Chinese economic reform

Deng's first reforms began in agriculture, a sector long mismanaged by the Communist Party. By the late 1970s, food supplies and production had become so deficient that government officials were warning that China was about to repeat the "disaster of 1959", the famines which killed tens of millions during the Great Leap Forward.[16] Deng responded by decollectivizing agriculture and emphasizing the household-responsibility system, which divided the land of the People's communes into private plots. Under the new policy, peasants were able to exercise formal control of their land as long as they sold a contracted portion of their crops to the government.[17] This move increased agricultural production by 25 percent between 1975 and 1985, setting a precedent for privatizing other parts of the economy.[18] The bottom-up approach of the reforms promoted by Deng, in contrast to the top-down approach of the Perestroika in the Soviet Union, is considered an important factor contributing to the success of China's economic transition.[19]

Reforms were also implemented in urban industry to increase productivity. A dual-price system was introduced, in which (State-owned enterprise reform 1979) state-owned industries were allowed to sell any production above the plan quota, and commodities were sold at both plan and market prices, allowing citizens to avoid the shortages of the Maoist era. Moreover, the adoption of Industrial Responsibility System 1980s further promote the development of state-owned enterprise by allowing individuals or groups to manage the enterprise by contract. Private businesses were allowed to operate for the first time since the Communist takeover, and they gradually began to make up a greater percentage of industrial output.[20] Price flexibility was also increased, expanding the service sector.[21]

in December 1978, Deng announced a new policy, the Open Door Policy, to open the door to foreign businesses that wanted to set up in China.[22][23] For the first time since the Kuomintang era, the country was opened to foreign investment. Deng created a series of special economic zones for foreign investment that were relatively free of the bureaucratic regulations and interventions that hampered economic growth. These regions became engines of growth for the national economy.[21]

During this period, Deng Xiaoping's policies continued beyond the initial reforms. Controls on private businesses and government intervention continued to decrease, and there was small-scale privatization of state enterprises which had become unviable. A notable development was the decentralization of state control, leaving local provincial leaders to experiment with ways to increase economic growth and privatize the state sector.[24] Township and village enterprises, firms nominally owned by local governments but effectively private, began to gain market share at the expense of the state sector.[25] Conservative elder opposition, led by Chen Yun, prevented many major reforms which would have damaged the interests of special interest groups in the government bureaucracy.[26] Corruption and increased inflation increased discontent, contributing to the Tiananmen Square protests of 1989 and a conservative backlash after that event which ousted several key reformers and threatened to reverse many of Deng's reforms.[27] However, Deng stood by his reforms and in 1992, he affirmed the need to continue reforms in his southern tour.[26] He also reopened the Shanghai Stock Exchange closed by Mao 40 years earlier.

Although the economy grew quickly during this period, economic troubles in the inefficient state sector increased. Heavy losses had to be made up by state revenues and acted as a drain upon the economy.[28] Inflation became problematic in 1985, 1988 and 1992.[27] Privatizations began to accelerate after 1992, and the private sector grew as a percentage of GDP. China's government slowly expanded recognition of the private economy, first as a "complement" to the state sector (1988) and then as an "important component" (1999) of the socialist market economy.[29]

The Lujiazui financial district of Pudong, Shanghai, the financial and commercial hub of modern China

In the 1990s, Deng forced many of the conservative elders such as Chen Yun into retirement, allowing radical reforms to be carried out.[26] Despite Deng's death in 1997, reforms continued under his handpicked successors, Jiang Zemin and Zhu Rongji, who were ardent reformers. In 1997 and 1998, large-scale privatization occurred, in which all state enterprises, except a few large monopolies, were liquidated and their assets sold to private investors. Between 2001 and 2004, the number of state-owned enterprises decreased by 48 percent.[25] During the same period, Jiang and Zhu also reduced tariffs, trade barriers, and regulations; reformed the banking system; dismantled much of the Mao-era social welfare system; forced the Chinese army (PLA) to divest itself of military-run businesses;[30] reduced inflation; and joined the World Trade Organization. These moves invoked discontent among some groups, especially laid-off workers of state enterprises that had been privatized.[31]

The domestic private sector first exceeded 50% of GDP in 2005 and has further expanded since. Also in 2005, China was able to surpass Japan as the largest economy in Asia.[32] However, some state monopolies still remained, such as in petroleum and banking.[33]

