China - Long-term development issues and options

OGob 1156 CHIS Long-Terin Development Issues and Options A WORLD BANK COUNTRY ECONOMIC REPORT FILE,XC . rI N I F I" U I     m C:HINA AWorld Bank Country Economic Report  This report is supplemented by six annex volumes published by the World Bank: 1 China: Issues and Prospects in Education 2 China: Agriculture to the Year 2000 3 China: The Energy Sector 4 China: Economic Model and Projections 5 China: Economic Structure in International Perspective 6 China: The Transport Sector In addition, nine background papers, numbered here as they are referred to in the text, have been prepared in connection with the report. They are available as World Bank staff working papers. I The Asian Experience in Rural Nonagricultural Development and Its Relevance for China (Staff Working Paper 7 57) 2 International Experience in Urbanization and Its Relevance for China (Staff Working Paper 758) 3 Alternative International Economic Strategies and Their Relevance for China (Staff Working Paper 759) 4 International Experience in Budgetary Trends during Economic Development and Their Relevance for China (Staff Working Paper 760) 5 Productivity Growth and Technological Change in Chinese Industry (Staff Working Paper 761) 6 Issues in the Technological Development of China's Electronics Sector (Staff Working Paper 762) 7 The Environment for Technological Change in Centrally Planned Economies (Staff Working Paper 718) 8 Managing Technological Development: Lessons from the Newly Industrializing Countries (Staff Working Paper 717) 9 Growth and Structural Change in Large Low-Income Countries (Staff Working Paper 763) These supplementary works may be ordered, by annex or working paper number, from local distributors of World Bank publications and from the World Bank Publications Sales Unit, 1818 H Street, N.W, Washington, D.C. 20433, US.A.  > CH[INA Long-Term Development Issues and Options Tbe report of a mission sent to China by The World Bank Edwin Lim Adrian Wood Cbief of mission Deputy chief of mission Contributing autboars Ian Porter Robert P. Taylor William Byrd Gene Tidrick Timothy King Wouter Tims Gerhard Pohl Publisbedfor The World Bank The Johns Hopkins University Press Baltimore and London  Copyright ' 1985 by The International Bank for Reconstruction and Development/The World Bank 1818 H Street, N.W, Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First hardcover and paperback printing October 1985 The Johns Hopkins University Press Baltimore, Maryland 21218, U.S.A. The World Bank does not accept responsibility for the views expressed herein, which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitation of its boundaries or national affiliation. Library of Congress Cataloging in Publication Data Main entry under title: China, long-term development issues and options. "A World Bank country economic report." 1. China-Economic policy-1976- . 2. China- Social policy. l. Lim, Edwin. II. International Bank for Reconstruction and Development. HC427.92.C46452 1985 338.51 85-22777 ISBN 0-8018-3313-2 ISBN 0-8018-3314-0(pbk.) Cover photograph by Curt S. Carnemark: Family outing at Tiananmen Square, Beijing  Foreword The idea for this study originated during my visit to China in 19 8 3. In Beij- ing, I had the opportunity to meet with Chairman Deng Xiaoping and Pre- mier Zhao Ziyang. Through (discussion with them and with other distin- guished Chinese leaders, I learned a great deal about the Government's perspective on development ond the long-term goals for the country. We talked about the national aim to raise China's annual per capita income to US$800 by the year 2000, and we contemplated some of the exciting possi- bilities and complex questions that China would encounter in the process of reform and modernization. Out of these discussions in Beijing came the agree- ment that the World Bank would undertake a study of some of the key devel- opment issues that China might face in the next twenty years. In particular, this study would examine, in light of international experience, some of the op- tions for addressing these issues. This report summarizes the conclusions of that study. It is based primarily on the findings of an economic mission led by Edwin Lim and Adrian Wood, which visited China in early 1984. It was presented to the Board of Exccutive Directors, which represents the 148 member governments of the World Bank, in May 1985. This report, in my view, is a good example of one of the many ways that the World Bank can assist its member countries. Indeed, China's ambitious at- tempt to modernize and reform its economy will shape the future of not only the Chinese people but also people throughout the world. We hope that this report will be a useful contribution to the debate in China about some of the important issues of economic and social development. A. W. Clausen President The World Bank September 6, 1985  I  Contents SUMMARY AND CONCLUSIONS . ...................................................... I Pattern of Growth .................................... ... ................... I Managing the Economy ............................................................ 8 Social Issues and Policies ............................................................ 16 Overview .... . .......................1............9.......... ... 19 1 GROWTH AND CHANGE ...................................... 21 Objectives ...................................................................... 21 Macroeconomic Chang ............................................................ 22 Microeconomic Change ............................. ............................... 26 Inequality .................................................................. .... 29 2 ILLUSTRATIVE PROJECTIONS .................. .................................. 32 Description of the Model ......................... .................................. 3 2 Three Alternative Projections ..................... ..... 3 3 Growth and Demand .............................................................. 3 6 Production and Investment .................................... 3 8 Employment and Income .............................. ........................... 40 Projections and Predictions .................................... 43 3 AGRICULTURAL PROSPECTS AND POLICIES ................... ............... 44 Production Possibilities ............................................................. 44 Potential Demand-Supply Imbalances .................................................. 45 Changing Food Demand ............................................................ 50 Managing Household Agriculture ..................................................... 5 3 Agricultural Incomes Policy .......................................................... 5 5 4 ENERGY DEVELOPMENT ....................................................... 58 Demand and Supply: Trends and Balances ............................................... 58 Coal Production, Transport, and Utilization ............................................. 60 Oil and Gas . .................................................................... 65 Electric Power . .................................................................... 67 Rural Energy and Biomass ........................................................... 68 Investment, Planning, and Prices ............................................... ...... 69 5 SPATIAL ISSUES . ................................................................... 7 3 Specialization and Trade ........................................... ................ 7 3 Transport, Commerce, and Other Services ............................................ 82 Urban and Rural Development ....................................................... 86 Rural Poverty and Regional Inequality .........9..................................... 91 vii  6 INTERNATIONAL ECONOMIC STRATEGY .......................................... 97 China in the World Economy ........................................................ 97 Foreign Trade Prospects and Policies .............................................. .... 101 External Balance and Finance ..................................... 107 Regional Issues .................. ................................................. 109 7 MANAGING INDUSTRIAL TECHNOLOGY .......................................... 110 Technology in Perspective ................................................... 110 Planning for Technological Development ................................................ 112 The Make or Buy Decision ....... ..................... ... ................. 116 Incentives for Innovation and Diffusion .... ............................................. 118 Obsolescence and Scrapping .. .................................. 121 8 HUMAN DEVELOPMENT .......................................................... 123 Education and Training Issues .. ...................................................... 123 Employment and Productivity ..................... ................... ... 127 Allocating and Motivating Workers ............................. ...... ...... 130 Population Issues beyond the Year 2000 . ............................................... 136 9 MOBILIZING FINANCIAL RESOURCES .............................................. 143 Alternative Sources of Saving ....................................................... 143 Subsidies and Transfers .......................................... .. ............ - - 148 Revenue Needs and Sources .................. 152 Tax Reform ......1........................... 156 10 DEVELOPMENT MANAGEMENT ............................ ............. 160 The State and the Individual ......................................................... 160 The State and Enterprises ........................................................... 164 Investment and Price Reform ........................................................ 171 Economic Planning ................................................................ 177 Overview ............................................................ 181 Tables 1.1 Size Distribution of Industrial Enterprises in Selected Countries ............................... 28 1.2 Rural Income Distribution, 1979-82 .................................,,,,... 29 2.1 Average Annual Growth of National Income, Alternative Projections, 1981-2000 ..... 36 2.2 Composition of Final Demand, Alternative Projections, 1981-2000 .... 36 2. 3 Average Annual Growth of Sectoral Gross Output, Alternative Projections, 1981-2000 ... 38 2.4 Composition of Capital Stock, Alternative Projections, 1981-2000 .39 2.5 Sectoral Composition of the Labor Force, Alternative Projections, 1981-2000 .................... 40 2.6 Sectoral Composition of National Income, Alternative Projections, 1981-2000 ................... 42 4. 1 Energy Supply and Demand, Alternative Projections, 1981-2000 . ............................ . 60 4.2 Share of Solid Fuels in Commercial Energy Use in Selected Countries, 1960, 1980, and 2000 .. . 62 4.3 Estimated Investment Requirements in the Energy Sector, 1986-2000 .......................... 70 5.1 Dispersion of Production Activities among and within Provinces, 1982 .......................... 73 5.2 Gross Output and Profits of State-Owned Industry, by Province and Subsector, 1982 .74 5.3 Industrial Concentration, by Region and Key City, 1982 .................................... 74 5.4 Extent and Composition of Rural Nonagricultural Activities in Selected Countries ................. 79 5.5 Urbanization and Economic Development in Selected Countries .......................... . 87 5.6 Per Capita Income in Urban and Rural Areas, 1982 ..... ......................... .. .... 87 viii  5.7 Distribution of Employment and Population, Alternative Projections, 1981-2000 ................. 89 5.8 Average Annual Growth of Urban and Rural Income, Altern ative Projections, 1981-2000 .... ...... 90 5.9 Urban-Rural Income Disparities, Alternative Projections, 1931-2000 ........................... 90 5.10 Rural and Provincial Poverty, 1982 ..................................................... 92 5.11 Rural Development in Dingxi County (Gansu) and Wuxi County (iangsu), 1983 .................. 92 5.12 Wage Levels, by Province and Type of Unit, 1982 ...... .................................. 94 5.13 State Budget Revenues and Expenditures in Wuxi and Dingxi Counties, 1983 .................... 96 6.1 Total Foreign Trade Ratios, Alternative Projections, 1981-2 300 ............................... 102 6.2 Share of Manufactures in Total Merchandise Exports, 1960 and 1981 ........................... 103 6.3 Sectoral Foreign Trade Ratios, Alternative Projections, 1981-2000 ............................. 104 6.4 Average Annual Growth of Foreign Trade, Alternative Projcctions, 1981-2000 ................... 104 6.5 Structure of Foreign Trade, Alternative Projections, 1981-2000 ............................... 105 6.6 Foreign Trade Balance and Debt, Alternative Projections, 1 5'8 1-2000 ........................... 107 7.1 Index of Total Factor Productivity in State-Owned Industry, 1952-82 ......................... 111 7.2 Sources of Successful Innovations in European Firms ........................................ 118 8.1 Educational Attainment of the Population, by Age and Sex, in Selected Countries ............ .... 124 8.2 Population Growth, Alternative Projections, 1980-2 100 .................................... 137 8.3 Population of Working Age, Alternative Projections, 1980- 2100 ............................. 139 8.4 Population Sixty-Five Years Old or More, Alternative Projeztions, 1980-2100 .................... 139 9.1 Gross Domestic Savings in Selected Countries, 1976-80 .................................... 145 9.2 Subsidies, 1981 ..................................................................... 148 9.3 Subsidies and Transfers as Percentages of Government Revenue in Selected Countries ..... ......... 149 9.4 Subsidies and Transfers, Alternative Projections, 1981-2000 .................................. 151 9.5 Government Expenditures, Alternative Projections, 1981-2000 ............................... 153 9.6 Illustrative Projections for Figure 9.2 .................................................... 155 9.7 Illustrative Projections for Figure 9.3 .................................................... 157 Figures 1.1 Composition of Aggregate Demand in China and Other Developing Countries, 1981 ..... .......... 22 1.2 Structure of Production in China and Other Developing Countries, 1981 ........................ 2 3 1.3 Structure of Employment in China and Other Developing Countries, 1981 ...................... 24 1.4 Enrollment Ratios in Formal Education in China, 1965-83 and Targets for 2000, and in Other Developing Countries, 1965-80 ....................... ............................. 31 2.1 Share of Agriculture in Total Employment in China, Alternative Projections for 1981-2000, and in Other Selected Countries, 1960-82 .............................................. 41 3.1 Crop Exports and Imports, Alternative Projections, 1981-2000 ............................... 48 3.2 Per Capita Food Intake in China, 1981-2000, and in Other Selected Economies, 1960-80 .... ...... 51 3.3 Share of Animal Products in Total Food Intake in China, 1980-2000, and in Other Selected Economies, 1960-80 .............................................................. 52 5.1 Variations in Per Capita Gross Agricultural and Industrial Output, 1982 .. . ....................... 76 5.2 Distribution of Employment, Capital, and Gross Output, Alternative Projections, 1981-2000 .... .... 88 6.1 Exports of Goods and Nonfactor Services in Selected Countries, 1978-82 ....................... 98 6.2 Trade in Goods and Nonfactor Services, 1978-83 ................... ...................... 102 6.3 Direction of External Trade, 1983 ...................................................... 105 6.4 External Balance, 1978-84 .. . .......... .......... 107 7.1 Output and Cost of Production ofthejA 1-1 Sewing Machine, by Enterprise, 1980 ................ I11 8.1 Population, Alternative Projections, 1980-2100 .................... ...................... 137 9.1 Sources and Uses of Funds, 1981 ...... ............. ...... 144 9.2 Income Flows and Taxation, Alternative Projections, 1981-2000 ............................ 154 9.3 Sources and Composition of Saving, Alternative Projections, 1981-2000 ........................ 156 ix  Boxes 1.1 Size and Growth of Enterprises in Market Economies . ....................................... 27 2.1 Wages, Profits, and Prices ................................................ 42 3.1 World Grain Trade, Past and Future ................................................ S0 4.1 Cogeneration for Industry and District Heating . ........................................... 6 3 5. I The Spatial Distribution of Dairy Production ............................................. 77 5.2 Locational Issues in the Iron and Steel Industry . ........................................... 80 5.3 Locational Issues in the Bicycle Industry ................................................ 81 5.4 Trade, Pricing, and Transport of Cement ................................................ 84 5.5 Agriculture on the Loess Plateau ....................................................... 93 5.6 The Benefits and Costs of Migration to Communities of Origin ......... ...................... 94 6.1 Contrasting Types of International Economic Strategy .............. ........................ 99 7.1 Continuous Casting of Steel . ................................................. 113 7.2 Strategic Options in Power Station Boiler Technology . ....................................... 114 7.3 A Successful Strategy in Electronics ............................................ .... 115 8.1 The Second Health Care Revolution ................................................ 140 10.1 Dispersed Social Ownership in the Federal Republic of Germany ........ ...................... 167 10.2 Monetary Control . ..................................................... 174 Maps 5.1 Per Capita Net Material Product, by Province, 1982 ....................................... 75 5.2 Provincial Budget Expenditures and Revenues, 1982 ........................................ 95 Relief and Administrative Divisions ..................................................... 18 3 %  Preface This report was prepared principally by members of an tant), and Fred Bentley (consultant on arid agriculture). economic mission that visited China twice in 1984, for * Energy. Roberto Bentjerodt (senior economist, coal four weeks in February-March and for five weeks in projects), Weigong Cao (power engineer), Abdel El- April-May. In addition to visiting Beijing, the mission Mekkawy (engineer, petroleum projects), Robert Taylor went to three provinces: one coastal and relatively high- (energy economist), and Darrel Fallen-Bailey (consultant); income (Jiangsu); one inland and average-income (Hu- D. C. Rao (assistant director, Energy Department) led the bei); and one interior and low-income (Gansu). It re- team in the field. ceived a lot of information, as well as numerous valuable * 1I4dustrial technology. Gene Tidrick (team leader), comments and suggestions, from officials and others in Anupam Khanna (industrial economist), Reza Amin (in- these provinces, as well as from those in many central dustrial specialist), and Josephine Woo (research assis- agencies and institutions, including: the State Planning tant). and State Economic Commissions; the Ministries of Fi- * Location and trade. Ian Porter (team leader), Vernon nance, Agriculture, Coal, Communications, Education, Henderson (consultant on urbanization), John Sheahan Foreign Economic Relations and Trade, Labor and Per- (consultant on industrial location and trade), and Samuel sonnel, Petroleum, Railways, Urban and Rural Construc- Ho (consultant on rural nonfarm activities). tion, and Water Resources and Electric Power; the State The following also contributed to the preparation of Statistical Bureau; and various universities and research the rLport: Wlodzimierz Brus (consultant on socialist institutes of the Chinese Academy of Social Sciences. A economies); Gerhard Pohl (energy and transport); Robert series of seminars was organized by the Technical-Eco- Drysdale (Annex 1); Helena Ribe and Nikhil Desai (An- nomic Research Center under the State Council. The nex 3); Shujiro Urata (Annexes 4 and 5); and Lily Uy generous and thoughtful assistance of all these people in (Annex 6). Larry Westphal, Carl Dahlman, and Bruce China contributed greatly to this report. Ross-Larson organized background work on technology. The Bank mission was led by Edwin Lim (mission Behrouz Guerami-N, Tejaswi Raparla, and Kong-Yam chief) and Adrian Wood (deputy mission chief) and also Tan helped with the multisectoral model, the input-out- consisted of William Byrd (economist), Mats Hukin (se- put table, and data for international comparisons. Ann nior education adviser), Erh-Cheng Hwa (senior econo- Orr, 'Kenneth Hill, Moshe Syrquin, J. V. S. Sarma, Ken- mist), Timothy King (senior economist), Jacques Yenny neth Cochran, Chang Hsin, Liu Ying, and Cai Jinyong (senior transport economist), Umnuay Sae-Hau (research unde took research. Linda Mitchell, Terrice Bassler, and assistant), Betty Ting (interpreter), Luc De Wulf (senior Caro Cole Rosen edited the report; Helen Kung assisted economist, International Monetary Fund), Benjamin in irs processing; and Catherine Ann Kocak prepared King (consultant on statistics), Wouter Tims (consultant graphics for the text. on planning and agriculture); and the following teams. The report also benefited from comments of a review * Agriculture. J. Goering (team leader, April-May), pane] consisting of Anne 0. Krueger, Luis de Azcarate, Tom Wiens (team leader, February-March), Lang-Seng Kemal Dervis, Janos Kornai (consultant), and managers Tay (irrigation specialist), Lo-Chai Chen (fisheries consul- of the East Asia and Pacific Regional Office. xi  I I  Technical Notes Currency equivalents. The Chinese currency is called renminbi (RMB). It is de- nominated in yuan (Y): I yuan = 10 jiao = 100 fen. In early 1984 the official exchange rate of the yuan to the U.S. dollar was around Y 2 = US$1. The in- ternal settlement rate (ISR) of Y 2.8 = US$1, however, was used in most mer- chandise transactions. The official exchange rate is now about Y 2.8 = US$1. OnJanuary 1, 1985, the Government abolished the ISR. Weigbts and measures. Chinese statistics are usually in metric units; in addition, mu and jin are often used: I mu = 0.1647 acres = 0.0667 hectares; I jin = 0.5 kilograms. Fiscalyear. The fiscal year is January I to December 31. Transliteration. The Pinyin system is used in this report. Terminology. With the recent reorganization of rural administration, "com- munes" have been replaced by "townships," and "production brigades and teams" by "villages." This report retains the former terminology in one respect, however, by referring to "commune and brigade enterprises." The term "national income" is used in this report to encompass both the Chinese measure (net material product) and the Western measure (gross na- tional product). Where the context makes the distinction between these two measures important, they are more precisely identified. Tables. Individual items may not sum exactly to totals because of rounding er- rors. The following symbols are used: . . indicates data are not available; (.) indi- cates