CHINA'S SEARCH FOR AN ECONOMIC REFORM STRATEGY: SCHOOLS OF THOUGHT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00907R000200160001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 22
• Document Creation Date: December 22, 2016
• Document Release Date: May 29, 2012
• Sequence Number: 1
• Publication Date: May 1, 1987
• Content Type: REPORT

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Directorate of
Intelligence 25X1
China's Search for an
Economic Reform Strate~y:
Schools of Thought
A Research Paper
EA 87-10021
May 1987
ropy 3 4 6
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Directorate of Secret
Intelligence
Schools of Thought
China's Search for an
Economic Reform Strategy:
Division, OEA
This paper was prepared by~ffice of
East Asian Analysis. Comments and queries are
welcome and may be directed to the Chief, China
Secret
EA 87-10021
Ma~~ l987
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Secr
Summary
lrtlorniutiun nrnilnhle
u.c q/~ _'4 .~april 1987
u'u.c ~ece~/ iii this repor(.
Schools of Thought
China's Search for an
Economic Reform Strategy:
above objective economic criteria in decisionmaking.
When Mao died in 1976, China's economy was riddled with waste and low
labor productivity. Inefficiencies caused by rigid economic planning had
been exacerbated by Maoist policies that used political campaigns in futile
efforts to achieve economic goals and that elevated ideological orthodoxy
Two years later, China's new leaders convened the Third Plenum of the
1 1 th Party Congress, which made economic modernization China's top
priority. All believed economic reform was necessary to prevent China
from falling further behind the industrialized nations, and all were united
in viewing reform as a limited process involving decentralization of some
decisionmaking authority and greater involvement of scientists and engi-
neers in the operations of state enterprises. No one advocated allowing
market forces to play a major role in China's economic development.~~ 25X1
believed that reforms should remain narrowly focused.
Initial incentive-based agricultural reforms proved more successful than
anyone imagined, however, and Deng Xiaoping, Zhao Ziyang, and other
leaders began pressing for much wider use of market mechanisms in
China's economy. As the scope of reform broadened, the consensus about
economic policy quickly dissolved. A split emerged between those who
supported comprehensive reforms and more "conservative" leaders who
These two loose groups differ in how they view three core issues:
? The Locus oJ'Economic Decision Making. Reformers see devolution of
authority to factory managers and increased use of market mechanisms
as the key to boosting efficiency and growth. Conservatives are more
concerned about the wider fluctuations in prices and in growth rates this
introduces, and believe that stable economic development can be
achieved only by continuing to rely primarily on central planning.
? The Social Costs o./'Development. All leaders recognize the potentially
destabilizing aspects of reform, but reformers are more willing to tolerate
the greater income disparities and social tensions they see as the price of
progress. As with economic performance, conservatives place a premium
on stability.
Secret
EA 8~-loo~r
Ma~~ 1987
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? The Primacy of the Party. All agree that the party must loosen its control
over day-to-day economic decisions, but conservatives worry that, if this
goes too far, party control over other areas will erode and give rise to de-
mands for political liberalization.
[n high-level debates the reform view has generally prevailed, and, since
the early 1980s, reformers have implemented elements of their program-
including abolishing mandatory procurement quotas for grain; relaxing
state price controls over vegetables, meat, and major consumer durables;
and reducing the number of goods that are produced under the central plan
to fewer than 60. For the future, they want to extend price reforms, allow
state enterprises to experiment with issuing stocks and bonds, and establish
labor, capital, and raw materials markets that will allocate a significant
share of resources:
? In putting together a development strategy, reform leaders have relied on
Chinese economists who increasingly have accepted Western economic
theory as a guide. Chinese econo-
mists-particularly young scholars at Chinese universities and govern-
ment think tanks-demonstrate increased understanding of market tools,
frequently use concepts from Western economic theory to illustrate
shortcomings in their planning system, and express a willingness to
broaden market forces in China.
? Chinese reformers apparently have been influenced, in part, by their
exposure to the ideas of US officials and educators. US economic
textbooks reportedly are popular in China, the official press often reports
the views of US professors, and Beijing openly solicits advice from US
Conservatives, on the other hand, seem more sure of what they do not want
than how they would spur growth while maintaining economic and social
control. Generally, they believe that reform has gone far enough, and what
is needed is greater attention to the problems that it has created, such as
inflation, runaway outside-of-plan investment, and a big jump in China's
foreign debt. Conservative solutions to these problems include tighter
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controls on how enterprises can spend their retained earnings and sharp
limits on the ability of local authorities to import or borrow foreign funds
independently of the central plan.
The debate over reform strategy may be approaching a critical juncture. In
a speech in March 1987, Zhao Ziyang revealed that a major review of
China's eight-year-old experiment with economic reform currently is under
way. According to US Embassy sources, the purpose of the study is to
develop a comprehensive, coordinated blueprint for further reforms that
will be submitted to the 13th Party Congress in October. Reformers
probably hope to use the study to reassure conservatives that new policies
will be implemented prudently, while building a consensus over which steps
to take next. Zhao's vigorous defense of price reform in recent speeches and
advocating further experiments with ownership
reforms in state enterprises indicate that reformers expect difficulty
resolving these sensitive policies.
