terms at around 10% p.a. in 1957-79, and is now on a per capita basis (at Chinese prices and official exchange rates) close to three times the average for other low-income countries, though only slightly over a quarter of the average for middle-income countries. Special efforts have been made to spread manufacturing into remote regions and rural areas, with much reliance on small plants and older techniques; and in the energy sector, whose technology is generally outmoded, China has developed a techno- logical lead in biogas and small-scale hydropower. 19. Almost the entire range of modern industries has been built up, but with particular emphasis on those making capital equipment. Thus although in many respects China's industrial structure is similar to other developing countries (the share of textiles, for instance, is quite close to that of India), the share of machinery and metal products is not much smaller than in the industrialized market economies - which is particularly striking in view of the low level of China's consumer durables production. As a result, China is now largely self-sufficient in capital goods (less than 10% are imported): this has been the result of deliberate policy; but it has contributed to isolation from the international mainstream of technological advance. 20. Despite this strong bias toward heavy industry, per capita avail- ability of manufactured consumer goods has also expanded rapidly - at 7% p.a. in 1952-79. Production of cotton cloth, the largest single item, grew at  only 2% per capita p.a.; but the output of such things as bicycles, sewing machines, wrist watches, radios and cameras has greatly increased. Indeed, during 1957-77, when food availability increased very little, most of the increase in private consumption consisted of manufactured goods. 21. Productivity growth has been less impressive. Good progress was made in the 1950s: but since 1957, industrial output growth has been achieved mainly by increasing the quantity of inputs (capital, labor and materials), rather than by increasing the efficiency with which they are used. Moreover, the current level of efficiency in converting inputs into output is on average low. In addition, there are serious problems of product quality (the volume of useable output may well have grown more slowly than the production statistics suggest); the design of many industrial products is outdated; and the balance of capacity within and between subsectors is inappropriate to the present and likely future pattern of demand. 22. One increasingly important area in which Chinese industry is strik- ingly inefficient is its use of energy. Industry accounts for over 70% of a total of commercial energy use that on a per capita basis is nearly four times the average for other low-income countries. Energy consumption per dollar of GNP in China is about three times the average both for other developing and for industrialized market economies. 23. The low level of efficiency in Chinese industry is partly the result of technological isolation. But it is also a reflection of weaknesses in planning and in the economic system - in particular, inadequate contact between producers and users, and insufficient incentive for producers to use scarce resources economically or to introduce technical innovations. 24. In parallel with industry, the transport system has been greatly enlarged in the past three decades, mainly through building up a nationwide railway network oriented primarily toward freight - especially bulk commodities such as coal and steel. The resulting system is strikingly efficient in terms of traffic density and turnaround time, though handicapped by steam traction and much short-haul traffic (which in other countries would go by road). Inland water transport, important for centuries, has also been extended and modernized. Roads have been neglected: the network is of very low density and quality, especially in rural areas; and the vehicle fleet is small and of obsolete design. Human energy continues to be an important source of motive power. Adjustment and Reform 25. Since 1977 there has been intense discussion within China concerning both the ends and the means of economic development. Though partly the result of political change, the debate has been fuelled by some important underlying economic considerations. Future growth will inevitably depend mainly on improving the efficiency of resource use, rather than on (as in the past) massive mobilization of resources and fundamental institutional change. The benefits of technological isolation as a stimulus to improvisation have been overtaken by its costs in terms of backwardness and bottlenecks. And the remarkable progress made in industrialization and in meeting basic needs has  - vi - not been matched by - and has created a demand for - a commensurately rapid rise in general living standards. 26. Although its precise form and direction are still the subject of conflicting opinions and pressures, there is a general consensus in China on the need for change. This has found expression in the past two or three years in many policy innovations. Some of these have been successful. But others have had less satisfactory - or unexpected - results. Thus although change must continue, a difficult period of transition lies ahead. A nation that has spent three decades pursuing a particular set of goals with parti- cular instruments will inevitably find it hard to shift to a path that is not only new for China, but has been successfully trodden by few, if any, other countries. Progress of Reform 27. One focus of the debate has been criticism of the economic system. Its record in mobilizing physical and human resources, and in reducing serious poverty, is outstandingly good. But the state economy is inefficient both in converting inputs into output and in matching supply with demand. Both problems have been aggravated in China by the virtual absence of medium-term planning since 1958, by technical weaknesses in annual planning and project appraisal, by the difficulty of achieving an appropriate balance of responsi- bilities between central and local government, and by prolonged inattention to such economic instruments as prices and loans - all of which have been partly the result of political turmoil. The commune economy, though fundamentally an efficient system, has been periodically handicapped by ill-considered instruc- tions from above and by dilution of production team autonomy in production and income distribution decisions. 28. These shortcomings have prompted a set of reforms aimed at providing lower-level units with more freedom of maneuver, stronger incentives to seek efficiency and serve the needs of consumers, and better signals. Since 1980, a formal revenue-sharing system has given provincial governments somewhat more incentive and opportunity to increase revenues, reduce waste, and tailor expenditures to local needs. Many state enterprises are now allowed to retain around 10% of their profits, and to use this money to pay bonuses, improve worker amenities, and modernize and expand their capacity. They have also been given a little more control over what they produce; and the scope for private and collective production in urban areas has been enlarged. To supplement and stimulate the state's unified distribution system, the number and variety of commercial channels has been increased, and joint ventures that cut across traditional administrative boundaries are now encouraged. The management of foreign trade - which has been expanding rapidly in the 1970s, after virtual stagnation in the 1960s - has been somewhat decentralized, and a number of initiatives have been taken to increase exports. 29. Linked with the diversification of commerce has been some increase in the freedom of producers and traders to alter product prices. Several moves away from the past practice of providing capital free of charge have also been made: most notably, budget allocations for much fixed and inventory investment are now in the form of interest-bearing loans. But there has been little change in the wage and labor allocation systems.  - vii - 30. In the commune sector, the role of the production team is being enhanced, and the linkages between individual effort and reward are being strengthened. Rural marketing arrangements are being diversified, and emphasis is being placed on exploitation of local comparative advantage and on indirect planning through procurement price adjustments. Future Directions for Reform 31. Though their implementation has not been free of problems (of which more below), these reforms are well focused on important weaknesses of the Chinese system of economic management. Thus far, however, they represent comparatively minor changes in a system that remains highly regulated and not very efficient. The ultimate destination of reform cannot possibly be settled at present. But there are four (interlinked) areas in which further reform deserves serious consideration. 32. The Price System. Partly because they have been used largely to generate government revenue, prices at present reflect neither relative costs nor relative scarcities. This has been made more of a problem by the recent reforms, since arbitrary prices are likely to lead profit-motivated enterprises and production teams to make socially suboptimal production and investment decisions, and in particular to waste scarce inputs and fail to produce a sufficient amount of scarce outputs. Provincial governments, with their newly increased interest in expanding profitable enterprises and closing those that operate at a loss, may also be influenced by wrong prices away from social cost effectiveness and the matching of supply with demand. But early decontrol of most prices, letting the pattern of rises and falls indicate scarcities and surpluses, would be undesirable, both because the resulting pattern of windfall gains and losses would partly reflect the many other rigidities in the system, and because rises in the prices of basic consumer goods could undermine a major strength of the Chinese system by reducing the living standards of poorer groups. 33. The alternative solution is to rehabilitate the old system through administrative changes in prices to bring them more into line with costs or underlying scarcities, as has already been done for some products. But this could not be done easily or quickly: the task would be not only vast, but greatly complicated by interdependence between prices, by the desirability of allowing higher profit rates on commodities in short supply and lower profit rates on commodities in surplus, and by the need to devise criteria other than the cost of production for pricing natural resources. Moreover, closer align- ment of prices with costs (however accomplished) could result in a reduction of industrial and commercial profits, and would probably have to be accompanied by reform of the tax system to maintain state revenues. In addition, the "administrative" approach to price reform could itself face political objec- tions because of price increases and redistribution of financial resources among ministries, localities and other units. 34. Price reform, by whatever means, is thus going to have to be a gradual process. But because it is crucial to the success of other reforms, and will indeed limit their pace, it cannot be neglected. The best approach to begin with may be a mixture of decontrol and change through administrative  - viii - means - for example, deregulating many producer goods prices, while retaining control of most consumer goods prices - but in any event giving priority to rectifying the most serious anomalies (e.g. the prices of energy and raw materials). In agriculture, too, a continuing mixture of direct planning and greater use of the price mechanism may be best, since regional price differ- ences at present do not realistically reflect marketing and transportation costs, and since there has been insufficient opportunity as yet to measure the production response to prices. Both within and outside agriculture, more use could advantageously be made of two-tier pricing, which can provide substantial incentives at the margin with only a moderate impact on the distribution of income (and government revenues). In addition, although the prices used in actual transactions can be changed only slowly, the accounting (or shadow) prices used in production and investment decisions could and should be brought more rapidly into line with economic realities. 35. Investment Decisions. Although some decentralization of investment decisions to enterprises is a necessary concomitant of allowing more autonomy in production decisions, making retained profits the major source of enterprise investment funds would have serious disadvantages: current profits are an imperfect guide to the social returns on new investment, especially in China, where arbitrary prices generate an erratic pattern of profits. A possible alternative (especially for light industry and investments in modernization, product improvement and energy saving) may be to delegate a larger role to banks and investment companies, which could support the investment of communes and urban collectives, as well as channelling retained profits from state enterprises with low prospective internal rates of return toward better invest- ment opportunities elsewhere. 36. Financial intermediaries, and indeed enterprises themselves, could and should appraise investment projects using shadow prices (established by central or local planners) for key inputs and outputs such as capital, labor, energy and cement. More generally, to increase the care with which investment projects are selected and implemented, charges for the use of capital should be extended, and the interest rate charged should be raised above that on long-term savings deposits. In addition, to combat the present tendency for localities and enterprises to enlarge their claims on central resources by starting as many projects as possible, such units should be made to bear a larger share of the costs from their own resources, and subjected to stiff financial penalties in the event of delays and cost overruns. 37. Especially in economic and social infrastructure and in heavy industry, most investment resources in China, as in many other countries, will continue to be centrally allocated. It is thus essential to improve the system of allocating investment funds, including the technical quality of project appraisal in the planning agencies. Without price reform, this will require extensive use of shadow pricing. It will also require better analysis of the interaction of major investment projects, which can be done only in the sort of medium-term planning framework that is currently lacking in China. 38. Foreign Trade. Institutional changes could contribute to securing the benefits of rapid export and import growth. Exporters, especially of  - ix - manufactures, should be given greater freedom to import materials and components where domestic substitutes are scarce or of poor quality; and administrative procedures should be streamlined. Most importantly, Chinese producers should be allowed to establish sustained and direct contact with (actual and potential) foreign buyers. Import allocation procedures also need reform, both to give economic criteria a greater role and to make the criteria in different sectors more uniform. (Imports of machinery and equipment should obviously also be based on better investment decisions.) 39. More generally, better choices are needed in all sectors between imports and domestic production, and between exports and domestic sales. In the longer run, individual producers and consumers should be given greater freedom to make export and import decisions - on the basis of rational prices. In the short to medium run, prior to price reform, the planners will also need to undertake cost-benefit analysis of foreign trade options using shadow prices. In both cases, it will be necessary to address the difficult issue of the appropriate relationship between domestic and world prices in a country of China's size. 40. Labor Allocation and Migration. The present system of allocating manpower and restricting population movement has important economic and social advantages, among which is the reduction of unemployment (and its attendant poverty) to very low levels. Thus any modifications should be gradual, selec- tive, and carefully controlled. At the same time, it should be recognized that the present system also has important disadvantages, and that limited changes in it could be very beneficial. 