a negligible amount; n.a. indicates not applicable. xiii  I  Summary and Conclusions China's ultimate economic objective is to catch up with highei than in China and will increase in the future by at the developed countries, while maintaining a socialist sys- least 2 percent and perhaps 3 percent per year. To catch tem in which the benefits of prosperity are widely shared. up by 2050, China's per capita income would have to Major, though uneven, progress toward this goal was increase at an average rate of at least 5.5 percent and made in the past three decades. During the next two perhaps 6.5 percent per year. Such rapid progress has decades, there could be substantial further progress. The been tare elsewhere. In 1960-82, excluding small and oil- foundations for rapid and equitable growth in the dominated economies, only two developing countries twenty-first century could also be laid. But this will re- achieved annual per capita income growth above 5 per- quire steering a difficult course, in both development cent: South Korea (6.6 percent) and Greece (5.2 percent). strategy and system reform. More generally, only one country-Japan-has indisput- This report looks at some of the key issues for China in ably caught up with the developed nations from a posi- the next twenty years, and at some of the options for tion of economic backwardness. addressing them, especially in light of international expe- China's past record, on the other hand, is quite encour- rience. It covers many specific topics, including agricul- aging. From 1952 to 1982, despite relatively rapid popu- ture, energy, technology, transport, industrial location, lation growth and periods of acute economic mismanage- internal and external trade, population, education, em- ment, per capita national income grew at an average ployment, and finance (health was addressed in another annua.l rate of 4.0 percent, with phases of significantly recent report'). The first section of this summary assem- faster growth. Of particular relevance is China's perfor- bles some of its conclusions in the context of a more mance during the past few years of policy and system general discussion of the pattern of economic growth. reforrs: from 1979 to 1984, per capita national income Common themes regarding the system of economic man- grew at 6.8 percent per year. agement and planning are pulled together in the second Although the basic objective is to improve living stan- section. A third section covers some related aspects of dards and eliminate poverty, the Government has set social policy. At the end of the summary there is a brief targets of quadrupling the gross value of industrial and overview. agricultural output (GVIAO) between 1980 and 2000 and The most careful forecasts are often confounded. The increasing per capita national income from about $ 300 to lessons of international experience are often ambiguous $800 (about 5 percent per year). If China's future invest- and controversial. In any event, they are hard to apply to ment efficiency were similar to the average of the past China, a country that in important respects differs from three decades, but allowing for increased investment in all others and is not easy for outsiders to understand. The economic and social infrastructure, quadrupling GVIAO projections of this report are thus not predictions, and its would require an investment rate of about 30 percent of suggestions are tentative. They are no more than an at- natio:zial income. This is comparable to the rates in other tempt to contribute to the debate in China about the fast-growing East Asian economies, as well as East Euro- difficult questions that must be confronted during the pean countries, and in line with China's past investment country s unique socialist modernization. rate. With reasonable improvements in energy and mate- Pattern of Growth Per capita national income in the industrial countries is 1 Dean T Jamison and others, China: The Health Sector (Wash- (in terms of purchasing power) approximately ten times ington, DC.: World Bank, 1984). 1  rials use, and provided that the population in 2000 is sector. The pattern in China, however, is characteristic fairly close to the official target of 1.2 billion people, also of the Soviet Union and Eastern Europe. Continued quadrupling GVIAO would allow the Government's per emphasis on increasing the physical volume of produc- capita income target to be attained. tion (for example, the target of quadrupling GVIAO) The target growth rate of per capita income is far might cause this pattern to persist. But China could also above the 2.6-3.6 percent range projected by the World shift to a different pattern of growth, with accelerated Bank for middle-income countries in 1985-95. It seems development of the service sectors. feasible because China's projected population growth is Rapid service sector expansion and reform of the sys- unusually slow (about 1 percent per year, compared with tem of economic management are closely related options. an expected 2.2 percent in middle-income countries) and Expansion of commerce would go hand in hand with because China's investment rate has consistently been expansion of market regulation and increased specializa- unusually high (the 1982 average for middle-income tion of production units and localities. Expansion of en- countries was 24 percent). But its attainment depends terprise support services, including finance, accounting, crucially on the efficiency with which resources are used. and law, would likewise be a corollary of increased enter- For example, if the overall efficiency of investment were prise autonomy and specialization. And expansion of per- similar not to China's 1952-82 average but to the 1957- sonal services would reflect a change in the relative 77 average-roughly comparable to that of the Soviet weights attached to planners' priorities and people's pref- Union in 1950-75 and India in 1960-82-the growth erences. Moreover, rapid growth of services probably rate of per capita income would be about one percentage could not be accomplished through administrative direc- point lower. tives and centralized resource allocation, but would have If agricultural or energy production (discussed below) to be pulled by demand. Individual and collective enter- increased unexpectedly slowly, or if domestic or interna- prises may also be better suited than state enterprises to tional misfortunes adversely affected China's efficiency or providing many types of services. investment rate, growth could be slower still. In any This association with system reform makes it likely event, experience in China and other socialist countries that the benefits of faster service sector growth would strongly suggests the desirability of cautious planning. more than offset its costs (in terms of investment, skilled Unrealistically high growth targets cause fluctuations, labor, and-to a lesser extent-materials). In addition to shortages, and inefficiency, while aiming too low has few the direct benefit to households from more convenient adverse consequences. Indeed, continuation of China's retail commerce and from more restaurants, tailors, and recent practice of setting modest annual and medium- so on, there would be indirect contributions to the effi- term targets could greatly facilitate reform of the system ciency of industry and agriculture. A bigger, better- of economic management. equipped, and more responsive commercial sector could reduce requirements for both circulating capital and-by Sectoral Balance permitting greater specialization and realization of econo- Experience elsewhere also confirms the importance of mies of scale-fixed capital. Enterprise support services striking an appropriate balance among the different broad also make fuller use of specialized equipment and person- sectors of the economy. In particular, favoring industry at nel, while financial institutions can contribute to better the expense of other sectors does not seem to generate investment decisions. Larger commerce and enterprise rapid and efficient growth. In China, incentives for agri- support service sectors may also contribute to reducing cultural production have recently been substantially in- material input requirements, especially by accelerating creased, but additional measures to support agriculture improvements in product quality, which make the cost of (discussed below) will be needed. Moreover, emphasis on materials a smaller fraction of the price. quadrupling GVIAO should not imply neglect of infra- An alternative development path, involving both structure and services, which are vital for industrial and greater emphasis on services and more efficient resource agricultural efficiency. The adverse consequences of past use, is therefore analyzed in the report. With a level of underinvestment in electricity and transport are well rec- investment efficiency similar to the average in Japan in ognized in China, but there are still difficulties in divert- 1950-80 and in all middle-income countries in 1960-82, ing sufficient funds from directly productive investment it could attain the Government's target national income into infrastructure. And the importance of commerce and growth rate with an investment rate of only 26 percent, other services (including finance and enterprise support and hence faster growth of consumption. (The growth services) has only recently come to be appreciated. rate of industry would be 7 percent per year rather than The share of the service sectors-including com- 8 percent, however, and hence GVIAO would less than merce-in output and employment in China is at present quadruple.) On this path, China would also have the strikingly small by comparison with other developing option of maintaining the investment rate at 30 percent, countries, despite an untisually large education and health which would cause national income to grow one percent- 2  age point faster than the target rate (and GVIAO to slightly target -or 2000. Given the growth rate of nonagricultural more than quadruple). output implied by this target, and the present very large agricultural employment share, such a large decline in Human Resources agricultural employment could be achieved only if nonag- Faster service sector expansion could also make it easier ricultural labor productivity grew slowly. This might well for China to absorb growth in the labor force, averaging be incompatible with efficient industrialization. In the about 10 million workers per year in 1980-2000. In the early (lecades of the twenty-first century, however, agri- usual pattern of development-even in rapidly industrial- cultural employment is likely to shrink rapidly. izing countries-the main intersectoral employment shift Especially because many of the children of today's is from agriculture into services, with a more moderate farmers will move into nonagricultural employment at increase of employment in industry, which is less labor some point during their working lives, it will be impor- intensive. In China, however, employment has grown tant for China to continue to emphasize the wide diffu- faster in industry than in services. Continued emphasis on sion of basic education and to improve its quality. Inter- increasing the physical volume of production could per- national experience strongly suggests that this could petuate this pattern. This is especially likely because the contribute not only to faster economic growth, but also prospective decline in the primary school age group will to a less unequal distribution of its benefits. In recent cause the number of teachers-now approaching a quar- years, however, there have been problems in maintaining ter of all service sector employment in China-to increase the primary school enrollment ratio (although it remains only modestly. Service sector employment in 2000 might well above the developing country average); and the sec- thus remain as low as 70 percent of industrial employ- ondary school enrollment ratio has dropped below the ment (similar to the ratio in the Soviet Union in 1959). develcping country average. Wide variations among lo- On the alternative development path, by contrast, ser- calities in enrollment ratios and school quality also per- vice sector employment in 2000 could be as much as 150 sist. These problems are being aggravated by increased percent of industrial employment (similar to the ratio in local financial self-reliance in basic education, as well as Japan in the early 1950s). Such a change in the composi- by key schools (recently modified in name, but less in tion of nonagricultural employment could ease some substance) at primary and secondary levels. Policy problems in China's urban areas, which now suffer from chang2s, and greater financial support from central and a combination of surpluses of some sorts of labor and provincial authorities, will be needed if the important shortages of other sorts of labor (including competent, target of making nine years of basic education universal able-bodied workers even at relatively low skill levels). A by 2000 is to be attained. much higher ratio of service sector to industrial employ- As regards advanced education and training, the need ment would help to reduce this structural mismatch be- for rapid progrcss to make up for the damage inflicted by tween labor demand and supply, since service sector jobs the Cultural Revolution is well recognized in China, but tend to be disproportionately filled by the categories of some changes in emphasis seem advisable. University- labor that are now in surplus in urban China-particu- level courses are too specialized, partly because many larly women. educational institutions are subordinate to sectoral minis- Perhaps more important, faster service sector expan- tries and other agencies. The Government's present pol- sion, by raising the overall level of nonagricultural em- icy oi vocationalizing secondary education could suffer ployment, could reduce the proportion of China's labor from s;imilar problems. The case for sound general educa- force that must remain in agriculture, where the earnings tion, supplemented by subsequent, briefer training in and contribution to production of most workers are highly specialized skills, is particularly strong in China likely to remain unsatisfactorily low for the next two or over the next few decades. Rapid technical advance and three decades. On the material-production-oriented quad- structural change will require constant alterations in the rupling path, the proportion of the labor force in agricul- skill ccmposition of the labor force. The slow prospective ture-excluding brigade industries-might decline by growth of the labor force in the twenty-first century will 2000 to only slightly under 60 percent. On the alterna- reduce the scope for achieving such alterations through tive development path, though, with the same growth changes in the pattern of training of n-ew labor force rate of national income, it could decline to nearer 50 entrants. It will correspondingly increase the required percent, a difference of perhaps 40 million workers. amount of retraining, which is more difficult for people Even the latter percentage, which implies an absolute whose original education was highly specialized. increase in agricultural employment of 13 million, is much higher than most Chinese projections, which envis- Food ind Agniculture age a decline in the agricultural employment share to Despite its long history of food problems, China's per under 40 percent. This would be normal for a country capita consumption of calories and protein is currently with a per capita income roughly double the Chinese similar to the average for middle-income countries. The 3  share of animal products in the diet, however, is that of a Feedgrain imports could make up any conceivable short- low-income country, and a major issue is how far and fast age, probably without an appreciable increase in world this share should increase. This issue is hard to address prices, but it would be possible to export only a part of because of uncertainty about China's agricultural produc- the potential rice surplus at economically attractive tion potential: depending on whether the recent remark- prices. Even if overall crop production targets can be able surge in production wanes or persists, the future attained, it may thus be necessary to switch some rice trend growth rate of agricultural output could lie any- land either into coarse grains or into other crops that where between 2- 3 percent and 5-6 percent per year. could be more easily exported. In addition to the successful measures already imple- The future pattern of agricultural production and for- mented in recent years, especially introduction of the eign trade thus depends quite heavily on the rate of in- production responsibility system, the Government could crease in consumption of animal products. The possibility take a number of steps to enhance agricultural growth of a rapid increase cannot be ruled out, but there are prospects. These include improvements in agricultural re- some significant problems and uncertainties, which could search, education, and extension services; irrigation and be greater in the twenty-first century. (Even with a favor- drainage projects; better nutrient balance in fertilizer sup- able feed conversion ratio, an increase of ten percentage plies, as well as changes in the pricing and distribution points in the share of animal products in the average diet system so that fertilizer is allocated among crops and is equivalent to the disappearance of 3S-40 percent of localities more in accordance with its potential contribu- China's cultivable land, or a 35-40 percent increase in tion to production; increased availability of agricultural population.) Particularly undesirable would be an in- credit; and improvements in rural transport, storage, and crease in per capita consumption of animal products to a marketing facilities. level that could not be sustained-because of a slowdown To permit consumption of animal products to rise from in crop production growth, poor feed-meat conversion 6 percent of total caloric intake in the early 1980s to 1 5 ratios, or unwillingness or inability to sustain large feed- percent by the end of the century, gross agricultural out- grain imports-and therefore had to be reduced. put would have to increase at about 4.5 percent per year, Although there appears to be little danger of a decline with crop production growing at 3.6 percent per year in China's present very satisfactory food intake level, (less than the 1965-8 3 average) and animal husbandry at caution is accordingly needed in managing food demand. 7.5 percent per year (well above past rates). This agricul- It seems especially important that consumers should pay tural growth rate could simultaneously satisfy the other the full economic cost of animal products, without subsi- demands of economic growth at the government's target dies or administrative restrictions on prices. Japanese ex- rate, with agricultural exports and imports more or less in perience suggests that high prices can bring consumer balance in 2000. But it is very high by international demand for animal products into line with limited sup- standards-well above the 3.0 percent average for mid- plies in a socially acceptable manner. By contrast, the dle-income countries in 1960-80 and surpassed only by experience of countries which have subsidized and ra- Thailand and the Philippines, which started with more tioned consumption of animal products has been ex- uncultivated land and lower yields. tremely unfavorable. To achieve such rapid growth of animal production would also not be straightforward. China's pastures are Energy Production and Use IIow seriously overgrazed, which makes it unlikely that Because China's initially high consumption of energy per present targets for beef and mutton production growth unit of output offers great scope for conservation, it can be achieved. Much higher priority than at present would be possible to attain the Government's target of would need to be given to improving techniques for the quadrupling GVIAO with a much smaller proportionate production of poultry, a potentially efficient converter of increase in energy production-though probably not as feed into animal protein. The most important issue, how- small as the originally envisaged doubling. Electricity pro- ever, appears to be availability of grain and protein-based duction probably has to quadruple by 2000 to meet de- feeds, on which an increasing proportion of animal hus- mand, which will require a huge amount of investment bandry will have to be based. This is a matter partly of (averaging about 2 percent of national income), although the backwardness of China's feed-processing industry, it is technically feasible and in line with current plans. partly of achieving the required level and pattern of crop Crude oil production in 2000 is hard to predict, since it production. depends heavily on success in replacing the output of With rapid growth of animal husbandry, the Govern- existing fields with that of new discoveries, but the 200 ment's present targets for increasing production of spe- million ton target (twice the present level) could be more cific crops would tend to create a large shortage of the than enough to meet the likely level of domestic demand. coarse grains needed for animal feed and a large surplus of It is coal, however, that will bear most of the burden of rice, whose consumption is likely to grow only slowly. bringing future energy production into line with demand. 