September 1999, No.45
Introduction1. The Chinese Economy since the Start of the Reform and Open-door PolicyThe reform and open-door policy of China began with the adoption of a new economic development strategy at the Third Plenary Session of the 11th Central Committee of the Chinese Communist Party (CCPCC) in late 1978. Under the leadership of Deng Xiaoping, who had returned to the political arena after his three previous defeats, the Chinese government began to pursue an open-door policy, in which it adopted a stance to achieve economic growth through the active introduction of foreign capital and technology while maintaining its commitment to socialism.The obvious aim of this policy shift was to rebuild its economy and society that were devastated by the Cultural Revolution. The policy shift also appears to have been prompted by recognition that the incomes of ordinary Chinese were so low, in comparison with incomes in other Asian economies, that the future of the Chinese state and the communist regime would be in jeopardy unless something was done to raise living standards of its people through economic growth.The government subsequently established a number of areas for foreign investment, including the special economic zones, open coastal cities, the economic and technology development zones, the delta open zones, the peninsula open zones, the open border citiees, and the high-tech industry development zones. The establishment of these zones provided the trigger for massive inflows of foreign investment, primarily from companies in Hong Kong and Taiwan. At the same time, China promoted its socialist market economy concept. The changes brought an entrepreneurial boom that resulted in the emergence of huge numbers of entrepreneurs and venture businesses within China.Inflows of foreign capital, technology, and management knowhow enabled China to turn its vast labor resources and space to rapid economic growth. The shift to an open-door economic policy ushered in a period of high economic growth in the first half of the 1980s. The economy stagnated around the time of the Tiananmen Square Incident in 1989, but in the first half of the 1990s, China was again boasting high growth rates. Rapid economic growth was accompanied by a rise in per capita GDP (Fig. 1). In 1998, per capita income, though still only about US$770, was 14 times higher than in 1980. Therefore, it seems reasonable to conclude that Deng Xiaoping's first goal, which was to improve the economic status of the people, has been accomplished.2. Emerging ConfictsThe positive consequences of the reform and open-door policy have been economic development and rising national incomes. Naturally, there have also been negative effects, and these have become increasingly obvious over the years. The problems outlined below are closely linked to the living standards of people in China.First, there is now regional disparities in income levels, and the gap between rich and poor is now extremely wide. Under the socialist controlled economy, living standards were relatively low, but there was no big gap between rich and poor. The idea, taken from the writings of Mencius, that inequality is more lamentable than poverty, has applied throughout society. With the shift to the open-door policy, however, Deng Xiaoping indicated that it was acceptable for some regions to become wealthy before others. The result was a huge wealth disparity between coastal and inland regions, and between the cities and rural areas. Fig. 2 shows the per capita annual incomes of urban households in municipalities and provinces where incomes are relatively high, and those of peasant households in relatively poor provinces. Incomes in Guangdong Province are about eight times higher than incomes in Gansu Province.Apart from a massive influx of foreign investment, entrepreneurial activity within China was also encouraged. This led to the formation of countless foreign-owned companies, private enterprises, individual enterprises, and other types of business, in addition to the existing state-owned enterprises and township enterprises. These newly established enterprises are classified as "enterprises under other ownership structures." Many of them operate more efficiently and pay their employees more than state-owned or township enterprises (Fig. 3). This has been reflected in a growing income gap between the owners, directors, and executives of these enterprises and the employees of state-owned enterprises.There are also clear gaps among urban office workers. At one extreme of this polarization are workers who can afford to own imported cars, while at the other are those who can afford only a bicycle. Some parents can easily afford to pay annual fees worth three million yen per child to send their children to the private boarding schools that have appeared in Beijing. Yet, on the other hand, there are aging employees of state-owned enterprises, laid off after decades of service and basically living on the street with a monthly benefit of around 3,000 yen. These are the realities of contemporary China.The existence of this income disparity under a socialist regime is inevitably causing a variety of alarming social phenomena. Worship of money has spread among the people. Huge numbers of rural people have flooded into the cities in search of higher incomes, leaving many rural communities deserted and