CHINA: ECONOMIC PERFORMANCE IN 1987 AND OUTLOOK FOR 1988

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP11S00229R000301520001-8
• Release Decision: RIFPUB
• Original Classification: K
• Document Page Count: 35
• Document Creation Date: December 23, 2016
• Document Release Date: January 8, 2013
• Sequence Number: 1
• Publication Date: May 1, 1988
• Content Type: REPORT

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Directorate of
Intelligence
Reverse Blank
China: Economic Performance
in 1987 and Outlook for 1988
This paper was prepared by the Central
Intelligence Agency for submission to the
Subcommittee on National Security Economics
of the Joint Economic Committee, Congress of the
United States.
EA 88-10018
May 1988
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China: Economic Performance
in 1987 and Outlook for 1988
Summary Two economic problems most concerned China's leaders last year?
Information available
as of 21 April 1988
was used in this report.
excessive inflation and lagging grain output:
? China's official inflation rate was 7 percent in 1987?an improvement
over the 9-percent rate of 1985, but higher than any other year in the last
decade. Urban consumers were especially hard hit. Food prices rose at
double-digit rates. Inflation rates of over 20 percent were reported in
several major cities. Indeed, Beijing has acknowledged that the real
incomes of one-fifth of China's urban dwellers declined.
? Grain production did not meet Beijing's admittedly ambitious target level
of 405 million metric tons, though China produced more than 400 million
tons?a feat accomplished only once before. Strong consumer demand
for grain-based foods?bread, meat, and beer?and moderate interna-
tional grain prices led China to more than double its grain imports,
becoming a net grain importer after two years as a net exporter. To
dampen demand and inflationary pressures, Beijing resumed the practice
of issuing ration tickets for pork, eggs, and sugar in several major cities.
Inflation and lagging grain output have led Beijing to avoid economic
policies that run the risk of worsening, rather than improving, price
stability and grain production. Tighter central controls over prices, bank
credit, and out-of-plan investment, plus increased state spending on
agricultural infrastructure projects?proven ways of reducing upward
pressure on prices and stimulating agricultural output?form the core of
Beijing's approach to these problems this year.
The economy turned in a solid performance in other areas. Urban
industrial output rose nearly 15 percent, profits and taxes remitted to the
state increased nearly 10 percent, and labor productivity was up about 8
percent in 1987. Chinese leaders generally credited the implementation of
a contract system in industry?under which enterprises sign performance
agreements with their supervisory bureaus specifying minimum output,
earnings, and taxes?for the improved industrial performance. By last
December, three-fourths of China's larger state enterprises had signed
such contracts, and a majority of collective enterprises had adopted a
parallel contract/leasing system. The contract system will remain in place
for the near term, and some Chinese leaders would like to see it become a
permanent feature of industrial policy. To introduce even greater fiscal
accountability and managerial autonomy to enterprises, China adopted a
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new state enterprise law in March 1988 that spells out the responsibilities
of factory managers and factory-level party officials, and Beijing may also
implement bankruptcy regulations enacted in late 1986 before the end of
this year.
The contract system also forms the basis for reforms of China's foreign
trade sector, which also performed well in 1987. China's trade deficit
declined by 70 percent, from $12 billion in 1986 to only $3.7 billion.
Foreign direct investment picked up after a disappointing 1986, and
China's foreign exchange reserves jumped more than 50 percent, to $15
billion. The particularly strong record has permitted the leadership to
consider adopting more fundamental reforms in the management of foreign
trade than it is likely to risk in agriculture or pricing industrial output. Vir-
tually all of China's leaders have endorsed the strategy of export-led
development in China's coastal areas enunciated by party Secretary Zhao
Ziyang last January. Beijing also has placed many local branches of
national trading corporations under provincial or municipal jurisdiction,
increasing their autonomy from Beijing. To encourage individual factories
to step up exports, Beijing has increased the portion of foreign exchange
they may retain from exports. Beijing has even begun to allow Chinese
enterprises to exchange surplus foreign exchange for domestic currency at
premium rates in officially sanctioned swap centers, another inducement to
export. As in industry, these changes are designed to make individual
factories and corporations more responsive to market conditions.
China's economy will probably turn in another mixed performance in 1988.
There are preliminary indications that droughts may decrease grain yields,
limiting the near-term benefits of price and investment increases. In
contrast, Chinese statistics for the first quarter of the year indicate that
growth in industrial output may surpass last year's level. Primarily because
of continued strong growth in exports, moreover, China's first quarter 1988
trade deficit was 40 percent below the level of a year earlier. Imports will
probably pick up, however, as Beijing eases controls over purchases of
materials, components, and equipment for use in export-processing ven-
tures in China's coastal areas.
Beijing's chief problem in 1988 may be managing inflation. China's retail
price index reached double digits in the first quarter of 1988?twice the
level of first quarter 1987?and Chinese officials acknowledge they will
have a difficult time keeping inflation below 10 percent for the year, even if
iv
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it tapers off in the second half as planned. Sharp increases in industrial out-
put will strain already tight supplies of energy and raw materials. Inflation,
moreover, will also be fueled by workers' demands for increased bonuses
after a year of belt-tightening.
Crucial but politically sensitive price reforms will proceed slowly over the
near term in order to minimize economic dislocations among consumers.
This year, Beijing will incrementally increase state-set prices for grain in
order to stimulate production. But efforts to erode differentials between in-
plan and market prices for raw materials and other industrial inputs will be
slowed until Beijing reduces inflationary pressures.
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Contents
Page
Summary
iii
Economic Performance in 1987
1
The Rural Economy
1
Industrial Performance
4
International Trade and Investment
4
US-China Trade
7
Sino-Soviet Trade
8
Government Budget and Spending Priorities
11
Defense Spending
12
Economic Policy in 1988
13
Controlling Investment and Inflation
13
Managing Agriculture
14
Improving Enterprise Profitability
15
Reforming the Foreign Trade System
17
Outlook for Price Reform
19
Appendixes
A. Evaluating Beijing's Reforms
21
B. China's Foreign Investment Policies
27
C. A Comparison of Chinese and Soviet Economic Reforms
29
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China: Economic Performance
in 1987 and Outlook for 1988
Economic Performance in 1987
China's real GNP rose 9.4 percent in 1987, up from a
7.8-percent increase in 1986, but below the double-
digit growth rates of 1984 and 1985. After particular-
ly rapid growth during the first half of the year,
Beijing tightened credit in order to rein in investment,
which had seriously strained industrial supplies and
exerted upward pressure on prices. Fixed asset invest-
ment nonetheless increased 17 percent in 1987, with
the strongest gains coming from collectives and pri-
vate individuals. State investment in raw materials,
energy, light industry, and factory renovation projects
also grew fairly rapidly.
China's retail price index rose 7.3 percent during the
year, according to official Chinese statistics, and some
cities recorded double-digit inflation rates. Food price
increases?up more than 10 percent?were responsi-
ble for most of the rise in the price index, roughly half
of which is based on food. In real terms, accordingly,
urban per capita income increased only 1.7 percent,
and one-fifth of China's urban households experi-
enced a decline in their real incomes. Inflation also
eroded gains in rural per capita income, which showed
a 5.3-percent increase in real terms.
The Rural Economy
Gross agricultural output rose 4.7 percent in real
terms last year, up from 3.4 percent in 1986, largely
because of a strong performance in cash crop produc-
tion. Grain production reached 402 million metric
tons, up 3 percent from 1986, but still below the
record harvest of 407 million metric tons in 1984 (see
figure 1). After two years of being a net grain
exporter, China last year resumed its status as a net
importer of grain, purchasing approximately 16 mil-
lion metric tons?primarily from Canada, Australia,
and the United States (see figure 2).
China's lagging grain production is in part a reflection
of the success of reforms in the rural sector. For
example, after achieving double-digit growth rates in
the early 1980s through a combination of favorable
1
Table 1
Chinese Output of Major Agricultural
Crops, 1987
Million Metric
Tons
Percent of
Change From
1986
Grain
402.4
+2.8
Cotton
4.2
+18.4
Oil-bearing crops
15.3
+8.1
Sugarcane
46.9
?6.7
Fruit
15.5
+15.1
Pork
17.8
?0.9
Beef and mutton
0.2
+16.9
Aquatic products
9.4
+14.1
Source: China's State Statistical Bureau.
weather, increased financial incentives for peasants,
and implementation of household-based farming,
Beijing loosened central controls over peasants in
1985, allowing them to produce the crops of their
choice after fulfilling contractual obligations to the
state for grain production. At the same time, Beijing
relaxed state controls over the prices of nonstaple
foodstuffs such as vegetables, fruit, and meat. Free
market prices for cash crops soared, while the state
dropped grain prices to avoid another grain surplus
the size of that in 1984. Cash crop production conse-
quently began to draw an increasing share of China's
farmland, and as a result, cash crop output gains have
far outpaced increases in grain production. Low feed-
grain prices also encouraged peasants to raise live-
stock. However, the ensuing jump in meat production
in 1985 and 1986 reduced the profitability of produc-
ing livestock and led to last year's return to rationing
of pork (see table 1).