4  How much coal will be needed could vary widely, de- in exis:ing large-scale uses such as steel and cement pro- pending on the rate and sectoral pattern of growth, as duction-and to invest heavily in suitable production and well as on the degree of energy conservation achieved distribution facilities. Careful studies will be needed to within individual sectors. With growth of national in- select the least costly of the various alternatives (for exam- come at the Government's target rate, the material-pro- ple, coal gasification versus cogeneration and district heat- duction-oriented quadrupling path would require 1,400 ing) in each case; and their implementation and operation million tons of coal to be produced in 2000 on the most will elntail much closer cooperation than at present optimistic assumptions about progress in conservation, among a variety of agencies and organizations. and more probably 1,600 million tons (as compared with 770 million tons in 1984). At the same national income TransptPnionties growth rate, the alternative-more service-oriented and There is concern in China that economic growth over the efficient-development path mentioned earlier could re- next decade or two might be held back by transport duce coal demand in 2000 to 1,200 million tons on the shortages, especially given the length of time needed to most optimistic conservation assumptions, and 1,400 construct new railways and roads. But the volume of million tons on intermediate assumptions. freight transport in China is now so high (per unit of Especially because less optimistic, but still plausible, outpu:) by international standards-though lower than in assumptions about progress in conservation could in- the Soviet Union-that it is hard to predict how rapidly it crease the potential demand for coal in 2000 to over will nced to increase in the future, given any particular 1,800 million tons, it wiU be vital to promote economical trend growth rate of national income. This will depend use of all forms of energy. The mixture of administrative on the sectoral pattern of growth (for example, industry controls and financial incentives applied in recent years is more transport-intensive than services) and on its spa- has led to impressive energy savings. But a quota-based tial pattern (which influences average transport distance). energy allocation system is fundamentally unsuited to It will also be affected by system reform, which will on achieving large and economically rational reductions in the one hand tend to increase transport requirements energy intensity over the longer term. It gives enterprises because of increased specialization and exchange, but an incentive to exaggerate their needs and does not take could on the other hand greatly reduce wasteful use of enough account of the widely varying economic costs of transport facilities, for example, through less cross-haul- reducing energy consumption in individual enterprises. It ing, nmore preliminary processing of materials, and more is very probable that more energy could be saved, with rational location decisions. less waste of other resources, if enterprises were more If national income were to grow at the Government's strongly motivated to reduce all costs and faced with target rate, with continuing strong emphasis on material prices that better reflected the economic values of all their production, and with agriculture and industry using inputs and outputs. transport only moderately more efficiently than in the It should be possible to mine the required quantities of past, freight volume could reach 3,200 billion ton-kilo- coal, given China's ample reserves and the straightfor- meters by 2000 (approaching four times its 1980 level). ward production technology, although this would require But with the same growth of national income achieved some advance planning, substantial investment, and con- through faster expansion of services and slower expansion tinued support for small collective mines. Much more of of industry, and with somewhat greater efficiency in a challenge will be to transport the coal (as discussed transport use, freight volume in 2000 would be 2,400 below) and to use it cleanly and efficiently. The share of billion ton-kilometers. Even in the latter case, China's coal in total commercial energy use is likely to remain at projected freight intensity would remain high in compari- 70-75 percent (compared with 30-35 percent world- son with other countries, which suggests that the possibil- wide), which will require it to be put to an unusually ity of even slower growth of freight volume cannot be wide range of uses, including many where backward ruled out. technology and small scale in China today result in waste- Althaough the overall volume of transport requirements ful and dirty combustion. in the longer term is highly uncertain, there will certainly To prevent further increases in already unacceptably have :o be significant changes in the composition of trans- high levels of urban air pollution, as well as to economize port investments, as well as in organization and manage- on fuel, will often require the replacement of decentral- ment Agricultural and industrial specialization will in- ized and uncontrolled burning of coal in households and volve much movement in fairly small lots of a great enterprises with centralized, large-scale, environmentally variety of goods, often perishable or fragile, over short to controlled combustion to produce cleaner forms of en- medium distances, to and from dispersed origins and des- ergy (gas, electricity, steam, hot water) for distribution to tinations. This is generally only feasible by road. The final users. This in turn will require China to import and demand for road passenger transport will also increase disseminate new technology-which will also be critical rapid y. However, China now has a rural road network 5  half the size of India's and fewer trucks per rural person sufficiency. This appears to result partly from transport than the impoverished Sahelian countries of West Africa. problems, but also from shortcomings in commerce and Major intercity highways, the vehicle fleet, and vehicle material supply, the nature of the fiscal system, distorted fuel production and distribution are also at present strik- prices, and insufficient competition. It could have a seri- ingly backward. ous adverse effect on China's overall investment effi- That road transport should play a larger role in the ciency. future is widely recognized in China. Yet there seems to To prevent continued proliferation of industrial plants be no strategic plan to bring this about. Underutilized of suboptimal scale and product quality, there is thus an agricultural labor could, as in the past, be mobilized to urgent need for measures to reduce the present conflict build up an adequate rural road network. But higher between what is rational for a particular locality and what levels of government (central and provincial) will need- is rational for China's whole economy. Of particular im- as in other countries-to play a much more active role in portance would be better transport, fiscal reform, and planning, coordinating, and financing the road develop- changes in the system of economic management (dis- ment schemes implemented at lower levels. In addition, it cussed below), regarding enterprise motivation, competi- will be essential to produce a much larger number and tion, and prices. In addition, the central government wider range of more fuel-efficient trucks, to improve the might consider legal measures to back up its existing gene- utilization of vehicle fleets, to upgrade the quality of ral prohibition of barriers to interlocality trade, including motor fuels, and to distribute and price these fuels more possibly the establishment of a special regulatory institu- rationally. All this will require improved coordination tion, with the power to levy large fines. among higher-level government ministries and agencies. Suboptimal plant size is not China's only current indus- Railways will remain the most efficient means of trans- trial location problem. There is also too much concentra- porting raw materials and heavy industrial products over tion of industry in large and medium-size cities. Research long distances. There will be a large increase in demand and experience in other countries suggest that economic for coal transport, even with more coal washing and efficiency requires weight-reducing heavy industry (for minemouth power generation. But there is apparently example, iron and steel production) and agroprocessing much scope for economizing on rail transport of all com- to be located near raw material sources, with other space- modities through stronger incentives for cost reduction intensive or standardized industrial activities in special- and less administrative intervention in materials alloca- ized small cities. Industries such as petrochemicals and tion and pricing. It also seems physically and financially bicycles benefit from large-scale operation, but not from possible to accommodate the overall increase in rail trans- proximity to other industries-or at any rate not enough port demand. This could be accomplished largely by to justify the much higher economic cost of land and switching from steam to diesel and electric traction, al- labor in large cities. By contrast, industries whose tech- though substantial double tracking and some new lines nology is evolving rapidly or which must respond to will also be necessary. constantly changing demand, as well as many specialized Increased use of water transport could appreciably re- service activities, benefit substantially from mutual prox- duce the load on the railways, expecially if future heavy imity and clustering in large urban areas. Development of industrial investments were appropriately located. And both large and small cities, as well as smaller towns pro- China's entire transport system could benefit from better viding goods and services to rural areas, could thus con- intermodal coordination: this is partly a matter of im- tribute to rapid and efficient growth in China; but plan- proving technology and infrastructure (for example, con- ners and prices (discussed below) will need to give better tainers and their handling facilities), but it also depends guidance on what activities should go where. on rationalizing tariffs, increasing competition, and en- How much the overall level of urbanization should couraging new specialized entities to provide an appropri- increase in the decades ahead is a difficult issue, partly ate variety of transport, leasing, storage, and transfer ser- because the distinction between urban and rural is itself vices. blurred in many densely populated parts of China. In any event, substantially increased rural-urban migration Specialization and Urbanization seems probable and desirable. Indeed, without some ru- China's size and past emphasis on local self-sufficiency ral-urban migration, China's overall urbanization rate (as offer opportunities for enormous economic gains through officially measured) would decline from 20 percent in increased specialization and trade among localities. In re- 1981-quite normal for a low-income country-to 19 cent years, agricultural specialization has proceeded rap- percent by 2000, simply because the natural population idly. In industry, by contrast, specialization does not seem growth rate in existing urban areas over the next two to be increasing, and indeed local planning bureaus are decades is likely to be much lower than in rural areas. still promoting the development of a wide range of indus- This could cause the general labor shortages that have trial activities, with continuing emphasis on local self- already appeared in some Chinese cities to become wide- 6  spread within a few years. Increasing urbanization would income country to run foreign trade surpluses, as China probably be a more economically efficient response to has done in recent years, has some obvious disadvantages, such shortages than accelerated automation of urban pro- as compared with a net inflow of foreign capital to sup- duction. An urbanization rate in 2000 of 30 percent plemeni: domestic savings. But experience in other coun- (implying that more than a third of the urban population tries, including socialist ones, has shown how easy it is to would have come from rural areas) would still involve an slide into excessive or unproductive borrowing, especially unusually large amount of rural nonagricultural employ- when domestic enterprises and planners are not suffi- ment. Lower-middle-income countries today (at a similar ciently conscious of investment costs or responsible for income level) have an average of 34 percent of their bad decisions. population in urban areas. However, China also seems wise to encourage direct Whatever the overall rate of urbanization, efficient de- foreign investment, less for the foreign capital or ad- velopment of towns and cities will require a very large vanced technology it brings than for the demonstration increase in urban infrastructure and services. The admin- effect of modern management techniques. The example istrative responsibilities for their provision, and potential of, and competition from, well-run foreign companies financing and cost recovery mechanisms, need to be care- can help domestic firms identify weak links in manage- fully reviewed. In many countries, efficient and equitable ment, product design, material supply, and so on, and development of urban services has been seriously con- spur them to make changes they might otherwise never strained either by fragmented and unclear allocation of consider. But such examples of the way modern industry responsibility among different administrative levels or by operates in more advanced countries are effective only if inadequate growth of urban revenue sources. In China, contrasted and competing with locally managed firms. moreover, special attention should be given to the poten- This requires foreign and joint ventures to be spread-as tial impact of economic and social reforms on the level is increasingly the case in China-among a wide range of and composition of local government revenues and ex- localities and activities, rather than confined to special penditures. zones cr particular sectors. International experience suggests that decentralization Foreign Trade and Capital of foreign trade to the enterprise level can also make an China's recent resumption and expansion of external eco- important contribution to realizing the potential benefits nomic contacts have raised exports to 9-10 percent of of increased external economic contacts. Direct exposure national income, which is well within the normal range of exporting firms to foreign buyers and competitors has for large countries. However, inflows of foreign loans proved elsewhere to be an extremely effective way not and direct investment have remained small, partly be- just of learning in the abstract about new and better cause of foreign trade surpluses. For the future, there products and processes, but also of learning how (and appear to be two large and related issues. The first is how being put under pressure) to introduce them in practice. much, and in what directions, to further increase external Similarly, allowing enterprises-including commercial en- contacts. The second is how best to manage such con- terprises-and consumers to choose directly between im- tacts, and in particular whether to continue the present ported and domestically produced goods could greatly insulation of the domestic economy from the world out- increase competitive pressure on Chinese producers to side by administrative intermediation and separate price introduce new, better, and cheaper products. systems. Such decentralization of foreign trade could have some Over the next two decades, China will need to change potentially serious disadvantages, too, including damage the composition of its manufactured exports. Exports of to promising but newly established industries in China, as textiles and clothing, in particular, are likely to grow well as greater exposure to world price instability and fairly slowly. China will therefore need to make a major unpreclictable fluctuations in foreign markets. But skillful effort to expand exports of machinery and metal prod- use of policy instruments-including the exchange rate, ucts. Rapid growth in such exports would permit rapid tariffs, and selective administrative interventions-could growth of intermediate and capital goods imports, as well minimize the costs while securing many of the benefits. as consumer goods imports (which can stimulate impor- China will also always be a large and diverse economy, tant improvements in domestic production). Exports of with a relatively small foreign trade sector, which greatly manufactured goods could also be used to pay for pur- reduces the possible damage that unexpectedly unfavor- chases of licenses and technological assistance, which in able external developments could inflict, even though many advanced as well as developing countries have particular industries and localities might experience quite proved to be very effective ways of upgrading domestic sharp swings in prosperity. technology. Especially following the recent unification of foreign As regards foreign borrowing, the Government's pol- exchange arrangements-and given the current account icy of cautious progress seems well founded. For a low- surpluses of recent years, large reserves, and the ready 7  availability of external capital-China appears to be well not only in bringing together the several elements of placed to move toward a decentralized and mainly indi- market regulation, but also in combining them with an rectly regulated foreign trade system, without the prob- appropriately modified system of planning. lems (of external insolvency or internal inflation or defla- tion) that many other countries attempting a similar Enterprise Motivation move have simultaneously had to contend with. To do The unsatisfactory results of direct administrative control this immediately, or at one stroke, would probably be of enterprises-whether by central ministries or local gov- unwise, since most domestic enterprises do not yet have ernments-lead irresistibly to the principle of greater en- appropriate motivation or independence, and since some terprise independence. Yet establishing independent and prior changes of domestic prices would ease the adjust- appropriately motivated enterprises may be the hardest ments required. But it could proceed in parallel with single aspect of reform in a socialist system-and perhaps internal economic reform. also the most fundamental, since an unmotivated enter- prise cannot be expected to motivate its workers, or to Managing the Economy respond to price and tax signals, or to compete. Appropriate enterprise motivation should include a How far China will have risen into the middle-income strong desire to increase profits. Avoidance of losses is an range by 2000 will depend crucially on how successfully important aspect of this, but is insufficient, since China the economy is managed. This is a matter partly of mobi- needs enterprises that not merely pursue a passive strat- lizing financial and human resources, and of importing egy of staying out of trouble, but actively seek to increase and developing modern technology, partly of putting production and sales and to cut costs of all kinds. With these things to effective use. China's past record of eco- rational prices and competition, the best single measure nomic management, for all its unevenness, is superior to of enterprise performance in this regard is usually me- that of other low-income countries, both in promoting dium-term profits (especially after deduction of the cost- growth and in reducing poverty. But maintaining the past depreciation and interest-of the capital employed). The pace of economic progress is likely to require greater active desire of peasant households to increase sales and efficiency. cut costs, because their standard of living depends on it, Efficiency in the relevant sense means ceaseless, intense lies at the heart of China's recent agricultural successes. efforts by producers to reduce costs, to increase produc- Outside agriculture, the same motivation is a natural fea- tivity, to improve product quality, to introduce new ture of individual and family enterprises, and of small products, and to seek out and respond to changing needs enterprises owned and operated collectively by their and opportunities. It involves bold yet frugal investment workers. In medium-size and large enterprises, however, decisions, increasing specialization, and the constant dis- things are not so simple. placement of more expensive or inferior products and processes by cheaper and better ones. STATE ENTERPRISES. Some important enterprises These conditions for rapid, sustained growth are at should clearly remain subject to direct government con- present far from fully met in China, except in agriculture, trol and should not primarily pursue profit. At a mini- where outstanding progress has been made in recent mum, this applies to public utilities (for example, electric- years with the introduction of the production responsibil- ity, railways, and telecommunications), large-scale ity system. Recognizing this, the Central Committee of mineral exploitation, and many defense-related indus- the Chinese Communist Party in October 1984 an- tries. Direct control of other key enterprises might also nounced a program of urban economic reforms, with help to achieve specific development objectives, including invigoration of state enterprises as its central theme, to be the technological upgrading of particular sectors. implemented over a period of about five years. Much of What is less clear is the best way to organize and the discussion in the present report is premised on the motivate the remainder-probably the great majority-of Central Committee's decision. state enterprises, which would be relatively independent. To be efficient, enterprises must be motivated to im- Once a suitable economic environment is created through prove their economic performance; they must have some price reform and increased competition, and provided freedom of maneuver; they must be faced with economi- that indirect levers such as taxes and credits are skillfully cally rational prices; and they must be subjected to com- applied, pursuit of profit should lead most state enter- petition. None of these elements is individually easy to prises in economically appropriate directions. It would establish, and the absence of any one of them reduces or thus no longer be necessary for particular individuals nullifies the benefits of the others. In addition, the state within enterprises to be charged specifically with repre- must retain the ability to direct the overall pace and senting the interests of the state. But each of the alterna- pattern of development. The essence-and the diffi- tive possible internal management arrangements has culty-of a successful and comprehensive reform thus lies strengths and weaknesses. 