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					China’s Economy
Global and Political Economic Environment
Global and Political Economic Environment                                                   China’s Economy

Answer: China has been one of the world’s most dynamic economies in recent decades,              but the
industrial revolution occurred in Europe rather than China because European entrepreneurs were eager
to adopt machines to cut down on high labor costs.
One of the big debates in economics is about the causes of the arguably most dramatic change in
development trajectory in (recent) world history, the industrial revolution.
     Before about 1800, growth did occur, but it was mainly “extensive”, leading to more people but
        almost no growth in income per capita.
     After about 1800 this changed, and growth became (increasingly) “intensive”, focused on an
        almost continuous growth of GDP per head.
 There is consensus about the fact that this change in growth pattern started in northwestern Europe,
and gradually spread to large parts of the western and, after a lag, eastern and southern world.

The Great Divergence debate
Recent literature, most famously Kenneth Pomeranz’s The Great Divergence (2000), has suggested that
China’s level of economic performance was more or less at par with that of Western Europe. Moreover,
the lower Yangzi delta formed a core of economic prosperity comparable with the North Sea area, the
most developed part of Western Europe.

Pomerantz argues that even in the eighteenth century, China was not inferior to Europe in terms of
technology, social structures that could support technological innovation, large pools of accumulated
capital, etc. According to him, the reason that Europe “succeeded” and China did not was largely
determined by pure chance—a lack of large deposits of coal and iron ore close to each other and the
absence of large outward migration (after Zheng He, the greatest world traveler before Columbus,
discovered Madagascar, the African Horn, and Saudi Arabia in the early fifteenth century, the emperors
of the Ming Dynasty prohibited the construction of big ships and the Middle Kingdom experienced self-
imposed isolation for four centuries). Pomeranz’s argument is that mass emigration from Europe played
a crucial role in the transition to the modern growth regime from a Malthusian regime.2 When
technological progress accelerated in the nineteenth century but the population growth rates still
remained high and growing (0.6 percent in 1820-70) because the demographic transition had not yet
occurred, mass migration to North America helped to alleviate pressure on a scarce resource, land, and
to avoid diminishing returns.
In a similar vein, land scarcity is seen as a factor that stimulates urbanization and industrialization. It is
argued that “during the Song Dynasty, despite the fact that China lost a significant amount of arable
land to invading nomads as its population peaked, China witnessed a higher urbanization level, more
prosperous commerce and international trade, and an explosion of technical inventions and institutional
innovations. However, after China significantly improved its man-to-land ratio in the period after the
Song only to find itself induced deeper into the agrarian trap, resulting in reduced urbanization,
withering foreign trade, a declining division of labor, and stagnation in technology”

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Global and Political Economic Environment                                                   China’s Economy

 Li’s The Early Industrialization in Jiangnan is particularly noteworthy for its systematic narrative of the
growth of industries in cotton textile, food processing, apparel, tobacco, papermaking, printing, tool
making, construction and shipbuilding in the Lower Yangzi during 1550-1850. His depiction of the rise of
a dynamic, diverse and commercialized printing industry reveals the existence of a mass reading public
in the Lower Yangzi.4 Overall his work attests to industrial progress throughout these three centuries,
not only in the scale and technology of production, but also in its organization and the extent of the
division of labor.
Rea Wages
Asian living standards, at least in the Lower Yangzi, were on par with that of Northwestern Europe is
built on rather fragile evidential base. They relied on indirect comparison based on scattered output,
consumption or demographic data. This on relatively rigorous comparison of the purchasing power of
real wages of unskilled laborers in Asia and Europe reconstructed based on the systematic price and
wage data. The Yangzi Delta is reputed to have the most advanced economy of any Chinese province,
but the real wage there was not noticeably higher than the real wage in Beijing or Canton. Overall, the
Chinese cities were in a tie for last place with the Italian cities, which had the lowest standard of living in
Europe. And they were far behind that in London or Amsterdam – about 30-40% of that of earning levels
there in terms of purchasing power measured by our reconstructed subsistence basket during the 18-
19th centuries. This makes any optimistic assessment of China’s performance is difficult.