Hu Jintao and his conservative administration began to reverse some of Deng Xiaoping's reforms in 2005. Observers note that the government adopted more egalitarian and populist policies.[34] It increased subsidies and control over the health care sector,[35] halted privatization,[6] and adopted a loose monetary policy, which led to the formation of a U.S.-style property bubble in which property prices tripled.[36] The privileged state sector was the primary recipient of government investment, which under the new administration, promoted the rise of large "national champions" which could compete with large foreign corporations.[6]

Under Party general secretary Xi Jinping and his administration, the Communist Party of China has sought to increase its control over state-owned and private enterprises. At least 288 firms have revised their corporate charters to allow the Communist Party greater influence in corporate management, and to reflect the party line.[10] This trend also includes Hong Kong listed firms, who have traditionally downplayed their party links, but are now "redrafting bylaws to formally establish party committees that previously existed only at the group level."[13]

China is widely seen as an engine of world and regional growth.[42] Surges in Chinese demand account for 50, 44 and 66 percent of export growth of the Hong Kong SAR of China, Japan and Taiwan respectively, and China's trade deficit with the rest of East Asia helped to revive the economies of Japan and Southeast Asia.[42] Asian leaders view China's economic growth as an "engine of growth for all Asia".[43]

Production of wheat from 1961 to 2004. Data from FAO, year 2005. Y-axis: Production in metric ton.

During the pre-reform period, Chinese agricultural performance was extremely poor and food shortages were common.[45] After Deng Xiaoping implemented the household responsibility system, agricultural output increased by 8.2% a year, compared with 2.7% in the pre-reform period, despite a decrease in the area of land used.[45] Food prices fell nearly 50%, while agricultural incomes rose.[46]

A more fundamental transformation was the economy's growing adoption of cash crops instead of just growing rice and grain.[46] Vegetable and meat production increased to the point that Chinese agricultural production was adding the equivalent of California's vegetable industry every two years. Growth in the sector slowed after 1984, with agriculture falling from 40% of GDP to 16%; however, increases in agricultural productivity allowed workers to be released for work in industry and services, while simultaneously increasing agricultural production.[47] Trade in agriculture was also liberalized and China became an exporter of food, a great contrast to its previous famines and shortages.[48]

In the pre-reform period, industry was largely stagnant and the socialist system presented few incentives for improvements in quality and productivity. With the introduction of the dual-price system and greater autonomy for enterprise managers, productivity increased greatly in the early 1980s.[49] Foreign enterprises and newly formed Township and Village Enterprises, owned by local government and often de facto private firms, competed successfully with state-owned enterprises. By the 1990s, large-scale privatizations reduced the market share of both the Township and Village Enterprises and state-owned enterprises and increased the private sector's market share. The state sector's share of industrial output dropped from 81% in 1980 to 15% in 2005.[50] Foreign capital controls much of Chinese industry and plays an important role.[25]

From virtually an industrial backwater in 1978, China is now the world's biggest producer of concrete, steel, ships and textiles, and has the world's largest automobile market. Chinese steel output quadrupled between 1980 and 2000, and from 2000 to 2006 rose from 128.5 million tons to 418.8 million tons, one-third of global production.[51] Labor productivity at some Chinese steel firms exceeds Western productivity.[51] From 1975 to 1992, China's automobile production rose from 139,800 to 1.1 million, rising to 9.35 million in 2008.[52] Light industries such as textiles saw an even greater increase, due to reduced government interference. Chinese textile exports increased from 4.6% of world exports in 1980 to 24.1% in 2005. Textile output increased 18-fold over the same period.[53]

This increase in production is largely the result of the removal of barriers to entry and increased competition; the number of industrial firms rose from 377,300 in 1980 to nearly 8 million in 1990 and 1996; the 2004 economic census, which excluded enterprises with annual sales below RMB 5 million, counted 1.33 million manufacturing firms, with Jiangsu and Zhejiang reporting more firms than the nationwide total for 1980.[54] Compared to other East Asian industrial growth spurts, China's industrial performance exceeded Japan's but remained behind South Korea and Taiwan's economies.[55]