8  Giving direct control of state-owned enterprises to are banks, pension funds, and insurance companies.) their workers is a socially attractive possibility. Japanese Such a system of socialist joint stock ownership could experience also shows the economic advantages of strong perhaps be created initially by suitable dispersion of the worker commitment to the enterprise. But there are also ownership capital of existing state enterprises. Over time, disadvantages, especially because state enterprises should it could be reinforced by a more diversified pattern of operate for the benefit of the whole society and not only investment finance (discussed below), with a variety of of those who work in them. Experience in Yugoslavia and state institutions acquiring financial interests in existing elsewhere suggests that worker control could result in and new enterprises. excessive wages and worker benefits, inadequate labor discipline and effort, restriction of employment, and COLLECTIVE AND INDIVIDUAL ENTERPRISES. China's comparative indifference to profitability. policy is to encourage the coexistence of state and other Experience in industrial capitalist economies suggests sorts of enterprises. In small-scale economic activities, that giving control of enterprises, instead, to their man- whose importance will increase with economic develop- agers would increase their propensity to expand, im- ment and reform, individual and collective enterprises are prove, and innovate. But completely independent man- already making a valuable contribution. They could be agers sometimes choose a quiet life or, more commonly, even more productive if given better access to materials, pursue personal power through expansion with insuffi- credit, skilled labor, and technology. Their potential role cient attention to profitability. In socialist countries, in medium- and large-scale activities, however, remains to moreover, managerial control tends to differ only slightly be determined. from worker control, since managers find it hard to resist Experience elsewhere suggests that genuine collectives worker demands for greater benefits or to insist on the flourish only in certain lines of activity and rarely above a often unwelcome changes in work practices that are certain size. Many of the most successful examples else- needed for innovation and increased efficiency. This is where are in commerce and are marketing or purchasing already a problem in China: studies of experimentally cooperatives. There are far fewer examples of medium- reformed enterprises controlled mainly by their managers size gcnuine worker collectives or of any sort of collec- reveal large increases in worker benefits, but small in- tives in manufacturing. China's numerous township and creases in economic efficiency. village enterprises may appear an exception; however, An alternative approach, common in nonsocialist these are not collectives in the ordinary sense, but com- countries (and now being tried in Hungary), is to give munity enterprises. They have been successful partly be- strategic decisionmaking authority in each enterprise to a cause of restrictions on personal mobility among commu- board of directors. Such a board could contain some nities, which has given local residents a strong common representatives of society at large, as well as of the work- interest in their establishment and profitability. ers. But to impart the necessary motivation, the board Collectives and community enterprises could in the would mainly have to represent institutions with a strong future constitute a significant proportion of China's me- interest in the enterprise's profits. It could insist that the dium-size enterprises. Many individual enterprises could enterprise managers behaved accordingly, partly by ap- also giow rapidly to medium size, if allowed to do so, and pointing and dismissing them, partly by linking their re- could be an important dynamic force in the economy. As muneration to profitability. The managers might in prac- an alt-rnative to the present restrictions on the size of tice make most decisions, but would be greatly influenced individual enterprises, these enterprises might be obliged by their ultimate accountability to the directors. to sell (at a fair price) majority ownership to one or more Such boards should be free from direct government state institutions once they reached a certain size. The intervention. But, precisely because these are state enter- then rniinority owners could continue as managers, super- prises, this may be difficult to achieve. In China, for vised by a board of directors representing all the owners. instance, even if the boards were to consist of representa- tives of the Ministry of Finance or a new Ministry of ACC:OUNTING AND LAW. The best way of motivating State Property, rather than of sectoral ministries or the independent state enterprises, and the best balance governments of the localities in which the enterprises are among state, collective, individual, and mixed enterprises, situated, informal connections and pressures for direct can only emerge from experience and experiment over a administrative control could persist. A possible solution protracted period. But certain necessary conditions for might be to spread the oNvnership of each state enterprise success can already be identified. among several different institutions, each in some way One is improvement of enterprise accounting and au- representing the whole people, but with an interest diting, which at present leave much to be desired. With- mainly in the enterprise's profits rather than directly in its out accurate accounts, subject to thorough, compulsory, output, purchases, or employment. (Examples of such and independent audits, with severe penalties for non- institutions, in addition to central and local governments, compliance, it is hard to see how any system of indepen- 9  dent enterprises-state or nonstate-could function prop- Another important step toward free entry could be to erly. allow individual and collective enterprises to operate in Moreover, a decentralized economy cannot function more lines of activity, including technologically dynamic properly without a comprehensive system of commercial sectors. Studies in other countries have shown that small and contract law and institutions and personnel to imple- enterprises are just as innovative as large ones. (Chinese ment it. Laws are also needed to regulate the economic visitors to foreign countries are often given a misleading activities of independent enterprises. Among other impression in this regard, because they are usually taken things, laws or decrees should prohibit specified types of only to well-known, large enterprises.) Particularly be- monopolistic, anticompetitive, or exploitative behavior, cause of the strong incentive that small enterprises have with legal institutions to interpret and implement these to innovate, the overall pace of technological advance prohibitions. At present in China, the situation is unsatis- could very probably be accelerated by letting them com- factorily vague, with enterprises and local officials free to pete for some of China's skilled manpower, technology place their own interpretations on general guidelines imports, and research support. from the center. Lastly, effective competition has to involve the elimina- tion of obsolete or unwanted products and processes. Competition Subsidies or protection for backward technology and in- As the Central Committee's 1984 decision clearly states, efficient enterprises-other than on a temporary basis to competition among enterprises is crucial to efficient permit reorganization-hold back the growth of efficient growth-without it, customer requirements are ne- enterprises and remove a powerful negative stimulus to glected, innovations diffuse slowly, and market-regulated innovation and improved efficiency. At the same time, prices are distorted for monopolistic gain. One key ingre- this aspect of competition can obviously cause hardship, dient of competition is allowing purchasers to buy from especially for displaced workers. Social policies and insti- the best and cheapest source. China has already taken tutions (discussed below), and government retraining some significant steps in this direction, but further schemes, can alleviate this hardship. But the conflict be- progress is needed. It could probably be assisted by dis- tween the gains of the majority from greater competition mantling the annual production planning and allocation (and faster technological change) and the losses of particu- system, either in one step (as in Hungary) or more gradu- lar individuals and groups cannot be completely elimi- ally, by reducing each year in each enterprise the propor- nated. tion of material requirements covered by the state alloca- tion and, in parallel, the obligatory state production and Pnices procurement quota. The Government is well aware of the need to establish It would also be assisted by dismantling administrative economically rational prices, without which the decisions barriers to internal trade, which would be easier if fewer of independent, profit-oriented enterprises would often enterprises were directly controlled by government or- be inefficient for the whole economy. The Government gans anxious to avoid competition within their "families" also recognizes that this must be accomplished by chang- of enterprises. Consolidation of enterprises into large sec- ing the price-setting system to give market supply and toral corporations, by contrast, would normally tend to demand forces a greater role, and not only by adminis- reduce competition, although this could be offset by in- tered changes in prices set by the state, which tend to lack creased exposure to foreign competition. Equally impor- the flexibility, complexity, and precision needed in a mod- tant would be measures to enlarge, diversify, and ern economy. The prices of many minor items, and of strengthen commerce and related services. Individual and some transactions in more major items, have already collective enterprises might be given a greater role in been successfully decontrolled. wholesaling and material supply and better access to Further progress in this direction is impeded by chronic transport facilities. shortages of many goods. It is feared that these shortages, Another key ingredient of competition is free entry of if prices were no longer subject to direct state control, new producers into particular markets. One step in this would cause general price inflation, as well as obstructing direction for China could be to allow larger enterprises to the allocation of materials to key projects. For this rea- diversify more freely out of their existing lines of busi- son, it is often argued in China that further price decon- ness. Provided that prices are rational, such diversifica- trol should be postponed until rising production has elim- tion can transfer profits earned in one line of activity into inated most of the shortages. other lines where the economic returns to investment are Soviet and East European experience suggests, how- greater. And it can permit enterprises to transfer workers ever, that chronic shortages are not the temporary result who can no longer be profitably employed in one line to of inadequate production capacity, but an enduring fea- other lines, without having either to discharge them or to ture of administrative economic management, which can keep them idle. be eliminated only by systemic reforms, including price 10  decontrol. This view is supported by China's experience ternative would be to have wholly market-determined in the past few years, especially in agriculture, where prices, but with a price stabilization scheme-Govern- relaxation of direct controls has turned long-standing ment intervention to keep fluctuations at any given time shortages into abundance. The same could happen in within a predetermined range by purchasing for addition industry. Increases in specific prices could eliminate spe- to stocks at the lower end and selling from stocks at the cific shortages by stimulating supply and reducing de- upper end. mand. These price increases, moreover, would tend to A third instance concerns the relationship between pro- reduce purchasing power over (and hence the prices of) ducer and retail prices, which needs to be altered not only other goods, provided that the government kept strict to reduce the presently high level of subsidies, but also to control of the budget balance and credit. encourage consumers to buy less of things (such as energy Nonetheless, there is substance to the fear of immedi- or animal products) in short supply or whose production ate and general decontrol of prices in China. The down- costs are increasing and more of things in abundant sup- ward inflexibility of some prices, and of wages, could ply ancl whose production costs are falling. This could be obstruct the smooth adjustment outlined above. The full achieved by establishing relatively rigid margins between response of demand and supply to price changes may producer and retail prices, sufficient to cover the costs take years. China lacks experience in indirect fiscal and and normal profits of commerce as well as indirect taxes monetary regulation of the general price level, and other (whose rates could vary from commodity to commodity). countries with much greater experience still suffer from In the near term, what is mainly needed are some rising prices. The elimination of shortages, moreover, substantial increases in the retail prices of staple food and would also require increased competition and stronger coal and in rents. These should be as fully and accurately enterprise motivation to hold down costs, including in- compensated as possible, by wage increases and income vestment costs, which cannot be brought about over- supplements to households with high dependency ratios night. For these reasons, price decontrol probably has to (discussed later). Special supplementary interest payments be gradual though steady-perhaps in conjunction with on saving deposits which would otherwise lose part of the gradual dismantling of annual production planning their real value might also be needed (financed perhaps by and allocation mentioned earlier. a corresponding special levy on borrowers, whose loan Some steps, however, could be taken more quickly. repayment burden would otherwise decrease in real Large increases, either administratively imposed or mar- terms). A large-scale program of selling state- and enter- ket-determined, in the prices of most forms of energy- prise-owned housing to its present tenants, who would and some other materials-are a case in point. Without otherwise face increased rents, could soak up a large frac- them, there would be little chance of achieving the essen- tion of existing saving deposits and hence reduce the tial reductions in energy use discussed earlier. There is possible scale of panic buying in anticipation of price concern in China that large energy price increases would increases. have ripple effects, since energy-intensive industries and There is room for disagreement as to whether such a enterprises could not absorb all the increased cost major realignment of retail prices, incomes, and assets through conservation and profit reduction and would should be done in one step, or more gradually. The social therefore have to raise their prices. But most such ripple problems that have sometimes followed large retail price effects should in fact be welcomed (and cushioning increases in other countries seem to have occurred mainly through reduction of taxes and profit remittances because of the absence of compensation-often deliber- avoided): experience elsewhere suggests that increases in ate, because of the need to reduce real consumption in the prices of energy-intensive products, by discouraging the face of economic difficulties. In China, however, their use, can make a vital contribution to raising the there is no need for a cut in household consumption, and economy's overall energy efficiency. full compensation could be provided (although this Agricultural prices are another instance. With the new would mean no net improvement in the state budget system of household agriculture, if production is to be balance). A carefully prepared and well-explained one- efficient and surpluses and shortages of particular com- step adjustment could thus be quite acceptable and would modities avoided, prices must be allowed to respond flex- avoid the protracted uncertainty and delays to other nec- ibly to supply and demand trends. At the same time, it essary reforms associated with gradual adjustment. But it would be desirable to avoid the large short-term price would also obviously increase the cost of errors in prepa- fluctuations-often because of weather-that characterize ration (especially calculating the required changes in unregulated markets for agricultural commodities. The prices wages, and other forms of compensation) or im- Government's present strategy is to decontrol completely plementation. the prices of minor items and, for major items, to have Following this initial phase of adjustment, subsequent two-tier pricing (flexible prices for amounts in excess of rises and falls in producer prices could be reflected in official, fixed-price procurement contracts). A possible al- retail prices. Experience in other countries suggests, how- 11  ever, that it would be inadvisable to provide continuing constraining China's growth in the next two decades, automatic compensation for retail price increases in the measures to improve their allocation and motivation form of general wage or income indexation, since this seem worth considering. Among the more important tends to aggravate inflation. Even selective indexation (of possibilities would be freedom of job choice, for both state income supplements to poor households, for exam- new graduates and experienced staff, allowing employers ple, or for pensions) should be approached cautiously. to recruit and release freely and competitively, and higher A fourth instance concerns prices that influence the and more flexible salaries. Provided that they were ac- spatial location of economic activities. One is transport: companied by reform of enterprise motivation, competi- prices for each mode should more accurately reflect long- tion, and prices, these measures could help move highly run marginal economic costs, without cross-subsidies skilled labor to where its economic contribution was among different length hauls, to provide incentives to greatest, speed the diffusion of new technology, improve reduce the present waste of rail facilities, to encourage motivation (with better matching of jobs to personal pref- greater use of roads, and to enable proper assessment of erences and skills just as important as more money), and the costs and benefits of locating particular activities in send much clearer signals of needs and priorities to educa- particular places. The other is urban land: for social as tion and training institutions. well as economic reasons, enterprises and planners should More generally, it will be essential to make better use be made to feel the dramatically varying economic useful- of all categories of labor. This is because long-term ness (or opportunity cost) of different sites-higher in growth of average per capita income will be almost en- coastal cities than in more remote regions, higher in large tirely determined by growth of labor productivity, most than in small cities, higher near the center than in the of which must come not from movement of labor out of outskirts (in a city the size of Shanghai, experience in agriculture into other sectors, but from higher productiv- other countries suggests that a central site is worth ap- ity within each sector. Unskilled labor is currently in proximately 150 times as much as one in the suburbs). surplus, but this will change in the twenty-first century; A differentiated urban land tax reflecting these varia- experience elsewhere shows how hard it is at a late stage tions could be introduced. Alternatively, a competitive to break out of an established pattern of low productivity rental market might be established-which would in prin- and indifference to labor costs. ciple be more efficient and quite consistent with public It might therefore be desirable to give enterprises pro- ownership of all land. (Either or both could provide a gressively more discretion in deciding how many, and useful supplement to municipal revenues.) This would which, less-skilled workers to employ. This should in encourage better use of existing sites and more economi- principle encompass not only the right to dismiss idle or cally efficient location decisions. The presently huge in- negligent workers, but also to release or reject workers centives for rural-urban migration would likewise be re- who are simply not needed for production. Lifetime em- duced to more economically rational proportions, ployment would not necessarily disappear (Japanese expe- especially if differing land values were reflected in house rience confirms its potential advantages in training and rents and wages, and hence in the costs of living and motivation), but would be likely to be limited to larger employing workers in large urban areas. enterprises, which would be highly selective recruiters. Finally, further strengthening of the linkages between Some open unemployment would be an inevitable con- internal and world prices could be beneficial, though sequence of these changes. In addition to its adverse hu- there would need to be some exceptions-for example, man consequences (which could be mitigated by changes rice, where an increase to the present world price could in social policies and institutions, discussed below), this aggravate incipient overproduction. For most goods, es- would involve waste of human resources. The waste of pecially manufactures, enterprises should eventually di- unemployment, however, has to be weighed against the rectly feel the relationship between their value (for ex- waste of human resources associated with the present ports) or cost (for imports) to China in world markets employment system, which transfers unemployment and their domestic prices. Such linkages (which are now from the streets into the factories and discourages man- standard in Hungary and have begun to be introduced in agers from realizing the full productive potential of their China) are essential for the efficient functioning of a de- workers. It is also important to bear in mind the tremen- centralized foreign trade system. They would also con- dous potential for creation of new jobs in the service and tribute to a much-needed widening of price differentials small enterprise sectors. Nonetheless, movement should between low- and high-quality products, without which be gradual, perhaps with an early end to the obligation of enterprise incentives to innovate and improve quality will enterprises to accept unwanted new workers (usually as remain small. part of a package also containing some useful recruits), and subsequent release of unneeded workers each year up Labor and Wages to a specified percentage of an enterprise's labor force. To reduce the risk of shortages of highly skilled workers Greater flexibility of less-skilled wages might smooth 12  this transition, as might stronger linkages between indi- Experience suggests that this would encourage bold and vidual pay and performance. But these changes, too, innovative thinking combined with thorough analysis, could be only gradually introduced, to avoid a sharp drop hard-headed calculation, and the avoidance of waste. in unskilled wages. It will also be necessary for some time Delegating more responsibility for investment decisions to retain administrative control of total and average to independent enterprises might also help in striking a wages (and other benefits) in state enterprises, to prevent better overall balance between infrastructural and other excessive increases in response to pressure from workers. investment. China's local governments have proved dedi- In this regard, the Government is contemplating formal cated and resourceful investors, but are probably unduly linkages between the remuneration of workers and the biased :,n favor of directly productive industrial invest- performance of their enterprises. But experience else- ment. Making enterprises independent, with more invest- where suggests that this could generate inequities and ment responsibility, could thus give local governments a misrepresentations that might undermine aggregate wage stronger incentive-as in other countries-to improve in- control. It might be preferable to have wage guidelines frastructure in order to attract industrial investment. that were more uniform across enterprises, coupled with China's recent mixed experience with devolution of greater managerial discretion in the distribution of wages investment decisions to enterprises, however, confirms among workers within particular enterprises. that without other systemic changes such an arrangement Gradual wage adjustments could also help remote and can have undesirable results. Inappropriate managerial backward localities. At present, nationally uniform state incentives, irrational prices, lack of competition, and sector wages, and unofficial pressure to tie collective