Given what is at stake and the sharp differences in how Chinese leaders
view the risks of further reforms, we believe that a consensus will remain
elusive. Moreover, China remains a political system dominated by a
paramount leader who sets the tone and resolves differences, and the views
of that individual-whether Deng or a successor-will have much to say
about reform strategy. In a period of leadership transition that will see
significant turnover at the top of an aged leadership, we believe battles over
economic reform strategy are likely to be lengthy and intense.
Beijing's choice of a development strategy will have significant implica-
tions for US-Chinese economic relations. A reformist strategy involving
price reform and less government control over access to foreign exchange
would improve the investment climate for foreign firms. Moreover, the
reformist program-including decentralizing trade authority-probably
would spark faster growth in bilateral trade, with Chinese imports of US
machinery, computers, consumer goods, and scientific equipment growing
rapidly. Because of China's strong demand for these and other products,
China probably would register balance of trade deficits-forcing Beijing to
step up borrowing from US banks. Diminished central control over CI}inese
enterprises and greater incentives to sell abroad would sharply increase
Chinese exports-particularly textiles, electronic components, and other
light manufactures-and might disrupt US markets and cause increased
trade frictions.
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A conservative development strategy, on the other hand, probably would
mean slower growth in bilateral trade and less willingness on Beijing's part
to borrow money from US banks or allow US firms to set up operations in
China. Tightened central restrictions over trade, however, would give
Beijing greater control over the volume and mix of Chinese exports
thereby decreasing the probability that its exports would disrupt US
markets.
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Summary
From Unity to Fragmentation
Who Are the Players?
At Stake Privilege, Stability, and Control
Economic Control
Social Stability
Party Primacy
The "Mainstream" Reform Strategy
The Influence of Western Economic Thought
The Influence of the "Radical" Reformers
Reform Policies and the Conservative Agenda
The Scope of Market Forces
__
Rural Reforms
---
Industrial Reforms
- -___ ---
Wage Policy
Price Reforms
Foreign Trade Reforms
Signposts
The US Stake
9
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China's Search for an
Economic Reform Strategy:
Schools of Thought
From Unity to Fragmentation
When the Third Plenum of the 1 lth Party Congress,
meeting in December 1978, made the landmark deci-
sion to reject Maoist notions of class struggle and
devote full attention to economic development, Chi-
nese leaders, as indicated by their public statements,
viewed reform as a way to patch up the planned
economy and reassert the role of rationality and
expertise in economic decision making. Although
senior officials were unclear over how extensive the
reforms should be, ~~o one advocated giving much
scope to market forces.
We believe the success of initial economic reforms,
however, convinced Deng Xiaoping and other senior
leaders to implement a much more far-reaching re-
form program. In particular, raising state procure-
ment prices and allowing rural households increased
autonomy over production decisions proved more suc-
cessful than Beijing had anticipated-from 1981 to
1984 grain production shot up at an average annual
rate of almost 8percent-apparently convincing some
leaders that wider use of market mechanisms would
stimulate rapid growth in other sectors. We believe
that these leaders-at the same time-viewed diffi-
culties with initial efforts to loosen state controls over
enterprises as evidence that industrial efficiency could
not be raised unless the whole urban economy was
transformed through price, wage, financial, planning,
and management reforms.
On the basis of public statements by Chinese leaders,
we believe that, as the scope of economic reforms
expanded, the consensus about economic policy
quickly eroded among senior officials who previously
had been united by their opposition to Maoist prac-
tices. Asplit emerged between those who supported
comprehensive reform policies and party "conserva-
tives" who believed reforms should be much narrower.
Who Are the Players?
Chinese leaders have denied the existence of "reform-
ist" and "conservative" factions within the top ranks
of the Chinese Communist Party. Although we agree
that neither grouping constitutes a unified faction-
members have their own interests and agendas and
often line up differently on particular political
issues-a large body of press report-
ing points to sharp disagreement between the two
groups over the extent to which market forces should
govern economic activity in China. Deng Xiaoping
and other reform proponents-including Premier and
Acting General Secretary Zhao Ziyang, Vice Pre-
miers Wan Li and Tian Jiyun, Politburo member Hu
Qili, and former General Secretary Hu Yaobang-
support broadening the use of market mechanisms in
China. Conservatives include diehard central planners
and party ideologues-such as President Li Xiannian,
Politburo Standing Committee member Chen Yun,
National People's Congress Chairman Peng Zhen,
Vice Premiers Yao Yilin and Li Peng, Politburo
member Hu Qiaomu, and former Propaganda Depart-
ment chief Deng Liqun-who believe that ideological
orthodoxy and strong central controls over agricul-
ture, industry, and foreign trade are necessary to
maintain stability and party control.
At Stake: Privilege, Stability, and Control
Chinese leaders realize that individual power and
perks, the role of the Communist Party, and even
China's security are at stake in the reform process. At
a party conference in January 1986, Tian Jiyun
admitted that economic reform involves a "readjust-
ment of power and interest" in China. Throughout the
economy, from the head of a ministry asked to
relinquish control of its factories, to a party secretary
in a small state enterprise asked to cede authority over
personnel decisions to the factory manager, reforms
are causing a fundamental shift in the locus of
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Chen }lm, Deny .A'iaopinR. Hu
1 ~uubong, Li .A~iunnion, and
Lhuu Liru~{q in f98/. These
lruders luonched Chino's eco-
nun~ic rc~(urni proKrom, but
(~hcn and Li later opposed H~id-
enin,? the scope oJmarket-ori-
decisionmaking and, therefore, power. All senior offi-
cials realize that problems may emerge from reforms,
but conservatives assess the risks of economic, social,
and political instability arising from too great a
reliance on market-oriented policies as being unac-
ceptably high.