Trade, Market Efficiency and Legal Regime

Institutions have figured relatively little in revisionist literature on Chinese economic history. In fact,
Pomeranz views the property rights or the freedom to contract in traditional China as no less secure or
flexible than in Western Europe. This naturally leads the revisionist school to an explanation of the Great
Divergence based on resource endowments. The efficiency of market institution seems to find some
strong empirical confirmation from market integration studies based on statistical correlation of
regional grain prices.

Measures of Integration

Although foreign trade in the 18th century was not significant, China’s expansive empire meant that
even domestic trade involved large distances. Trade between the fertile agricultural areas in the upper
reaches of the Yangzi River of Sichuan Province and the urban regions of Shanghai at the Yangzi Delta
involved covering distances of at least 1700 kilometers. This is approximately the distance of the trade
route between Antwerp and Lisbon. There are also comparable historical accounts of how grain was
paid and transported along routes that connected the Yangzi Delta with Sichuan and Hunan, or,
Amsterdam with Spain and France.

We may know about large specific transactions of grain, but trade volume statistics are spotty at best. In
Europe, rough calculations suggest that 1 % of total consumption of the Mediterranean area was traded
in the 16th century, and the situation may have remained much the same in the 17th century.11 Much
depends on whether one includes only the urban area importing the grain, or the entire population of

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potential exporters as well, but some kind of per capita weighting is essential. In China, the Yangzi Delta
alone with an area of 43,000 square kilometers and a population of approximately 20-36 million
inhabitants in the 18th century may have imported as much as one-quarter of its total grain
consumption, but adding in the potential number of exporters supplying this grain, the relevant per
capita trade statistic must be much smaller indeed.12 Available estimates on disaggregated trade flows
are also vague on considerations such as the date of purchase and delivery or the point of origin and
destination of each shipment. Even if we had more detailed information on the volume of trade,
however, this would not be enough to establish the efficiency of markets.

In China in the 18th century, as in Europe, the labor force was predominately engaged in agriculture.
The majority of the population was engaged in small-scale, producer-cum-consumer farming, and
available estimates suggest that agricultural output made up at least 60 % of GNP in re-industrial
economies.13 Grain was an important commodity, not only in overall output, but in consumption as
well. Monotony in foodstuffs, with a large share of consumption being in cereals, was common in the
lives of both European and Chinese. The share of cereals in the diet of urban dwelling northern
Europeans, who it is said ate more meat and fish than their southern neighbors, was still nearly 60%, a
figure also likely to be significantly lower than for the average farmer.
Fig 1: PPP GDP per capita in major countries at Appendix A

   1. Chinese family structure, although differing from that in Europe, produced neither unlimited
       fertility nor unusually large or rapid population growth.
   2. Chinese and Indian domestic economic activity in such areas as textile production and food
       processing was quite sophisticated with regard to large-scale mass production and trade.
   3. Chinese and Indian merchants operated with substantial autonomy, and had far larger
       commercial fortunes than most European merchants well into the late eighteenth century.
   4. Chinese international economic activity was vigorous and dynamic through the entire Ming and
       Qing periods.
   5. Chinese agricultural productivity and standards of living were comparable to those in the leading
       regions of Europe as late as the eighteenth century.
   6. China's eighteenth and nineteenth centuries were marked by substantial geographical
       expansion and economic integration of new regions.
   7. It was not European eagerness for trade, but China's desire to obtain silver bullion via trade,
       that was the motive force in the global trading system of the sixteenth through early nineteenth
   8. Chinese and Ottoman political dynamics were not wholly different in nature from those of
       European monarchies, for the major political crises in seventeenth century China and the Middle
       East had similar fiscal, social, and material causes, and often greater institutional consequences,
       than European revolutions and rebellions of the same era.