State investment in agricultural infrastructure has
continued to decline both in real terms and as a share
of total capital construction expenditures, and neither
local government agencies nor peasants have taken up
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Figure 1
China: Trends in Agriculture, 1978-87
Grain Production
Million metric tons
450
Grain Yields
Tons per hectare
3.5
2.0
1.5
1.0
0.5
1
1
1
1
1
1
1
1
1
1
1978
79
80
81
82
83
84
85
86
87
Agriculture's Share of State Capital
Construction Investment
Percent
12
-.1
10
8
6
4
2
7
7 1
0 1978 79 80 81 82 83 84 85 86 87 0 1978 79 80 81 82 83 84 85 86 87
Source:. Official Chinese statistics and
US Department of Agriculture.
316736 5-88
2
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Figure 2
China: Grain Trade, 1981-87
Exports and Imports
Million metric tons
Exports ED Imports
20
1981 82
83
84
85
86
a Calculated by volume of exports.
Source: Chinese Customs statistics and partner country
trade statistics as reported to the United Nations.
87
Major Grain Suppliers, 1987 a
Percent
Australia
(wheat)
29
United States
(wheat, corn,
soybeans)
23
Canada
(wheat)
38
the slack. Beijing has permitted local officials to
exercise greater autonomy in deciding how to allocate
state investment funds in rural areas?and rural
officials often have chosen to develop profitable rural
industries on farmland rather than to make invest-
ments in agricultural infrastructure projects. Mean-
while, peasants have invested their savings in housing
or consumer goods, fearing that changes in Beijing's
agricultural policies might deprive them of benefits
from infrastructural investments. Thus, total farm-
land has decreased and improvements needed in rural
infrastructure have been lacking.
Tight grain supplies in 1987 were also the result of a
continuing rise in consumer demand, as rapidly rising
incomes raised purchases of a variety of foodstuffs
3
316737 5-88
requiring grain inputs. Strong demand for bread,
beer, cooking oil, meat, and eggs has strained supplies
of high-quality grains, oilseeds, and feedgrains. To
dampen demand and minimize inflationary pressures,
Beijing has resumed the practice of issuing ration
tickets for such food products as eggs and sugar in
several major cities.
In contrast to grain, China's rural industrial output
posted strong growth in 1987. Indeed, rural industry
and commerce are among the most dynamic segments
of the Chinese economy, and now employ about 15
percent of China's labor force?more than 85 million
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Table 2
China: Major Trade Partners, 1987
Billion US $
Percent
Billion US $
Percent
Imports
Exports
Total
43.2
100
Total
39.5
100
Japan
10.1
23
Hong Kong
14.2
36
Hong Kong
8.6
20
Japan
6.4
16
United States
4.8
11
United States
3.0
8
West Germany
3.1
7
West Germany
1.2
3
Soviet Union
1.3
3
Soviet Union
1.2
3
Source: Chinese Customs statistics.
people. Rural industrial output grew by 36 percent in
1987 in real terms, and rural industries earned $5 bil-
lion from exports?about 15 percent of China's total
export earnings.
Industrial Performance
China's urban industrial output grew 15 percent in
1987 in real terms (see figure 3). Growth was especial-
ly rapid in the private and collective sectors, and the
output of foreign-invested enterprises nearly doubled
during the year?although it remains a very small
portion of China's total industrial output. Production
of consumer goods, farm machinery, motor vehicles,
and chemical fertilizers and pesticides grew at double-
digit rates.
China's output of electricity grew at a recordsetting
pace?roughly 10 percent?but nonetheless failed to
match the growth in industrial output. Power short-
ages continued to idle roughly one-fifth of China's
industrial capacity. In contrast to healthy growth in
electricity output, China's production of coal and oil
rose only 3 percent.'
Chinese statistics indicate that state enterprises im-
proved their operating efficiency in 1987. Profits rose
6 percent and labor productivity increased by nearly 8
percent. But one-eighth of China's state enterprises
'China is the world's second-largest producer of coal, after the
United States, and fourth-largest producer of crude oil, following
the Soviet Union, the United States, and Saudi Arabia.
continued to lose money, and the size of those losses
was larger last year than in 1986. By and large,
factory managers have faulted rising input prices for
their losses. Beijing last year deliberately increased
state procurement prices for industrial crops such as
cotton in order to stimulate production; at the same
time, Beijing has encouraged the development of a
raw materials market in which producers and users of
such goods as steel, cement, and lumber buy and sell
industrial inputs at free market?and substantially
higher than state-set?prices. Last year, for example,
for the first time a majority of China's rolled steel was
distributed outside of the state plan.
International Trade and Investment
Concerned about the level of foreign exchange re-
serves resulting from two years of substantial trade
deficits and lackluster foreign direct investment in-
flows, Beijing tightened controls over imports and
foreign exchange expenditures last year. At the same
time, Beijing stepped up efforts to boost the country's
export earnings. As a result, China's trade deficit
shrank from $12 billion in 1986 to only $3.7 billion in
1987, according to Chinese Customs statistics (see
table 2 and figure 4). With a net gain of $3.4 billion in
earnings from tourism and other services, Beijing's
current account was nearly in balance. Accordingly,
official foreign exchange reserves grew from $9.9
billion in January to $15.2 billion in December 1987,
sufficient to cover more than four months' imports.
4
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Figure 3
Trends in Chinese Industry, 1979-87
Industrial Output Growth
Percent
20
15
10
5
0
1979
Growth by Sector, 1987
Percent
0
20 40 60
State sector
Collective sector
Private sector
Foreign-
invested
enterprises
a In state-sector enterprises.
Source: China's State Statistical Bureau.
80 81 82 -83 84 85 86 87
80 100
Industrial Output by Sector, 1987
Percent
Total=1,278 billion yuan
Foreign-invested sector 1
Private sector 1
Collective sector 32 711 State sector 66
316738 4-88
5
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Figure 4
China: Imports, Exports, and Trade Balance, 1978-87
Note scale change
Impii-tis and Exports
Billion US $
50
Imports
Exports
1111111111
0 1978
79
80
81
82
83
84
85
86
87
Source: Chinese Customs statistics.
Trade Balance
Billion US $
-15
-20 1978 79 80 81 82 83 84 85 86 87
Hong Kong displaced Japan as China's top trading
partner as Beijing curbed its purchases from Japan to
reduce the large bilateral trade imbalance, diversify
sources of supply, and find lower cost suppliers less
affected by currency appreciation. Hong Kong also
drew a larger share of China's exports, many of which
the territory subsequently reexported to the United
States and other destinations?including Taiwan and
South Korea. The United States, West Germany, and
the Soviet Union followed Hong Kong and Japan as
China's major trade partners.
China's imports remained stagnant for the second
year in a row as a result of tighter procedures for
allocating foreign exchange and closer monitoring of
purchases to avoid duplication and encourage import
substitution when possible. Purchases centered on
industrial machinery not available domestically,
equipment and raw materials to be used in export
processing, and agricultural inputs such as fertilizer
and pesticides. Reflecting Beijing's concerns about
316739 4-88
lagging grain output, imports of grains increased by
more than 60 percent in value terms, totaling
$1.6 billion. Reduced international grain prices also
contributed to the surge in grain imports; Beijing took
advantage of prices driven down by subsidies from the
European Community and by the US Export En-
hancement Program to complement domestic output
(see table 3).
On the export side, China's 1987 performance demon-
strates the success of Beijing's efforts to promote
rapid growth by:
? Providing priority domestic investment funds to
export-producing projects.
? Allowing export-producing Chinese factories to re-
tain a share of their foreign exchange earnings.
? Providing state subsidies to cover the losses of
exporters selling goods at world prices that are
below China's costs of production.
6
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? Devaluing the Chinese currency relative to most
major world currencies.'
? Giving foreign investors special tax and other incen-
tives for participation in factories producing for
foreign markets.