Economic Control. When reforms were launched,
conservatives warned that Beijing could lose control of
the economy if the central planning mechanism were
weakened, and they argued that strict limits should
therefore be placed on decentralization. Nonetheless,
reformers were able to sharply curtail the scope of
mandatory planning during the past eight years, in
part by arguing that indirect economic levers such
as taxes and interest rates-could be used to regulate
economic activity outside the plan. Conservatives felt
vindicated when, in 1985, investment spending sky-
rocketed, inflation tripled, imports surged, and foreign
exchange reserves fell precipitantly-and they strong-
ly criticized reformers for excessively decentralizing
economic decision making. In a sharply worded
speech to the National Party Delegates Conference in
September 1985, Chen Yun, the senior conservative
spokesman on economic policy, warned that central
planning was still the "essence of macroeconomic
control."'
Social Stability. Hong Kong press reports and public
comments by orthodox officials indicate that conserv-
atives believe spillovers from economic reforms-such
as growing income disparities, inflation, and corrup-
tion-will damage the party's image and, in a worst
case, lead to widespread social unrest including mas-
sive demonstrations in Chinese cities. No senior offi-
cials support a return to strict Maoist egalitarianism,
but conservatives believe that, by encouraging some
people to "get rich before others," by publicizing the
achievements of successful peasants and urban entre-
preneurs, and by sanctioning purchases of consumer
durables and fashionable clothing, market-oriented
policies will create social polarization. Although re-
form-minded journalists have identified envy as
China's top social problem, Deng Xiaoping and his
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On the basis of public statements by Chinese officials,
we believe that there is broad agreement within the
leadership over some aspects of China's development
strategy. Most significant, all leaders view economic
reform as necessary to make China a prosperous and
powerful nation with worldwide influence. Reformers
and conservatives also agree on broad guidelines for
reforms of the planning system and on investment
priorities:
? The planning apparatus must be overhauled. The
old ,system is too extensive and rigid, and some
degree of decentralization is necessary.
? Output targets in the plan should be set low, and
greater emphasis should be placed on meeting
qualitative goals, such as improving product quali-
ty and boosting industrial efficiency. Economic
decisions should be based on objective criteria,
including cost-benefit analysis. Even mandatory
planning must take supply and demand into
consideration.
? Bureaucratic interference in economic activities
should be reduced, and responsibility systems-
such as granting factory managers increased deci-
sionmaking authority but holding them account-
ablefor profitability-should be set up in industry
and agriculture.
supporters believe that reforms will cause general
living standards to rise fast enough to keep social
tensions from boiling over. Conservatives also worry
that loosened central controls and the emphasis on
making money have opened the floodgates of fraud,
bribery, smuggling, black-market trading of foreign
currencies, and graft by local officials
Party Primacy. Conservatives fear that decentraliza-
tion of economic decision making and increased expo-
sure to Western ideas will give rise to demands for
political liberalization that Beijing will have difficulty
? Productive capacity should be increased through
technological transformation of existing factories,
rather than building new factories or importing
whole plants.
? Development of heavy industry, light industry, and
agriculture should be balanced.
? Priority in investment spending must be given to
developing energy, transportation, and communica-
tions facilities.
? Technical expertise must be respected and reward-
ed. Scientists and engineers should play a larger
role in factory decision making, and the skills of
factory managers should be enhanced through
education.
? China should import technology and managerial
skills from Western countries.
suppressing. In a speech to the Party Central Adviso-
ry Commission in October 1984, Deng Xiaoping
admitted that some officials who joined the party 50
years ago fear that economic reforms may erode party
control and lead to the restoration of capitalism in
China. Other critics worry over what role local party
officials can play when the power to make economic
decisions is transferred to peasants and factory man-
agers.2 All senior leaders are firmly committed to
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Last summer a US Embassy contact placed Chen
Yun at the head of those in China who believe in the
importance of improved state planning. In our view,
the fact that in the late 1970s Chen was considered
the leading proponent of an expanded role for the
market indicntes how sharply the development
.etrnteer debate has swung toward acceptance of
market mechanisms
Although Chen is considered a leading conservative,
all Chinese leaders frequentlti~ quote his remarks to
support their own policies indicating that,
he still has enormous personal
longevity in the party he has been a member of the
Party Central Committee since 1931, longer than
anyone else-and his role as China's chief economic
troubleshooter over the past 40 years. When the
Communists came to power in 1949, Chen ended the
hyperirtflation then plaguing China, restored produc-
tion, and guided the transformation of the economy
from private to public ownership. !n 1958 Chen was
one of the few leaders to oppose Mao's ill-conceived
Great Leap Forward, and in 1961-62 he helped bring
the economy back from the disaster it caused. After
Mao died, he played a key role in reducing the
irtffation and large budget deficits caused by Hua
Guofeng's overly ambitious development plans. ~
At the Eighth Party Congress in September 1956,
Chen proposed that the market could be an important
supplement to central planning. Over 20 years later
he described his views on the relationship between the
market and the plan as being like that of a bird and a
cage: if the cage is too restrictive, the bird will
suffocate, but the cage is too loose, the bird willhy
away. In our view, the fact that his views are widely
accepted by conservative leaders provides a degree of
protection to Chinese economic theorists who-
according to the metaphor can argue over the size
of the cage, and not whether the bird has a right to
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prestige. Respect for Chen probably stems from his
maintaining one-party Communist rule, but reformers
are more confident of their abilities to moderate
demands for political reform, and therefore more
willing to risk "ideological contamination" from con-
tacts with the West.
