CHINA'S CONTRACT MANAGEMENT RESPONSIBILITY SYSTEMS: TOUCHSTONE FOR ECONOMIC REFORM IN 1988?

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP90T00114R000302520001-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 9
• Document Creation Date: December 22, 2016
• Document Release Date: February 14, 2012
• Sequence Number: 1
• Publication Date: December 14, 1987
• Content Type: MEMO

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Central Intelligence Agency
DATE
DOC NOPi
OIR .3
P&PD
-20227
DIRECTORATE OF INTELLIGENCE
14 December 1987
China's Contract Management Responsibility Systems:
Touchstone for Economic Reform in 1988?
Summary
Chinese reformers are touting contracts that spell out performance
targets for large state-owned enterprises as the prescription for China's
sagging industrial sector. We believe the contracts will reduce
unwarranted enterprise spending by increasing Beijing's ability to supervise
bonuses and construction outlays. But we also believe that irrational
prices, controlled markets, and bloated work forces will limit gains in
enterprise efficiency and competitiveness. Resistance from workers,
managers, and local authorities may also dilute the effectiveness of the
system. In any case, orthodox leaders will probably use whatever
short-term improvements in enterprise performance that do occur under
the contracts to argue that more far reaching market-oriented reforms are
This memorandum was prepared by Office of East Asian Analysis.
Information available as of 14 December 1987 was used in its preparation. Comments
and queries are welcome and may be directed to the Chief, Economic Assessments
EA M 87-20227
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The Contract System: A Prescription for Ailing State Industries
Early this year, Chinese leaders began pushing contracts between the government
and large- and medium-size state enterprises as the new centerpiece for industrial
reform through at least 1988. Although they account for less than 2 percent of all
Chinese enterprises, the 9,000 large- and medium-sized enterprises:
? Produce 46 percent of China's industrial output.
? Dominate the heavy industry, energy, and transportation sectors.
? Produce 60 percent of the profits and taxes earned by China's industrial 25X1
enterprises.
? Provide 60 percent of central government revenue,
These firms are scoring impressive production gains, but they are making little progress
in improving efficiency or raising quality, while rising costs and expenditures are
contributing to stagnating profits. According to Chinese statistics, although the output
of all state enterprises increased over 11 percent in the first five months of 1987, profit
increased by less than 1 and nearly one-fourth of state enterprises are now
Beijing hopes the contract system will reverse this sagging performance. In
limited use since the early 1980s, the "contract management responsibility system" had
been adopted by only one-third of China's large-and medium-size state enterprises by
June, but the portion jumped to three-quarters by late October. And party chief Zhao
Ziyang told last month's oartv Congress that, in the future, all enterprises must use
nnn?ro +.
Under the system, the enterprise manager and the supervisory government
department sign an agreement that commits the enterprise to specified performance
targets.' In some cases, party leaders and worker representatives also sign the contract,
according to US Embassy reporting. The system provides factory managers with
Because the targets are negotiated individually between the enterprise and the
supervisory department, features of the contracts vary. They usually have three- to
five-year terms, and can list up to eight targets, including profits, taxes, wage bills,
technical upgrading, and quality standards. Some use a base year--usually
1986--and specify annual increases in profits and taxes the enterprise is to achieve
through the contract period. Most contracts also build in incentives; for example, one
formula taxes profits equal to those in the base year at 55 percent and additional
profits at only 30 percent. Contracts with selected key industries--such as steel,
petroleum, and the railroads--emphasize input and output targets similar to past
planning criteria, probably to reduce the risk of disruptions from more substantial
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operating discretion but affirms state ownership and retains sufficient government
control to assure output of key goods and to safeguard the labor force. If the
enterprise fails to meet the contract obligations, the factory director may lose his job
d
-
an
1-1-Enterprise Management Reforms
The contract management responsibility system is one of several
management tools Beijing has introduced to spur economic growth. Each of
these targets an aspect of industry or economic management:
? Since the early 1980s, reform leaders have advocated the
factory director responsibility system--a management reform that
increases the authority of factory managers to make business decisions
free from the meddling of enterprise party officials and government
bureaucrats. For example, the manager can independently appoint
deputy directors and other management personnel under this system.