sec- shortcomings in commerce and material supply can lead tor wages to state wages, make it harder for enterprises in enterprises to undertake investments of little economic these localities to compete effectively against enterprises merit, while neglecting other investments of much in more advanced regions or in international trade. Non- greater use to the economy. agricultural employment in backward areas might there- Reforms in enterprise motivation, competition, and fore increase faster if unskilled wages in these areas de- prices could eventually overcome many of these prob- clined in relative terms. At the same time, though, these lems, making it possible to consider devolving a much areas probably need to offer skilled workers higher wages greater proportion of investment decisions to enterprises than elsewhere. and, relatedly, allowing state enterprises to retain a much larger proportion of their profits. More mobility of in- Investment Decisions and Finance vestment funds, through more varied channels, could also In energy, transport, education, health, and defense, the increase the efficiency of decentralized investment deci- Government will undoubtedly retain direct control over sions. most investment decisions, mobilizing the necessary fi- Investment flows in China in the past have been largely nance through the budget. The same will apply to major vertical, with most savings being mobilized upward land and water development projects. Budgetary saving through the budget and dispensed downward through to finance other sorts of investment may also have to sectoraL ministries and state banks. In addition, there has remain substantial, if the high aggregate saving rate neces- been some compartmentalized reinvestment of savings sary for rapid growth is to be attained. But households generated within particular sectors and localities. In the and enterprises could contribute a much larger share of future, although vertical flows and compartmentalized aggregate saving than in the past and could make an reinves ment will remain important, they could advanta- increasing proportion of investment decisions. This pat- geously be supplemented and replaced to an increasing tern is already established in agriculture and other small- extent by horizontal investment fund flows of three main scale activities. In larger-scale industry and services, how- types. The first, mentioned earlier, would be allowing ever, the degree to which investment decisions should be existing enterprises to diversify into new lines of activity. devolved to enterprises remains an important issue. The second, which overlaps with the first, is direct invest- Such devolution could have a number of advantages. It ment linkages among economic units: enterprises could would give greater meaning to enterprise independence, increasingly be permitted to invest in other enterprises, especially since the economic performance of an enter- establish new enterprises, or participate in various sorts of prise at any given time depends heavily on previous in- joint ventures. The third sort of horizontal flow is vestment decisions. It would increase the medium and through socially owned financial institutions, acting as long-term responsiveness of production to evolving needs intermediaries between the suppliers and users of re- and demands. It would make fuller use of the detailed sources. knowledge of enterprise managers. It might also provide Such financial institutions, offering interest rates that a way of strengthening incentives for sound investment reflected the scarcity of capital, could mobilize funds decisions, in whose outcome enterprise managers could from households and institutions, including enterprises be given a substantial direct personal financial interest. with lmited internal investment opportunities. They 13  could make these funds available to potential investors, INDIRECT CONTROL. In the remaining areas of the especially enterprises of all kinds, perhaps mainly in the economy, where decisions will increasingly be made by form of loans, but also in the form of ownership capital- households, farmers, and independent enterprises, there partly because many worthwhile projects are too risky to will be a shift from direct to indirect control. This, how- be largely loan-financed, partly because directly sharing in ever, need not diminish-and indeed might well in- the risks and benefits would motivate financial institu- crease-the Government's ability to manage the econ- tions to provide more assistance in project design and omy. For up to now in China, what has not been directly implementation, including information on markets and controlled has often not been properly planned. The technology. These institutions could in effect create a broader reach of indirect controls, which shape the envi- socialist market for investment funds. ronment in which all economic units operate, could more For such a market to function well, the financial insti- than compensate for the associated loss of direct control tutions should be numerous and diverse, acting in most over particular economic units. respects as independent state or collective enterprises. Instruments of indirect control fall into two main cate- Nonetheless, government regulation of their activities gories-those connected with credit and those connected would be essential. At a minimum, as in all other coun- with taxes or subsidies. A third category is prices. But tries, rules to protect depositors would need to be de- indirect control through administrative determination of signed and enforced, with other rules and central bank prices has the drawback of being able for any particular intervention in the financial market to regulate the over- commodity to govern either demand or supply, but not all supply of money and credit. In addition, the govern- in general both, and hence having to be supplemented ment could-as for many years in Japan and South Ko- with administrative quotas either on demand (in the case rea-influence the allocation of funds in accordance with of shortages caused by a low price) or on supply (in the strategic economic objectives. This could be done in varn- case of surpluses caused by a high price). Moreover, re- ous ways, including channeling some budgetary savings duction in the scope of administrative price determina- through these institutions and subsidizing or taxing loans tion will gradually change prices-apart from their tax or for particular purposes, as well as by selective direct con- subsidy element-from instruments of government con- trols on interest rates and loan allocation. trol into independent indicators of value, cost, and scar- For China, continued experimentation and exploration city. These both influence and are influenced by the in the area of investment decisionmaking and financing actions of producers and consumers, usually in economi- will be necessary, especially since the experience of other cally appropriate directions. Government intervention, countries provides no precedent for a socialist financial however, may still be needed in some cases to dampen market. The relative shares and importance of the various fluctuations, as well as to set one very basic price, namely possible elements discussed above-vertical and compart- the exchange rate, which strongly affects exports and mentalized, as well as horizontal-should be allowed to imports in a decentralized economy. evolve with experience and the development of institu- Control of the overall level and growth of credit, which tions. In general terms, however, it seems likely and desir- depends not only on caution in financing budget deficits able that diversified investment arrangements will emerge by note issue or borrowing from banks, but also on as both consequence and cause of a diversified pattern of regulating the whole banking system (according to well- enterprise ownership. established rules), is a fundamental element of indirect macroeconomic management. And, as mentioned earlier, preferential interest rates and repayment terms in certain Planning sectors or regions, as well as direct government interven- Reform of the system of economic management along tion in the allocation of credit, are feasible and effective the lines of the Central Committee's 1984 decision will ways of influencing the composition of investment. But reduce the Government's direct involvement in produc- experience elsewhere suggests that they should be used tion, commerce, prices, employment, and so on, but cautiously, to avoid undesired side effects. Low interest should not diminish its responsibility or capacity to pro- rates on rural credit, for example, can lead to uneconomic mote and steer China's development. The preceding dis- mechanization in areas with surplus agricultural labor. cussion has touched repeatedly on areas in which contin- Personal income taxation, including progressive rates ued, and often enlarged, direct government involvement and selective relief, can influence the proportion of is needed, especially in establishing the physical, educa- household income saved and the composition of con- tional, scientific, institutional, and legal infrastructure es- sumer demand. Above-average indirect taxes on particu- sential for rapid and efficient growth. The Government lar goods (for example, luxuries) can reduce the amounts will also continue to intervene directly in some other key purchased and supplied by driving a larger wedge be- sectors and enterprises, though more in investment deci- tween the price paid by the customer and that received sions than in current operations, by the producer; the reverse is true for below-average 14  indirect taxes or subsidies (as on food, children's clothing, government agencies and between the center and local books and the arts in many countries). Taxes on enter- governments (who would still have their own, comple- prise profits, including selective concessions by product mentary, medium-term plans, at least at the provincial or locality, can be designed to regulate the total amount level). Other sorts of planning could also play an impor- of funds available to enterprises, the proportion of profits tant role. reinvested, and the amount of external finance used and One is what is called in other countries "policy plan- can stimulate investment in certain activities or regions ning." This is the design of packages of policies to achieve while discouraging it in others. Similarly, import tariffs specified medium-term objectives-for example, improv- can be used to promote increased production in particu- ing road transport, or increasing machinery exports, or lar sectors through import substitution (although without raising primary school enrollment. It is of particular value complementary export incentives they produce an ineffi- when indirect policy instruments are used, or when sev- cient bias toward the domestic market), and in certain eral dif'ferent government organizations are involved, or cases it is rational to tax exports. when different objectives and policy instruments are in- This range of instruments can enable planning and mar- terrelated. For this reason, policy planning is generally kets to coexist reasonably harmoniously, though it in- the responsibility of a high-level government agency, with volves greater emphasis than hitherto in China on manag- strong analytical capabilities, which can evaluate alterna- ing demand rather than supply. Direct control of supply tive approaches to an objective, make recommendations will, as mentioned earlier, continue in some important to the political leadership, and monitor implementation. sectors. But in most cases, rather than dictating what Anoi:her is location planning. Even with more econom- should be produced, the Government could use taxes and ically rational pricing of transport and urban land, most credits to guide the changing composition of demand and countries have found that zoning plans and regulations to influence the relative profitability of different sorts of are necessary to preserve urban amenities. Moreover, in production and investment, allowing supply to respond industries where a single optimal-size plant would supply through the decentralized decisions of enterprises and a high proportion of the national market (for example, farmers. automobiles or electronic chips), but many alternative Experience in other countries suggests that this indirect sites would be equally attractive in economic terms, the approach can be as effective as direct controls in shaping Government needs to arbitrate among competing locali- the pattern of development and often can be more eco- ties to prevent wasteful duplication. In other industries nomically efficient. But the relationship between objec- (cement and fertilizer, for example), government inter- tives and indirect instruments is much less precise and vention is required because the location and scale of all predictable, especially in the absence (as in China) of the enm:erprises need to be simultaneously determined to much systematic study of the behavior and responses of minimize transport plus production costs. economic units. This element of unpredictability can be In addition, Japanese experience suggests the potential reduced by research and by flexible and responsive imple- usefulriess of long-term sector planning, especially where mentation, with adjustment of policies to achieve desired major technological changes are expected or desired. (In objectives over the medium term. But it can never be China, such plans would provide a particularly useful eliminated, and many countries (including Hungary in framework for establishing industry-specific priorities for recent years) have experienced practical difficulties in in- modernization-a very difficult task because of the com- directly regulating their economies. The increased uncer- prehersiveness as well as the backwardness of the whole tainty associated with greater reliance on indirect controls industuial sector.) However, Japanese experience also sug- thus has to be weighed against the inefficiency of direct gests that such plans should not be designed and imposed controls. from above and must have competitiveness in interna- tional narkets as their not-too-distant objective. Through SCOPE OF PLANS. To the extent that direct control of close contact with the enterprises in an industry, sectoral production and allocation was reduced as part of the planners need to create a consensual 'vision" of future reforms, annual plans would become less significant in development, which increases the consistency (and re- themselves, although they (and the budget, with which duces :he risks) of investment decisions. This vision has to they should be linked) would remain important as a be backed up by, for example, government financial par- means of monitoring and adjusting medium-term plans. ticipat on in-or loans to-key investments, including pi- The medium-term plan, by contrast, would become the lot plants, or by temporary restrictions on imports and core of the entire planning process. Although the instru- assistance to exports. But enterprises that wish to pursue ments for its implementation could be different, the gene- a different strategy should often be allowed to do so: ral form of the plan document might be much the same as though this may seem wasteful, the flexibility it provides at present. Its preparation could serve even more than has pioved valuable, since neither planners nor enter- now as a focus for the exchange of views among different prises can pick technological winners consistently. 15  Long-term (ten- to twenty-year) plans in individual sec- trends, and major changes in the pattern of disease, will tors need not, and probably cannot, be coordinated in also pose new problems. Some changes and innovations detail. But they could benefit from a projected long-term in social policies and institutions may thus be necessary. framework for the whole economy-a broad and fairly aggregated "vision" of future growth and structural Income Dispanties change, worked out and regularly revised by central gov- Improving the allocation and motivation of skilled labor ernment planners. Such a plan could also provide guid- could involve some substantial increases in relative wages. ance to enterprises in industries without specific sectoral Even higher incomes could be earned-and in some in- plans, as well as for the planning of direct state invest- stances already are being earned-through entrepreneur- ment in infrastructure and natural resource development, ship. Although perhaps not yet fully accepted in China, and as a context for the medium-term plans. entrepreneurship can make an important economic con- In all these areas, although the common sense and good tribution. Entrepreneurs perceive and supply hitherto un- judgment of planners will remain fundamental, China met needs, initially at a high profit, thus luring others could make some significant technical advances in plan- into the same activities, which increases supply and drives ning methods, including greater use of quantitative profits down. If allowed to, entrepreneurs in China could models of various kinds. This could be assisted by im- also-as in other countries-play a major role in techno- provements in economic training (for both planners and logical innovation, whose risks may require the stimulus other relevant people). Increased use of computers could of high rewards. permit better and more flexible use of the large amounts In such cases, there is unavoidably some conflict be- of data now collected at lower levels. These, and other tween considerations of economic efficiency and the de- sorts of economywide and sectoral information, should sire for minimal income inequality. But this conflict can increasingly be disseminated to lower-level decision- be eased by progressive income taxation (tax rates that makers, including enterprises-who at present receive far rise with income level) and by high indirect taxes on less information from the Government than in many luxury goods. China already has a progressive personal other countries. income tax, aimed mainly at resident foreigners, which could be extended to cover, say, the top quarter of per- Social .ssue andPoliciessonal incomes. Although this would have administrative Social Issues and Pollcies D costs, it would probably make it easier for the central China has been outstandingly successful in reducing ex- government to prevent the informal income redistribu- treme poverty. Although there is substantial income in- tion that is now reportedly occurring in some localities. equality between urban and rural areas and among differ- International experience also suggests the desirability of ent rural localities, the hunger, disease, high birth and not attempting to conceal economically necessary income infant death rates, general illiteracy, and constant fear of disparities. In some countries, for example, bribery has destitution and starvation that haunt very poor people in been aggravated by keeping the wages of public officials other countries have been more or less banished. It will low for political reasons. In other countries, formal in- be of the utmost importance in the future to preserve and comes are fairly equal, but for important people there is build on this achievement. But will the policies and insti- access to shops providing goods not available elsewhere, tutions that have worked so well in the past meet the and sometimes even unrecorded but regular supplements social objectives of a middle-income China? And are they to official salaries. Since these and similar practices compatible with changes in the system of economic man- quickly become well known, their social benefits are tem- agement? porary, while they seem to have a high long-term cost in To a large extent, the answer to both questions is "yes." terms of corruption and the evolution of a society based Social ownership of land and other productive assets, on special privileges. widely dispersed access to basic education and health care, and a guaranteed minimum food intake should all Social Security contribute to maintaining much less inequality and pov- At the other end of the income spectrum, a social secu- erty than in other developing countries. Continued en- rity system consistent with a reformed economy is ur- couragement of agriculture and of other small-scale and gently needed. It will be increasingly difficult to reconcile labor-intensive activities should also-in light of experi- the need for greater enterprise independence and effi- ence both in China and elsewhere-play a vital role. ciency with the present role of enterprises as providers of However, economic reforms and greater technological social welfare benefits and lifetime employment. Prices dynamism could increase income disparities, while eco- and wages will be increasingly governed by economic nomically desirable changes in the price, wage, and em- considerations, which will make it much harder to use ployment systems could make it more difficult to use them to guarantee minimum urban living standards. these things as instruments of social policy. Demographic Faster structural change will involve contraction and clo- 16  sure of some enterprises. Some skills will become obso- including the self-employed as well as state and collective lete, and some workers-often through no fault of their employees. It could be hard, however, to extend the own-may become at least temporarily unemployed. same scheme to rural areas, because incomes are much In devising new institutions and policies to tackle these lower and vary widely among localities. A compromise problems, China might draw on the experience of the also always has to be struck among the desire to alleviate developed Western countries, all of which over the past existing poverty, the need to give people an incentive to few decades have established social security systems avoid poverty, and the wish to minimize budgetary and aimed at providing an adequate income for all citizens administrative costs. For example, setting unemployment and at eliminating poverty due to old age, illness, disabil- benefits high, though it reduces hardship, also reduces the ity, and unemployment. These systems have not been incentive to seek (or remain at) work, particularly if the free of problems, but have effectively attained their main alternat.ve to unemployment is a monotonous or ardu- objectives. All but a few developing countries, however, ous job at a low wage. have been deterred from introducing such comprehensive Especially if noncontributory income supplements social security systems by their financial cost and adminis- were chosen in preference to state-run social insurance, trative complexity. The challenge for China will thus be the statc should encourage collective and local develop- to devise a social security system that is effective, afford- ment of contributory pension and insurance schemes. able, and workable for a lower-middle-income country. Some of these pension and insurance schemes might, as In industrial countries, the social security system con- in other countries, be organized by enterprises and other sists mainly of a state-run insurance scheme, financed employers. But they should be financially independent primarily by compulsory wage-related contributions (or "funded"), so that, for example, a