41. First, the labor allocation system causes inefficiency in the use of manpower, the country's most valuable resource: thus the recently increased freedom for technical and skilled manpower to transfer from one organization to another should be extended. Second, most of the poorest people in China are in areas whose soil and water conditions are very adverse to agriculture, and whose remoteness gravely handicaps the development of commune industry. In some of these areas, natural obstacles to income growth are not insurmount- able, but in many the high cost of development would make it cheaper (even taking the cost of urban or other infrastructure into account) to increase people's incomes by allowing some of them to move away, either to a city or to newly developed agricultural land. Progress of Adjustment 42. It is now felt in China that too low a priority was given in the past to raising living standards, and in particular that both the overall investment rate and the share of heavy industry in production and investment have been too high. The Government has accordingly taken steps to raise the share of consumption in aggregate demand and the share of consumer goods in aggregate production. It planned to reduce the share of investment in budget expenditures, and to spend more on housing, education, health, agriculture and light industry. Urban workers received promotions and bonuses which, in conjunction with employment creation, raised the wage bill between 1977 and 1980 by about 50%. Agricultural procurement prices were raised by an average of 36% between 1977 and 1980; this raise was only partly passed on to urban  consumers. Agriculture and light industry have been favored in the allocation of materials, fuel and power, credit and foreign exchange. 43. In important respects, as noted earlier, these measures achieved their objectives. In the three years from 1977 to 1980, in real terms, agri- cultural output rose by 22%, light industrial output by 44% (much more than heavy industry's 26%), and total net material product by 28%. Real consumption per capita increased between 1977 and 1979 by over 17%, with a considerable further increase between 1979 and 1980. 44. In other respects, the measures were less successful. The Government miscalculated their effects on the budget and on the balance between aggregate supply and demand, partly because it failed to achieve the planned reductions in investment (both within and outside the budget). There were large unplanned budget deficits in 1979 and 1980, coupled with strong inflationary pressure that was only partly suppressed by the price control system. 45. This led in early 1981 to an emphasis on further adjustment and economic stabilization. Price controls have been stiffened. On the demand side, the Government proposes to ease the pressure on resources by slashing state capital construction expenditure from around Y 50 billion in 1980 to Y 30 billion in 1981. Efforts are also being made to ease some critical con- straints on expansion of domestic production - most notably energy and agricul- tural raw materials for industry. Inputs in short supply are to be channelled to the most efficient plants, and the least efficient are to be closed down, while the cuts in industrial investment are to be focused not only on heavy industry (with the exception of energy and building materials), but also on projects that would aggravate existing shortages of energy and materials. 46. Although only limited information is available concerning the current financial situation and the Government-s course of action, some of the proposed measures could have important disadvantages - even if it is accepted that the alternative of a temporary cutback in consumption would be politically infeasi- ble. Thus, while substantial cuts in the existing investment program are badly needed (especially to increase the Government's room for economic maneuver in the medium term), a 40% reduction within a year may not be attainable. Even if attained, it could involve major costs in terms of the idling of resources and labor for which there is no immediate alternative use. In addition, since these cuts are apparently not being made in the context of an overall medium- term investment program, the costs in terms of future capacity constraints on production growth in particular sectors could be very great. 47. For these reasons, a less costly alternative (or at least a com- plement) to drastically cutting investment and restraining the output of useful commodities because certain inputs are in short supply might be to substantially increase imports of raw materials such as cotton, petroleum products, timber and metals. Larger imports of finished goods could also contribute to easing inflationary pressures. The Government is in fact apparently contemplating a modest rise in the trade deficit (through a reduc- tion of export growth). But the large unused lines of foreign credit and negligible outstanding debt could permit a much more substantial short-term inflow of foreign resources. Such a purchase of (in effect) time for reform and adjustment could be well worth its cost in interest charges.  - xi - Reform, Adjustment and Planning 48. The current problems underscore the urgent need to restore and improve every aspect of economic policy making - short-term demand management, project appraisal, foreign trade strategy, medium-term investment planning, and the programming of system reform. 49. Reform versus Adjustment. In two respects, the recent reforms have made macroeconomic adjustment more difficult: greater freedom in price setting has made it harder to suppress inflation; and greater financial autonomy for production units and local governments has made it harder to achieve the desired reduction and redirection of investment. The Government's response has been to reimpose more central control of investment, public finance and prices. 50. But much of the apparent conflict between reform and adjustment is the result of trying to reform part of the economic system without addressing its other defects. Material incentives have been offered and greater autonomy given to peasants, workers and managers, while price reform - correction of the signals to which they are responding - has had to be much slower. Consi- derable funds have been put under the control of enterprises, communes, and local governments: but their use for socially desirable investment has been impeded by misleading price (and hence profitability) signals, by inadequate financial institutions, and by the absence of a national long-term plan. 51. Thus the appropriate response to the present problems may be increased attention to designing a balanced and integrated program of reforms for the next few years. This need not aim at more than a modest interim stage of reform. Nor need it imply that reform should be implemented quickly, which in fact seems inadvisable given the present structural imbalances, gross price distortions and weaknesses of financial institutions and instruments. But better account should be taken of the linkages between different aspects of reform, and of the need to progress on different fronts at a mutually consistent pace and in an appropriate sequence. It is also important to recognize that the current effort to regain central control of investment and prices could go too far: experience in both China and other countries suggests that the central planner is always "partially ignorant" and that attempts to plan everything directly and rigidly from above can result in gross inefficiency and sometimes even a breakdown of the system. 