After the establishment of the People's Republic of China in 1949, the economy began to recover after
years of wars. In 1953, the government adopted the Soviet-style central planning in the form of the first

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Five-Year Plan of 1953-1957. Private enterprises and enterprises formally controlled by the government
of the Republic of China were reorganized into state enterprises. In agriculture, the farmers were first
given land after the land-owners as a class was brutally destroyed. They were then organized into
cooperatives, more advanced form of cooperatives and into Communes in 1958 as a part of Chairman
Mao's Great Leap Forward Movement. The Great Leap led to the death of over 25 million people from
1959 to 1962, as can be calculated by officially published death rates. The death rate was about 11 per
thousand in 1957 and 1963, but went up to 17 per thousand in 1962. China had the most severe famine
in its history.

Chinese Economy Prior to Reforms
Prior to 1979, China, under the leadership of Chairman Mao Zedong, maintained a centrally planned, or
command, economy. A large share of the country’s economic output was directed and controlled by the
state, which set production goals, controlled prices, and allocated resources throughout most of the
economy. During the 1950s, all of China’s individual household farms were collectivized into large
communes. To support rapid industrialization, the central government undertook large-scale
investments in physical and human capital during the 1960s and 1970s. As a result, by 1978 nearly
three-fourths of industrial production was produced by centrally controlled, state-owned enterprises
(SOEs), according to centrally planned output targets. Private enterprises and foreign-invested firms
were generally barred. A central goal of the Chinese government was to make China’s economy
relatively self-sufficient. Foreign trade was generally limited to obtaining only those goods that could not
be made or obtained in China.
Government policies kept the Chinese economy relatively stagnant and inefficient, mainly because most
aspects of the economy were managed and run by the central government (and thus there were few
profit incentives for firms, workers, and farmers), competition was virtually nonexistent, foreign trade
and investment flows were mainly limited to Soviet bloc countries, and price and production controls
caused widespread distortions in the economy. Chinese living standards were substantially lower than
those of many other developing countries. The Chinese government in 1978 (shortly after the death of
Chairman Mao in 1976) decided to break with its Soviet-style economic policies by gradually reforming
the economy according to free market principles and opening up trade and investment with the West, in
the hope that this would significantly increase economic growth and raise living standards
Economic Reforms
Beginning in 1979, China launched several economic reforms. The central government initiated price
and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free
market. In addition, the government established four special economic zones along the coast for the
purpose of attracting foreign investment, boosting exports, and importing high technology products into
China. Additional reforms, which followed in stages, sought to decentralize economic policymaking in
several sectors, especially trade. Economic control of various enterprises was given to provincial and
local governments, which were generally allowed to operate and compete on free market principles,
rather than under the direction and guidance of state planning. In addition, citizens were encouraged to
start their own businesses. Additional coastal regions and cities were designated as open cities and
development zones, which allowed them to experiment with free market reforms and to offer tax and
trade incentives to attract foreign investment. In addition, state price controls on a wide range of

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products were gradually 1978 was the year when Deng Xiaoping took over control of the Communist
Party. He was responsible for initiating reform of the planned economy towards a more market-oriented
economy. There were four reasons why the time was ripe for reform.

Table 1: China’s Average Annual Real GDP Growth: 1960-210: Annexure B

First, the Cultural Revolution was very unpopular and the Party and the government had to distance
themselves from the old regime and make changes to get the support of the people. Second, after years
of experience in economic planning government officials understood the shortcomings of the planning
system and the need to change. Third, successful economic development in other parts of Asia including
Taiwan, Hong Kong, Singapore and South Korea, known as the four Tigers, demonstrated to the Chinese
government officials and the Chinese people that a market economy works better than a planned
economy. This lesson was reinforced by the contrasts between the different rates of economic
development in North and South Korea, and in countries in Eastern and Western Europe. Fourth, for the
same reasons as stated above, the Chinese people were ready for and would support economic reform.