scheme would be from workers and their employers, which provides old- able to continue paying pensions even if the enterprise age pensions, unemployment benefits, sickness and ma- that hac. originally organized it were closed. Such pension ternity benefits, and so on to those who have contrib- and insurance schemes, which would have substantial uted. In addition, some noncontributory income funds tc invest, might play an important role in a socialist supplements are usually provided to households whose financial market. per capita income (including social insurance benefits) Becau.se many complex issues are involved, and be- would otherwise fall below some minimum level. This cause improved social security arrangements could be es- would be one possible approach for China, which could sential to a successful reform of the economic system, a be implemented by consolidation and extension of the commission could perhaps be established soon to formu- present enterprise-based labor insurance and welfare ar- late proposals. These might be implemented in stages, rangements. and should probably initially be of a modest kind. But the An alternative approach might be for the state in China long-term objective should be to maintain China's social to concentrate its resources on noncontributory income achievements, as in the past, well above those of other supplements to low-income households. These could per- countries at comparable income levels. haps advantageously be financed partly from the taxes on high incomes mentioned above, although some addi- Housing and Social Services tional contribution from general revenues might well be China's large and medium-size enterprises are now required. The total fiscal cost of these supplements could unique in the degree to which they provide housing and be substantial, but, because they would be targeted on education and health services to workers and their fami- the poor, would be a fraction of the cost of equivalent lies. As with social security arrangements, it would be price subsidies, which benefit rich and poor alike. Their much easier for enterprises to function as independent, administrative cost could be minimized, and their effec- efficient economic units if these obligations were re- tiveness maximized, by making use of existing institu- moved from them. This would enable managers to con- tions. In urban areas, there is the household registration centrate on economic activities, facilitate labor mobility, system used to administer grain rations. This might be a reduce the social problems caused by the release of un- particularly useful basis for providing income supple- needed workers and closure of inefficient enterprises, and ments to households with high dependency ratios that diminish the present reluctance of many workers to con- would otherwise on balance lose from the upward adjust- sider employment in small urban enterprises. ment of retail prices and wages mentioned earlier. In rural The social services now provided by enterprises could areas, the scheme could be implemented by the adminis- be taken over by local governments. So might some of trative successors to communes, brigades, and teams. the hotsing. But experience in China and elsewhere (in- In administering either state-run social insurance or an cluding Eastern Europe) suggests the advantages of giving income supplement scheme, China, like other countries, households as much responsibility as possible for their would face some difficult choices concerning coverage own homes, through individual ownership or housing and benefits. There might be a uniform urban scheme, cooperalives. This can provide a powerful stimulus to 17  personal saving, release government resources for other force, with shortages especially of younger, more recently purposes, and produce a higher quality and better main- trained, more adaptable workers. In addition, maintain- tained housing stock. The Government could usefully ing very low fertility could cause the proportion of el- assist this, as mentioned earlier, by selling more existing derly dependents (those age sixty-five or more) to bulge urban housing to tenants, as well as by "sites and ser- temporarily above its ultimate long-term level. vices" projects (planning and providing basic utilities for The increase in the proportion of elderly people will be new individually constructed housing), coupled with a serious social issue in the twenty-first century even with technical assistance and limited subsidies or tax conces- a more moderate reduction in fertility. It will increase sions to housing cooperatives. At the same time, univer- from about 5 percent today eventually to about 20 per- sal entitlement to a minimum standard of accommoda- cent. Though there will be an offsetting decline in the tion could be maintained, through both income proportion of young dependents, providing financial sup- supplements and direct provision. port to elderly people is more costly and more difficult to Increased central and provincial government support of organize. China's existing institutions, including the fam- rural social services seems to be needed, especially in poor ily, for supporting elderly people are unlikely to be able and backward localities. The introduction of the produc- to cope with their increased numbers. This strengthens tion responsibility system adversely affected social set- the arguments mentioned above for starting now to plan vices in such places, with a sharp decline in cooperative long-term reform of the social security system. The early health programs, as well as in primary and secondary establishment of wider and better pension schemes in school enrollment rates, especially among girls. This is rural areas would, among other things, make it easier to unfortunate, especially since powerful evidence from reduce fertility. other countries confirms that improvement of basic edu- cation and health is one of the most effective ways of Health helping poor people, as well as contributing to economic The aging of the population will also contribute to the growth. Thus although self-reliance may remain an ap- fundamental changes that are occurring in the nature of propriate policy in more prosperous rural areas, the state China's healh problems. These have already moved should consider financing a larger proportion of the costs from the pattern typical of low-income countries to one of social services in poor areas, for example, through where the leading causes of death are heart disease, matching grants. strokes, and cancer, as they are in high-income countries. These chronic diseases constitute a fundamental challenge Population for China, which other countries have had difficulty in A further reason for taking financial and other steps to meeting despite vast financial outlays. maintain and improve basic social services is that studies One essential ingredient of the required "second health in other countries have shown that both education- care revolution" will be prevention. Some steps-particu- especially of females-and health are major contributors larly control of salt intake and tobacco consumption- to voluntary fertility reduction. As noted earlier, the ex- could be taken straightaway. But much additional re- pected slow rate of population increase, due also to suc- search is needed to identify and field test appropriate cessful birth planning policies, is an important ingredient preventive strategies, which are much less straightforward of China's relatively favorable economic growth pros- than with communicable diseases. Another essential in- pects. Given, in addition, the limited amount of cultiva- gredient will be strategies for dealing with the large num- ble land in China, the achievement of replacement level ber of cases of chronic disease that will, inevitably, occur. fertility (2. 1 children per woman) is clearly desirable. These strategies should include capacity for treatment It might not be so desirable, however, to hold fertility where treatment holds promise of results and can be well below the replacemcnt level for a long time (which afforded; they should pay careful attention to affordable would be necessary, for example, to attain the ultimate plans for rehabilitation of incapacitated individuals; and population of 700 million suggested by some Chinese they should be concerned with humane care for the ter- demographers). This is because the gains from having a minally ill (an area in which there have been major and smaller population in the late twenty-first century could quite affordable advances in Western medical practice). be more than offset by the costs of transitional changes in A third ingredient of the second health care revolution the population's age structure. Of particular concern will be designing an insurance and financing structure would be the long-term impact of very low fertility on that encourages prevention and discourages current ten- the labor force, which could decline rather rapidly in the dencies toward overuse of facilities and introduction of middle decades of the twenty-first century. Negative la- high-cost procedures. Assembling these three ingredients bor force growth might have some economic advantages, will, inevitably, be difficult. But, to the extent that success but would inevitably cause problems of adjustment. is achieved, China could become a world leader in the There would also be a rise in the average age of the labor effective and humane handling of the burden of chronic 18  disease without succumbing, as other countries have, to ally require packages of complementary measures, whose endlessly costly investments in medical technologies of composition would vary according to the particular cir- limited efficacy. cumstances of the locality and other government priori- ties. Improved education and health services, in addition Rural Poverty to meel:ing immediate social needs, build up capacity to Increases in agricultural labor productivity should permit work and innovate. Focused research and extension ser- agricultural incomes to grow quite rapidly over the next vices can release untapped agricultural potential. Agricul- two decades. It is not easy, however, to find a plausible tural specialization and industrial development can be set of assumptions under which agricultural productivity made possible by better roads and other infrastructure, would grow fast enough to narrow the large agriculture- and as5isted by temporary subsidies for local industry. nonagriculture earnings gap (even in proportionate terms) Allowing part of the population to move elsewhere, thus until the twenty-first century. Because members of farm increasing per capita land and water availability, can also families will increasingly be engaged in nonagricultural be an efective and economical way of reducing poverty. activities, their total incomes will rise faster than their earnings from agriculture, but could still remain unsatis- Overview factorily low. Additional measures to raise them are worth considering. To sustain rapid growth for several more decades will be a Higher agricultural product prices and lower prices for hard and complicated task for China. Better access to agricultural inputs could conflict with other objectives of advanced foreign technology than in the past will make it agricultural pricing policy, including avoidance of surplus easier, but will not be sufficient: the cumulative economic production and encouragement of efficient input use. effect of individually inconspicuous improvements in The present two-tier pricing system, though, would in processes and products has been shown to be larger than principle make it possible to boost the incomes of farmers that of radical innovations, and the size of the technologi- by increasing offical procurement prices, while allowing cal gap between the best and the average enterprise in an market-determined above-contract prices to balance sup- industry to be as important as the technological level of ply and demand for the various agricultural commodities. the best enterprise. Nor will availability of energy, land, But this would be quite complicated, especially if unac- and other natural resources-despite their importance- ceptable inequities among farmers in different places and be the deciding factor. China's economic prospects will situations were to be avoided. Direct income supple- depend, rather, on success in mobilizing and effectively ments to broad categories of farm households might pose using al available resources-especially people. fewer administrative problems. This in turn will depend largely on success in reforming Increased government expenditure on things that the system of economic management, including coordi- mainly benefit the agricultural population, financed by nated progress on three fronts. First is greater use of taxation of other sectors, could provide another means of market regulation to stimulate innovation and efficiency. transferring nonagricultural productivity gains to those Second is stronger planning, combining indirect with di- who must remain farmers. Development of agricultural rect economic control. Third is modification and exten- and other rural infrastructure, improvements in agricul- sion oi' social institutions and policies to maintain the tural research and extension services, and support to rural fairness in distribution that is fundamental to socialism, social services are obvious examples. Another possibility despite the greater inequality and instability that market is subsidies to rural participants in social security schemes. regulation and indirect controls would tend to cause. Though generally low agricultural incomes are an im- On cach of these fronts, there are promising ways for- portant problem, the most serious rural poverty in China ward, but also problems and hard choices to be faced. In is concentrated in specific localities, where incomes are addition, it is hard to overstate the importance and diffi- far below the average. (For example, in Dongye town- culty of striking a correct balance among the three. Very ship, in Dingxi county, per capita income in 198 3-the few countries have combined state and market regulation township's best-ever year for agricultural production- in such a way as to produce rapid and efficient growth, was about one-sixth of the national rural average.) Many and fewer still have also managed to avoid intolerable such localities will benefit absolutely, and some relatively, poverty among substantial segments of their populations, from reform of the economic system-this appears to be On the contrary, there are far more countries in whichi the reason why the production responsibility system has unhappy combinations of plan, market, and social institu- not yet generated the anticipated increase in overall rural tions have produced neither rapid growth nor efficiency income inequality. But others will tend to remain very nor poverty reduction. poor and could even become worse off, especially if they There is thus a vital need to guard against losing the are remote or have meager land and water resources. strengths of the existing system-its capacity to mobilize To solve the problems of poor localities would gener- resources, as well as to help the poor-in the course of 19  overcoming its weaknesses. This will surely not deter progress in the urban economy. Though in many ways China-a successful pioneer in many areas-from moving more complicated and troublesome than rural reform, ahead. But it argues for a gradual advance, with experi- urban economic reform probably has the advantage of mentation and evaluation at each step, even though a not needing to be so uniform. Other countries have suc- one-stroke change would in principle involve fewer inter- cessfully applied different management methods in differ- nal inconsistencies. Experience in Eastern Europe also ent sectors and enterprises, and China should be able to suggests the importance of moving steadily and of trying do the same, while constantly seeking to refine and im- to avoid ill-judged steps in the direction of market regula- prove the mixture. tion that subsequently have to be reversed or administra- In system reform, and in the many other areas covered tively tampered with, thus creating needless uncertainty. by this report, both the potential for progress and the Not all the steps need be small, though. In some cases, problems involved are so large, and there is so much that despite the greater risk of error, it may be best to intro- is without historical precedent, that an even-handed and duce substantial packages of simultaneous reforms. Nor credible conclusion may be impossible. At a minimum, need progress be slow. What has been accomplished in though, China's long-term development objectives seem China's rural areas in the past few years has provided not attainable in principle, and if recent experience is any only an example, but also an excellent opportunity and guide, there is a good chance that they will be attained in indeed a vital need for complementary and similarly rapid practice. 20  Growtb and Change Over the next two decades, China-now a low-income percent: South Korea (6.6 percent) and Greece (5.2 per- country-will become a middle-income country. This cent). chapter explores possible implications for China's devel- More generally, only one country-Japan-has indis- opment strategy of international experience during the putably caught up with the developed nations from a low- to middle-income transition. Its three main sections position of economic backwardness. Several Latin Ameri- deal with macroeconomic change, microeconomic can countries, including Brazil and Chile, entered the change, and inequality. But first are some objectives- modern growth phase at least as early as Japan and have both for China and for this report. subsequently experienced periods of rapid growth, but still reriain far behind.3 Even the Soviet Union, with an Objectives exceptiDnally high rate of investment in physical and hu- man resources over many decades, has raised its per cap- China's ultimate economic objective is to catch up with ita GN]P in real terms to only about half the U.S. (and the developed countries, and as quickly as possible. The two-thlirds of the West European) level.4 impressive progress of the first three decades of the Peo- China's past record, nonetheless, is quite encouraging. ple's Republic, described in an earlier World Bank report From .952 to 1982, despite relatively rapid population (China: Socialist Economic Development, 1983) represents the first step toward that goal. The next step envisaged by Chinese leaders is to give most Chinese people a relatively 1. "A relatively comfortable living standard" is a rough trans- comfortable living standard and eliminate the worst man- lation cf the Chinese term xiaokang, which originated from a ifestations of poverty. ' Toward this objective, quadru- Chinese classic Li Ji. In that context the term was contrasted with pling of agricultural and industrial output between 1980 datong, xhich refers to a very rich society. Some people in China now cItssify the various stages of development in terms of im- and 2000 has been set as a target, with per capita GNP to proveme-nt in living standards, as follows: jihan (poverty), wenhao increase from about $300 to $800 (in 1980 dollars). (basic needs satisfied, which is considered applicable to the present Beyond this, the path is as yet uncharted. But the direc- situation in China), xiaokang (which is to be achieved by the end of tion of development during the next two decades will this century), and fuyu (rich). See Liu Guoguang, ed , Zbongguo powerfully and perhaps irreversibly influence China's Jingi F,zhban Zhanlue Wenti Yanjiu (Issues of China's economic economic prospects in the twenty-first century. development strategy) (Shanghai: Shanghai Renmin Chubanshe, The magnitude of the task ahead is readily illustrated 1984), p. 98. Inhreal (purcasning power) taskher is, G percapit inathed 2. At actual prices and exchange rates, the gap is much larger- In real (purchasing power) terms, GNP per capita in the a factor of thirty rather than ten. But the huge nominal income gap industrial countries is approximately ten times greater between rich and poor countries is apparently due more to differ- than in China2 and will increase in the future by at least 2 ences in prices than to differences in purchasing power, large percent and perhaps 3 percent per year. To catch up by though the latter are. See 1. B. Kravis and others, World Product 2050, China's GNP per capita would have to increase at and Income (Washington, D.C.: Vorld Bank, 1982), and China: an average rate of at least 5.5 percent and perhaps 6.5 Socialist Economic Development (Washington, D.C.: World Bank, percent per year (the Government's 2000 target implies a 1983), Mvlain Report, para. 3.32. rate of 5.0 percent). Such rapid progress has been rare 3. See, for example. Lloyd G. Reynolds, T09he Spread of Eco- nomic Growth to the Third WVorld: 1850-1980,; Journal of Eco- elsewhere. In 1960-82, excluding small countries and nomicLmterature, vol. 21 (September 1983), pp. 941-80. economies dominated by oil, only two developing coun- 4 This is the conclusion of several Western studies. Soviet tries achieved annual per capita income growth above 5 calculations suggest smaller gaps. 21  Figure 1.1 Composition of Aggregate Demand The future is inherently unpredictable, and the most in China and Other Developing Countries, 1981 careful forecasts are often confounded. The lessons of (shareof GDP) international experience are commonly either obvious (though frequently ignored) or ambiguous and controver- Foreign sial and in any event are hard to apply to China, a ,.z-borrowing country that in important respects differs from all others and is not easy for outsiders to understand. Thus, al- though this report is about planning in the broadest sense, its projections and calculations are not predictions, _ ,,-- ---____ 4 1 ! l l l l 1ll and its suggestions are no more than an attempt to con- , ,-___ | | | | 0 X tribute to the debate in China about the difficult ques- tions and problems that must be confronted during the country s unique socialist modernization. Macroeconomic Change China's future economic growth will require and cause changes in economic structure. At the macroeconomic level, the pattern of structural change associated with rising income has been broadly similar in most countries, ____----- and many of its features are likely to recur in China. But China Typical Typical because individual countries have deviated significantly large large from the average pattern, it is also important to consider low-income middle-income country' country' China's particular starting point and circumstances. Figures 1.1 to 1.3 summarize some essential results of Investment available research.6 Each figure juxtaposes three things: China in 198 1; a typical large low-income country; and a a. Data are from the period 1980-81. typical large middle-income country. The first figure deals Sources Annex 5, Table 3. 