China's export earnings grew by more than one-fourth
last year?to nearly $40 billion. Export earnings from
industrial and manufactured goods increased from 63
percent of the total in 1986 to 66 percent. China's
most striking export gains have come in textiles and
apparel shipments?which last year accounted for
about one-fourth of China's total exports. According
to Chinese press reports, China is the world's largest
silk producer and exporter?with its raw silk exports
accounting for 90 percent of global sales volume, and
silk fabric exports making up 40 percent of the world
market. China also has become the world's second-
largest supplier of raw cotton by volume, after the
United States. Raw cotton exports earned Beijing
nearly $750 million last year, a 50;percent jump over
1986.
Beijing recognizes that foreign managerial and tech-
nical expertise has contributed significantly to
China's ability to boost exports. Export earnings by
foreign-invested enterprises doubled in 1987 to $1 bil-
lion. According to China's Ministry of Foreign Eco-
nomic Relations and Trade, China has signed con-
tracts for more than 10,000 foreign-funded
enterprises, 4,300 of which are now in operation.
China's paid-in foreign investment reached $8.5 bil-
lion by the end of last year, showing a $1.9 billion
increase in 1987?probably reflecting both investors'
more favorable view of China's investment climate in
the wake of new legislation adopted in late 1986 and
appreciation of the Japanese yen and other currencies
that have encouraged investment in regions with
lower labor costs. But the apparent improvement in
China's ability to draw foreign investment also re-
flects the depressed level of investment in 1986 as
Beijing curbed inflows of foreign funds to nonproduc-
tive activities such as hotels.'
'Beijing has not devalued the Chinese yuan against the US
dollar?to which it is unofficially pegged?since mid-1986. As the
dollar has fallen, however, the value of the yuan has effectively
declined relative to many other currencies.
For further information in China's changing foreign investment
picture, see appendix B.
7
Table 3
China: Major Import and Export
Commodities, 1987 a
Billion
US $
Percent
Imports
Specialized machinery
4.8
11
Iron and steel
4.8
11
Cereals and cereal prepara-
tions
1.6
4
General industrial machinery
1.5
3
Electrical machinery
and apparatus
1.4
3
Telecommunications
equipment
1.3
3
Fertilizers
1.2
3
Road vehicles
1.1
3
Plastics
0.8
2
Textile fibers
0.8
2
Exports
Textile yarn, fabric
5.3
13
Petroleum
3.7
9
Clothing, apparel
3.5
9
Textile fibers
1.5
4
Miscellaneous manufactured
articles
1.2
3
Oilseeds
0.8
2
a Projected. Based on data available through September 1987.
Source: Chinese Customs statistics.
US-China Trade. China's exports to the United
States rose by one-third last year, according to US
Commerce Department statistics, reflecting the suc-
cess of China's overall export push. US sales to China
increased by 12 percent?recovering from a slump in
1986?but remained below the record level of 1985..
Accordingly, the US deficit widened to $3.4 billion,
60 percent higher than in 1986.
Paralleling trends in China's overall exports, light
industrial goods are becoming an ever larger share of
China's sales to the United States. Exports of sporting
goods, toys, travel goods, handbags, footwear, and
tape recorders have grown especially rapidly. Textiles
and apparel last year accounted for 40 percent of
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Table 4
Selected US Imports From China, 1987
Table 5
Selected US Exports to China, 1987
Million
US $
Percent
Million
US $
Percent
Total
6,287.3
100
Total
3,488.6
100
Clothing
1,987.5
32
Aircraft and parts, railway stock
500.8
14
Miscellaneous manufactured articles,
including toys and sporting goods
1,170.6
19
Fertilizers, manufactured
270.0
8
Plastic materials
254.6
7
Textile yarn, fabrics
521.3
8
Specialized machinery
234.6
7
Petroleum
476.8
8
Cereals
234.1
7
Travel goods, handbags
294.5
5
Office machines, ADP equipment
189.3
5
Telecommunications and recording
equipment
239.6
4
General industrial machinery
177.4
5
Scientific instruments
169.0
5
Electrical machinery
146.3
2
Wood, lumber, cork
167.4
5
Metal manufactures
140.7
2
Organic chemicals
149.9
4
Footwear
139.3
2
Source: US Department of Commerce. Imports valued free along-
side ship.
China's exports to the United States (see table 4). In
value terms, according to US Commerce Department
statistics, China ranked as the United States' second-
largest supplier of textile yarns and fabrics and as its
fourth-largest supplier of clothing. The United States,
in turn, was China's largest market for clothing, and
third-largest purchaser of yarns and fabric, after
Hong Kong and Japan, according to Chinese Customs
statistics. Despite the signing of a four-year bilateral
textile accord last December that limits increases in
the volume of China's exports in specified categories
to 3.3 percent annually, the value of China's textile
exports to the United States will probably continue to
increase as Chinese apparel producers continue their
move into higher quality and higher priced articles.
Regarding US exports to China, the most rapid gains
have occurred in agricultural commodities. China's
purchases of US grains jumped more than twentyfold
in 1987, while its imports of fertilizers, organic chemi-
cals, edible oils, live animals, and oilseeds more than
doubled. Machinery and transport equipment ac-
counted for more than 40 percent of US sales to
China in 1987, as the United States continued to
Source: US Department of Commerce. Exports valued free on
board.
benefit from China's strong demand for capital equip-
ment for upgrading factories and aircraft for upgrad-
ing the civil air transportation network (see table 5).
High-technology equipment (computers, aerospace
equipment, telecommunications gear, scientific instru-
ments, machine tools, and microelectronics devices)
accounted for roughly one-third of China's purchases
from the United States, as it has for the last three
years. By the same token, the United States continued
to supply about one-third of China's imports of high-
technology goods, a share of the market that has
remained strong for the last five years (see tables 6-8).
Sino-Soviet Trade. Sino-Soviet trade dipped in 1987
to $2.5 billion, after reaching $2.6 billion in 1986. A
number of factors contributed to the modest decline:
? Tight domestic grain supplies constrained Beijing's
ability to meet export commitments.
? Chinese dissatisfaction with the quality and techni-
cal level of Soviet industrial equipment postponed
many of the 24 industrial cooperation projects slated
to take place under the five-year accord signed in
July 1985.
8
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Figure 5
China: Trade With the United States, 1977-87
Chinese Statistics a
Billion US $
0 Chinese
exports
El Chinese China's trade
imports balance
US Statistics b
Billion US $
El Chinese 0 Chinese
exports imports
? China's trade
balance
8 8
6 6
4
4
2
2
0
0
-2
-2
-4
-4
-6 1977 78 79 80 81 82 83 84 85 86 87 "6 1977
a Source: Chinese Customs statistics.
b Source: US Commerce Department.
111
? 1111a2
1111110:11111M11111
1-74' 2.1111111.:INIIIIMEIN
II II 1111 111
78 79 80 81 82 83 84 85 86 87
Statistical Discrepancies
China's Customs statistics differ considerably from
those recorded by the US Commerce Department.
China calculates it had a $1.8 billion deficit with the
United States last year, rather than a $3.4 billion
surplus. A major reason for the discrepancy is that
the United States tallies all goods shipped to and
from China, regardless of whether they are shipped
directly or through third parties such as Hong Kong;
China only includes direct shipments. In addition, the
practice of including insurance and freight costs in
the value of imports from the other partner accounts
for about $1 billion of the $5.2 billion gap in trade
statistics. The discrepancy between Chinese and US
trade statistics has grown in recent years because
China is shipping a larger share of its exports to the
United States via Hong Kong.
9
316740 5.88
? Trade reform and decentralization in both countries
have made it more difficult for Beijing and Moscow
to ensure that individual factories and trade corpo-
rations adhere to trade commitments made at the
central level.
Other factors will doubtless continue to constrain
Sino-Soviet trade even if the countries iron out some
of the specific problems that arose last year. For
example, barter trade is by nature a cumbersome
arrangement, with trade officials required to meet
annually to negotiate the types and values of goods to
be traded. Moreover, China and the Soviet Union
both generally prefer to export their better goods to
the West for hard currency instead of to each other,
leading to reciprocal complaints about the dumping of
inferior goods. Bilateral trade should therefore remain
a small percentage of each country's total trade and
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Table 6
Known Chinese Imports of High-Technology
Equipment, 1979-86 a
Million US $
1979
1980
1981
1982
1983
1984
1985
1986
Total
867
930
674
581
1,103
1,422
3,336
3,561
Australia
1
1
1
1
2
3
7
11
Austria
2
25
10
0
1
1
10
18
Belgium/Luxembourg
3
2
2
3
1
6
28
73
Canada
4
3
7
4
6
11
34
54
Denmark
8
6
5
6
11
16
17
20
Finland
1
2
1
0
1
1
5
14
France
26
44
34
40
32
41
238
192
Hong Kong
5
11
11
17
33
114
199
108
Ireland
0
0
0
0
0
0
1
3
Italy
6
11
11
6
10
23
70
121
Japan
139
204
310
176
279
467
887
1,040
Netherlands
11
10
10
4
4
7
13
24
New Zealand
0
1
0
0
0
0
0
0
Norway
0
4
1
1
4
6
7
7
Singapore
0
2
2
4
7
16
22
24
Spain
0
0
0
0
0
1
5
5
Sweden
15
11
10
7
16
20
47
59
Switzerland
48
32
40
76
48
47
86
126
Thailand
0
0
0
0
1
1
1
0
United Kingdom
152
129
70
55
53
76
113
139
United States
91
257
105
145
514
471
1,332
1,085
West Germany
354
175
43
36
79
96
214
438
a High-technology equipment includes advanced computers, tele-
communications equipment, aerospace equipment, scientific instru-
mentation, machine tools, and microelectrics devices. We have
defined the category based on five-digit commodity categories
according to the United Nations' Standard International Trade
Classification (Revision 2) to exclude items for which research and
development expenditures constitute a small share of final product
cost, such as calculators, telephones, and simple machine tools.