Given the above four reasons was economic reform in 1978 inevitable? The first two reasons alone were
sufficient for the government to initiate reform. The Cultural Revolution had made the government so
unpopular that both the government and the people wanted to change eagerly. The direction of change
was clear because economic planning was recognized to be a failure. Given such a situation there was
no other way for China to go. The urgency of the case was such that it had to occur as soon as the
political leadership was ready after Chairman Mao's death. Chinese economic reform in 1978 is an
example of the possibility of predicting a major social change by examining the prevailing conditions.
Such prediction is easy to do by hindsight but more difficult to do before it occurs.

In my opinion, Six major components of economic reform beginning with agriculture. The remaining
areas are state-owned enterprises, price reform, the banking sector, foreign trade and investment, the
non-state sectors and institutional infrastructure. I point out that the reform process has been a
combination of the effort of the central government and the natural desire of the Chinese people and
lower level government units to improve the economic institutions for their own benefits. For example it
was a combination of the efforts of the farmers and the government which changed the Commune
System. As far as the role of the central government is concerned, the process has been a gradual and
experimental one and has proceeded in steps.

Reform of Chinese state-owned enterprises is an example of a gradual approach to economic reform
through experimentation. In this case, the following concepts were accepted and carried out step by
step. The first was to give state enterprises some autonomy in production decisions rather than simply
carrying out the production targets under a system of central planning. The second was to make them
financially independent, allowing them to keep the earnings as their own profits after paying taxes to
the state, rather than as revenue belonging to the government. The third was to introduce a contract
responsibility system, first to selected parts of the enterprise under the important reform decision of
October 1984, and later to an enterprise in 1987. Under the contract responsibility system, a part of an

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enterprise or the entire enterprise was allowed to keep all the gain (such as output produced) or profit
after surrendering a fixed amount of it to the enterprise controlling the part, or to the government
controlling the enterprise. The fourth was the reform of the price system that gradually allowed prices
to be determined by the market forces of demand and supply. In the meantime a two-tear price system
was introduced to allocate scarce resources formerly under the control of central planning, including
material inputs to state enterprises and foreign exchange. Under such a system, the government
continued to distribute the scarce resource to designated users at an official, below market price. At the
same time a second market was allowed to trade the scarce resource at market price. The fifth,
introduced in 1997, was to restructure the state enterprises into share-holding companies. It will be
useful to keep this general picture in mind when studying China's reform process in general or in a
particular sector.

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Already in 1977, Deng Xiaoping made it clear that performance should be the main consideration in the
economic and social advancement of individuals. In other words, professionalism and results should
count. Furthermore, he emphasized the importance of academics and scientists for the future of the
economic development and the international standing of China. He thought that this should be more
widely recognized by the Chinese people. During 1978, Deng Xiaoping’s reform philosophy gained
growing support in the CCP and its desirability was accepted in December 1978 at the Third Plenary
Session of the Eleventh Central Committee. This session proved to be a turning point in the direction of
China’s policies for its economic and social development.

It was decided at this meeting that the system and methods of economic management in China would
be transformed; economic co-operation with other countries would be expanded; special efforts would
be made to adopt the world’s advanced technologies and equipment; and that scientific and educational
work would be greatly strengthened to meet the needs of modernization. The importance of the four
modernizations (modernizing agriculture, industry, national defense, science and technology) was
emphasized. Furthermore, it was stated that ‘The general task put forward by our Party for the new
period reflects the demands of history and the people’s aspirations and represents their fundamental
interests. The CCP now intended to concentrate on ‘rapid growth in production *to+ improve the
people’s living standards significantly and strengthen national defense. Several other important
decisions about reforms were made at the Third Plenary Session. There was recognition of the need to
reduce bureaucratic centralized management of the economy and eliminate bureaucratic and political
impediments to achieving economic efficiency and development, particularly at lower leves (such as
local levels) of economic activity . This was consistent with Deng Xiaoping’s emphasis on professionalism
and efficient economic management. It was decided that the economic reforms should begin with
agriculture because at that time it was ‘the foundation of the national economy’. Particular attention
was given to the rule of law, decentralization and resource ownership in undertaking the agricultural
reforms. These features were applied later to the rest of the economy. The importance for China’s
economic development and its future international standing and welfare of maintaining political stability
under the continuing leadership of the CCP was stressed.