The factory director responsibility system is often used in conjunction
with the contract management responsibility system in larger state
enterprises.
? Beijing has endorsed leasing systems as the key to management reforms
in smaller state and collective enterprises. Under this reform, also
referred to as the contracted management responsibility system, an
enterprise manager is selected through competitive bidding, and then
signs a contract stipulating the taxes he will remit during the lease
period. Unlike the contract system in larger state enterprises, leasing
arrangements make the manager the virtual temporary 'owner' of the
enterprise, allowing the manager to retain aftertax profits, and often
requiring the manager to put up collateral to cover potential losses.
One reason to believe the contract system will produce results over the next year
is that it is receiving considerable attention and assistance. Indeed, Chinese officials are
already pointing to improved efficiency, quality, and profits at several large enterprises.
Further improvements can be expected for several reasons. For one, the
contracts should boost the accountability of the enterprise manager. In the past,
managers have not been directly responsible for meeting both output and fiscal targets.
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Contracts in the Chinese Context
"Contract" is the latest buzzword in Chinese reform, but Chinese
contracts differ substantially from the Western concept. In China, parties tend
to view contracts as memorandums of understanding rather than binding
agreements. For example, the head of the State Economic Commission recently
remarked that, once enterprises signed contracts with supervisory bureaus, if
they found that the terms were too harsh or if the enterprise benefited
"
"
excessively,
the contracts should be "readjusted."
China's approach to contracts in part reflects the decades of Maoist rule
when Beijing subordinated legal procedure to government fiat. In addition, key
elements of Western legality do not exit in China's legal system; for example,
there are strict limits on holding private property--land and capital goods in
particular are "publicly owned," although they may be leased for fixed terms.
I
Finally, we believe China's fledgling legal system reinforces the
nonbinding, informal nature of Chinese "contracts." The number of contracts is
increasing exponentially: millions of new state workers and a growing number
of government bureaucrats and factory managers are signing fixed-term
contracts for their jobs; entrepreneurs are leasing smaller state and collective
enterprises by contracts; and enterprises themselves are entering into contract
agreements with government departments and other enterprises. At the same
time, the number of lawyers and courts to help advise on contracts and to
handle disputes is severely limited. Shanghai, for example, with the nation's
highest ratio of lawyers to population, has only 400 full-time and 1,100
part-time lawyers to serve over 11 million people, and they must handle both
criminal and civil cases. Although cases involving contract disputes in Shanghai
mushroomed 76 percent in 1986, we believe many more disputes were handled
outside of the le al system because of the lack of lawyers and jammed court
dockets. ~
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Once the manager signs the contract, however, he is likely to feel more committed to
Workers and party members may also believe the contracts increase their
accountability, particularly if they must sign them. In such cases, bickering between
managers and party and worker representatives may wane. And, even if all parties do
not sign, terms that directly link bonuses to enterprise performance should relieve
pressure on managers to issue blanket bonuses. This will help control the drain on
enterprise funds from bonuses, which jumped 45 percent in the first half of 1987. 25X1
Regarding other dividends, we believe this system will help Beijing regain some
control over other unwarranted enterprise spending. Identification of fiscal goals, in
conjunction with other reforms, including the establishment of the Ministry of
Supervision and more stringent banking controls, should help reduce unauthorized
investment and other expenditures that have contributed to enterprise deficits. 25X1
We also believe the contract system will help identify good managers. Managers
who meet or exceed contract terms should stand out under the system, and managers
who fail can be moved to other jobs. In addition, the contracts may help some
managers gain more independence from supervisory bureaus. Managers will be able to
argue that if they fulfill the targets they should be free to make decisions without
What the Contract System Cannot Do
On the down side, we believe the contract system will encounter many of the
problems associated with the Stalinist-style command planning system, under which
enterprises are handed specific targets and given incentives for overquota production.