Data are based on sales reported to the United Nations by China's
trade partners. Several of China's trade partners?including Soviet
Bloc countries and South Korea?do not report trade with China to
the United Nations.
10
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Table 7
High-Technology Equipment Share of
US Exports to China, 1979-86
Table 8
US Share of China's Known Imports of
High-Technology Equipment, 1979-86
Percent
Percent
1979 ,
5
1979
10
1980
7
1980
28
1981
3
1981
16
1982
5
1982
25
1983
24
1983
47
1984
16
1984
33
1985
35
1985
40
1986
35
1986
30
will be dwarfed by their trade with the United States
and other Western partners. The Soviet Union is
China's fifth-largest trade partner, accounting for
about 3 percent of China's total trade, according to
Chinese Customs statistics.
Government Budget and Spending Priorities
China's budget deficit widened in 1987 to $2.2 billion
(8 billion yuan), equivalent to 3 percent of state
revenue and about 1 percent of GNP' (see figure 6).
This increase was not unexpected. Increased state
investment expenditures accounted for some of the
drain, as Beijing targeted priority construction pro-
jects in energy, raw materials, and light industry. But
higher state subsidies to cover the losses of money-
losing enterprises and state trading corporations ex-
porting goods priced higher in China than in foreign
markets, as well as payments to urban consumers to
soften the impact of higher food prices, accounted for
a growing share of the budget. Subsidy payments
exceeded one-fourth of state expenditures.
? Using Western accounting procedures, China's budget deficit was
probably twice the level reported, equivalent to 7 percent of
government revenue and 2 percent of GNP. China records receipts
from domestic bond sales and central government borrowing from
foreign sources as state revenues. China's net domestic bond issues
in 1987 were equivalent to $1.1 billion (4 billion yuan), and its net
foreign borrowing to cover state expenditures was equivalent to $1.4
billion (5.1 billion yuan).
11
Beijing expects the budget to remain in the red for
several more years, and is projecting another $2.2
billion shortfall for 1988, despite an anticipated $500
million (2 billion yuan) gain in tax revenues and a
planned 50-percent increase in treasury bond issues.
According to the Finance Minister, food subsidies will
rise by 22 percent, and state investment in agriculture
will jump 15 percent. Earlier this year, China's State
Council instructed government offices and state-
funded institutions to reduce spending by 20 percent
in 1988 and banned purchases of a variety of items.
The streamlining of government ministries and com-
missions announced at the National People's Congress
(NPC) in March is also expected to cut costs. Begin-
ning in June, China will create a new State Economic
Planning Commission by merging two existing com-
missions, and replace 12 other industrial ministries
and bureaus with nine new ministries and four state-
operated corporations. The net result is an expected
reduction in State Council personnel from approxi-
mately 50,000 to 40,000. In addition to the fiscal
benefits expected from the reshuffling, China's lead-
ers expect it to reduce government interference in
enterprise management and to transform ministries
into more efficient government organs.
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Figure 6
China: Budget Surpluses and Deficits, 1977-87
Billion yuan ($1=3.72 yuan)
5
0
-5
-10
-15
-20
1977 78 79 80 81
Source: Official Chinese statistics.
82 83 84 85 86 87
Defense Spending. China releases statistics on nation-
al defense spending as a line item in the annual state
budget, but provides neither a definition of the cate-
gories of expenditure included in the figure nor a
breakdown of the total. Our own estimates of Chinese
defense expenditures cover spending for investment
(primarily weapon procurement); operating expenses
(including maintenance and personnel costs); and re-
search, development, testing and evaluation
(RDT&E). Using a building-block approach for valu-
ing the costs of these various components, we estimate
that China's total defense expenditures for 1986 were
roughly 45 billion yuan, more than twice that of the
announced budget of 20 billion yuan. Using current
exchange rates, this is about $12 billion. We believe
the defense budget increased modestly in 1987.
Despite the difference in absolute values, China's
announced figures and the CIA estimates both show
declining trends in the defense Sector's share of
China's budget as well as in the size of the defense
316741 4-88
budget relative to gross national income (GNI). CIA
estimates indicate that defense expenditures account-
ed for about one-third of China's total budget in 1978,
and only one-fifth of the budget in 1987. Moreover,
we estimate China's defense spending dropped from
12 percent of gross national income in 1978 to only 5
percent in 1987?somewhat less than the 7 percent
for the United States, and significantly less than the
20 to 25 percent for the Soviet Union (see figure 7).
China has cut military spending by slashing personnel
costs and postponing the procurement of most major
weapon systems. Beijing has reduced its armed forces
by about 3 million men since 1977, with most of the
China began to publish gross national product (GNP) figures in
1985, but has provided gross national income (GNI) statistics for
the entire 1949-87 period. In recent years, GNI has been roughly
equal to 80 percent of GNP.
12
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Figure 7
Estimated Chinese Defense Expenditures, 1978-87
Defense Burden
Percent
40
Spending Trends by Resource Category
Index: 1978=100
125
30
20
10
I I I I I I I I I
Share of state
expenditures
Share of gross
national income
1
0 1978 79 80 81 82 83 84 85 86 87
100
75
50
25
I I I I I I I I I
RDT&E
Investment
Operating
0 1978 79 80 81 82 83 84 85 86
cuts coming from its ground forces. We believe
China's military operating budget?nearly half of
which goes for salaries?has declined by about one-
fifth during the last eight years. Beijing intends to
complete the force reduction by the end of this year,
but we believe that it may take several more years
before demobilized men find civilian jobs and are
moved from military posts. Expenditures on weapon
procurement also declined about 10 percent between
1978 and 1986 because Beijing has elected to post-
pone major weapon purchases until more technologi-
cally advanced systems become available. In contrast,
we estimate that RDT&E expenditures have in-
creased about 25 percent since 1978, although this
category continues to account for only about one-
eighth of China's defense expenditures.
13
316742 5-88
Economic Policy in 1988
Beijing has announced a modest reform agenda for
this year that postpones crucial but politically sensi-
tive price reform pending reductions in the inflation
rate, increases in grain output, and improvements in
enterprise efficiency. Premier Li Peng announced in
mid-February?and reaffirmed in his report to the
National People's Congress in March?that China's
top economic priorities in 1988 would be controlling
inflation and improving agricultural output.
Controlling Investment and Inflation
Complementing a freeze imposed on state-controlled
prices of consumer goods and public utility fees last
fall, in January Beijing announced tighter state con-
trols on prices of key raw materials?including goods
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The 13th Party Congress
The 13th Party Congress of October-November 1987
was a crucial test of strength for China's reform
leaders. In the aftermath of the ouster of Party
Secretary Hu Yaobang in January 1987, reform-
minded Chinese officials sought to install younger,
more pragmatic leaders in positions of authority,
defuse ideological questions about the reform pro-
gram, and obtain an endorsement for a wider role for
market forces in the Chinese economy. Those goals
were generally achieved:
? Zhao Ziyang was confirmed as Party Secretary,
and joined by four new appointees on the Politburo
Standing Committee?the most powerful body in
the party. These represented a balance between
market-oriented reformers aligned with Zhao and
officials who, like Premier Li Peng, favor a greater
role for the central government in managing the
economy. New appointees to the Politburo and the
Central Committee also gave these bodies a more
reformist cast. And former Party Secretary Hu
Yaobang remained on the Politburo, a rebuff to
reform opponents who forced his ouster as General
Secretary.