The "Mainstream" Reform Strategy
Since the early 1980x, reformers have implemented an
increasing amount of their program and the "main-
stream" position in the debate over reform strategy
consequently has shifted in an increasingly market-
oriented direction. In our view, reformers have had
live
success implementing their policies because of politi-
cal victories' and rapid gains in production. Beijing's
most notable success was increasing grain produc-
tion which made China a net grain exporter in 1985
for the first time in 25 years. Moreover, gross national
product grew at an average annual rate of about 9
percent in real terms between 1978 and 1986, accord-
ing to official statistics.' Although reforms have also
' Some long-stagnant sectors also have shown significant wins. For
instance, production of rolled steel and coal grew at average annual
rates of 9 and 7 percent, respectively, between 19ri1 and 19t{6.~
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Beijing's Nightmare of Solidarity-Style
Labor Unrest
Beijing had just launched its reform program when
the Polish Solidarity trade union movement arose in
.full force. A variety of information, including that
.from Hong Kong journals and speeches by Chinese
intellectuals, indicated Beijing was deeply troubled
~~? the specter of widespread labor unrest being
sparked by attempts at reform in a socialist state.
At the time, many leaders viewed Solidarity as an
example of what can happen the party loses touch
with the people and fails to satisfy their desire for
progress. The episode apparently also reirtforced the
tears of some conservatives who believed that
ex7reme caution should be exercised in implementing
economic reforms.
Although overt signs of worker unrest have been
relatively rare in China since Beijing began imple-
menting reforms, there have been a few notable
exceptions. Most recently, a Hong Kong newspaper
reported that 20,000 workers at a tractor factory in
Henan Province went on strike for two days last
December, protesting lew wages.
Despite the relatively small number of incidents that
have been reported, we believe Chinese leaders fear
widespread labor unrest and the cycle of declining
labor productivity and falling standards of living that
would accompany it. For example, a Hong Kong
journal reported that Deng Xiaoping reacted harshly
to protests by university students in December
because he was extremely worried that workers
would join the students.
sparked inflation and budget and trade deficits, Deng
and his supporters continue to view these problems as
secondary when compared with the overall increase in
China's standard of living.
On the basis of important speeches by reform lead-
ers-particularly Zhao Ziyang's annual reports to the
National People's Congress and his speech to a party
conference in September 1985 we believe that main-
stream reformers want to establish an economy in
which the market plays a large, but not dominant,
role. In the countryside, peasants would have wide
latitude to plant crops or start local industries-but
important inputs, such as fertilizer and diesel fuel,
would continue to be distributed through state supply
channels. The production and distribution of key
industrial products would be controlled by the state,
but managers of state enterprises would make all
operational decisions, including appointing subordi-
nates and hiring and firing workers, purchasing raw
materials, and directly marketing a significant share
of output. Some firms producing exports would be
allowed to contact foreign purchasers directly.
Unprofitable enterprises would be shut down, and
laid-off workers could seek employment with other
enterprises or join the service sector-and would be
protected by unemployment insurance until they
found a new job. Overall market activity would be
controlled by China's central bank through adjust-
ments in credit availability, and by changes in taxes.
The Influence of Western Economic Thought
We believe that a driving force in the reform program
has been the significant inroads that Western
economic thought has made over Marxist theory in
the minds of China's economists, as has been evident
in their conversations with US officials and in Chinese
press reports. For instance, the director of the Com-
prehensive Planning Department of China's central
bank told US officials that policymakers in the bank
hope eventually to control China's money supply using
the same tools-open market operations, discount rate
adjustments, and changes in reserve requirements-
that the US Federal Reserve Board uses. And the
director of the Institute for Planned Economy in
China's conservative State Planning Commission
reported that he favors gradually eliminating price
controls over key products such as coal.
On the basis of conversations between US and Chi-
nese officials, we believe that increased familiarity
with Western economic concepts is not limited to one
group of scholars or bureaucrats. Growing economic
sophistication is evident from conversations with econ-
omists in China's central ministries and organizations,
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particularly the State Commission to Restructure the
Economic System-a State Council think tank for
reform policies-and the Economics Institute of the
Chinese Academy of Social Sciences.~~
the evolution in
economic thought in China has been caused, in part,
by exposure to the views of US officials and educa-
tors. According to a knowledgeable Chinese econo-
mist, an introductory economics textbook by a well-
known US professor is more popular in China than
Marxist writings.` The Chinese press reports the views
of US professors on China's reform program, and
Beijing openly solicits advice from US experts.
China's central bank, for instance, invited a delega-
tion of US financial experts-including the chairman
of the New York Stock Exchange-to Beijing last fall
to discuss how to run securities markets. At annual
meetings of the US-China Joint Economic Committee
and the Joint Committee on Commerce and Trade,
US economists of ethnic Chinese origin have strongly
influenced the thinking of Chinese leaders-and the
Chinese press has reported meetings between those
economists and China's top reform leaders.