For one, contracts will not make good managers out of bad ones. A senior Chinese
management researcher pointed out to US officials recently that weak management is
one of the major problems of China's larger enterprises, noting that managers frequently
are drawn from the ranks of engineers and have a "narrow vision" of business
management techniques. The system in larger enterprises will probably reinforce this
deficiency by focusing management attention on narrow financial objectives.
In addition, the system will reward managers for bargaining for and achieving
targets, rather than simply encouraging managers to make sound, innovative business
decisions on the basis of market signals. Indeed, because Beijing forces larger state
enterprises to employ surplus workers, to produce goods according to plan rather than
market needs, and to absorb rising input costs while holding the line on prices,
managers have only limited areas where they can improve performance. At the same
time, although contracts may increase their accountability, managers know that because
Beijing cannot tolerate bankruptcy or widespread layoffs, the government must
underwrite enterprise deficits. Thus, managers may continue to look for loopholes in
Beijing's supervision to spend indiscriminately, without significantly improving
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We also doubt that contracts will eliminate bureaucratic interference. Contracts
do not alter most of the factors that bind administrative departments and enter rises
such as access to materials funds and m r
because the
.U11t1C1 Lb are negorraz ivi ua y, they tie the enterprise and the supervisory bureaus
together. Participants at a recent World Bank symposium in Beijing reportedly raised the
same point, suggesting that the systems could encourage "sweetheart" contracts
between the enterprises and the bureaus.
We also believe that many workers, enterprise managers, and local officials may
resist the contract system. Because many managers have been granting blanket
bonuses to maintain shop floor harmony, contracts that link worker bonuses to
performance could stimulate discord among workers. Hong Kong press reports have
already referred to growing worker dissatisfaction with the system. Managers, too, are
reportedly reluctant to sign contracts unless they are certain the targets are achievable.
For their part, local officials may fear that contracts will restrict their power to tax
profits, and thus may reduce revenues. Such concerns may lead managers and local
officials to take a cautious approach, perhaps signing bare-bones contracts to claim
they are implementing reform, without making any substantial changes. Indeed, the
stunning growth in the use of contracts this year suggests they may be negotiating
Interim Measure or Step Back for Reform?
We believe the duration of the contract system to a large degree will presage the
future of Beijing's broader economic reform program. Orthodox. leaders are championing
an enduring contract system because it fits well with state planning and reinforces the
role of the bureaucracy in enterprise management. Reform leaders and economists
support the system to maintain the appearance of reform momentum, but are concerned
that it is a step back from market-oriented reforms. For example, a Chinese official told
US diplomats that the contract system sidetracks the introduction of uniform tax rates,
which market reformers advocate. The official confided that he hopes the contract
system will be in effect for only one or two years. Another reform economist pointed
out to US officials that, if they become widespread, the contracts could stall further
reforms by binding enterprises and bureaus to set prices and tax rates. These
statements reflect fears of many reform advocates that the system may develop from a
Orthodox leaders will probably cite any improvements in enterprise performance
to argue that the contract system and other such reforms that tinker with the
bureaucracy--rather than tackle tough problems such as irrational prices and bloated
work forces--are the best solution for China's economic problems. If this occurs, the
short-term success of the contract system may make it harder for reform proponents to
achieve more fundamental changes in China's price, ownership, and financial systems.
Thus, the success registered by the contract system may prove a mixed blessing.
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Subject: China's Contract Management Responsibility Systems:
Touchstone for Economic Reform in 1988?