52. Finally, it should be emphasized that important complementarities exist between adjustment and reform. On the one hand, macroeconomic stabili- zation and improvement of structural balance would greatly facilitate the smooth implementation of reform. On the other hand, the increases in economic efficiency to be expected from reform could ease some difficult medium-term tradeoffs and choices. In addition, infrastructure projects apart, the reforms (including the devolution of some investment decisions to enterprises) should facilitate the matching of sectoral supplies and demands. More gener- ally, a rigid system of central controls is much better suited to simple objectives, such as increasing steel or grain production, than to the new and more complex objective of raising living standards, which involves very many commodities and the subjective desires of innumerable households. Allowing consumer preferences to have a direct impact on enterprises' production decisions could thus make a major contribution to achieving the underlying purpose of adjustment.  - xii - 53. Market versus Plan. The future of economic reform in China, however, does not lie simply in an expansion of the role of the market at the expense of the plan. Indeed, without more effective planning of macroeconomic variables and major investment decisions, many of the prospective benefits of reform will be lost. 54. The most fundamental need is for medium to long term economy-wide planning. Efforts to overcome immediate obstacles, without anticipating future obstacles, will lead to no more than a slow and uncertain advance toward long-term goals. It is thus necessary to make a plan that incorporates consistent and realistic decisions in several interrelated areas: balance between demand and supply, both in aggregate and in each sector, and allowing for exports and imports; balance between present and future consumption, as expressed in the aggregate investment rate; sectoral allocation of investment, taking account of indirect linkages between sectors; balance between public consumption (some of which is investment in human resources) and private consumption; and distribution of private consumption both between urban and rural households and between households at different income levels. 55. To draw up a plan of this kind, because it forces explicit choices, is always politically hard, but not technically too difficult. The principal technical (and indeed some of the political) problems arise in implementation, especially because of the size and unpredictability of the agricultural sector and the difficulty of forecasting other important variables. Part of the solution may lie in a "rolling" plan, that covers the coming five years but is annually or biennially revised in the light of actual developments. But what is chiefly necessary is to strengthen the planning process itself (both technically and politically), so that sound decisions can be quickly made and implemented when circumstances warrant a change in direction. This can be facilitated by close integration between the planning and budgetary processes. 56. Better planning, both economy-wide and sectoral, will require more and better training of planners, especially in modern empirical planning techniques. It will also require improvement of the statistical system. In addition to repairing past damage, there should be greater use of sample surveys, more information should be collected on costs and consumer expendi- tures, and relatively more resources should go into analyzing and presenting data in ways useful to economic planners. Wider dissemination of statistics could also contribute to constructive economic research and debate, and could help enterprises and communes to exercise their increased autonomy wisely. Prospects and Options in the 1980s 57. The need for better planning is especially urgent because the Government's drive to improve living standards will in the coming decade be subject to a tight set of interlocking constraints. Some of these are of long standing - agricultural land, foreign exchange, trained manpower. Others are more recent - domestic energy production, and financial resources for new investments (which are being squeezed between the Government's desire to reduce the saving rate and the claims of an enormous existing investment  - xiii - program). In many respects, however, the future looks promising: population growth is slow; better planning and system reform could substantially increase efficiency; and access to foreign markets, technology and capital is much improved. The challenge is therefore to harness this promise to ease the constraints on growth. Population and Human Resources 58. Largely because it is already very low, the birth rate is likely from now on to fall only gradually. But if the vigorous birth planning campaign is continued, population growth from 1980 to 2000 can probably be maintained at its currently low level of 1.2% per year. This will ease pressure on foodgrain supplies; it will be associated with a decline in the relative size of the school-age population, which will permit improvements in the quality and coverage of education; and in the 1990s, it could cause the absolute size of the agricultural population to decline, which would widen the range of rural development options. 59. In the 1980s, however, the working-age population will continue to grow at nearly 2% per year. The need to provide a commensurate volume of additional productive employment makes relaxation of the constraints on growth more urgent, and reduction of the investment rate less attractive. In parti- cular sectors, it might also conflict with the need to increase efficiency: but this problem could be eased by allocating most new entrants to faster growing sectors, by increased intersectoral labor mobility, by continued use of labor-intensive techniques in both agriculture and industry, and by focus- ing the drive for greater efficiency on energy, materials and capital. 60. In health and nutrition, the current level of achievements and fiscal constraints together dictate a selective approach in the next decade. Some general improvements in the health care system could be effected at low cost; but the most urgent need is to consolidate the gains that have already been made, and to extend some state support to commune and brigade-level health posts in the poorest rural areas (both for reasons of equity and to strengthen the birth planning program). In nutrition, efforts should likewise be concentrated on bringing the poorest groups closer to the average - partly through increasing their incomes. 61. In education, the highest priority is to repair the damage done by earlier neglect and political upheavals to the supply of high and middle-level technical manpower. In 1979, only 0.5% of the labor force had a higher education, and only 0.9% a technical or vocational education; the shortages are most conspicuous in accountancy, economics, statistics and management science. The current university enrollment rate is one quarter of the average for other developing countries, the technical and vocational school enrollment rate one half. Many teachers in advanced education are underqualified, the curricula are outdated, and scientific equipment is scarce. 