In mid-1981, the CPC again stressed the importance of striving for the modernization of China’s
economy by acting systematically and in a staged fashion while basing its development policies on the
realities of Chinese conditions and the level of available resources in China. Only modest and realistic
goals would be sought. This contrasted with the much earlier attempt by China to make massive
economic advances during China’s Great Leap Forward. The issuing by the CCP of the document ‘On
Reform of Economic Structures’ in 1984 marked an important milestone in the strengthening of China’s
economic reforms and their extension. It was agreed that following the success of China’s rural
economic reforms, similar reforms should be extended to the whole economy with the focus now being
placed on the urban economy. By continuing and extending reforms, it was hoped to establish a
dynamic economy, invigorate enterprises and establish an economic system in which economic activity
and production would be responsive to economic values. Several important goals were outlined in the
document ‘On Reform of Economic Structures’. It was stressed that a rational price system should be
established for the whole economy and that this system should make use of economic incentives as

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levers. This would mean the extension of reliance on market systems for organizing economic
production – in essence, the development of market socialism with Chinese characteristics.

Enterprise functions were to be separated from those of the Government. This was to ensure that
investment and production decisions by enterprises were made on economic grounds rather than
political ones. Furthermore, it was confirmed that economic responsibility systems should be
established for enterprises. This meant that the government no longer intended in the long-run to prop
up uneconomic state enterprises with soft loans and other forms of financial support.
Notice was also given that it would no longer be the case that state enterprises would have an
unassailable position in the economy. A diversity of enterprise forms was to be encouraged. In addition,
it was decided to press ahead with payment according to work as an economic incentive even though it
was realized that this would result in greater income inequality. A continuing feature of China’s reforms
would (according to this document dealing with economic reforms) be further promotion of economic
openness through international economic cooperation, investment, trade and exchange. Great success
was subsequently achieved in pursuing this goal.

         Time                                                 Event
Jan 1976                 Premier Zhou Enlai dies.
Sept 1977                Chairman Mao Zedong dies. Hua Guafeng becomes Chairman of the CCP and
                         subsequently Deng Xiaoping returns from political exile.
Dec 1978                 Increasing CCP support for Deng Xiaoping’s reformist agenda culminates in its
                         basic acceptance by the 11th Central Committee of the CCP. It was argued that
                         the reforms should begin with agriculture
1979                     Deng Xiaoping becomes Chairman of the Military Commission. He criticizes
                         dogmatic approaches to policy and favours a pragmatic approach
1980                     Hua Guofeng steps down as Chairman of CCP
Mid-1981                 Under the influence of Deng Xiaoping, the CPC stresses that China’s policies for
                         modernization must be realistically based, systematic and staged, and take
                         account of Chinese conditions.
1984                     The CCP decides that the economic reforms commenced in agriculture should
                         be extended to the whole economy. An end to the privileged position of state
                         enterprises is signaled. Increasing emphasis occurs on greater economic
                         openness as an instrument of development policy.
1989                     Chairman Jiang Zemin confirms the direction of China’s development policies,
                         such as extension of the market system and greater economic openness as
                         well as measures to limit population growth. He saw the need for China to
                         improve its science and technology policy because as China catches up with
                         the rest of the world’s technology; it will need to do more to advance its own
                         scientific and technological improvements