? The Congress endorsed an ideological justification
for a wide range of reform proposals contained in
Zhao Ziyang's work report to the Congress. The
"initial stage of socialism" theory provides for a
century of experimentation with economic re-
forms?including private ownership, and the leas-
ing of land and enterprises?as long as the "public-
ly owned" sector of the economy is predominant.
? Zhao 's work report endorsed greater use of markets
for distributing raw materials, capital, technology,
and labor. The report also indicated that central
ministries should focus primarily on making over-
all industrial policy, leaving the implementation to
lower-level entities responding to economic levers.
Zhao also previewed some of the foreign trade
reforms planned for 1988 as a result of impressive
trade performance in 1987.
Reformers' gains were not unqualified, however.
Decisionrnaking by consensus continues to involve a
wide spectrum of opinion about the pace and scope of
reform, and a number of influential Chinese leaders
remain more comfortable with an economy predomi-
nantly controlled by administrative fiat, rather than
by market forces. Moreover, reformers face signifi-
cant practical problems in implementing many poli-
cies in the face of high inflation, growing state budget
deficits, and large out-of-plan capital investments.
produced in excess of state quotas and previously sold
at market prices. In addition, Beijing plans to limit
growth in the money supply by tightening controls
over bank lending, and by requiring successful state
enterprises to fund planned expansion by issuing
bonds rather than drawing on bank loans, which carry
a lower interest rate. The state is also reducing its
investment in capital construction. Finally, Beijing is
trying to trim personal consumption. Leaders hope
that enterprise reforms will slow growth in worker
wages and bonuses, thereby curbing demand. Mean-
while, Beijing expects that rent increases resulting
from a reduction in state housing subsidies will soak
up some of the excess funds now available to
consumers.
Managing Agriculture
In the agricultural sector, Beijing is undertaking
several major initiatives designed to stimulate grain
production:
? Raising purchase prices for grain produced and sold
under state contracts. Beijing intends over time to
phase out the current dual-track agricultural pricing
system either by reducing the share of grain pro-
cured under contracts and increasing free market
transactions, raising the prices the state pays for
contract grain, or instituting price differentials
based on quality with the aim of eventually selling
high-quality grain at free market prices.
14
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? Increasing state investment in fertilizer and pesti-
cide production, in transportation and distribution
networks, and in agricultural infrastructure projects
such as irrigation. Beijing is concentrating rural
loans as well as state investment on grain produc-
tion. Beijing may also invest tax revenues collected
from nonfarm rural land use in agriculture.
? Allowing peasants to purchase and transfer land-use
rights, which would permit more efficient, larger
scale operations. Beijing also recently lengthened
the leasing period for rural land from 15 to 30 years.
These measures are designed to give farmers a
greater stake in the land's upkeep.
? Encouraging peasants to use better seed strains and
more tractors and other agricultural machinery in
production. Beijing has introduced several state-
sponsored S&T initiatives in the last few years that
are designed to improve productivity by providing
training and funds to rural areas.
Beijing is sensitive to the inflationary impact that
substantial increases in grain purchase prices could
induce and is searching for ways to minimize costs
that must be borne by urban consumers. At the same
time, Beijing recognizes that it cannot continue to
increase subsidy payments, which are already a sub-
stantial drain on the state budget. A variety of
possibilities are under consideration and will likely be
the subject of continued debate in 1988.
Improving Enterprise Profitability
In the industrial sector, Chinese officials have said
that the "contract system"?under which state enter-
prises sign performance contracts with supervisory
bureaus specifying minimum output, earnings, and
taxes?will form the basis for improvements in enter-
prise management and efficiency in 1988. China's
leaders acknowledge that enterprises must become
more efficient before they can absorb increases in
input prices that would result from price reform and
believe they must be put on a sound financial footing
before they can cope with a hardening of the budget
constraint.
Three-fourths of China's large- and medium-sized
state industrial enterprises and commercial entities
had adopted the contract system by the end of 1987,
15
according to Chinese statistics. In addition, a majority
of China's smaller state and collective enterprises had
adopted a parallel contract/leasing system that allows
factory managers to retain a share of aftertax profits
and requires them to put up collateral to cover
potential losses.
Chinese leaders believe the contract system has im-
proved labor productivity and increased profits. In
addition, they maintain that the contract system has
helped Beijing improve control over unwarranted en-
terprise investment spending, although China's prac-
tice of permitting enterprises to deduct loan principal
repayments from taxable income still tends to encour-
age excessive credit demand. Proponents of the con-
tract system also contend that contracts have relieved
some of the pressure on managers to issue blanket
bonuses to workers, keeping real wage increases in
1987 below the rate of improvement in labor produc-
tivity (see figure 8).
Chinese critics argue that the prospects for continued
gains under the contract system in 1988 and beyond
are less bright, however. For example, many of the
one-year contracts were signed in the second half of
1987, thus large worker bonuses for fulfillment of
annual contract targets will not be paid until the
second half of this year. This, in turn, could exacer-
bate Beijing's difficulties controlling inflation while
also cutting into enterprise profitability.
Critics have found fault with several more fundamen-
tal shortcomings as well:
? Contracts do not make good managers out of bad
ones, and China's 1987 statistics suggest that, while
the number of unprofitable enterprises is not in-
creasing, poorly run enterprises are losing ever
larger amounts of money.
? The system rewards managers for negotiating low
targets that can be easily achieved, rather than for
necessarily improving production efficiency.
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Figure 8
Real Growth in Urban Wages and Productivity, 1979-87 a
Percent
El Real urban wages 20
I I Urban labor productivity
15
10
5
0
-5 1979 80 81
a In state-sector enterprises.
Source: China's State Statistical Bureau.
INM?1?1
82 83 84 85 86 87
? The ability of the contract system to encourage
greater managerial accountability is limited by Bei-
jing's requirement that large state enterprises em-
ploy surplus workers and produce specified goods,
regardless of profitability or market demand.
? Rising prices for industrial inputs?and a freeze on
the prices most enterprises can charge for their final
products?means that some factory managers have
legitimate excuses for low profitability or even
deficits.
? Finally, contracts?which generally carry a one- to
five-year term?tend to discourage investments in
new technology and capital equipment, which have
substantial long-term benefits but little immediate
payoff.
Still others point to the stultifying effect of the
contract system on China's reform program as a
whole, especially on needed changes to the wage and
price system. Because last year's strong industrial
317101 5-88
performance can be traced?at least in part?to the
implementation of the contract system, advocates of
other industrial and price reforms will face an uphill
battle in any attempts to introduce changes to the
current tax or price structure that would significantly
affect the performance of enterprises that have signed
performance contracts.
Chinese leaders expect a new enterprise law approved
during the National People's Congress to further
improve enterprise performance by curbing the med-
dling by party officials in factory operations and by
paving the way for the institution of bankruptcy
proceedings against faltering state enterprises. The
state enterprise law is one of several recent changes in
industrial policy designed to professionalize enterprise
management and to hold enterprises and managers
responsible for deficits. But, like the contract system,
16
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Declassified and Approved For Release 2013/01/08: CIA-RDP11S00229R000301520001-8
ambiguities remain. Moreover, almost every responsi-
bility spelled out for managers and enterprises in the
legislation is subject to other plans and regulations.
For example, although the law allows enterprises to
set prices for their finished goods, they are still subject
to extensive price controls imposed by Beijing. More-
over, the law is vague about the powers of factory
party committees, assigning them responsibility for
implementing "all party and state policies." Finally,
the law does not reduce the authority of government
administrative bureaus to set mandatory production
targets for factories and to manage supply and distri-
bution of most industrial inputs.
Passage of the enterprise law provides the legal
framework for Beijing to institute bankruptcy pro-
ceedings against unprofitable state enterprises under
the provisions of a trial bankruptcy law passed by the
NPC Standing Committee in December 1986. But
managers will resist moves to institute bankruptcy
proceedings, arguing that they cannot be held ac-
countable for deficits resulting from an irrational
price structure, raw material shortages, and bloated
work forces. Beijing will probably close only a few
enterprises at first and will find new jobs for displaced
workers in order to minimize workers' fears that
enterprise reforms are a threat to their job stability.
Reforming the Foreign Trade System
Following the 13th Party Congress, Chinese leaders
announced plans to undertake a major reform of the
country's trade system?originally planned for 1987
but derailed by both political uncertainties and the
tight foreign exchange situation at the start of 1987.
In recent months, trade reform has been reaffirmed in
several major policy statements:
? The State Council approved a Draft Plan for Re-
form of the Foreign Trade Sector in December 1987
that calls for individual factories and trading corpo-
rations to have greater autonomy in conducting
import and export transactions and to become more
responsible for their profits and losses.