62. The Government accordingly plans to substantially increase university enrollment by 1990, as well as to improve its quality. This should be supple- mented by rapid expansion of the already impressively developed system of nonformal tertiary education, with emphasis on upgrading the managerial and  - xiv - technical skills of those already working in agriculture, industry and indeed education itself. The Government also proposes major expansion of technical and vocational schools: but this will require improvements in curricula and in linkages with prospective employers, and will be slowed by a shortage of qualified teachers. Planned improvements in the quality of primary and secondary schooling are to some extent necessary for the expansion of advanced education. But both they and planned increases in primary and secondary enrollment will, for financial reasons, probably have to be stretched over a longer period than is currently envisaged. Moreover, the planned expansion of advanced education itself may not be financially viable unless advantage is taken of the substantial scope for cutting unit costs. Agriculture 63. The problems facing agriculture in the 1980s are similar to those in the past. On the demand side, foodgrain production and food security will continue to require high priority, especially because the food intake of a substantial minority of the population remains barely adequate. But competition for land will be sharpened by the new emphasis on raising living standards, which will require relatively greater supplies of both higher quality foods and agricultural raw materials for light industry. Population will be growing more slowly; but this will be partly offset by a rise in the proportion of adults. 64. As regards supply, the amount of land per worker has shrunk, and some of the factors that have raised yields remarkably rapidly in the past are unlikely to help so much in the future. The rate of expansion of the irrigated area will be slower; there is less scope for switching from low-yielding to high-yielding crops; and tight energy supplies will limit the rate of increase in the use of chemical fertilizer and other agricultural chemicals. Moreover, although there is no shortage of machinery, there are only limited opportunities for using it to increase yields rather than displace labor (although the latter might be desirable where working hours are currently very long). 65. On the positive side, however, substantial gains will probably be realized through improved policies and management. Especially important is the Government's present emphasis on stronger incentives and more producer autonomy, on greater specialization of output mix in line with local comparative advantage, and on agricultural research. Similarly, the effectiveness (includ- ing the nutrient balance) of the large amounts of chemical fertilizer that are now being applied could be substantially improved through local fertilizer trials and soil analysis, while upgrading of older irrigation systems and drainage programs in areas of salinity could also significantly increase production. The scope for improving average yields in maize and other coarse grains seems considerable, while average wheat yields (considering that the crop is largely irrigated) are still moderate; and for most crops, average yields could be raised appreciably by advances in the technically more backward parts of the country. 66. Thus output of grain could grow in the 1980s at 2.0-2.5% per year. Even so, the foodgrain balance will remain precarious: with output growth at  - xv - 2.3%, and imports maintained at their 1980 level, the margin for raising foodgrain consumption standards above their 1980 level in 1990 would be under 7%. Total agricultural output should grow somewhat faster, probably at around 3% p.a. - though this will depend on rapid expansion and modernization in the other sectors of the economy that provide agriculture with inputs and technical knowledge, as well as a dynamic source of demand. 67. With the rural population growing by at least 1.0% per year, this agricultural output growth rate would in itself imply continued slow growth of rural incomes. As in the past, however, much faster growth of commune and brigade enterprise output is likely to boost rural income growth by perhaps another percentage point - although growth in sectors where small-scale use of energy and raw materials is inefficient will (and should) be retarded by the emerging nationwide shortages of these inputs. In addition, also as in the past, some of the faster growth of urban labor productivity could (and should) be transferred to rural people by increasing the relative prices of agricul- tural products: this could indeed further stimulate agricultural production; but it will be limited by the need to increase urban real incomes and to avoid further strain on the budget. 68. Measures to increase agricultural efficiency, growth of commune industry, and even-(since many of them are net purchasers of food) increased agricultural prices will do least for the poorest rural groups, whose rela- tive incomes could decline. To counteract this, increased state support for poor areas is needed to promote the development of agriculture and nonagricul- tural activities, and to provide more food and better social services. This, like general increases in agricultural prices, could be financed in part by progressive taxation of agricultural income or land. In addition, the rural poor might benefit from long-term regional development plans: these could address the special problems of particular localities, focus money and manpower on them, and promote coordination between different government agencies. Energy Production 69. The outlook for domestic energy production has recently deteriorated. Oil output peaked in 1979 at 106 million tons and is likely to fall to about 100 million tons in 1985, with little prospect of an increase in the latter half of the decade. To prevent an even larger decline, immediate steps should be taken to improve reservoir engineering in existing fields and the effective- ness of exploration. Coal output (which contributes about 70% of total commercial energy) also declined in 1980, to 620 million tons. Although this decline was partly the result of a deliberate diversion of resources to seam development, and although new mines are under construction, output (and/or coal transport capacity) is unlikely to exceed 730 million tons in 1985 and about 900 million tons in 1990, even if high priority is given to the sector. 70. Total primary energy production in the 1980s will thus not grow much faster than about 2.8% per year, with the growth rate in 1980-85 unlikely to exceed 2.2% - less than one quarter of the 1952-80 growth rate. Electricity production, given existing capacity and projects under way, cannot grow during 1980-85 at more than 4-5% p.a., around one third of the 1952-80 rate. In the  - xvi - latter half of the 1980s, there is more room for maneuver, especially in electricity generation. But the energy sector is already absorbing over 40% of industrial investment; and the capital outlays that would be required in the first half of the decade to markedly accelerate the growth of energy output in the second half, even if feasible in terms of specialized manpower and equipment, would be so large as to crowd out vital investment in other sectors. 71. Prospects for economic growth in the 1980s thus depend critically on reducing energy use per unit of output. This is doubly important in the case of oil, whose availability for use as an industrial raw material will also fundamentally influence growth prospects. With only moderate energy saving (and limited switching from oil to coal) GDP growth in the 1980s could well be no more than 4.5% p.a. - as compared with 6% in the 1970s - and oil exports of 17 million tons in 1980 would turn into oil imports of 17 million tons by 1990. Even this, it should be emphasized, would imply an elasticity of energy consumption-to-GDP growth of 0.75, substantially smaller than in the past. 72. High energy saving and switching (oil consumption 15-16% lower, and coal consumption 12-13% lower, than with moderate savings) would substantially enlarge the range of options available. For example, with GDP growth of about 4.5% p.a., oil imports in 1990 could probably be avoided. Alternatively, GDP growth could be 5.5% with oil imports in 1990 of about 14 million tons. Industrial Energy Conservation 73. Because agriculture, commerce, households and transport are lesser users of energy, with relatively limited scope for conservation and interfuel substitution, the outcome will turn mainly on what is achieved by industry (including the energy sector itself). Altering the balance between heavy and light industry in favor of the latter has already contributed to a significant reduction in energy use, and will continue to do so until the middle of the decade. Thereafter, heavy industry cannot grow much slower than light industry, since it produces most of the inputs (capital and current) for light industry, agriculture and the service sectors. 