White House and National Security Council
1 - Douglas Paal, Senior Assistant for China, Taiwan and Hong Kong, Old
Executive Office Building, Room 302
Department of State
1 - Rena Epstein, Policy Planning Staff, Room 7330
1 - Jeff Bader, Deputy Director, Office of Chinese and Mongolian Affairs
(EAP/CM), Room 4318
1 - Nick Lang, Deputy Director of Economic Affairs, Office of
Chinese and Mongolian Affairs (EAP/CM), Room 4318
1 - Bob Goldberg, Office of Chinese and Mongolian Affairs (EAP/CM),
Room 4318
1 - Robert Duncan, Director, Office of Economic Policy (EAP/EP), Room 5321
1 - John Danylyk, Chief, INR/EC/CER, Room 8662
1 - William Newcomb, INR/EC/CER, Room 8448
1 - Robert L. Suettinger, Director, INR/EAP, Room 8840
1 - Tom Fingar, Chief, INR/EAP/CH, Room 8840
1 - Chris Clarke, INR/EAP/CH, Room 8840
Department of Treasury
1 - Randall Fort, Deputy Assistant to the Secretary for National Security,
Main Treasury, Room 2049
1 - Art Long, Senior National Intelligence Adviser, Main Treasury,
Room 2049
1 - Jonathan Hill, Office of East-West Economic Policy, Main Treasury,
Room 4448
1 - Office of Intelligence Liaison, Main Treasury, Room 2049
Federal Reserve System
1 - Charles Siegman, Senior Associate Director, International Finance,
20th & C Streets, NW, Washington, DC 20551, Room 1127
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Department of Commerce
1 - Melvin W. Searls, Jr., Deputy Assistant Secretary for East Asia and
the Pacific, Room 3820
1 - Christine Lucyk, Office of PRC and Hong Kong, Room 2317
1 - Jeffrey Lee, Office of PRC and Hong Kong, Room 2317
1 - Office of Intelligence Liaison, Room 6854
Office of the Trade Representative
1 - Joseph Massey, Assistant Trade Representative for China and Japan,
600 17th Street N.W., Washington, D.C. 20506, Room 300
1 - Todd Egland, Office of Intelligence Liaison, 600 17th Street N.W.,
Washington, D.C. 20506, Room 123
Department of Defense
1 - Ed Ross, OSDISA, Pentagon, Room 4C840
Central Intelligence Agency
1 - DDI, Room 7E44
1 - DCI/DDCI/Executive Staff, Room 7D60
1 - senior Review Panel, Room 5G00
1 - PDB Staff, Room 7F30
1 - NIO/EA, Room 7E62
1 - NIO/ECON, Room 7E62
1 - C/PES, Room 7F24
1 - D/OEA, Room 4F18
2 - C/OEA/CH, Room 4G32
1 - C/OEA/CH/PA, Room 4G32
5 - C/OEA/CH/EA, Room 4G32
1 - C/OEA/CH/IS, Room 4G32
1 - C/OEA/CH/TT, Room 4G32
1 - OEA/Production Officer, Room 4G48
1 - C/OEA/SDS, Room 4G32
1 - C/OEA/NEA, Room 4G43
1 - C/OEA/SEA, Room 4F38
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1 - FBIS/NEAAD/China Branch, Room 306, Key
1 - FBIS/AG/China Branch, Room 2S37G, RCC
1 - LDA/AN/CHINA, Room 1H18
1 - SOVA/NIG/DPD, Room 4E65
1 - SOVA/NIG/DPD, Room 4E65
1 - SOVA/NIG/EPD, Room 5E66
1 - C/DO/PPS, Room 3D01
1 - C/EA/RR, Room 5D10
1 - C/EA/CORR, Room 5D38
1 - EA/CO/SA Room 5D54
1 - CPAS/ILS, Room 7G50
6 - CPAS/IMC/CB, Room 7G07
2 - Office of Con ressional Affairs, Room 7802
1 - Room 814, Key
1 - DCI/COMPT, Room 7C36
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