? In January 1988, after making several trips to
China's coastal provinces, Zhao Ziyang pronounced
that the country should undertake an export-driven
economic growth strategy centered on attracting
17
China's Private Sector
During the 1988 National People's Congress, China's
constitution was amended to provide a legal basis for
China's growing private sector. Chinese statistics
indicate that the country's private sector now in-
cludes up to 300,000 enterprises and an additional 20
million "individual enterprises." Most of these are
one-person or family-run operations, although a few
employ several hundred people, according to Chinese
press reports. Although the private sector generally
leads the country in growth in productivity and
output, it employs less than 3 percent of China's
industrial labor force and produces less than 1
percent of the country's industrial output. The private
sector is more prominent in retail trade, however,
handling nearly one-fourth of all retail sales in 1987.
foreign investment and expertise to coastal areas.
The strategy focuses on using imported raw materi-
als and parts to produce higher value-added labor-
intensive industrial goods for export. Acknowledg-
ing the crucial role of foreign managerial and
technical expertise in developing China's export
industries, Zhao's plan calls for further improve-
ments to China's investment climate.
? Beijing sponsored three high-level meetings in Feb-
ruary and March of this year to discuss foreign
trade reforms, China's environment for foreign in-
vestors, and the coastal development strategy. Lead-
ers discussed reform experiments planned for
Guangdong and Fujian Provinces, as well as for
Hainan Island?China's newest province and spe-
cial economic zone.
? Premier Li Peng's March work report to the Na-
tional People's Congress listed trade reform and the
coastal development strategy among China's priori-
ties for 1988.
Two factors account for the attention Chinese policy-
makers are giving to foreign trade this year. Chinese
leaders have said they believe recent changes in the
world economy occurring as a result of the apprecia-
tion of the currencies of Japan, South Korea, and
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Taiwan present China with an historic opportunity to
make inroads in Western markets with Chinese export
goods priced low relative to similar products from
other Asian countries. Second, China's strong trade
performance in 1987 and buoyant foreign reserves
have given this sector more room for experimenting
with reforms.
China has not yet approved a final plan for reforming
the foreign trade sector. From the numerous state-
ments by Chinese leaders on the topic, however, we
believe the reforms will include:
? Decentralization. Provinces and municipalities will
assume control over local branches of national trade
corporations and sign contracts with them?similar
to those now used throughout China's industrial
sector?assigning levels of exports and foreign ex-
change earnings. More individual factories will be
allowed to handle trade transactions. China's Minis-
try of Foreign Economic Relations and Trade
(MOFERT) and central foreign trade corporations
will continue to provide overall policy guidance,
handle most of China's barter trade with the Soviet
Union and Eastern Europe, approve large-ticket
purchases, and monitor foreign sales of items China
must restrict because of either domestic supply
shortages or foreign import restrictions.
? Raising Foreign Exchange Retention Rates. Corpo-
rations exceeding their contract targets for foreign
exchange earnings will be allowed to keep a larger
share of the surplus. Beijing has also begun to allow
exporters of light industrial goods, arts and crafts,
and garments to keep a higher percentage of their
foreign exchange earnings than most other enter-
prises. The foreign exchange retention rate also
varies from province to province, and as part of
China's experimentation with economic reforms in
Guangdong, Fujian, and Hainan, these areas have
been given higher rates than the norm.
? Easing Currency Controls. As an outgrowth of the
new policies on foreign exchange retention, Beijing
has announced that Chinese entities with excess
foreign currency will be allowed to swap foreign
funds for Chinese currency at premium exchange
rates in swap centers to be set up in many large
Chinese cities. This is an extension of a practice
Beijing has permitted for more than a year for
foreign-invested enterprises in China and for state-
sector Chinese enterprises operating in the special
economic zones. While easing central control over
the exchange of Chinese currency for foreign ex-
change, Beijing is also preparing to loosen controls
over arbitrage between convertible foreign curren-
cies. China's State Administration for Exchange
Control, in March of this year, authorized financial
institutions to handle the buying and selling of
convertible foreign currencies on behalf of Chinese
enterprises. This will allow enterprises that earn
foreign exchange in one currency to import goods
purchased with another currency. Chinese factories
also will be able to avoid losses in the value of their
primarily dollar-denominated foreign exchange
holdings if the dollar continues to decline.
Other changes are also contemplated. For example,
Beijing may adjust the domestic tax system to favor
exporters of high-value-added products. Some Chi-
nese leaders have also proposed that wages of workers
in enterprises producing for export be linked to for-
eign exchange earnings. Finally, there has been much
discussion of a plan to make trading corporations into
commissioned agents that handle import and export
transactions for a simple service fee. This approach
would be designed to make enterprises?rather than
subsidized trade corporations?shoulder the financial
burden of their imports and reap the benefits accruing
from successful export programs.
The impact of these reforms will probably be limited
as long as wide discrepancies exist between China's
domestic prices and those prevailing in the interna-
tional marketplace. Although trade corporations and
factories will be asked to take responsibility for profits
and losses, many will point to factors beyond their
control as being responsible for deficits. As a result,
decentralization of trade authority may merely trans-
fer responsibility for subsidizing enterprise losses from
the central government to a lower level, rather than
eliminating the practice. In addition, even though
some factories and corporations will be allowed to
have foreign exchange accounts, Beijing will retain
18
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control over most of the country's foreign currency
reserves, as well as the use of retained foreign ex-
change for imports subject to license approval by the
central government. Members of the General Agree-
ment on Tariffs and Trade (GATT), to which China is
applying for membership, will be watching the pro-
gress of China's foreign trade reforms closely to
determine whether the changes bring China's foreign
trade system more in line with GATT principles.
Outlook for Price Reform
Chinese leaders apparently have not reached a con-
sensus on how and when to make further changes in
China's irrational price structure, although most now
probably accept the need for prices to accurately
reflect relative scarcities in the economy. Without
price reform, China's attempts to make enterprises
more responsive to market signals?and to hold them
accountable for poor investment, production, and
personnel decisions via the initiation of bankruptcy
proceedings?will fall short. Firms that are well run
and turn out needed products may operate at a loss
simply because production costs exceed their product
prices. Similarly, Beijing probably recognizes that the
Reverse Blank
19
problems in China's agriculture sector cannot be
resolved without an increase in the price paid to
farmers to encourage production of needed agricultur-
al commodities as well as an increase in the state-
controlled prices paid by consumers for nonessential
foodstuffs for which Beijing wants to curb demand.
But considerable uncertainty remains over precisely
how to accomplish needed price adjustments without
disrupting the economy, provoking complaints among
consumers, or substantially increasing the state's sub-
sidy burden. Chinese leaders apparently are willing to
proceed slowly in order to minimize dislocations.
Rather than simply freeing all prices and having
current economic conditions determine their equilibri-
um level, Beijing is working to erode the differentials
between in-plan and market prices for a variety of
commodities?including grain and raw materials?
while also boosting production of items in short supply
by gradually reducing the share of such items pro-
cured under state plans and by increasing the share
sold at market prices.
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Appendix A
Evaluating Beijing's Reforms
China is approaching the 10th anniversary of the
watershed Third Plenum of the 11th Party Congress
(December 1978), which marked the emergence of
Deng Xiaoping as preeminent leader and the adoption
of Beijing's economic reform policies. The core of
China's reforms is pragmatism. Beijing has scrapped
Maoist-period theories of "class struggle" and the
pursuit of modernization through political mass mobi-
lization in favor of rational development strategies,
including decentralization of economic decision mak-
ing authority, greater use of material incentives, and
increased economic contact with the West. Many of
the reforms are not new to China, but had been tried
or were at least discussed in the mid-1950s and the
early 1960s. But the period since 1978 is the first time
that these policies have been implemented without
interruptions such as the Cultural Revolution of the
mid-1960s.
Changes came first and have progressed furthest in
the countryside. Only isolated remnants remain of the
Maoist commune system under which local party
officials exercised almost absolute control over rural
production decisions and peasants' daily lives. Farm-
ing is now conducted by individual households, which
lease land from the state under long-term contracts.
Apart from having to supply some grain to the state
according to procurement agreements worked out at
the local level, peasants have wide latitude to decide
whether to grow grain or cash crops and livestock.
Millions of peasants have left farming in the past few
years to work in rural industries and transport or
commercial enterprises. Nevertheless, the government
still retains an important role in the rural economy.
For instance, peasants still depend on state supply
units to market some of their excess grain and to
supply farm inputs, including machinery and
fertilizer.
Significant changes in the leadership and operations
of urban state enterprises have also been implemented
in the past nine years. Beijing has replaced many
factory directors with younger and better educated
21
managers. Moreover, Beijing has increased the
amount of revenues that factories can retain and has
allowed managers greater discretion to use those
revenues for capital construction or worker wages.