74. Of greater and more enduring importance, therefore, will be cuts in energy use, and substitution of coal for oil, within industrial subsectors. In this regard, not much can be expected from light industry, whose unit energy consumption (after an initial round of economies) may actually need to increase during modernization: the bulk of the large potential for energy saving is in heavy industry, which accounts for about 60% of national commer- cial energy use. 75. Substantial savings could be obtained at negligible cost by minor operational improvements. Further savings, and substitution of coal for oil, could be achieved at moderate cost by limited equipment and technology improve- ments, including the replacement of many industrial boilers. Beyond that, major changes in some processes are called for; and in certain industries (most notably metallurgy), it will be both desirable and feasible to eliminate most small plants.  - xvii - 76. These measures could very substantially reduce energy use per unit of industrial output, at a capital cost far less than that of achieving an equivalent increase in energy supply. But to accomplish this will require thorough advance planning in each of the major subsectors, and the integration of energy conservation with other aspects of industrial restructuring and modernization. It will also require reform of energy allocation procedures. And it would be greatly facilitated by changes in energy prices (especially a large rise in the price of fuel oil), in conjunction with further reforms to increase the incentive effect of prices on users. Other Industrial Issues 77. Industrial expansion in the next few years may be constrained not only by energy, but also by raw materials, foreign exchange, and finance for new investments. But in a broader sense, and over the longer term, the performance of the industrial sector - in economizing on energy, materials and capital, in earning foreign exchange, and in technological innovation - will itself largely determine the extent to which the main constraints on economic growth can be eased. 78. Expansion of light industry is already being held back by shortages of raw materials - industrial (petrochemicals and appropriate metals) as well as agricultural. These could be eased by restructuring the metallurgical industry and expanding the petrochemical-based industries, while substituting coal for oil to supply the needed feedstock. But the domestic supply of agri- cultural raw materials and oil will remain tightly constrained. Increased imports are thus both necessary and desirable. The situation could also be improved by further reforms to give stronger financial incentives to economize on material use, by eliminating inefficient plants, and by shifts in industrial structure toward subsectors that are less raw material-intensive (most notably electronics). 79. Economy in the use of industrial capital will be essential if sus- tained rapid growth is to be reconciled with a reduced aggregate investment rate and higher investment in nonproductive sectors. As with energy, a sig- nificant reduction in the use of capital per unit of output can be expected from the shift in emphasis from heavy to light industry. But there will also need to be substantial reductions within subsectors, and in this regard exhor- tation and administrative regulations are likely to prove less effective than the sorts of reform measures discussed earlier. 80. Given the shortage of foreign exchange, and the knowledge to be gained from exposure to world markets, expansion of manufactured exports must have high priority. The outlook is promising, given the abundance of skilled low-wage labor and the enormous potential for economies of scale. At present, moreover, China's manufactured exports are roughly 3% of gross manufacturing output; growth at even 15% in the 1980s would raise this share to only 7% in 1990. Furthermore, China-s share of total developing country exports of manufactures is currently less than 6%. But at present, three fifths of China's manufactured exports consist of products other than machinery or  - xviii - equipment sold to developing countries or European socialist countries. To achieve rapid growth, China must therefore increase its currently very small share of the richer markets, especially in the OECD. 81. On this basis, the volume of China-s manufactured exports could grow in the 1980s at a rate of about 10% p.a., and quite possibly 15%. In the latter case, the value of manufactured exports in 1990 (in the prices of that year) could be over $60 billion. This would substantially increase China's import capacity, both directly and through easing debt-servicing constraints on external borrowing. 82. Achievement of rapid export growth is contingent on sustained expansion of world economic activity and trade, including no substantial increase in protectionism in the industrialized market economies. But it will also require appropriate policies in China. Various institutional changes (see para. 38) are needed if Chinese manufacturers are to compete successfully in world markets. In addition, improvements need to be made in the design of both consumer and capital goods, whose styling (and to a lesser extent, performance) tends to be deficient or unsatisfactory by international standards. This calls for direct measures to strengthen Chinese design capabilities, and for greater exposure of Chinese designers and manufacturers to foreign pro- cesses, products, tastes and requirements. 83. More generally, the updating of industrial technology can produce major gains in productivity and product quality, both in industry and in the other sectors that use its products. It is being actively pursued in most industrial subsectors. But it could be accelerated and made more cost effec- tive by stronger incentives for innovation, and by improving the quality of decisions on whether, when and how to purchase technology from abroad. Progress in new and rapidly changing technological fields could be assisted also by establishing more enterprises and organizations that cut across the administrative boundaries between industrial ministries. Foreign Borrowing Options 84. Despite a real increase of 40-50% between 1977 and 1980, China's exports - $18 billion in 1980 - remain only 6-7% of GNP. In 1980, energy (mainly oil) accounted for about a quarter of the total, and manufactures for about two-fifths, the remainder being primary (mainly agricultural) products. Oil exports will almost certainly decline in volume, and could disappear by the end of the decade, while slow agricultural growth will restrict primary export expansion to at best 4-5% p.a. Thus manufactured exports will have a critical influence: if they grow at a moderate pace (10% p.a.), total foreign exchange earnings would expand in real terms by about 5% p.a. over the decade; if they grow fast (15% p.a.), total foreign exchange earnings could expand at more than 8% p.a. over the decade, even allowing for the faster growth of domestic oil consumption (and hence faster decline of oil exports) that would be necessary to maintain a high GDP growth rate. 85. The need for imports will be great. Even if energy conservation is successful, substantial imports of other raw materials will be required to maintain a rapid rate of industrial growth. Pressure to increase consumption  - xix - and constraints on agricultural production are unlikely to permit any reduction of food imports. And a well-chosen program of capital goods imports could make a major contribution to modernization and the easing of constraints on growth in many sectors. 