exposing China to the danger of future food shortages. There has been a breakdown of law and order in the cities, and corruption is rife among party officials and government bureaucrats. Government organizations are involved in tax evasion and smuggling, wwhile army, police, and court are operating businesses on the side. None of these phenomena are compatible with a socialist system, and they are indicative of inner contradiction in the political system.China has maintained a one-party socialist dictatorship on the political level, while moving to a market system on the economic level. This conflict has exposed inadequacies in the legal system, and with each passing year, it has become increasingly apparent that there is no system of checks to prevent the arbitrary exercise of power by the Communist Party. The government has accelerated the shift to a market economic system, but it has so far failed to provide a clear definition of what is meant by a "socialist market economy." For this reason, Party and government agencies no longer function as monitors and arbiters of the market. Instead, these agencies have been given leeway to participate in business activities as direct players in the market. This situation has led them to involve in monopolistic trading and insider trading. The accepted wisdom among modern Chinese is that "those in authority (quan) will be able to acquire money (qian)."An extreme example of this problem relates to the export rebate system for value-added taxes. Since its implementation in 1994, the rebate rates have been lowered frequently, and the range of prices covered by the tax has also been changed. The fundamental reason for this is the fact that export rebates were greater than the amount of revenue generated by the value-added tax. Behind the scenes, exporters, customs officials, tax officials, and central and regional Party officials were conspiring to obtain massive rebates by means of fraudulent export documents.The economic development gap between coastal cities and other regions has engendered a sense of grievance on the part of regional government officials, who have misappropriated government money to create hastily planned development zones in an attempt to attract foreign investment. The resulting shortage of public money has frequently meant that residents have not received payments to which they were entitled.According to a Chinese newspaper, 158,000 senior Communist Party officials were punished for violating the Chinese Communist Party Constitution in 1998. Public prosecutors are currently investigating 35,000 cases of corruption involving 1,820 government agency officials with ranks of section manager or above. Still, those prosecuted represent only a small minority of the total number of people engaged in corrupt activities.China is frequently criticized for delays in updating its legal system. Despite the enactment of numerous new laws, in step with the open-door policy, China has still not established the rule of law. The collapse of the Guangdong International Trust and Investment Corporation (GITIC) in October 1998 had focused attention on the proliferation of trust and investment companies and their financial problems. At the height of the boom in the 1980s, there were almost 1,000 of these companies. Yet, China has still not established a trust and investment company law.The declining competitiveness of the state-owned enterprises, which are the actual and ideological pillars of the socialist economy, is a problem with serious implications for China's economic and industrial structures. In essence, the state-owned enterprises were social microcosms created to feed the people and realize the ideals of socialism.However, China began to move toward a market economic system under the reform and open-door policy. One result was an influx of foreign companies with resources that made them powerful competitors in the international marketplace. The changes also triggered an upsurge of entrepreneurial activity within China. Private and individual enterprises staked their survival on business efforts that enhanced their competitiveness. Meanwhile, the state-owned enterprises were unable to modify their corporate cultures that had evolved in China's controlled economy. In the face of this onslaught, many lost their advantage in such areas as manufacturing production, domestic sales channels, and exports.Inextricably linked to this problem is the state of the financial system. China's main financial institutions are state-owned banks. Under the controlled economy, state-owned banks tended to see lending to state-owned enterprises as a mechanism for distributing fiscal funds. The state-owned enterprises that received these loans similarly regarded them less as loans than as allocations of public money.When the economy was opened up, however, there was a massive inflow of foreign investment. The government was forced to establish financial policies and exercise macro-level controls, while state-owned banks were required to provide support to leading enterprises under the government's financial policies, and to improve their credit assessment capabilities. Unfortunately, credit assessment capabilities of state-owned banks have not been developed, and there was a tendency to provide continuing credit to state-owned enterprises in an environment influenced by guidance or interference