(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000605850001-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 6
• Document Creation Date: January 12, 2017
• Document Release Date: March 28, 2011
• Sequence Number: 1
• Publication Date: March 28, 1986
• Content Type: MEMO

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y 4' /
Central Intelligence Agency nc
DATE 13 / f S(p r G
DOC NO
DIRECTORATE OF INTELLIGENCE
28 March 1986
China: Policy Response to Economic Instability
Summary
Economic developments in 1985 highlighted the fundamental
problem of managing an economy that is being transformed from a
centrally planned system to one that mixes planning and market elements.
We believe Beijing's response to the problems, particularly the absence of
a reflexive clamp down on reforms, provides insight into the leadership's
approach to economic policymaking, and reform prospects in general. F
As Premier Zhao Ziyang stated in a recent interview, one of the key problems
Beijing's reform program faces is how to maintain economic stability while reducing
direct government control over state enterprises. Reforms implemented in the past two
years have significantly diminished administrative control over production, investment,
and pricing decisions. Enterprises now retain a much larger share of earnings--which
they can use for investment or worker remuneration--and are permitted to sell
This memorandum was prepared by Office of East Asian Analysis. 25X1
Information available as of 28 March 1986 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Domestic Policy Branch, China
Division, OEA, 25X1
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P&PD
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overquota production of industrial goods at prices above state-set levels. Price controls
have been relaxed for some products, and more retail goods are marketed outside
government-run commercial channels.
Although mandatory planning still plays an important role in China's economy, in
our view, Beijing has given up an element of direct control over aggregate demand by
allowing increased enterprise autonomy. Reformers hope to control aggregate demand,
and maintain economic stability, by employing indirect economic levers such as interest
rates, credit levels, and taxes.
We believe Beijing's ability to implement comprehensive economic reform
depends on its success in using indirect economic levers in place of administrative
directives. When reforms were launched in 1979, opponents warned that Beijing could
lose control of the economy if the central planning mechanism was weakened--and
argued that strict limits should therefore be placed on economic decentralization.
Reforms proceeded, in part, because Chinese leaders became convinced that
macroeconomic levers could be used to regulate economic activity occurring outside of
the plan.
We believe economic developments in 1985 highlighted the fact that Beijing has
not yet perfected a new macroeconomic control mechanism. A surge in investment,
wages and bonuses, and credit that began in the middle of 1984 caused industrial
output to shoot up at a 23-percent annual rate during the first half of last year. Efforts
to cool the overheated economy gradually reduced the industrial growth rate, but
inflation tripled and Chinese imports soared. At the beginning of 1986, Beijing was still
concerned with overly rapid growth in credit, capital construction, and wage levels. F
Party conservatives, who oppose some aspects of the pragmatic reform program,
criticized reformers for the economic problems last year. The sharpest attack came at a
party conference in September 1985, when Chen Yun, a Politburo Standing Committee
member and the doyen of China's economic bureaucrats, warned that market forces
were unreliable economic levers. According to Chen, "market regulation involves no
planning, blindly allowing supply and demand to determine production... planning is the
essence of macroeconomic control." We believe, that in a broader sense, Chen's
argument carried the clear implication that economic reform was progressing too
quickly and that there are limits on how far economic decentralization can go without
threatening social disorder. In our view, reformers themselves recognized the need to
improve economic controls and have therefore decided that major economic reforms
will be put on hold until after 1986.
In one sense, the potential for economic dislocations is endemic to the reform
process. In the transition from a centrally planned economy to a more market-oriented
system, Beijing must loosen some types of central controls before testing the economic
levers slated to replace them. In our view, enterprises have been quick to respond to
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enhanced decisionmaking authority--such as the right to sell overquota production at
market prices--but have not been as responsive to macroeconomic levers as Beijing
expected. For instance, higher interest rates on loans do not effectively curtail
borrowing by some enterprises that rely on the state budget for their operating
expenses. Other enterprises have proved adept at evading taxes or raising funds for
capital construction outside of the banking system. To increase the responsiveness of
enterprises to economic levers, we believe Beijing must press ahead with industrial
reforms--but further decentralization may temporarily increase economic instability. In
our view, the conflict between enhancing enterprise autonomy and maintaining
macroeconomic control will impart a pattern of rapid growth followed by
government-induced retrenchment to China's economic performance.
Sources of Instability
We believe that policy errors, a one-sided grant of enterprise autonomy, and
strong local pressures for rapid growth contributed to economic problems last year. 25X1
Policy Errors
A major source of economic instability was the 50-percent increases in currency
in circulation and loans to industrial enterprises that occurred in 1984. In our view, the
money supply surge was caused by errors in the implementation of new banking
reforms. In 1984, Beijing granted increased autonomy to local banks and urged them to
adjust their loan policies to support economic reform. Intense demand for funds by
enterprises and local officials, and lax oversight and muddled accounting by the central
bank, however, allowed credit to increase much more than Beijing intended.