The Influence of the "Radical" Reformers
A few Chinese economists have argued that Beijing
should renounce central planning and adopt a market
economy:
? Li Yining, an economics professor at Beijing
University, told a US Embassy officer that the best
way to improve China's industrial efficiency would
be for the government to cede ownership of state
enterprises to workers and managers. Li believes
that over the next 15 years Beijing should transform
China's state-owned enterprises into firms run by
boards of directors whose composition would be
determined by stock ownership. Shares in what are
now state enterprises would be sold to workers and
Only a handful of Chinese students have learned economics in the
~L'est. ~~ccurding to the Chinese press, about ISO Chinese scholars
managers, with the government retaining a control-
ling-though not necessarily amajority-interest.
The economic planning apparatus correspondingly
would be dismantled, and enterprises would com-
pete in a market environment.
? Wang Jue, a senior economist at the Chinese Com-
munist Party's Central Party School, told a US
Embassy officer that he teaches market concepts to
high-level party officials attending the school.
Among other things, Wang apparently presents the
idea that the central plan should be sharply cur-
tailed and that prices, wages, and rents should be
market determined.
and communications.
Even these progressive economists, however, believe
that some type of government planning is necessary-
for instance, to determine which industries to encour-
age-and believe that the state should directly run
important sectors, such as banking, transportation,
According to the US Embassy in Beijing, these
progressive ideas have received a hearing from reform
leaders. Li Yining, for instance, told a US Embassy
officer that he has briefed Zhao Ziyang on his reform
proposals. Limited evidence suggests that Zhao may
have been influenced by the ideas of China's most
progressive economists. A contact of the US Embassy,
for example, reported that Zhao is the chief sponsor of
experiments with multiple ownership forms in state
enterprises. Nevertheless, in conversations with US
officials, including Secretary of State Shultz in
March 1987, Zhao has maintained that the economy
will remain predominantly publicly owned and that
China will not adopt the US free market model.
The fact that radical proposals by some economists
received an open airing in the Chinese media last year
indicates that reform leaders-if not necessarily
accepting these ideas-believe that China's most mar-
ket-oriented economists have an important role in the
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"Chao Ziyang: Innovator and Patron oJChina's
Reform Economists
Zhao Ziyang, as Premier of China's State Council
since 1980, has been the leader most directly respon-
.ciblefor designing and implementing economic
rcJornrs. A senior Chinese economist told the US
F'nrbassy in March that-even with his added respon-
sibilities ns Acting General Secretary-Zhao contin-
ues to guide the reform program
In our view, Zhao is one of the strongest supporters
within the Chinese leadership of the use of'economic
incentives. As party secretary in Sichuan Province in
the late 1970x, he was one of the first leaders to
promote rural reforms linking peasant income with
individual production. And, as Premier, he has con-
.cisterulr argued that monetary and fiscal tools
should replace administrative means to regulate the
Zhao has also been one of the chief advocates of
practical and theoretical exploration of new reforms.
In his speech to the National People's Congress in
March 1986, he complained that economic theory in
China lagged reforms, and encouraged economists to
"boldly explore" new ideas. This exhortation sig-
naled the start of an increasingly open debate in 1986
in the Chinese press over the relevance of Western
economic thought in China's reform process. Accord-
ing to iIS Embassy contacts, Zhao listens to the
views of China's most progressive economists and has
protected them./rom party ideologues who in the past
have tried to prevent them from conducting research
on non-Marxist theories.
We believe that Zhao has gone further than any other
senior leader in advocating the use of market forces
to drive China's development program. According to
the Chinese press, when Zhao-on a visit to Romania
last summer-was reminded of Chen Yun's birdcage
metaphor, he replied that "a really good bird keeper
can let a bird out and summon it back as .soon as he
calls ... we are trying to learn just that trick. "In our
view, Zhao's remark was a clear, and calculated,
rebuke to Chen's advocacy of the primacy of the
P(YJilorr! i'.
debate over development strategy. Li Yining's propos-
al to transform state enterprises into joint stock
operations was reported in Beijing's party daily as
well as in its leading English-language journal. And,
according to the US Consulate in Shanghai, Zhao
Ziyang recently prevented conservatives from closing
a newspaper the Shanghai World Economic
Herald --that published bold commentaries last year
advocating, among other things, that the state plan be
tailored to meet the needs of a market economy.
planned economy.
Reform Policies and the Conservative Agenda
In our view, conservatives have a much clearer idea of
what they do not like than of what they would do if
they had the chance to implement their own program.
Nevertheless, statements by conservative leaders indi-
cate how their development strategy differs from
recently implemented reforms (which are enumerated
below in italics).~~
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The Scope of Market Forces. Because of regulations
pro~ntdgated in 1984 that allow enterprises to sell
over quota production at market prices, about 50
percent of steel, 60 percent of coal, and 84 percent of
cement are distributed outside the central plan.
Moreover, production of fewer than 60 goods is now
controlled through the plan. Last year, reformers
called for the establishment of labor, capital, and raw
materials markets, and Beijing set up experimental
interbank loan markets, steel markets, and rudimen-
tarr bond markets in several Chinese cities.0
Party conservatives believe that the market has a
small, but important, role in the economy. This view
was reiterated in March, when Li Xiannian told
Secretary Shultz that "the private economy can exist,
but only as an auxiliary." In practice, conservatives
believe that market forces should govern production
of subsidiary agricultural products, handicrafts, out-
put of small workshops, and minor consumer items. In
past speeches, Chen Yun argued that about one-
fourth of all retail sales should be permitted to occur
completely outside government channels.