Because factories are allowed to sell at market prices
any production exceeding the quotas assigned in the
central plan, output of key industrial materials, such
as coal and steel, have increased rapidly. Thus many
enterprises now purchase at least some output at
prices well above those set by Beijing for in-plan
production. However, upper-level economic bureau-
cracies and factory party officials still maintain close
ties to and supervisory control over most state enter-
prises. And political and economic restraints limit
managers' decisionmaldng authority. For instance,
managers have the right to fire workers, but choose to
maintain bloated work forces rather than face the
wrath of displaced workers. To diminish resistance to
layoffs, reformers have argued that China should
construct a social safety net that would supplant the
welfare functions that state enterprises now assume,
but Beijing has not made much progress in imple-
menting one.
That Chinese workers on the whole have benefited
from reform is indisputable. Rapid gains in standards
of living are evident in the countryside, where a
housing boom is under way, and in Chinese cities,
where an improvement in the quality and style of
clothing is readily apparent. Increases in agricultural
and industrial output have caused an improvement in
workers' diets and an increase in per capita ownership
of durable goods such as bicycles and refrigerators.
However, despite these signs of improvement, urban
residents complain about housing shortages, pollution,
and inadequate services such as an overcrowded trans-
portation system. Moreover, the real income of some
urban residents has fallen in recent years, and both
urban and rural per capita income remains low by
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Figure 9
China: Selected Economic Indicators
Percent change over eight-year period
Macroeconomic Indicators
1978 1986 0 100 200 300 400 500 600 700 800 900 1,000
GVAO a (billion yuan) 180.1 301.0
_-
Grain (million tons) 304.8 391.0
Fruit (million tons) 6.6 13.5
NMI
Pork/beef/mutton (million tons) 8.6 19.2
1 _ ii
GVIO b (billion yuan) 439.9 1,0310
Raw steel (million tons) 31.8 522
IMI
Coal (million tons) 618.0 894.0
Crude oil (million tons) 104.1 130.7
0
Electricity (billion kWh) 256.6 449 5
Chemical industry (billion yuan) 47.7 108.5
---,
Textile industry (billion yuan) 52.2 131 7
011
Machine-building industry (billion yuan) 101.8 235.1
Village-run industry (billion yuan) 18.3 128.1
. .
GVIO b (by ownership)
State (billion yuan) 356.0 711 o
min
-.11111?111INIMINIMMIII.MOR
Collective (billion yuan) 84.0 2990
? rmi
we al
I It
Private and individual (billion yuan) Less than 1.0 10.0
NNW
W..
Imports (billion US $) 11.0 88.0
MIIIIIIIIIIIIIK
I
mu=
iMINIi
Exports (billion US $) 10.0 64.0
I
MO
.
Graduates of higher education 164,581.0 392,800 0
WM-,
Engineers 1,571,200.0 3,581,200.0
[11
Scientific researchers 90,500.0 365,8000
WOW
NUM
Standard of Living Indicators
Per capita income
Peasants (yuan) 134.0 4240
Linn
.111?1
Urban workers (yuan) 614.0 1,3290
Olin
A
Per capita savings (yuan) 21.9 211.0
OEM
III
MIIMIIIIIIIIMMIN
IMO
MIS
WPM
Pli
Per capita living space
Urban (square meter) 4.2 80
Mat
Rural (square meter) 8.1 15.3
OM.
Per capita food consumption
Grain (kilogram) 195.5 255.9
ki
Pork (kilogram) 7.7 143
WI*
Sugar (kilogram) 3.4 6.1
MIEI
Ownership of consumer goods
2,970.0
Bicycles (million) 74.3 258 0
1?Iim
WI
?I
Televisions (million) 3.0 92 1
0111
1111111101111110
0110111111M?WW/M
MINN
MIME
MOM
Sewing machines (million) 34.0 109 4
IWEI.
Wi=
ii
a Gross Value of Agricultural Output.
b Gross Value of Industrial Output.
All figures in 1980 constant prices. GVAO and GVIO calculated
according to new coverage, with village-run industry included
under GVIO. Per capita peasant income and per capita urban and
rural living space figures based on sample surveys.
316743 5-88
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world standards. Finally, media discussion of an
enterprise bankruptcy law and policies that would
increase labor mobility have probably increased wor-
kers' concerns that new reforms will decrease job
security.
Deng Xiaoping and other key reformers maintain that
the gains from reform far outweigh the negative
spillovers and argue that the shortcomings can be
corrected only through implementing additional poli-
cies. Even so, the reform program has been buffeted
by both political controversies and unforeseen eco-
nomic developments. To track the progress of reforms
to date, it may be useful to divide the program into
three periods.
Phase One: Agricultural Success 1978-84
From 1978 to 1984, implementation of rural policies
dominated the domestic reform program. The period
began with limited experiments with the "household
responsibility system," under which individual farm
households took control of fields, making planting
decisions and working the land with little interference
from outside authorities. These experiments began in
Sichuan Province under the leadership of Zhao
Ziyang, and in Anhui Province under Wan Li. By the
end of the period, this system had displaced the
production team approach?the last vestige of the
collective system established in the middle and late
1950s?throughout most of the country. Along with
increased state prices for farm produce, greatly ex-
panded free market outlets, and good weather, the
reforms produced a string of bumper harvests culmi-
nating in the record 1984 crop. Indeed, China became
a net grain exporter in 1985.
Most other domestic reforms?including those in
industrial management, finance, and science and
technology?have their roots in this period as well.
Chongqing city in Sichuan, for example, was an early
test site for experiments granting greater autonomy to
factories. And selected research institutes began to
sign contracts with factories as enterprises attempted
to improve production and efficiency by applying new
technology, and as researchers sought to make science
23
serve the economy as a whole. But the scope of these
nonagricultural reforms remained relatively limited
through the early 1980s.
Domestic reforms during this period were accompa-
nied by a more open economic policy toward other
countries and regions. Beijing, in particular, sought to
attract Western investment and technology to Chi-
nese industry. To persuade potential investors of its
enduring commitment to open up to the outside world,
Beijing passed a law on joint ventures in 1979 and
began a massive technology import program that
centered on purchases of complete plants and equip-
ment from Japan, the United States, and Western
Europe. By 1980, Beijing had also established four
Special Economic Zones in South China to entice
foreign investors by offering favorable tax rates and
investment terms. Beijing intended for these zones to
be "windows" where China could study foreign manu-
facturing technology and management, while keeping
the negative side effects of capitalism out of China
proper. The zones also had a political objective?to
demonstrate Chinese tolerance of non-Communist
economic forms as part of efforts to woo Hong Kong
and Taiwan by Deng's "one-country, two-systems"
approach.
Phase Two: Urban Reform 1984-87
Building on the success of rural reforms and having
rebuffed a challenge during late 1983 by party mem-
bers who believed that Western "spiritual pollution"
threatened China's social fabric, reform leaders in
late 1984 moved to apply market-oriented policies to
the urban industrial sector. Zhao Ziyang's work
report to the National People's Congress in May 1984
and Hu Yaobang's speech to the Party Plenum in
October 1984 both marked this phase and stand as
high water marks for reform optimism.
Despite this optimism, the period following Hu's
speech brought reformers unexpected economic diffi-
culties and sobering choices. To begin with, grain
output fell in 1985 after four years of strong growth,
initiating a period of lagging production and trigger-
ing debate over agricultural policies that continues.
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Furthermore, reformers misjudged their ability to
maintain macroeconomic control once urban reforms
began. Beginning in late 1984, a surge in wage and
bonus payments and imports contributed to economic
overheating in 1985, forcing Beijing to rein in credit,
slow price reforms, and recentralize control over
foreign trade in the face of mounting inflationary
pressure and a precipitous decline in China's trade
balance.
Reform policies suffered another blow in early 1985
when criticism of the Special Economic Zones?
especially Shenzhen?surfaced. Despite massive in-
frastructure buildup at Beijing's expense, the zones
had failed to attract manufacturing investment, be-
coming centers of real estate and currency speculation
instead. They were also a breeding ground for inde-
pendent "briefcase" trading companies that engaged
in profitable?but unproductive?import and export
transactions. Shenzhen, in particular, became a con-
duit for imports of high-demand consumer goods and
microcomputers entering China at reduced tariffs;
independent traders also made money by exporting
and then reimporting Chinese goods and collecting
state subsidies on both transactions to cover the
difference between domestic and international prices.