86. Faced with these constraints and needs, the Government must decide how much to borrow (or raise by other means) abroad. The report analyzes two possible options: a moderate borrowing scenario, in which the net resource inflow (gross borrowing minus debt service payments) in 1980 prices rises from $1.2 billion in 1980 to $2.7 billion in 1990; and a high borrowing scenario, in which the net inflow reaches $6.8 billion by 1990. These inflows, though large in absolute terms (especially when allowance is made for debt repayments and international inflation), are modest in relation to China's size and world capital flows. The level of debt outstanding in 1990 even in the high borrowing case is less than 6% of the World Bank's projection of the total debt of all developing countries in that year. 87. In deciding among these and similar borrowing options - whose attrac- tiveness will and should be influenced by the terms on which foreign capital is available - the Government must consider the need to keep the ratio of debt service payments to foreign exchange earnings low enough to maintain the confidence of lenders and thus avoid refinancing crises. Several illustrative cases are considered in the report. With moderate borrowing, even if the terms were on average rather hard, moderate export growth would cause the debt service ratio to be about 10% in 1995. With high borrowing on the same hard terms, and only moderate export growth, the debt service ratio would rise to 24% by 1995; but high export growth could reduce it to 14% (and in conjunction with somewhat softer terms, to 10%). These projections all assume that energy conservation is highly successful; if it were not, China's ability to service external debt would be reduced, both because foreign exchange earnings would be less and because a higher proportion of foreign exchange earnings would be preempted by essential imports such as oil and grain. 88. Provided that the debt service ratio can be kept within manageable bounds, the Government's borrowing decisions should depend on the value of the additional resources obtained in relation to the real cost of borrowing. In the long term, this is essentially a matter of comparing the marginal real return,on domestic investment with the expected real rate of interest on external debt. But in short and medium term situations of disequilibrium and adjustment, such as China is currently experiencing, it may also be necessary to take account of (a) the social or political utility of additional present consumption, if this (temporarily) exceeds the value of marginal investments, (b) the prospective benefits from fuller use of installed capacity, where this would otherwise be constrained by the availability of fuel, materials and spare parts, and (c) the damping effects of increased imports on domestic inflation. All these considerations (as mentioned earlier - para. 47) suggest the desirability of some external borrowing specifically to ease the transi- tional difficulties of the next few years. 89. Within the past year, the government has addressed the relationship between the cost of foreign borrowing and the returns to investment, and has postponed or cancelled import contracts for several large investment projects - some of which were extraordinarily ill prepared, even in engineering terms.  -xx- These cancellations have caused problems with potential suppliers, and financial penalties may have to be paid. Nonetheless, the apparently difficult decisions to cancel ill-prepared projects indicate that the management of foreign trade and capital may in future be based on economic considerations - a change that should be welcomed by potential exporters and lenders to China. 90. Looking further ahead, some key determinants of the optimal level of China's foreign borrowing, including the rate of growth of manufactured exports and the efficiency with which capital and energy are used, ultimately depend on reform of the economic system and improvement of economic management. But foreign borrowing could itself contribute significantly to the greater efficiency that is needed to accelerate growth. Overview 91. China's options for the 1980s are constrained from several directions. But the Government has room for maneuver in two general areas. The first concerns the choice (via investment decisions) between present and future consumption. The second concerns the improvement of efficiency, especially in the use of energy, materials and capital, through better policies and planning, system reform, and exploitation of opportunities for foreign trade, borrowing and technology transfer. 92. The success of policies in the second area will substantially affect the Government's freedom of action in the first area. Using capital more efficiently, for example, would ease the tradeoff between present and future consumption. Energy and material conservation would likewise reduce the amount of foreign borrowing needed to attain any given growth rate. And faster growth would enable more help to be given to the poor without a slower increase in the living standards of other groups. 93. The actual outcome will of course depend not only on the Govern- ment's choices and policies, but also on unpredictable factors such as weather, success in oil prospecting, growth of overseas markets, and the availability of foreign capital on concessionary terms. But the range over which the Govern- ment's actions could affect the outcome is illustrated in the report by two tentative and informal scenarios, each of which may be thought of as corres- ponding to a particular set of policy choices in the areas discussed earlier. In the first (Moderate) case, agricultural policy, energy conservation and other measures to increase efficiency are only moderately successful, and exports and foreign borrowing expand at only a moderate pace. In the second (High) case, agricultural policy and measures to use energy, materials and capital more efficiently are much more successful, and manufactured exports and foreign borrowing expand rapidly. 94. The projected differences between these two cases in terms of output growth are considerable (although both compare quite favorably with the projec- ted growth of other low-income countries). In the first half of the decade, in the Moderate case, the aggregate growth rate would be about 4% p.a., while in the High case it would be 5%. In neither case, however, is the rate as high as that attained in the 1970s, when energy and foreign exchange constraints were less pressing. In the second half of the decade, when these constraints should have eased somewhat, the growth rate in the Moderate case is 5% p.a., while in the High case, at 6%, it equals the rate achieved in the 1970s.  - xxi - 95. Future output growth is of course dependent upon investment. In the projections, in both cases, it has been assumed that the 1980 investment rate is on average more or less maintained throughout the decade, with the necessary cuts in the inherited investment program being offset by increases in new investment. But, despite the urgent need for investment in economic and social infrastructure, as well as for directly productive investment in industry (especially in restructuring and energy conservation), agriculture and services, it might be possible to maintain a lower investment rate. Such a reduction would have little effect on output growth in the first half of the decade. But it could reduce the growth rate in the late 1980s; and if the investment reduction were focused on infrastructure, the adverse effect on the growth rate would be even larger in the 1990s. 96. Clearly, the Government's choice of an investment rate in the 1980s should be determined by the priority it attaches to present as compared with future consumption (though the scope of this choice is constricted by the difficulty of increasing the volume of consumer goods available - either from domestic production or from imports). But, given any particular investment rate, the Government's desire to raise living standards will of course favor the various efficiency-increasing measures that underly the High case. On average over the decade, growth of per capita consumption in the Moderate case is below the rate achieved in the 1970s - though above the 1957-79 trend growth rate. In the High case, with significantly faster growth also of investment, per capita consumption growth in the 1980s averages 4.4%, which is above the rate of growth in the 1970s and more than double the 1957-79 trend. 