1. with the sectoral composition of domestic demand, the second with the sectoral composition of production, and the third with the sectoral composition of employment. growth and periods of acute economic mismanagement, Cbina's Present Economic Structure per capita national income grew at an average annual rate in International Perpective of 4.0 percent, with phases of significantly faster growth.' The figures show that China is in essence a low-income Of particular relevance is China's performance during the country with an unusual pattern of domestic demand and period of policy and system reforms that began in 1979 production. Output per agricultural worker is small and (described in more detail in World Bank Report 4072- agriculture's share of total employment is large-similar CHA, March 1983). From 1979 to 1984, largely as a to the typical low-income country. Output per worker in result of much accelerated agricultural growth, per capita manufacturing is higher than in the typical low-income national income grew at 6.8 percent per year. country, because of massive investment in heavy indus- The objectives of the present report are to identify try; with nonagricultural employment only 30 percent of some of the key issues and problems that China may face in the next twenty years and to review, in tight of inter- in the next twetyseasadtrvie,nlght5. State Statistical Bureau, Statistical Yearbook of Cbina, 1983 national experience, some of the options for addressing (Hong Kong: Economic Information and Agency, 1983), p. 6. them, with particular emphasis on decisions that might 6 The discussion in this section is based on Annex 5, which need to be made soon. As well as considering issues compares the present structure of China's economy with those of within specific sectors, such as agriculture and energy, other countries, and on Background Paper 9, which presents the and intersectoral linkages-the ways in which prospects results of empirical research on the structural changes normally and problems in each sector depend on circumstances and associated with the low- to middle-income transition in large coun- decisions in other sectors-the report ves special atten- tries. Figures 1.1-1.3 are derived from Tables 3.1, 3.6, 3.8, and n o t r e 3.9 of Annex 5. In the figures, per capita GNP is taken to be $ 300 tion to cross-sectoral or economywide Issues, including and $1,500 (1981 dollars) for the typical low-income and middle- human and financial resources, spatial location of eco- income country, respectively. In the Annex tables, the predicted nomic activity, and reform of the system of economic values for large lower-middle- and upper-middle-income countries management. are presented separately. 22  the total, however, the higher output raises China's per Figure 1.2. Structure of Production in China capita income only modestly.7 and Other Developing Countries, 1981 The most unusual aspect of demand in China (Figure (sbare oj GDP) 1.1) is the high share of saving-unique among low-in- come countries, well above the average for middle-in- come countries, and matched only byJapan and the East Mani-u European socialist countries. However, although house- faauilng hold consumption composes only half of China's low per _ - - capita income, basic living standards-as measured for struc:ure -' example by calorie intake, literacy, and life expectancy- are similar to those of middle-income countries. This has been achieved partly through a share of public spending (particularly on education and health) well above-and N better focused on basic needs than-that of the typical N low-income country, partly through imposing an austere but cost-effective pattern of household consumption. Al- though the share of food in household consumption ex- penditure is quite normal for a low-income country, sta- ples such as grain constitute an unusually high proportion China Typical Typical of food consumption. large large Especially because exports and imports are small in low-income middle-income relation to total output (though not unusually so for a country' country' very large country) and almost balance in both agricul- ture and manufacturing, China's unusual pattern of de- Note Inirastructure includes electricity, transport, and construction; services mand contributes to an unusual pattern of production includes housing. a. Data ire from the period 1 980-8 1. (Figure 1.2). The high saving share has its counterpart, Source Annex 5, Tables 3.8 and 3.9; World Bank, World Tables, 3d ed. because of the need to produce a large volume of invest- (Washington, D.C., 1984), vol. 2. ment goods, in a manufacturing share far larger than that of the typical low-income country and similar to that of the typical middle-income country. The share of agricul- ture in total production, by contrast, resembles that of in China is similar to that of the typical low-income the typical low-income country, simply because of the country, the composition of nonagricultural employment need to allocate a substantial proportion of limited re- is rather different (Figure 1.3). The share of manufactur- sources to feeding the population. The share of infra- ing in employment is significantly higher than in the structure (electricity, transport, and construction) is also typical low-income country, but by less than its share in similar to that of other low-income countries, despite output, since output per worker in manufacturing in China's large manufacturing share. China is unusually high (which in turn mainly reflects the The share of services in output is thus much smaller unusually low share of labor-intensive consumer goods (about 17 percent of GDP) than in the typical low-income within the manufacturing sector). The share of services in country (35 percent) or middle-income country (40 per- emplcyment in China is correspondingly lower than in cent). The share of education and health services is (as the typical low-income country. already mentioned) significantly above average. The low International comparisons of economic efficiency are overall service share thus mainly reflects the small shares difficult. But the available evidence (reviewed in Annex of commerce (including restaurants), banking and fi- 5) gives considerable support to the view that China's nance, and miscellaneous business and personal services. economy is relatively inefficient. Usage of intermediate This in turn reflects the small share of household con- material inputs-most conspicuously energy, but also sumption in national income and the high proportion of other industrial and agricultural products-seems high. food consumed directly by its producers, which tend to (Indeed, inefficient use of industrial intermediate inputs reduce trade (especially retail), as well as past official ne- appears just as important as the high saving rate in ex- glect of personal services. In addition, China's present system of economic management, and the high degree of enterprise and local self-sufficiency, reduce the provision 7. As explained in Annex 5, China's per capita GNP in 1981 is of (especially wholesale) trade, and financial and other $300 at Chinese prices and official exchange rates and is tentatively business services. estimat ed to be $ 3 50 at prices comparable to those in other devel- Although the share of agriculture in total employment oping countries. 23  Figure 1.3 Structure of Employment in China country levels of output per worker require about five and Other Developing Countries, 1981 times as much capital per worker as in a low-income (share of the labor force) country; to accumulate this capital rapidly requires a high investment rate, as for example in other fast-growing East Asian economies. structure s> China has, though, the option of supplementing do- -------- ~~~~~~~~mestic savings with external finance. In recent years, as Figure 1. 1 makes clear, China's balance of payments sur- _ _ ------ plus has added to the need for domestic savings-reduc- S. _ l l l oMining ">ing consumption below the already low level required to finance domestic investment. By contrast, the typical large developing country (low or middle income) runs an external deficit, with domestic investment exceeding do- mestic savings, thus easing the conflict between consump- tion and growth. Recent international experience, how- ever, has underscored the need-discussed further in Chapter 6-for caution and good judgment in external .--------- --------- borrowing, and the essential role of matching increases in China Typical Typical export earnings. large large low-income middle-income EFFICIENCY A high rate of investment (in education couor> ~~~countrvY country' country' and training, as well as physical capital), though neces- sary, will not be sufficient to attain China's growth tar- Note. Infrastructure includes electricity, transport, and construction; services gets. It must be accompanied by increased efficiency and includes housing. improved technology, which Wester economists cal a. Data are from the period 1980-81. prdc tivt ec Sources Annex 5, Table 3.6. growth of total factor productivity (TFP)-the difference between the rate of growth of aggregate output and that of some aggregate of inputs. Though different studies have often yielded signifi- plaining the large share of industry in China's total pro- cantly different estimates for particular countries and duction.) The data do not permit a firm conclusion re- time periods, most studies suggest that TFP growth has garding efficiency in the use of fixed capital, but the typically contributed about one-third of aggregate net amount of circulating capital used appears unusually output growth in middle-income developing countries, high. and nearly one-half in industrial market economies. In the Soviet Union, TFP growth has apparently been slower Possible Implicationsfor China's Future Development than in most industrial market economies and has con- Partly because China now differs in important respects tributed a smaller proportion of output growth. Rough from any other developing country, low or middle in- calculations for China suggest that TFP growth during come, the macroeconomic structural changes that occur 1952-82 was on average low by comparison with other during the typical low- to middle-income transition (sum- developing countries, though better in some sectors and marized in Figures 1 .1-1.3) are of only limited relevance subperiods than in others.8 to China's future development. Nonetheless, some impli- Research on the causes of variations in TFP growth cations-explored further in subsequent chapters-can be across countries and sectors and over time has had limited drawn from individual elements of this transition, the success, partly because of difficulty in quantifying poten- experiences of some other atypical countries, and China's tial explanatory variables (such as improved technology unusual starting point. and knowledge, increased division of labor, and incen- tives to economize on materials and capital and to use SAVING. China's saving rate is already so high-about workers more effectively). However, differences in TFP 30 percent of national income-by international stan- growth among sectors are apparently less systematic and dards that the usual low- to middle-income trend of a pronounced than differences among countries: in a fast- rising saving rate (Figure 1. 1) is unlikely to apply. In growing country, TFP growth in all sectors tends to be principle, indeed, China could reduce saving to a level- higher than in other countries. This-like China's experi- perhaps 20 percent of national income-similar to other developing countries. But this would be incompatible with China's long-tcrm growth targets. Middle-income 8. Annex 5, Table 3.16; Table 7.1 herein. 24  ence since 1978-confirms that the general orientation of those connected with housing, travel, and recreation, and policies and the system of economic management are with a disproportionate increase in expenditure on rele- crucial determinants of the pace of economic advance. vant services (as distinct from goods). The same finding-and much other evidence, including However, with any given level and distribution of in- China's own experience-confirms the need for a bal- come, the composition of household consumption varies anced allocation of resources among sectors. In particular, significantly among countries. This appears to be caused favoring industry at the expense of other sectors does not by variations not so much in national tastes (which influ- seem to generate rapid and efficient growth, even though ence only the details) as in the relative prices and availabi- industry is usually the fastest-growing sector and the shift lities of different items, which in turn vary partly because of employment from agriculture to industry contributes of natural resource endowments, partly because of gov- significantly to overall productivity growth. Countries ernment policies. For example, people in Japan, as com- that have stimulated agricultural production and incomes pared with those in the United States, eat less meat and have generally experienced faster, rather than slower, in- dairy products and are less well housed, mainly because dustrial growth. Similarly, even in countries where manu- land is scarcer, but also because imports of agricultural facturing production has grown very rapidly, infrastruc- products are restricted to protect Japanese farmers. In the ture and services-which are vital for industrial (and Soviet: Union and Eastern Europe, retail trade and other agricultural) efficiency-have absorbed a much larger services are a much smaller share of household consump- share of resources. For example, in South Korea in tion tnan in Western countries, mainly because planners 1965-74, manufacturing accounted for only 27 percent have allocated few resources to these activities. of total annual fixed investment, excluding housing, and China's future pattern of household consumption, in Japan in 1951-65, 30 percent. In China, the corres- though following certain universal trends, will thus to ponding share in the period 1950-80 seems to have been some degree accommodate itself to physical constraints, close to 40 percent (Annex 5, Table 3.11). as well as to government policies affecting the supply and prices of particular goods and services. Some of the Gov- CONSUMPTION. Like the domestic saving rate, the ernment's policy options (especially as regards consump- share of public consumption in national income in China tion of food, energy, and services) are examined in later is already above the normal level for a middle-income chapters. Naturally, at a given level of aggregate real con- country and will thus not necessarily follow the rising sumprion, if Chinese people are induced-by high prices trend observed in other countries (Figure 1.1). Indeed, it or restricted quantities-to consume less of one thing, could even fall, given the large weight of education in they must also be induced or allowed to consume more government expenditure, because of the large and highly of something else. But planners often find it difficult to atypical prospective decline in primary school enrollment identify items (other than basic necessities) whose con- in China over the next two decades, as a result of low sumpl:ion should be disproportionately increased. In most birth rates (see Annex 1). Increases in enrollment at market economies, by contrast, profit-seeking enterprises higher levels, improvements in educational quality, and seek continuously to produce consumer goods and ser- pressure for greater public expenditure on health, admin- vices whose consumption can be expected to increase istration, defense, and other public services will, on the unustLally rapidly (sometimes with the assistance of adver- other hand, tend to increase public consumption. Clearly, tising). Changes in China's system of economic manage- the Government has many options, whose budgetary ment (Chapter 10) may thus be needed, among other implications can only be assessed in relation to possible reasons, to enable household consumption to grow at the trends in subsidies, transfer payments, and public invest- same high rate as national income. ment-discussed in Chapter 9. But public consumption (much of which is in fact essential investment in human FOPEIGN TRADE. Choices connected with the level skills and knowledge) in the narrow sense of current pur- and pattern of foreign trade are less significant for large chases of goods and services seems unlikely to rise faster countries than for small ones, since the former generally than national income in the next twenty years. have rnore balanced resource endowments, higher inter- Since household consumption in China is probably nal transport costs, and domestic markets large enough to more concentrated on basic necessities than in the typical realize economies of scale in basic industrial activities. low-income country, it will almost certainly change, as China appears to be an exception to this generalization per capita income rises, in the same directions as it has only in respect of resource endowment: its 0. I hectares changed in other countries. These include a decline in the of cultivable land per person is one of the lowest ratios in share of expenditure on food, with an increase in the the world. The long-term possibility of net agricultural relative weight of nonstaple foods, especially meat; a imports paid for with manufactured exports-the pattern slight rise in the share of expenditure on clothing; and a observed in South Korea and Japan-thus requires careful sharp rise in expenditure on other items, most notably investigation. 25  But China's foreign trade options (Chapter 6) are sig- dence and specialization. And expansion of personal ser- nificant mainly because of the relationship elsewhere be- vices would reflect a shift in the balance between plan- tween foreign trade and economic performance. Devel- ners' priorities and people's preferences as criteria for oping countries-including Japan-that have become allocating resources. More generally, rapid and efficient sucessful exporters, especially of manufactures, have gen- expansion of the service sectors probably could not be erally also experienced faster growth. The causation runs accomplished through administrative directives and cen- in both directions, but exposure to trade seems to be a tralized resource allocation. International experience necessary ingredient of rapid and efficient growth. Thus, strongly suggests that growth of services should be pulled although the ratio of exports (and imports) to national by demand, with government in a permissive rather than product is typically no higher in large middle-income an active role. Individual and collective enterprises may countries than in large low-income countries, the possibil- also be better suited than state enterprises to providing ity of raising China's foreign trade ratio seems worth high-quality, flexible, and customer-oriented services. considering. SERVICE SECTORS. A declne in agriculture's share of Microeconomic Change production and employment is the most universal feature The changes in macroeconomic structure illustrated in of economic development, and one that will undoubtedly Figures 1.1-1. 3, and discussed in the preceding section, continue in China. The two issues are, rather, how fast are slow-at most, a few percentage points per decade. this decline will occur and what the relative sizes of the Moreover, these broad structural shifts are more a conse- various nonagricultural sectors will be. Especially as re- quence than a cause of growth. By contrast, microeco- gards employment, the two issues are intimately related, nomic structural change (affecting individual products, since, in the usual pattern of development, the main shift processes, enterprises, and workers) is typically much is from agriculture into services, with a more moderate faster, and its speed is a crucial determinant of the aggre- increase in employment in industry, which is less labor gate growth rate. intensive. The conspicuous smallness of the service sec- Microeconomic change contributes to growth mainly tors in China at present raises questions about their fu- by enabling cheaper and better products and processes- ture contribution: will they continue to be unusually in agriculture and services, as well as in industry-to small, or will they-as in the past few years-expand displace more expensive or inferior ones (Chapter 7). unusually fast? This involves introducing new technology-better seeds, China's small commerce, finance, personal and enter- faster machine tools, computerized inventory control- prise support service sectors, partly offset by a large edu- and abandoning obsolete products and equipment. It in- cation and health sector, constitute a pattern that also volves increasing specialization, which realizes technical emerges when the Soviet Union is compared with West- economies of scale and allows people to become expert in ern countries at comparable income levels. Neither in the particular sorts of work. It involves responding to needs Soviet Union nor in China can this pattern be explained and opportunities created by alterations in economic cir- by the "concealment" of service activities within other cumstances-energy and materials prices, the pattern of sectors.9 As in other countries, the share of employment demand, transport facilities, and so on. It involves innu- in services in the Soviet Union has risen with income, but merable small modifications to existing products, proc- has always been at an unusually low level, with a corre- esses and practices-in procurement and marketing, as spondingly above-normal share of employment in agricul- well as production-which cumulatively can reduce costs ture. There are variations also among developing coun- and improve the quality of products and services by strik- tries. But the striking contrast between the Soviet Union ing amounts. (and Eastern Europe) and virtually all other countries Much microeconomic change takes place within exist- (including Japan, which has always had a large service ing production units-farms and enterprises-sometimes sector) is more indicative of the range of options China involving radical transformation of the product mix. But has. This contrast also strongly suggests that rapid service sector expansion (discussed further in Chapter 2) and 9. Gur Ofer, The Service Sector in Soviet Economic Growth (Cam- reform of China's system of economic management are bridge, Mass.: Harvard University Press, 1973). See also Annex 5 closely interrelated options. Expansion of commerce of this report. Nor can this pattern be explained by the classifica- would go hand in hand with expansion of the role of tion in China and the Soviet Union of many services as not market regulation and increased specialization of produc- materially productive (and hence excluded from national income): the shortfall is in fact more conspicuous for material services (com- tnon units and localities. Expansion of enterprise support merce and enterprise support services) than for nonmaterial ser- services, including finance, accounting, and law, would vices (where the gaps in finance and personal services are offset by likewise be a corollary of increased enterprise indepen- education and health). 