The Reform of Institutions in China: An Overview

1
The Reform of Institutions in China An Overview

• Course Economic Development of China
• Lecturer Zhigang Li

2
Institutions

• Institutions are man-made constraints that
  structure political, economic and social
  interaction.
• Informal Sanctions, taboos, customs, traditions,
  and codes of conduct
• Formal constitutions, laws, property rights,
  regulation of market forces, bureaucratic
  structure (organization of governments).
• An institution establishes order and an incentive
  structure. Institutions couple with standard
  economic constraints to decide costs and benefits
  of economic activities.

3
Growth of China The Big Picture

• Significant real GDP growth rate 1978-98 (maybe
  6).
• Two views
• Alwyn Young The growth (about 6) is due to (1)
  rising labor participation rates and transfer of
  labor out of agriculture, and (2) better human
  capital.
• Wei Li State-owned Enterprises (SOEs) grew by 6
  1980-89 with about 5 TFP growth rate, which is
  mainly due to (1) more efficient resource
  allocation and (2) better incentive schemes.

4
Chinas Market Transition 1979-98 (Yingyi Qian,
2000)

• Stage One (1979-93) Unconventional reform
• Initialization of reform (1979-83)
• The high wave of reform (1984-88)
• Retreat and revival of reform (1989-93)
• Stage Two (since 1994) Converging to (western)
  conventional forms

5
Initialization of reform (1979-83) Incentives

• Support for commune-brigade enterprises
  (collectives)
• Allowed to seek profits
• Not restricted to agricultural industries, local
  resources and local markets
• Tax holidays to new CBEs
• CBEs sprouted in high-profit light industries
• Fiscal Decentralization
• 100 marginal revenue retention rate
• Autonomous local revenue and expenditure plans

6
Initialization of reform (1979-83) Incentives

• SOE reform (disappointing outcomes)
• Right to product and sell product to the market
  after fulfilling the plan quotas
• Authority to promote mid-level managers
• Profit retention schemes
• Agricultural reform (successful)
• Household responsibility system Control right
  of land and 100 marginal revenue retention
• Seems to be unexpected by the central government
• Opening up the economy

7
The high wave of reform (1984-88) Goods Market

• Market liberalization (Dual-Track)
• May 1984 The market track officially permitted
  for industrial goods
• February 1985 Market prices allowed to be freely
  determined by supply and demand (government
  retained regulation)
• Further opening up
• Deepening of Institutional reform
• Financial reform Competing specialized banks
• Faster entry and expansion of urban and rural
  non-state enterprises
• SOE contract responsibility system

8
Retreat and revival of reform (1989-93)

• Efforts to retreat failed
• Rural enterprises as an engine of economic
  recovery
• Three million rural enterprises (6) failed in
  1989-90
• Rural enterprise employment increased by 10 and
  17 in 1992 and 1993
• Price liberalization By 1993, planned prices
  ended for most goods
• Further opening up
• State-owned enterprise reforms

9
Impression of Growth 1979-94

• The most profound structural change came from the
  entry and expansion of the non-state sector,
  despite the fact that major reform efforts had
  been concentrated in the state sector
• The share of SOE output down from 78 to 43
  employment down from 60 to 30.
• Price formation mechanism established
• Decentralization

10
Stage Two (since 1994)Institution Modernization

• Rule-based market system
• Level playing field Uniform prices (including
  exchange rates and tax rates) for firms with
  different forms of ownership
• Market-supporting institutions
• Formal fiscal federalism
• Centralized monetary system
• Social safety net
• Property rights and privatization
• By 1997, over a half of small SOEs privatized and
  20 million workers laid off.
• More open economy?

11
Institution of China since 1979 E-School vs.
C-School (Wing Thye Woo)

• E (Experimentalist)-School
• No model institution to target
• Actual institution forms are tailored (by
  experiments) to special situation of China and
  are second-best
• Gradual reform is better for China than a
  big-bang reform
• C (Convergence)-School
• A model institution exist and is pursued by the
  reforming force
• Actual institution forms in China are distorted
  by political, cultural, and historical factors.
• Gradual reform is unfortunate
• E-School hints a risky and potentially dangerous
  China while the C-School suggests a predictable
  good China