A major car import scandal in South China that
broke in early summer 1985 added fuel to the charges
of corruption and mismanagement. China had invest-
ed too much political and economic capital in develop-
ing the zones to abandon them, but the developments
of 1985 temporarily tarnished the reputations of the
zones and of the local leaders.
Reforms in this period had their successes. Beijing
boosted exports of textiles and other manufactured
goods to make up for lost oil export earnings. The
booming rural enterprise sector made progress in
absorbing surplus farm labor. And overall economic
growth continued at an impressive pace. But perfor-
mance in key areas?particularly China's state-owned
industrial sector?was disappointing. If anything, ini-
tial urban reforms worsened performance in some
state factories, raising costs and making managers
more concerned about worker welfare than about
production efficiency. Critics also found fault with
China's massive technology imports after discovering
that shortages of qualified technical personnel, re-
source and energy constraints, inadequate incentives
for factory managers, and poor technology choices
idled much of China's expensive foreign equipment.
This period was also marked by an increasingly open
debate over appropriate reform strategy. Deng helped
maintain the appearance of leadership unanimity by
carefully positioning himself between those who fa-
vored bolder initiatives and those who favored a
slower pace and narrower scope for reform. But public
disturbances, including student demonstrations in late
1986, reinforced the fears of some leaders that re-
forms were proceeding too quickly and might even
undermine the authority of the party.
Party chief Hu Yaobang's fall in January 1987 was
precipitated by complex political forces, but, in the
process, reformers lost one of the most vocal and
powerful supporters of faster political liberalization
and of greater reliance on consumer-driven economic
development. Although the orthodox-oriented "anti-
bourgeois liberalization" campaign that followed Hu's
fall was brought to a close within a few months, high
inflation and lagging grain output during the year
narrowed the range of policy options open to China's
economic leaders in the near term, and thus limited
the scope of policy debates.
Phase Three: Stressing Stability 1987-Present
The current situation in China is a mixed bag for
reform proponents. "Reform" remains the political
watchword, Zhao Ziyang?a key reform leader?has
replaced Hu Yaobang as party chief, other young
reformers have taken their place on the Politburo, and
some party officials who voiced strong skepticism
about the reform program have been soundly re-
buffed. Indeed, it is no longer possible to speak simply
of "reform leaders;" all Chinese leaders are now
reformers in the sense that they are economic prag-
matists who favor some degree of expanded scope for
market forces in China's economy.
24
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At the same time, however, strains in the economy
have led Chinese leaders to postpone some important
aspects of the reform program?including price re-
forms?and have led leaders to use administrative
controls to rein in inflation and maintain control over
imports. One indication of the increased caution that
marks this period is the lengthening time frame for
reform?reform leaders and economists now speak of
decades to achieve basic reform goals. This trend
toward a longer time horizon may in fact be a more
realistic assessment of the changes China must go
through as it moves toward a more market-oriented
economy.
Another characteristic of the current period is the loss
of a clear goal as well as the proper path to be
followed, in contrast to 10 years ago when simply
implementing pragmatic policies constituted a reform
agenda. One assessment of the current state of re-
forms is that China now risks stalling out half way on
Reverse Blank
25
the road to a market economy. Such an assessment
can be read between the lines when some economists
point to China's current half-reformed, half-planned
state, or even in Zhao's statement that a "pause" in
reforms could turn into a retreat. Other Chinese deny
that the goal of reform is a market economy, asserting
instead that it has been to create "socialism with
Chinese characteristics" under which market forces
would coexist with state control. Therefore, although
all Chinese leaders now consider themselves reform-
ers, a consensus over the ultimate shape of a reformed
China is notably lacking.
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Appendix B
China's Foreign Investment Policies
In recent years, Western investors have publicly
voiced their concerns about limited access to the
Chinese market; difficulties in obtaining the foreign
exchange needed to remit profits and support their
operations; rising costs of materials and wages; bu-
reaucratic redtape; and China's inadequate transport,
communication, and power infrastructure. Many have
also expressed uneasiness with the paucity of commer-
cial legislation pertaining to important investment
issues.
Over the last year and a half, Beijing has published a
number of national laws fleshing out more general
guidelines on foreign investment that were promulgat-
ed in October 1986. The new legislation:
? Affirms the rights of joint ventures to hire and fire
Chinese workers.
? Exempts joint ventures from import licenses and
duties for components used to produce exports.
? Allows joint ventures with insufficient foreign ex-
change to obtain hard currency by exporting Chi-
nese goods not produced by the joint venture itself
or by using Chinese currency profits to buy foreign
exchange from joint ventures with a surplus.
? Exempts remitted and reinvested profits from in-
come tax, reduces tax rates for export-producing
enterprises and ventures that employ advanced tech-
nology in production, and cuts in half the tax on
income earned by foreigners resident in China.
? Gives joint ventures permission to charge Chinese
customers foreign exchange for goods produced in
Sino-foreign joint ventures that would otherwise
have to be imported.
Beijing also has permitted cities and provinces to
experiment with additional provisions designed to
encourage investment inflows into their localities, and
Reverse Blank
27
most have done so?often vying with other regions to
attract needed foreign investment. And the March
1988 National People's Congress approved a new law
on contractual joint ventures designed to encourage
foreign partners to engage in nonequity forms of joint
production activity. Although Beijing passed a law on
equity joint ventures in 1979 and a law on wholly
foreign-owned ventures in 1986, the legal status of
contractual joint ventures has been poorly defined,
leaving much room for negotiation during the initial
stages of an agreement?and subsequent differences
of interpretation. Even without the legislation, howev-
er, foreign firms signed more than 5,000 agreements
to set up contractual joint ventures in China, and 40
percent of China's paid-in foreign investment has
come from contractual joint ventures.
These changes have provided a legal basis for im-
provements in China's environment for foreign invest-
ment. Considerable uncertainty remains, however, in
how the regulations will be implemented. For exam-
ple, foreign investors must have their operations desig-
nated "export-oriented" or "technically advanced" in
order to be eligible for preferential tax and other
treatment; precisely how Beijing makes these determi-
nations is unknown. There is also a great deal of
discretion in how Beijing chooses to define "import
substitutes" that are allowed to charge foreign ex-
change for domestic Chinese sales, as well as the
percentage of the price that may be collected in hard
currency.
Beijing, moreover, continues to determine prices of
inputs supplied to foreign invested enterprises as well
as the prices at which joint venture products may be
sold within China. With the frequent price fluctua-
tions now occurring in China, potential investors often
have difficulty projecting their ability to earn a profit.
And, despite the legal basis for joint ventures to hire
and fire workers, as a practical matter, many continue
to have difficulty attracting skilled Chinese workers
to take jobs that are viewed as less secure than work
in state-sector Chinese enterprises.
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Agriculture
Appendix C
A Comparison of Chinese and Soviet Economic Reforms
Similarities
Family contract system.
Enterprise Management Enterprises have more decisionmaking
authority over day-to-day operations.
Prices, Wages
Enterprises may retain higher share of
profits.
Increasing mechanisms to link pay to
production.
Allowing some portion of goods to sell
at market-influenced prices.
29
Differences
In the Soviet Union, the family contract
is only one form of labor organization
on the farms; in China, family contracts
predominate.
Soviets retain collective and state
farms; Chinese dismantled communes.
Less than 15 percent of Chinese grain
output is under mandatory state pro-
curement; two-thirds of net Soviet farm
output under state procurement.
Chinese peasants have more latitude to
choose what to grow or to start rural
industries.
Soviet plan still predominates; Chinese
have considerably reduced central
planning.
Soviet workers elect all managers, min-
istries "confirm" plant directors; Chi-
nese supervisory bureaus appoint
managers.
Beijing already has decontrolled many
prices, but prices of key goods are still
controlled by central authorities; Sovi-
ets plan to give enterprises limited au-
thority to set prices.
Soviets plan revisions of centrally con-
trolled wholesale and retail prices; fur-
ther Chinese price reform on hold.
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Foreign Trade
Bankruptcy
Private Enterprise
Strong central control of trade.
Selected entities allowed to deal
directly with foreign firms.
Allowing joint ventures.
Used as a threat to boost efficiency.
Not intended to force widespread plant
closures.
Encouraging some small, individual
businesses, primarily in service indus-
tries.
30
China has opened Special Economic
Zones with broad incentives for foreign
investors.
China permits wholly owned ventures
and has agreed to thousands of-joint
ventures; Soviets limit foreign share to
49 percent and have established rela-
tively few joint ventures.
Soviets passed law last year; Chinese
passed law in 1986, will take effect in
late 1988 or early 1989.
Mostly confined to students, house-
wives, and pensioners in Soviet Union;
widespread in Chinese countryside,
about 3 percent of urban labor force.
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