Global distribution of Chinese exports in 2006 as a percentage of the top market

Some scholars assert that China has maintained a high degree of openness that is unusual among the other large and populous nations, with competition from foreign goods in almost every sector of the economy. Foreign investment helped to greatly increase quality, knowledge and standards, especially in heavy industry. China's experience supports the assertion that globalization greatly increases wealth for poor countries.[54] Throughout the reform period, the government reduced tariffs and other trade barriers, with the overall tariff rate falling from 56% to 15%. By 2001, less than 40% of imports were subject to tariffs and only 9 percent of import were subject to licensing and import quotas. Even during the early reform era, protectionist policies were often circumvented by smuggling.[56] When China joined the WTO, it agreed to considerably harsher conditions than other developing countries.[57] Trade has increased from under 10% of GDP to 64% of GDP over the same period.[58] China is considered the most open large country; by 2005, China's average statutory tariff on industrial products was 8.9%. The average was 30.9% for Argentina, 27.0% for Brazil, 32.4% for India, and 36.9% for Indonesia.[59]

China's trade surplus is considered by some in the United States as threatening American jobs. In the 2000s, the Bush administration pursued protectionist policies such as tariffs and quotas to limit the import of Chinese goods. Some scholars argue that China's growing trade surplus is the result of industries in more developed Asian countries moving to China, and not a new phenomenon.[43] China's trade policy, which allows producers to avoid paying the Value Added Tax (VAT) for exports and undervaluation of the currency since 2002, has resulted in an overdeveloped export sector and distortion of the economy overall, a result that could hamper future growth.[60]

Foreign investment was also liberalized upon Deng's ascension. Special Economic Zones (SEZs) were created in the early 1980s to attract foreign capital by exempting them from taxes and regulations. This experiment was successful and SEZs were expanded to cover the whole Chinese coast. Although FDI fell briefly after the 1989 student protests, it increased again to 160 billion by 2004.[61]

Shanghai Stock Exchange (SSE)

In the 1990s, the financial sector was liberalized.[62] After China joined the World Trade Organization (WTO), the service sector was considerably liberalized and foreign investment was allowed; restrictions on retail, wholesale and distribution ended.[63] Banking, financial services, insurance and telecommunications were also opened up to foreign investment.[64]

China's banking sector is dominated by four large state-owned banks, which are largely inefficient and monopolistic.[65] China's largest bank, ICBC, is the largest bank in the world. The financial sector is widely seen as a drag on the economy due to the inefficient state management.[66] Non-performing loans, mostly made to local governments and unprofitable state-owned enterprises for political purposes,[67] especially the political goal of keeping unemployment low, are a big drain on the financial system and economy, reaching over 22% of GDP by 2000, with a drop to 6.3% by 2006 due to government recapitalization of these banks. In 2006, the total amount of non-performing loans was estimated at $160 billion.[68] Observers recommend privatization of the banking system to solve this problem, a move that was partially carried out when the four banks were floated on the stock market.[69] China's financial markets, the Shanghai Stock Exchange and Shenzhen Stock Exchange, are relatively ineffective at raising capital, as they comprise only 11% of GDP.[70]

Due to the weakness of the banks, firms raise most of their capital through an informal, nonstandard financial sector developed during the 1980s and 1990s, consisting largely of underground businesses and private banks.[71] Internal finance is the most important method successful firms use to fund their activities.[71]

By the 1980s much emphasis was placed on the role of advertising in meeting the modernization goals being promoted by Deng. Lip service was still paid to old Maoist ideals of egalitarianism, but it did not inhibit the growth of consumerism.[72]

In the pre-reform era, government was funded by profits from state-owned enterprises, much like the Soviet Union.[73] As the state sector fell in importance and profitability, government revenues, especially that of the central government in Beijing, fell substantially and the government relied on a confused system of inventory taxes. Government revenues fell from 35% of GDP to 11% of GDP in the mid-1990s, excluding revenue from state-owned enterprises, with the central government's budget at just 3% of GDP.[74] The tax system was reformed in 1994 when inventory taxes were unified into a single VAT of 17% on all manufacturing, repair, and assembly activities and an excise tax on 11 items, with the VAT becoming the main income source, accounting for half of government revenue. The 1994 reform also increased the central government's share of revenues, increasing it to 9% of GDP.[75]