26  Box 1.1 Size and Growth of Enterprises in Market Economies The seemingly disorderly process of enterprise births and between profitability and growth; enterprises that are deaths and widely differing enterprise growth rates in most more profitable also grow faster. This is largely because market economies has a strong underlying element of evo- they depend mainly on retained profits to finance invest- lutionary natural selection: enterprises that provide ment needed for expansion, but also because higher profits cheaper and better products or services, and market them make it easier to borrow and issue new shares. Since more effectively, expand at the expense of their less effi- greater profitability generally reflects greater efficiency, this cient rivals, which are forced to improve or to disappear.' financial linkage between profitability and growth plays a Studies-mainly of U.S. and British enterprises-have also crucial role in enabling efficient enterprises to expand at established that this process exhibits certain statistical regu- the ex pense of less efficient ones. Success and failure, larities.2 Small enterprises are a large and stable proportion moreover, are persistent: enterprises with above-average of the total (whose overall size distribution is approxi- growth and profitability in one (say, five-year) period are marely lognormal). On average, small enterprises grow just likely also to have above-average performance in the next as fast, and are just as profitable, as large enterprises, but period. But the evolutionary process takes time: in every small enterprises display much more diversity of growth sector, there is always a wide spectrum of enterprise profit and profitability, which means that the most profitable and and lo6;s rates. fastest growing enterprises, as well as the least profitable and slowest growing (or contracting) enterprises, are mainly the smaller ones. As a result, a significant propor- 1R Several relevant studiei are Srh and Productivity Differenceso tion of initially very small enterprises are rapidly propelled Journal of Ec literature, vol 19 (September 198 1), pp. 1029- into the large enterprise category, while an equally signifi- 64. cant number collapse altogether. 2. Many studies are surveyed in Robin Marris and Adrian Wood. There is also a strong association, independent of size, eds., T1se Corporatm Economy (London, 1971), Appendixes A-C. microeconomic change is also associated with the birth of 1.1). Individual enterprises have expanded at widely vary- new enterprises, marked changes in the relative sizes of ing rates; some have merged, diversified, and changed existing enterprises, and the disappearance-through clo- their product mix, such as one Shanghai engineering en- sure or merger-of particular production units (Box 1.1). terprise, whose expansion from a repair shop to a manu- For individual workers, change may be less rapid, partly facturer-first of gear lathes, then of welding equipment, because workers with obsolete skills retire and are re- then of electrical cable equipment, then of pumps-re- placed by new entrants with new skills, partly because semb,es the history of many engineering firms in other processes change less than products, and partly because countries. Some enterprises, including many small ciga- changes in enterprise product mix reduce the need for rette and machinery manufacturers, have been closed workers to move among enterprises. But microeconomic dowr, especially in recent years. change inevitably entails considerable relearning of skills But: there have also been some basic differences be- and movement of workers among jobs and-in most tween China and most other countries in the area of countries-enterprises (Chapter 8). It may also affect the micrceconomic change. Product and process innovations relative prosperity of different localities-sometimes in a by existing enterprises appear to have been less frequent; persistent and even cumulative way-and thus create the trend of increasing specialization has been much more pressure for geographical movement of people and capital muteA; and producers have rarely sought new customers (Chapter 5). and markets (for example, smelters in China, unlike those The ingredients of microeconomic change described in the United States, normally produce only pure metals, above can be discerned, in some form or to some degree, with users having to make their own alloys). Changes of in China over the past three decades. Many new products product mix, diversification, merger, and spinoff of new and new processes have been introduced. New enter- enterprises seem to have been less common. Enterprise prises have been born at high rates, especially since 1970 closu,e rates have been low. Workers have generally re- with the expansion of commune and brigade enterprises mained employed by the same enterprise throughout and (more recently) individual enterprises. Largely as a their career. result, the proportion of small enterprises in China is Th- competitive process by which better and cheaper quite similar to that in a typical developing or industrial products drive out worse and more expensive products country, and far higher than in Eastern Europe (Table likewise seems to have been slow in China. Especially in 27  Table 1.1 Size Distribution of Industrial Enterprises in Selected Countries (ercent) United United Soutb Size of China, Kingdom, States, Korea, Japan, India, Yugoslavia, Hungary, enterprise 1982 1979 1977 1981 1972 1976-77 1981 1981 5-33 employees 59.2 65.2 56.4 70.6 80.2 51.7 6.6 2.2 33-75 employees 19.5 15.7 20.3 14.4 10.7 35.3 15.8 4.8 75-189 employees 12.2 10.8 12.4 9.2 6.1 7.8 32.1 18.7 189-243 employees 8.5 1.4 3.8 1.5 0.8 0.8 12.0 9.2 Morethan 243 employees 0.6 6.9 7.1 4.3 2.2 4.4 33.5 65.1 Note Data are percentages of the number of enterprises with five or more employees in the country. Sources For China, estimates based on data in the State Statistical Bureau, Statistical Yearbook of Cbina, 1983 (Hong Kong: Economic Information and Agency, 1983); for other countries, various national sources. the state sector, backward enterprises have been pro- In all countries, the potential for "extensive growth" tected, and progressive enterprises held back-sometimes through duplication of existing production is limited, no deliberately in order to maintain profits, capacity utiliza- matter how much capital is accumulated, by shortages of tion and employment in less efficient enterprises. In re- natural resources and (ultimately) of labor and by the cent years, for example, despite general agreement that unwillingness of consumers to buy ever-increasing there are too many bicycle producers, the output of en- amounts of the same goods. To attain a high level of terprises producing good-quality bicycles has been re- economic development thus requires "intensive growth" stricted by the Ministry of Light Industry in order to based on innovation, cost reduction, and product im- protect the producers of inferior bicycles. Similarly, a provement; this in turn requires much faster microeco- cotton mill in one province was recently obliged by the nomic change. With close to 70 percent of the labor provincial authorities to stop sending its cloth elsewhere force still employed in agriculture, extensive growth for dyeing and printing, because the province's own sub- alone could probably carry China up into the middle- standard printing and dyeing enterprise was underuti- income range over the next two decades or so, albeit at lized. Subsidies to keep inefficient plants and old equip- rather high cost. But, over the longer term, intensive ment in operation are common, partly because growth will be essential to China's catching up with the enterprises play a key role in providing housing and social industrial nations, and the experience of other countries services. such as the Soviet Union has shown the difficulty of Chronic shortages, strong emphasis on production tar- switching to intensive growth at a late stage of develop- gets, small price differentials between high- and low-qual- ment. ity products, and inadequate incentives have made prod- Faster microeconomic change in China will require- uct quality improvement, innovation, and cost reduction above all-changes in the system of economic manage- occasional, rather than everyday, concerns of Chinese ment, many of which have already been implemented or enterprises. The former policy of local self-sufficiency and proposed.10 System reform is thus a pervasive theme of deficiencies in the material supply system have led local this report: the general treatment in Chapter 10 builds on governments to construct many plants of suboptimal the discussion of specific aspects of system reform in scale and inferior product quality to supply local needs other chapters, especially those on technology, spatial is- for commodities such as steel. (This may explain why, by sues, and human and financial resources. In all chapters, comparison with all the other countries in Table 1.1, the need for difficult choices will emerge; this is partly China has so few enterprises in the largest size category.) because, beyond a certain point, the objective of faster Deliberate and incidental obstacles to microeconomic growth, with which this chapter has so far been solely change of course exist in other countries. Declining indus- concerned, conflicts with the objective of equity in in- trial sectors are protected by trade barriers; large firms in come distribution. difficulty are helped out with loan guarantees and subsi- dies. Monopolistic practices, distorted prices, corrupt or incompetent bureaucracies, and inadequate retraining fa- cilities, too, retard the speed and efficiency of develop- ment elsewhere. Nonetheless, the obstacles to microeco- mnom clsewha . ioneChinasee toh o bs e un usuall 10. In addition to the major reforms already carried out in rural nom vc change in China seem to have been unusually areas, and numerous experiments in urban areas, a general strategy substantial and comprehensive and could-if allowed to for reform of the urban economy is contained in the Communique persist-prove incompatible with China's objective of of the Third Plenary Session of the Twelfth Central Committee of sustained rapid growth. the Chinese Communist Party, October 20, 1984. 28  Inequality rates, general illiteracy, and constant fear of destitution The distribution of income-and of lving standards more and starvation that haunt very poor people in other coun- generally-is of critical importance fr a stries have been more or less banished from China. Life generally-IS of critical importance for a socialist country epc:ny hs eedneo ayohreooi suc as Chin , whs ceta ecnoi obetv is no expectancy, whose dependence on many other economic such as China, whose central economic objective IS not and social variables makes it probably the best single merely rapid growth, but growth whose benefits are indicator of the extent of real poverty, is on average in widely spread. Considerations of equity will inevitably China outstandingly high (sixty-seven years in 198011) play a central role in shaping China's future development ri statg an sytmreomor a low-income country; even in the p)oorest province, strategy and system reform. life espectancy is not far below the average for middle- Inequality in Cbina in International Penpective income countries. China's past strategy and present system have created, on 'NEW INFORMTION. Since the first World Bank eco- the whole, an extraordinarily equal society. The first World Bank economic report on China dealt with this at normc report on China was written, substantial addi- tional information has become available and further stud- length (Main Report, paras 3.46-3.102); its conclusions, ies made. The preliminary results (from a 10 percent which are essentially unaffected by more recent informa- sampl.) of the 1982 census have been published, as have tion and developments (to be described subsequently), more household survey results. Health nutrition and merit summary recapitulation. Inequality of urban incomes is uniquely low in China, populaton Issues were exammed by the World Bank m with virtually no extreme poverty in urban areas. There China The Healtb Sector (1984). In general, this material is, however, a large gap-comparable to that in other has reinforced the conclusions of the first report. But a developing countries-between average urban and rural few changes of emphasis are required. incomes,which in te rms of living standards is magnifie, The distribution of income in rural areas is less unequal incomes, which in terms of living standards is magnifed, than the World Bank's first estimate (based on fragmen- as in some other countries, by concentration of social services on urban residents. In addition, there is substan- tary ata) had suggested. Rural household survey dat a, . . ' . . ' ...................summ arized in Table 1 .2, show the Gini coefficient in tial inequality of rural incomes in China, largely because 199t ave Tble 0.26, rher than0 Thiseans of wide differences in the quantity and quality of agricul- that rural income inequality in China is significantly less tural land per person, coupled with tight restrictions on than ln other South Asian countries (with Gini coeffi- geographical mobility.tavnohrSuhAincut's(ihGn ofi geogr apcal moi it y cients of 0. 30-0.3 5), rather than in the same range. Thus because China is a low-income country, and be- The same data, however, underscore the importance of cause of substantial rural income inequality, a large mi- geographical differences in rural incomes. Table 1.2 al- nority of the population have extremely low incomes. These people, however, have a much higher standard of living than their counterparts in most other developing 11. World Bank estimate based on the 1982 census and other countries. Agricultural collectivization has prevented the recently released demographic data: see Kenneth Hill, "China: An emergence of a class of impoverished landless laborers; Evaluation of Demographic Trends-1950-82,' Technical Note the state guarantees.ainimumfoodspply r DEM 4 (Washington, D.C.: World Bank, Population, Health, and thrsat uu fd s y pri y Nutriton Department, 1984), which is Supplementary Paper I of school enrollment is high; and basic medical care and Dean r. Jamison and others, Cbina: The Health Sector (Washing- family planning services are available to most people. As a ton, D.C.: World Bank, 1984). The estimate for 1979 in the first result, the hunger, disease, high birth and infant death economic report (sixty-four years) was too low. Table 1.2 Rural Income Distribution, 1979-82 (percentage ofpopulation) Income National average Gansu, Jiangsu, per capita 1979 1980 1981 1982 1982 1982 Less thanY 100 19.6 10.1 4.9 2.9 21.1 Y 100-200 54.0 53.2 39.5 25.6 45.2 16.8 Y 200-300 20.7 26.0 36.2 39.3 22.5 36.2 Y 300-400 4.2 7.7 13.5 20.2 8.2 27.6 Y 400-500 1.1 2.2 4.0 7.4 2.3 11.4 More than Y 500 0.3 0.9 1.9 4.6 0.7 8.0 Gini coefficient 0.257 0.237 0.231 0.225 Source: Estimates based on household survey data (Annex 5, Appendix 1). 29  lows comparison of the rural income distribution for the income inequality in rural areas. The statistics in Table whole of China with the distributions in a relatively rich 1.2, although they may have various biases (Annex 2, province (Jiangsu) and in a poor province (Gansu); the para. 1 .34), suggest that so far this has not happened and differences are extremely striking, with four-fifths of the that if anything rural inequality has declined. This could people in Jiangsu in the Y 200-500 or more range, and be due to increases in inequality within localities having two-thirds of the people in Gansu in the range below Y initially been more than offset by reductions in income 200. Moreover, because Chinese provinces are large and differentials among localities: the reforms spread fastest in internally diverse, these provincial statistics do not ade- poor and backward areas, some of which had also been quately convey the range of incomes among localities. especially disadvantaged by the former policy of concen- For example, Gansu's average rural per capita income in trating on grain production even when other activities 1983 was Y 228 (as compared with the national average would have been more economic. In any event, the lack of Y 310); but in Gansu's poorest county, Dingxi, the of deterioration in the distribution of rural incomes has average was only Y 108; and in one of Dingxi's poorest meant that the sharp rise in average rural incomes has townships, Dongye, it was only Y 55-and this was the greatly reduced the number of households with very low township's best-ever year for agricultural production. incomes. On the basis of the data in Table 1.2, and a Census data on educational attainment by sex and age poverty line based on food intake requirements of 2,185 group (Table 8.1) confirm that China's performance in kilocalories per day, it is estimated that the proportion of basic education surpasses that of most low-income coun- the rural population in poverty declined from 31 percent tries. Moreover, they clearly reveal the adverse effect of in 1979 to 13 percent in 1982 (Annex 5, Table 1.7). the Cultural Revolution on the proportion of younger Though the latter figure still means 100 million people, people with postsecondary education. The same data and though people in places like Dongye township have also show a persistent (though narrowing) gap between gained little, the speed and scale of the improvement is male and female educational attainment. This, together probably unprecedented in human history. with the census data on occupation by sex, suggests that In other respects, however, the rural reforms have had the World Bank's first report may have overstated the some unfortunate consequences for inequality. One has degree to which China has reduced inequality between been a sharp decline in rural cooperative medical insur- men and women, though it is still less than in most ance, financed from collective welfare funds, to which developing countries. individual households are reluctant to contribute. This has been particularly pronounced in poor and backward RECENT DEVELOPMENTS. The data recently released areas (in richer provinces, the swelling profits of com- also allow an examination of trends over the past five mune and brigade enterprises have by contrast led to years-a period of important policy and systemic improvements in collective medical and other social ser- changes, including above all the replacement of collective vices). The drop in the proportion of production brigades agriculture by household farming. This, in conjunction covered by cooperative health insurance from 85 percent with major increases in procurement prices and rapid in 1975 to 58 percent in 1981 (with further declines since development of rural nonagricultural activities, has then) thus represents a considerable step backward, al- caused an astounding surge in agricultural production though the Government is making efforts to upgrade the (more than 7 percent per year since 1978) and rural quality of primary medical care by, for example, giving incomes-up in real per capita terms between 1979 and barefoot doctors more training. 1983 by about 70 percent (Annex 2, para. 1 .33). Urban Similar problems have arisen in basic education, mainly wages and employment have also increased and urban because the household responsibility system has induced staple food prices have been held constant, which has more rural parents-as in many other countries-to keep raised real urban per capita incomes by about 40 percent their children out of school to work on the family farm. over the same period, but the urban-rural income gap has As shown in Figure 1.4, the proportion of primary still narrowed significantly. Rising agricultural production school age children enrolled (the net enrollment ratio) has also caused a sharp increase in food consumption, dropped in 1980-82, although subsequent government which, at about 2,700 kilocalories per person per day in efforts seem to have reversed the decline; the gross enroll- 1982 (Annex 2, para. 2.03), compares favorably with ment ratio at the secondary level has dropped from about levels in most middle-income countries. Nonetheless, 46 percent to about 30 percent, below the developing- food consumption in many localities still falls far short of country average of 39 percent (Annex 1, paras. 2.04- the average, and the composition of the Chinese diet is 2.11). The declines have been particularly marked in still that of a low-income country. poorer areas, where enrollment ratios were already unsat- It was generally anticipated that the rural reforms, by isfactorily low (and actual attendance rates lower still); in making the incomes of individual households more de- richer areas, such as Jiangsu, rural parents see clearly that pendent on their effort, skill, and luck, would increase their children will not be able to join the rapid exodus 30  into nonagricultural employment without a good educa- making diligent workers and successful individual busi- tion. The declines in enrollment have also been particu- ness proprietors richer, and the idle or unlucky poorer. larly marked among girls. Increa,ed interlocality specialization and trade will surely benefit some localities more than others. Possible Future Trends in Inequality In addition, China may be affected by the forces that China may not in the future be able to achieve such a low have t:ended to increase inequality during the low- to degree of inequality as in the past-and indeed, the Gov- middle-income transition in other countries. The incomes ernment's position is that past strategy was excessively of the poorest 40 percent of the population have usually egalitarian. The rural responsibility system, though thus increa,ed more slowly than the average; the gap between far it has increased inequality only through its impact on agricultural and nonagricultural earnings has widened; education and health care, will probably also start to and interregional income disparities have increased.'2 At increase income inequality before too long. Systemic higher income levels, though, all these trends have usually changes in urban areas could also increase inequality, by been reversed, as the modern sectors have come to domi- nate the economy and people have moved in search of higher incomes. And even in middle-income countries with an unusually high degree of inequality, most people have a much higher standard of living than in a low- Figure 1.4 Enrollment Ratios in Formal Education in income country. China, 1965-8 3 and Targets for 2000, and in Other China will also have to deal with the losses that micro- Developing Countries, 1965-80 economic change may inflict on certain families, occupa- tions, enterprises, and localities-even though these may Enrollment ratio (logarithmic scale) not bL visible in aggregate measures of inequality and 100._ _ _ _ even though the gains of other groups may hugely out- 70. __ l___ Prrmaryyeducation- weigh these losses. An example would be a backward enterprise suffering from competition from cheaper or better goods. Governments in all countries, especially 3 Secondary ed lucation socialist ones, feel impelled to reduce the social and politi- 30/0 cal co,ts involved. Yet protecting potential losers, or rou- 20.0 ( 7 tinely compensating them, also has a high cost, because protection and compensation can slow microeconomic lo o change and reduce growth. Ways of easing this dilemma .____ _____ ___'_ will be discussed in subsequent chapters, but some com- 7.0 _ _ -e d_ _ promise between conflicting objectives is unavoidable. 4_0