A Review of China’s development strategies

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    1. Realigning the economy towards China’s comparative advantage: China’s rapid growth since
       the reform is mainly due to the rebalancing of China’s developments strategy away from a
       central focus on heavy industry and in the direction of more labor-intensive sectors
    2. Since the economic reforms beginning in the late 1970s, the central government has shifted its
       development strategies toward more labor intensive sectors, initially agriculture, and then
       increasingly export-oriented rural industries. In the global context, China possesses an obvious
       comparative advantage in the labor-intensive manufacturing sector. After introducing the open
       door policy, massive foreign direct investment flowed in and married with China’s cheap labor.
       As a result, both capital and labor resources were more efficiently allocated, which greatly
       boosted economic efficiency. China’s development path therefore reemphasizes the importance
       of adhering to comparative advantage in creating labor•]intensive, export•]oriented economic
    3. Experimentation and marginal reform as a solution to risk, uncertainty and opposition: In the
       economic arena, Chinese reformers used two related strategies to simultaneously promote
       economic learning and overcome political resistance to reform: (1) reforms at the margin (e.g.
       dual track pricing in agriculture and housing); and (2) more explicit experimentation.2 The
       economic role of these policies is self‐discovery in the face of uncertainty.
    4. Economic and Political Expansion: China’s remarkable economic success: (1) •”comparative
       advantage” (and conditional convergence); (2) •”incentives matter” (fiscal decentralization and
       realignment of incentives towards growth-maximizing activities); (3) experimentation (as an
       economic and political discovery mechanism); and (4) pressure and crisis as inducers of reform.
       We conclude this section by noting that all these explanations are highly compatible and
       complimentary with each other, and that together they comprise a compelling and holistic
       explanation of China’s economic miracle.

After three decades of growth: the challenges of the present and the future

After three decades of spectacular economic growth in China, the problem is no longer how to achieve
growth but how to manage growth consequences and how to sustain growth. China’s spectacular
growth and poverty reduction has been accompanied by rising inequality, environmental degradation,
and increasing social tensions. The institutions that have brought rapid growth so far are now under
stress, and there is a need to reform and innovate on this front in order to sustain rapid growth, and to
obtain growth with equity.

Rising inequality is one of China’s most serious problems. In particular, the regional dimension of
inequality rural/urban and inland/coastal dominates in a country as large as China, and especially with
its particular history. Regional inequality has become a key issue for China and a number of
interventions have been introduced to address the problem.

The pattern of China’s regional inequality closely follows the history of its development strategies in the
past half century. The heavy industry oriented development strategy justified the creation of the
household registration system (hukou) which was a major contributor to the large rural‐urban divide.

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The open‐door policy, which granted preferential treatment to coastal areas, has helped the coast to
better exploit its comparative advantage in the international markets, but left many interior provinces
lagging behind. Similarly, fiscal decentralization policy promoted local government officials to develop
their own economies, but differences in initial endowments tends to leave the effective tax rate
regressive across Chinese regions (Zhang, 2006b). Regions with better endowments thereby have more
revenues left to invest in public goods and improve business environment after turning over a portion of
their fiscal revenues to the upper level government and maintaining the daily operation of local
government. In contrast, the local governments in poor regions have difficulty in competing with the
governments on the coast to attract investment and develop the local nonfarm economy. Their local
revenues are sometimes barely sufficient to cover the salaries of civil servants on the public payroll.
Consequently, they are more likely to levy heavy taxes on existing enterprises, worsening the business
investment environment. In summary, the successful development strategies mentioned in the above
section also have some deleterious side effects.
The inter‐juridical competition is a key contributing factor to the increasingly serious environmental
problems. In order to attract investment, many local governments loosen their environmental
regulations to allow polluters to operate as long as they generate lucrative revenues for the local
government. In the rapidly industrializing coastal areas, such as Jiangsu Province and Zhejiang Province,
the degree of water pollution and industrial waste hazard is alarming. The cost of cleaning up the
environment problem may eat up a large portion of the gains from industrialization.
The investment‐driven growth model also induces local officials to collude with investors at the expense
of the rights of individuals. In order to attract investment, many local governments provide preferential
treatment to investors, such as free land. In the process of procuring farming land for industrial or other
commercial use, the compensation to farmers was often far below the market level. Resenting this
unfair treatment, many relocated farmers filed petitions to the upper level government for help, and
land disputes have become a breeding ground for social unrest all over China (Yu, 2003). How to make
local government officials accountable has become an increasingly important issue.

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Appendix A

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Annexure B

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