from the Communist Party and the government. Now that state-owned enterprises are experiencing financial problems, state-owned banks are inevitably being left with a growing mountain of non-performing loans. Most state-owned enterprises are in need of reform, and urgent steps are needed to reform a financial system that is still based on state-owned banks.3. The Necessity of ReformWhile China has achieved economic development and improvements in the living standards of its people, there is confusion about the direction of the state and the people under a single-party dictatorship that continues to claim that the revolution is not yet complete. Bureaucratic organizations and systems are out of step with contemporary needs, while state-owned enterprises and banks have fallen far behind the world-class technology and management skills of foreign-owned and private enterprises.The reform of organizations such as these has become an urgent priority. To become a modern state and superpower, China will need to develop a legal system that reflects contemporary needs and to establish highly efficient administrative organizations. It will also have to create a fair and objective judicial system. In other words, China must build a just society in which the existence of companies and individuals is guaranteed by law, in which administrative organizations are streamlined and orderly, in which there is no smuggling or insider trading involving the Party, the army, or government organizations, and in which both urban and rural people can experience the joy of working and dreaming of their future.4. The Reasons for taking Up the "Three Reforms"A wide range of reforms are needed in contemporary China. The tasks given highest priority and urgency are the reform of state-owned enterprises, the reform of the financial system, and the reform of administrative organizations. This report explores the current situation of these "Three Reforms," and considers the future outlook.The "Three Reforms" are more important than the many other reform programs in China. This is because the state-owned enterprises, the financial system, and the administrative organizations are the three pillars of state administration; all these areas are closely interwoven; and successful reform in one of these areas brings progress in the others. Moreover, the Communist Party has been able to start work on the reform process, for it still has the power to lead the state. As China shifts further toward a market economic system, the people will inevitably adopt values that do not depend on traditional ideology, and society will begin to demand political freedom.If the "Three Reforms" fail in this environment, China is certain to experience a major social upheaval. But the Communist Party still has the power to keep these pressures under control for a few more years. If the "Three Reforms" succeed, the result will be streamlined and efficient administrative organizations, internationally competitive state-owned enterprises with healthy financial structures, and a flexible financial system that is able to foster leading enterprises in line with financial policy. Moreover, the secondary result of this process will be an orderly society in which the people can enjoy lifestyles that let them dream.Such a society is consistent with the ideal party-state system claimed by the Chinese Communist Party. There is concern about the declining power of the Chinese Communist Party. It is fair to say that the Party has staked its survival on the "Three Reforms."What is certain is that, regardless of how the reforms proceed, the outcome of the "Three Reforms" will vary from the expectations of people in democratic capitalist nations. In a situation where one party has absolute power, administrative reform will inevitably lack thoroughness in such areas as enforcing discipline within the party. To quote Lord Acton, "absolute power corrupts absolutely." This is a serious issue for China. The reform of the state-owned enterprises will involve a number of difficult tasks. In March 1999, the National People's Congress (NPC) granted a degree of respectability to the private ownership economy, but socialist public ownership is still the norm in China.The state-owned enterprises may be corporatized or privatized, but there is a danger that the process will remain incomplete if the state is the shareholder, that is, if only the mode of ownership is changed. The same applies to financial system reform. Since executives of state-owned banks are also senior Party officials, it is still not clear whether the banks will be able to totally eliminate Party interference.If the "Three Reforms" are even marginally successful, there will be improvements in administrative efficiency and the international competitiveness of major state-owned enterprises, and China will make significant progress in its evolution into a modern superpower. However, the Communist Party will still need to establish an identity that will create China's new generation. That will depend on the extent to which it can reshape socialism and adapt it to suit contemporary needs. Unless it can makethese changes, the benefits of the "Three Reforms" will be limited.
II. Reform of State-owned Enterprises -Progress and Outlook
III. Financial System Reform -Progress and Outlook
IV. Reform of Administrative Organizations -Progress and Outlook