97. Similarly, the Government's concern for the rural poor may be expected to favor the sorts of measures that underly the High case. With appropriate safeguards, especially as regards employment and consumer prices, and maintenance of the existing food security and social service framework, measures to increase efficiency are unlikely to reduce the real incomes of poor people in absolute terms. They might tend to increase relative inequality: but even this could be offset by well-designed anti-poverty policies; and the resources available to implement such policies would clearly be increased by greater efficiency in production and investment. 98. For China, as for other developing countries, the 1980s will be a difficult period, and one whose problems will be compounded by errors made in the 1960s and early 1970s. But looking further ahead, China's economic pros- pects appear very favorable. The already low population growth rate will slowly decline (probably to under 1% p.a. by 2000), easing the pressure on agricultural land. By 1990, the great majority of new entrants to the labor force will have received some secondary education, and the skilled manpower deficit will have been reduced. Further progress will have been made in tapping China's large energy potential, and in using it more efficiently, while continuation of recent export trends would provide a foreign exchange-earning base large enough to permit greater confidence (and less concern about terms) in the use of foreign capital. Thus if the country's immense wealth of human talent, effort and discipline can be combined with policies that increase the efficiency with which all resources are used, China will be able, within a generation or so, to achieve a tremendous increase in the living standards of its people.   1. THE CHINESE INHERITANCE A. Introduction 1.01 This report represents the first attempt by World Bank staff to study the economic development of the People's Republic of China. The resources devoted to this task, though large relative to the Bank's efforts in other countries, have clearly been very modest in view of the enormous scale and complexity of the task of studying an economy such as China's. Moreover, China today is in the midst of a re-examination of its development priorities and strategy. Even for economists in China, an accurate appraisal of the country's economic performance over the past three decades is still difficult, partly because major gaps remain in the available statistics, especially between the late 1950s and the mid-1970s, and partly because the impact of economic factors is difficult to disentangle from that of political and other factors. 1.02 For these reasons, the report should be seen only as an initial step in gaining a better understanding of China's economic problems and prospects. As an introductory report, it attempts to be as comprehensive as possible and to compare, to the extent feasible, the economic situation and level of development of China with those of other Bank member countries. 1.03 The report comprises a main report and eight annexes. For readers unfamiliar with the country, this first chapter of the main report very briefly outlines China's physical setting, main historical developments and economic heritage, and the situation up to the revolution in 1949./1 The rest of the main report is primarily concerned with the development of China's economy after the early 1950s, when rehabilitation was largely complete and the basic framework of the new economic system had been established. Chapter 2 describes the main features of China's economic system, while Chapters 3 and 4 review the performance of the economy, beginning with the achievements in income growth and poverty reduction, and ending with a more detailed discussion of sectoral development and problems. The final two chapters analyze major development issues, Chapter 5 examining issues relating to the Government's current attempt to reform the economic system and adjust the structure of the economy, while Chapter 6 examines prospects and options for development in the 1980s. /1 The historical review in particular is drawn from a number of sources (mostly the work of foreign scholars), some of which are listed at the end of this chapter.  1.04 Annex A provides a review of China's statistical system, including a brief description of the concepts and methodology used, and contains basic statistical tables. Details of sectoral developments and issues are contained in seven Annexes. Annex B describes the policies and achievements in population control and health improvement. Annex C provides an analysis of developments in agriculture, including progress in output, technology and rural income, and of the evolution of major policies and institutions, as well as a discussion of current problems and future prospects. Annex D examines China's achievements in industry, outlines the organization and structure of the sector, and dis- cusses current constraints on industrial progress. Annex E contains a brief survey of the energy sector, including descriptions of the coal, petroleum and electric power industries, and discussion of possible problem areas. Annex F describes progress in developing the transport sector and examines issues in its future development. Annex G describes and analyzes education and training in formal and nonformal institutions, and reviews the Government's plans for education in the context of several major issues. Annex H describes the institutional framework of the external sector and examines the past trends and patterns of foreign trade and capital flows, and their future prospects. B. The Physical Setting 1.05 China occupies a central geographical position in continental Asia, bordering on virtually all the mainland nations of Asia except those of the Middle East. By land area, China, with 9.6 million square kilometers, is the third largest country in the world, being nearly half the size of the USSR and only slightly smaller than Canada. Northern China suffers from severe cold in the winter while southern China lies in the semitropical and tropical zones, with many provinces lashed by tropical typhoons in the summer. Unlike most other low-income developing countries, most of China is in the temperate zone, though its main population centers are farther south than those of, say, the United States or Western Europe. 1.06 China's large latitudinal span, combined with a complex topography, causes large variations in climatic conditions and thus agricultural potential among the different regions of the country. In fact, more than half of China's land area is accounted for by the largely desolate Qinghai-Tibet plateau, which covers an area of 2.2 million sq km and averages 4,000 meters above sea level, the Yunnan-Guizhou plateaus, and the steppe country and desert of Xinjiang and Nei Monggol (Inner Mongolia). Except for isolated valleys in the highlands of Xizang and a few oases in the deserts, these areas can only support marginal economic activities; they are thus sparsely populated, mostly by minority nationalities whose language and culture are very different from those of the Han nationality who mainly l;ve in the rest of China. Indeed, if China is roughly halved along longitude 103 E (which runs through eastern Sichuan), over 90% of the population is located in the eastern half. 1.07 The eastern half of China is further divided by the Kunlun-Qinling chain of mountains, which runs west to east, at a latitude of approximately 35