One-Sided Enterprise Autonomy
Chinese press reports indicate that many managers have taken advantage of
increased autonomy by excessively increasing capital construction and rapidly expanding
wages and bonuses. In our view, this growth in investment spending and worker
remuneration was another source of economic problems. Chinese reformers recognize
that the grant of autonomy is onesided--managers have more flexibility in using
enterprise revenues, but their decisionmaking is not yet disciplined by market forces.
Because Beijing still subsidizes state enterprises that lose money, managers increase
wages--or take more loans--without worrying about bankruptcy. We believe reformers
recognize that bankruptcy is a necessary lever for restraining autonomous enterprises,
but experiments with bankruptcy laws have been limited: a working group was formed
only recently to draft bankruptcy laws. A major impediment to enforcing bankruptcy, in
our view, is China's irrational price system, which makes it difficult to determine whether
enterprises are losing money because of inefficiency, or because of low state-set prices.
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We believe the implementation of bankruptcy laws also will meet strong resistance from
local officials who fear they will have to bear the economic--and political--costs of
workers who lose their jobs when enterprises close. F_~
We believe Beijing faces enormous pressure from workers, managers, and local
officials for rapid growth. Promotion of "10,000 yuan households" by the media in 1984
and exhortations to get rich through hard work generated rising expectations among
workers for an improvement in their standard of living. Rising food prices have
intensified worker demands for raises, while the relaxation of state controls over some
enterprises has weakened the ability of managers to resist them.
Given years of emphasis on meeting quantitative targets, many managers still
believe that they must prove their competence by rapidly expanding enterprise
production. To boost local revenues, low-level officials pressure enterprise managers to
increase output and speed completion of local construction plans. Although
downplaying the extent of the problem, recent editorials have warned that, if officials set
unreasonable output targets, enterprise managers may resort to falsifying production
data--making it more difficult for Beijing to judge how well control measures are
working. We believe Chinese leaders are also worried that rapid growth of enterprises
operated by rural towns has caused a proliferation of small, inefficient, and redundant
firms that compete with state enterprises for funds and raw materials.
Beijing's Response to the Economic Problems
We believe that the political strength of the reform coalition and the increased
economic sophistication of its leaders was evident in Beijing's reaction to the economic
problems in 1985. Instead of halting the reforms and quickly damping the overheated
economy by reimposing strict administrative controls--as they might have in the
past--Chinese leaders implemented a combination of market-oriented macroeconomic
adjustments and state directives that were designed to slow the economy gradually.
We believe Beijing's willingness to use economic levers to stabilize the economy
was particularly significant. China's 1985 budget, announced last April, called for a
reduction in the rate of growth of government spending and a 10-percent cut in
administrative expenditures. Beijing also clamped down on credit and twice raised the
general level of interest rates. Administrative directives were issued that required
enterprises to place wage funds in special accounts to be monitored by the banks, and
that prohibited banks from extending credit for construction projects not listed in the
state plan.
During the year, Beijing began to recentralize some aspects of its foreign trade,
and it ordered a halt in construction of some projects, but it did not backtrack on
fundamental reforms. Despite surging consumer and investment demands, Beijing
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implemented planned hikes in urban food prices, and introduced--after a lengthy
delay--new wage scales for teachers and government workers. At the national
conference last September, the Chinese Communist Party formally made reform its
primary economic goal for the five-year period beginning in 1986. Although Beijing
recently announced that major economic reforms will not be implemented this year, we
believe that some types of reforms, such as the removal of central government units
from the direct management of enterprises, will proceed.
Improving the Mechanisms of Macroeconomic Control
To improve its ability to maintain economic stability with indirect economic
levers, Beijing is increasing the powers of China's central bank and making greater use
of taxes as regulatory tools. We believe Beijing has given the central bank expanded
authority to administer China's specialized banks (such as the Agricultural Bank and the
Industrial and Commercial Bank). For instance, the central bank's credit plan now
includes the funds of all of the specialized banks, and the specialized banks no longer
have overdraft rights with the central bank. Beijing recently announced a new tax
scheme for individual entrepreneurs, and Chinese press reports suggest that in 1986
Beijing will increase enforcement of taxes on capital construction. Media reports also
suggest that Beijing will boost taxes on rural industries, in part to slow their rapid
growth. Beijing also is improving its ability to collect taxes from enterprises. We
believe these changes in the banking and taxation systems will eventually provide
Beijing with better economic levers.
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Subject: China: Policy Response to Economic Instability
1 - Mary Yee, Office of East-West Economic Policy, Room 4426,
Depatment of Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department of
State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316,
600 17th St., NW, Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820,
Department of Commerce
Central Intelligence Agency
2
- C/OEA/CH
1
- C/OEA/CH/FOR
1
- C/OEA/CH/DEF
1
- C/OEA/CH/DEV
1
- OEA/Production Officer, 4G48
1
- D/OEA
4F18
,
1
- DDI, 7E44
1
- Senior Review Panel, 5G00
1
- PDB Staff, 7F30
1
- NIO/EA, 7E62
1
- C/PES, 7F24
1
- FBIS/NEAAD/China Branch,
306 Key
1
- C/EAL5E18
1
- CPAS/ILS, 7G50
5
- CPAS/IMC/CB, 7G07
1
- Author
1
- Chrono
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