According to conservatives, mandatory state plans
should govern the production of important agricultur-
al, industrial, and consumer goods such as grain,
steel, and cloth. They believe, however, that a large
number of other goods can be produced under "guid-
ance" plans set by the state but flexible enough to
enable enterprises to adjust to changing market condi-
tions. For instance, many enterprises in light industry
could purchase raw materials and market some of
their output themselves-and Beijing would use a
combination of administrative restrictions and
changes in tax and credit policies to regulate their
activity. ~~
Rural Reforms. In 1985, Beijing eliminated grain
procurement quotas. Peasants now sign grain con-
tracts with state supply units and have autonomy to
sell the remaining output on the free market. Thev
have increased flexibility to raise cash crops and
livestock or to leave farming for rural industries. In a
.speech to China's Rural Work Conference in Novem-
ber 1986, Tian Jirun called for broadening market
forces in the countr}side to commercialize Chinese
agriculture. ~~
Conservatives support rural reforms that have given
peasants increased autonomy over production deci-
sions, but believe that administrative measures--such
as restrictions on how much farmland can be trans-
ferred to other uses should be employed to ensure
production of an adequate grain supply. In a speech at
the party plenum in October 1984, Chen Yun touted
policies allowing peasants who have fulfilled their
delivery obligations to the state to sell excess grain on
rural free markets. And at a party conference in
September 1985, Chen praised the "household
responsibility system" for increasing agricultural pro-
duction and raising rural standards of living.b
Conservatives, however, oppose policies that in the
past two years have encouraged peasants to leave their
land and start rural businesses and that have in-
creased incentives for raising cash crops and live-
stock.' In his 1985 speech, Chen complained that
peasants are no longer interested in growing grain
because they can earn more in rural industry, and he
warned that a drop in grain production would lead to
social disorder. Since then, conservatives have repeat-
edly urged peasants not to neglect grain production.
Open criticism of reformers' agricultural policies by
delegates to this year's session of China's National
People's Congress indicates that there is still a sharp
dispute within the leadership over how much autono-
my peasants should be given in determining the mix of
rural production.
Industrial Reforms. To enhance the prerogatives of
factory managers, and the penalties for poor deci-
sions, Beijing issued regulations last fall that allow
state enterprises to hire new employees under renew-
able contracts-rather than for life, as was the policy
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in the past-and approved an experimental bankrupt-
c,y law that provides guidelines for shutting down
inefficient state enterprises. Beijing also experiment-
e d with new ownership forms in industry by leasing
.cnrall state factories to individuals and allowing
other enterprises to issue shares to their workers.
According to conservatives, training factory directors
in modern management techniques and promoting
younger, better educated technocrats-not imple-
menting sweeping industrial reforms-are the keys to
boosting efficiency in state enterprises. They agree,
however, that enterprises and local governments
should be given increased decisionmaking authority.
Enterprises producing under the state plan, for exam-
ple, should be granted the right to make day-to-day
production decisions, but with factory managers and
party committees working closely to arrive at these
decisions. They support factory discretion on spending
retained earnings, but with strict guidelines to prevent
outside-of-plan spending from disrupting the state's
priority construction projects.R They do not object to
new ownership forms in small state enterprises, but
they believe that all medium and large enterprises
should be state owned, and they object to sales of
stock by these enterprises.
Wage Policy. /n 1986, Beijing continued to urge
factory managers to set wages and bonuses according
to productivity, and allowed some enterprises to base
their total wage bill on factory profitability.~~
Orthodox officials acknowledge that material incen-
tives can play a role in China's economic develop-
ment. In his October 1984 speech, Chen Yun blasted
"big pot" egalitarianism under which workers' wages
are unrelated to individual productivity. And, in the
past, Chen has supported the use of piece rate wages
for coal miners. But conservatives are concerned that
material rewards could create excessively wide in-
come disparities and they believe that equal weight
should be placed on altruistic incentives. In March,
' Outside-uf-plan investment by state enterprises made up almost 20
pcreent of the total investment spending by state enterprises in
1986. nccurding to the Chinese press, this outside-of-plan invest-
ment often pulled resources away from key projects.~~
while defending the use of wage differentials, Li Peng
argued that workers must be motivated by "socialist
ethics"-their love for China and respect for party
ideals.
Price Reforms. Beijing eased controls on the prices of
vegetables and meat in 1985, and freed prices of
major consumer goods-such as bicycles and refrig-
erators-last fall. The mayor of Guangzhou told the
US Consul General in January that Beijing had
planned to allow the prices of key raw materials-
such as coal, oil, and steel-to float within a broad
range this year, but has temporarily shelved those
plans because of concerns about the potential infla-
tionary impact.
Conservatives realize that China's distorted price
system needs reforming, but they generally favor
centrally regulated price adjustments rather than
relaxation of state price controls. In their view, prices
of sideline agricultural products and handicrafts may
vary according to supply and demand, price differen-
tials should be widened to reflect differences in the
quality of similar goods, and price ratios should be
readjusted periodically to encourage production of
scarce goods.
Foreign Trade Reforms. Last year, Beijing continued
to experiment with policies that bring Chinese enter-
prises, banks, and trade bureaus into closer contact
with the West; according to the US Consulate in
Hong Kong, for example, over 100 factories received
authority to export their products independently of
the state trading apparatus. Also last year, Beijing
granted provincial units increased autonomy to raise
funds abroad-Tor example, by issuing foreign-cur-
rency-denominated bonds-and allowed the Shenz-
hen Special Economic Zone (SEZJ ~ to operate a
` In 1980, Beijing set up four special economic zones in Shenzhcn,
Zhuhai, Shantou, and Xiamen to encourage investment in China.
