CityReads│China’s Reforms: Forty Years On

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China’s Reforms: Forty Years On

World Bank economist Bert Hofman reviews the path and achievements of the forty years of China’s reform and openness.

Bert Hofman, 2018. Reflections on forty years of China’s reforms, Speech at the Fudan University’s Fanhai School of International Finance.

Source:http://pubdocs.worldbank.org/en/934911517472447837/Reflections-on-40-years-of-reforms-final.pdf

Picture source: People's Daily

Forty years ago in December, Deng Xiaoping delivered his historic speech "Emancipate the mind, seeking truth from facts and unite as one to face the future." This triggered four decades of reforms that have transformed China into the world’s second largest economy. By some time in the next decade, China will be among the few countries in the world that will have transitioned from low income to high income status since World War II.

Understanding the path China traveled, the circumstances under which historical decisions were made, and their effects on the course of China’s economy will inform future decision makers. Increasingly, this reflection is important to the rest of the world as more and more countries see China as an example to emulate. With the 19th party congress last October China now also positions itself as such an example.

“It means that the path, the theory, the system, and the culture of socialism with Chinese characteristics have kept developing, blazing a new trail for other developing countries to achieve modernization. It offers a new option for other countries and nations who want to speed up their development while preserving their independence; and it offers Chinese wisdom and a Chinese approach to solving the problems facing mankind (Xi Jinping, 2017).”

In some ways, China’s reforms followed many of the prescriptions mainstream economists would recommend. The country opened up for trade and foreign investment, liberalized prices, diversified ownership, strengthened property rights, kept inflation under control, and maintained high savings and investment.  

But this is simplifying the reforms and obfuscates the essence of China’s reforms: the unique steps China took reforming its system are what makes its experience of interest. Its gradual approach to reform was in sharp contrast to Eastern Europe and the former Soviet Union.  Although often compared, China and other transition countries were simply too different in terms of initial economic conditions, political development, and external environment.  

Predominantly rural and among the poorest nations on earth, China was marred by the failure of the Great Leap Forward and the political disruptions during the Great Proletarian Cultural Revolution.Integration into the global economy was minimal. Industry was inefficient, but also far less concentrated than in Eastern Europe and the former Soviet Union.  Perhaps most importantly, because China retained political continuity, the country could focus on an economic and social transition instead of a political one.

In contrast, most of the other transition countries were middle income, highly urbanized and industrialized, and had experienced more than 40 years and sometimes 70 years of collectivization and state planning. They were highly specialized in production structure and integrated in the Council for Mutual Economic Assistance(COMECOM), with heavy concentration of industry in often monopolistic enterprises. But the biggest difference with China was undoubtedly the collapse of the political systems throughout much of the former Soviet Union and Eastern Europe, which made a gradual transition of the economic system virtually impossible for most. And for some, notably countries in eastern Europe, a new economic system was swiftly found in the EU, to which most of them have now acceded. This adoption of a ready-made economic system eliminated the need for a search for institutions that fit the individual country. Though perhaps less than fully suited for the middle-income transition countries, the EU framework offered stability and a clearly specified reform path.

Similarly, comparison with much of the Latin American reforms seems out of place—the likes of Brazil, Mexico and Argentine were far closer to a market-based system than China was in 1978, and their reforms--liberalization and macroeconomic stability—were of a different order of complexity than China’s.

China’s economic achievements since reform

Three phases of China’s reform

China's reforms can be distinguished in three phases: Market Seeking reforms, roughly from 1978 to 1993; Market Building reforms from 1993 to around 2003; and Market Enhancing Reforms from about 2003 onwards. 

The first phase saw a genuine search for the right economic institutions for China. Informed by reforms in Eastern Europe under communism, reforms concentrated largely on microeconomics, to some extent with a neglect of macroeconomics, and the highly volatile growth rate in the 1980s bears witness to that. It was a genuine search for what elements of a market economy would work in China, and which ones would be politically acceptable at the time—household responsibility system, dual pricing, TVEs, and special economic zones for foreign investment.

The 1993 Decisions of the 3rd Plenum of the 14th Central Committee signifies the start of the second phase by laying out a comprehensive plan to build the institutions for a market-driven economy.  These included a modern tax system, enterprise reforms, and a financial system that separated policy banks from commercial banking. The start of serious state enterprise reform in the mid-1990s allowed those commercial banks to indeed become commercial, and housing and (urban) social security reforms followed. Entry in the WTO not only served as a lever for those domestic reforms, but also ensured much greater competition on the goods market.  The slashing of import tariffs made China far more competitive in exports.  The inclusion of private property in the constitutions concluded the market building phase.

This phase can be seen as years in which the state left increasing room for the market.  Private investment in the economy exploded and increased its share in the economy from less than 2 percent in 1992 to some 15 percent by 2003 (some of this was due to a reclassification of collective enterprises as private).  In 1999, government also consolidated all the industry-related ministries into the Ministry of Commerce and the Ministry of Industry and Information Technology.

Since then, reforms have focused on what I would call enhancing the market. The two main ingredients? A gradual expansion of the social safety net (pensions, health care, welfare), and a return of Industrial policy as noted by Ling and Naughton (2016).  "Techno-industrial policy" had been on the defense after 1978 but re-emerged after Zhu Rongji left office. The Systems Reform Commission was merged with the State Development Planning Commission in 2003, to form the National Development and Reform Commission. In 2006, the Medium-Term Strategy for Science and Technology was launched along with 16 Megaprojects, returning industrial policy to the forefront. The global financial crisis, presenting China with a large domestic stimulus, encouraged the policy.

The 19th Party Congress and General Secretary Xi Jinping's report confirms these policy directions: market-based allocation, a dominant role for public ownership, and a strong emphasis on industrial policies and science and technology to achieve the goals of the "first phase of the New Era (2020-2035)" namely socialist modernization.  With the New Era, China seems to have found its distinct own economic system, with markets and state ownership living side by side, and with industrial policies guiding the market. 

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