Foreign firms that establish joint ventures in the zones arc o~Tered
favorable tax rates, lower tarifTs on factory imports, and autonomy
over most day-to-day operations including hiring local workers.
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limited foreign exchange market. [n October, new
regulations were established offering.loreign firms
increased inducements to invest in China such as
the right to hire and fire workers, and tax breaks 4T
profits are reinvested in the joint venture. ~~
Although cautious about opening to the West, conser-
vatives believe that China can benefit from trade with
capitalist countries if the central government-not
local authorities-retains complete control over
China's interaction with foreign corporations and
banks. For example, they support expansion of Chi-
nese exports as long as competition for foreign sales
by Chinese enterprises does not lead to competitive
price cutting. Chen Yun, Li Peng, and other orthodox
officials have touted the benefits of imported Western
equipment, technology, and managerial expertise-
but they believe that borrowing money from foreign
countries is a poor method of funding economic
development. These reservations are based on ideolog-
ical and practical concerns. Chinese press reports
indicate conservatives believe that capitalists are out
to make the most money possible from China and that
borrowing should not exceed Beijing's ability to repay
the loans. In particular, they oppose extending bor-
rowing authority to local ofFicials. Li Peng reiterated
the conservative apprehension about foreign debt
when he told Secretary Shultz in March that China
"would not become another Brazil."
Conservatives also have been sharply critical of the
SEZs. According to press reports,
orthodox officials believe that the SEZs have not
attracted the type of Western investment or earned as
much foreign exchange as reformers promised. A key
conservative criticism has been that provincial govern-
ments have used scarce investment funds to set up
redundant processing industries in the SEZs to earn
foreign exchange and take advantage of the zones'
less restrictive import policies. In 1985, Yao Yilin
reportedly argued that "blood transfusions" of funds
from provincial governments to the SEZs must end.
In our view, orthodox officials have not openly
attacked the policy of allowing foreign joint ventures
in China because they recognize there are certain
areas-such as offshore oil exploration where West-
ern expertise and financing are necessary. Li Peng
and other conservatives, however, have criticized the
preponderance of foreign investment going into hotels
and restaurants instead of high-tech enterprises. And
Hu Qiaomu has criticized restrictions on party work
in joint ventures in the SEZs, implying that without
party control Chinese workers may be explojted by
foreign businessmen.
Signposts
The debate over China's reform strategy took a
conservative turn in the wake of senior-level jockeying
for position following Hu Yaobang's ouster as Party
General Secretary in January.'? Delegates to a
National People's Congress Standing Committee ses-
sion, meeting at about the same time, reportedly
emphasized the importance of mandatory state plan-
ning, criticized the lack of sufficient attention to grain
production, and called for greater "coordination"
among trade departments. The Chinese media have
featured senior conservatives, such as Li Peng, assert-
ing the role of the party in economic decision making
and advocating "plain living and arduous struggle" by
workers to build a modern China. In January some
progressive economists broke off contact with US
Embassy officers whom they openly met with last fall.
Zhao Ziyang has attempted to rebuild momentum for
reform by vigorously defending reformist policies in
speeches this spring. In his annual work report to the
full session of the National People's Congress in
March, Zhao gave a spirited defense of the need for
new price reforms, and advocated measures that
would further decentralize economic decision making.
For instance, he called for wider use of public bidding
on state construction projects and ordered planners to
shift more rolled steel from the central plan to the free
market
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We believe the debate over reform strategy may be
approaching a critical juncture. In his March speech,
Z.hao also revealed that a major review of China's
reform program is under way. A senior Chinese
economist told the US Embassy in Beijing that Zhao
tasked participants in the study to construct a com-
prehensive, coordinated reform blueprint.
the blueprint will
be submitted to the 13th Party Congress that is
scheduled to convene in October. In our judgment,
reformers probably will use the study-which almost
certainly will endorse past policies while reassuring
conservatives of more prudent implementation of new
measures-to try to build consensus for more exten-
sive reforms.
Given what is at stake and the sharp differences in
how Chinese leaders view the risks of market-oriented
reforms, a consensus over reform probably will remain
elusive. Moreover, the ease with which Hu Yaobang
was sacked-even though his supporters dominated
important positions throughout the party hierarchy-
underscores abasic truth of China's system: despite
efTorts since Mao's time to institutionalize power
arrangements in party and government positions,
China remains a system in which one person is
recognized as the paramount leader-and that person
can exert strong influence over policy. In a period of
leadership transition that will see significant turnover
at the top of an aged leadership, battles over economic
reform strategy are likely to be lengthy and intense.
We believe an important indicator of the state of the
debate over development strategy in China is Beijing's
willingness to tackle price and ownership reforms.
Price reform is an integral part of the mainstream
reform program-inability to implement it will stall
other reforms. For example, Beijing continues to
subsidize enterprise losses; in part, because the ir-
rational price system makes it difficult to determine
whether firms are losing money because of poor
management or low state-set prices. But, without the
threat of bankruptcy, enterprises are not very respon-
sive to economic levers. Higher interest rates, for
instance, will not deter borrowing as long as the state
bails out enterprises that cannot repay their debts:
? A State Council circular issued in January stated
that Beijing would not free prices of any additional
products this year. Early in 1986, Beijing also ruled
out price reform for the year, and then went ahead
with new reforms late last summer. Chinese econo-
mists have explained to US Embassy officers that
Beijing is postponing price reforms this year-not
because of opposition from conservatives but
because of concerns that excessive demand would
push prices up if state price controls were removed.
According to other US Embassy and Consulate
reporting, Beijing has tightened credit and restrict-
ed investment expenditures to reduce inflationary
pressures. In our view, these measures should begin
to work by midyear. Therefore, if Beijing does not
ease price controls by the end of the year, we believe
that will indicate that conservatives have enough
influence to delay key reforms.
Reformers continue to call for experiments with
leasing and issuing shares by small state enterprises,
but a contact of the US Embassy in Beijing reported
sharp debate over whether medium and large state
enterprises should be allowed to sell stocks to their
workers. We believe a key test of reformers' political
strength will be whether they are able to conduct
experiments with stock sales by large state enter-
prises. Significant broadening of such ideologically
sensitive experiments-although probably unlikely in
the short run-would indicate that the ideas of
China's most progressive economists are making in-
roads in the thinking of reform leaders:
? In our view, Beijing probably will continue with
limited, tightly controlled experiments with stock
sales in 1987. The State Council issued regulations
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Deng Xiaoping: Arbitrator and Pragmatic Reformer
Deng Xiaoping-China's paramount leader since the
Gang of Four was deposed-has played a key role in
convincing party members that the risks of reform are
tolerable and in resolving top-level disputes between
reformers and conservatives. A Hong Kong journal
de.cc?ribed Deng's role at the Third Plenum of the
1 ?th Party Congress in October l 984 as an unbiased
arhitrator who listened to both sides and decided in
fnvor c~ffurther reform while truing to keep policy
diNerences from creating animosity between the two
groups.
By his own admission, Deng is a layman in the field
of economics and is not involved in day-to-day policy-
ntnkittg. In fact, he claimed that he did not write or
remise a single word in the landmark "Decision on
Reform of the Economic Structure =approved at
in April prohibiting state-owned factories from
issuing shares to the general public and restricting
stock sales to a small number of enterprises. But, in
the same week, Beijing also allowed Tianjin-a
major industrial city-to open asmall-scale securi-
ties market.)
The US Stake
We believe the outcome of the debate over China's
reform strategy will set the parameters on US-
Chinese economic relations in the next decade. A
more conservative approach probably would mean
the October 1984 Plenum-which extended economic
reforms to the urban sector. He has been, however,
the key champion of two politically sensitive econom-
ic reforms-the opening to the West and the use of
material incentives.
Deng publicly has blamed China's backwardness on
its past closed-door policies, and, according to Hong
Kong media accounts, was the,first leader to propose
establishing China's Special Economic Zones and the
14 "open cities" that are allowed to offer special tax
and tariff incentives to foreign investors. Deng
believes that foreign investment is indispensible to
China's modernization, but has reassured party
members that, no matter how much foreign capital
.flows into China, public ownership will dotninate and
China will retain its socialist system. Deng continues
to lend personal support to increased contact with the
West, for instance, by meeting last fall with the
chairman of the New York Stock Exchange, who was
visiting China at the invitation of China's central
bankl I
According to Deng, egalitarianism leads to "national
pauperism" because it erodes incentives to work. He
rejects the ideological concerns of senior officials who
fear that wider income disparities will cause class
polarization, arguing that the criteria for judging
whether a policy is sound is whether it increases
China's prosperity. Despite his pragmatism, however,
he remains,firmly committed to party control.
would disrupt US markets
slower growth in bilateral trade and less willingness
on Beijing's part to borrow from US banks or allow
US firms to set up operations in China. Strong central
administration of trade, however, would allow Beijing
to control the volume and mix of goods exported-
thereby decreasing the chance that Chinese exports
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A reformist strategy probably would increase the
opportunity for US firms to profit from China's
modernization. For example, by reforming the price
system so prices reflect relative scarcities in China-
and bear closer resemblance to world prices-and by
casing state controls over access to foreign exchange,
Beijing would si nificantly improve the climate for
US investor
In our view, US firms also would benefit if Beijing
expanded financial policies it has experimented with
in the past few years. For instance, China has allowed
a few foreign banks to set up branches in the Special
Economic Zones. As Beijing improves its ability to
control the economy with central bank monetary
tools, and as it gains experience in regulating these
foreign branches, we expect Beijing to allow more
foreign banks in China. In addition, since 1984 China
has issued over $2 billion in foreign-currency-denomi-
nated bonds in Japan, Hong Kong, and West
Germany. According to the US Embassy in Beijing,
Chinese officials are now considering issuing bonds in
the United States
We believe implementation of the reformist strategy
also would mean faster growth in bilateral trade. In
particular, Chinese imports of US capital equipment,
scientific instruments, data processing machines, and
high-tech products would probably grow rapidly.
Given the strong demand for machinery, consumer
goods, and raw materials in China, decentralizing
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ence a series of balance-of-trade deficits-therefore,
China probably would need to step up its borrowing
from US banks. Moreover, with decreased central
control over Chinese enterprises, and greater incen-
tives to sell goods abroad, exports of particular Chi-
nese commodities could expand rapidly-disrupting
US markets and causing increased trade frictions."
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