Symposium Report: The Market Economy in China

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Date: April 3, 2008

Panelists: Wu Jinglian (Development Research Centre of the State Council of P.R.C. Member)
Toyoo Gyohten (President, Institute for International Monetary Affairs; Senior Advisor, The Bank of Tokyo-Mitsubishi UFJ, Ltd.)

Moderator: Masahiko Aoki (Distinguished Fellow, Tokyo Foundation; Professor Emeritus and Senior Fellow at Stanford Institute of Economic Policy Research)

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Hideki Kato: China has in recent years have embraced the globalization trend, and it is now registering rapid economic growth. Today, we have invited Professor Wu Jinglian, the leading expert on the Chinese economy, to discuss the paths China's economic development have taken over the years and to consider the country's future prospects. I believe that Professor Wu's remarks will provide many clues to how we should relate with our neighbor.

Ongoing Reform and Prospects for the Future

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Wu Jinglian: China has experienced three phases of reform that have transformed the country from the planned economy of the past to the market-oriented economy we see today. The first phase was between 1978 and 1983. Before this, China had based its economy on the planned Soviet model, but this caused a number of major problems. The Cultural Revolution of 1966–76, moreover, drove Chinese society to the brink of collapse. After the confusion subsided, from around 1978 China began to grope for a new economic model. Several reforms were undertaken, with some of the central government's powers being delegated to local governments and the "household responsibility system" being implemented in rural villages. Many private enterprises were created, and the economy regained its overall stability. The power of the central government remained strong, though, leading to calls for further reforms.

To advance such reforms, China studied the various economic structures of other countries, choosing to pursue either the East Asian model of development of a government-led market economy - the system adopted by Japan - or the free-market model of the West. This was the second phase of reform, covering 1984 to 1993. In terms of policy decisions by the Communist Party of China, the Twelfth Central Committee of the CPC in 1984 adopted the reform goal of a "planned commodity economy."It avoided using the term "market economy" and instead said "commodity economy."But the Fourteenth National People's Congress in 1992 identified the country's goal as being to establish a "socialist market economy," and the Fourteenth Central Committee of the CPC the following year adopted comprehensive measures clearly designed to create a socialist market economic structure.

A period of full-fledged reform and opening up was launched in 1994. Four major state banks were turned into commercial banks, and the two-tier foreign exchange system was consolidated into a single rate. State-owned enterprises were progressively privatized. As a result of these reforms, the Chinese economy registered rapid growth, and today the private sector accounts for three-fifths of the total economic activity. At the same time, many problems have come to light. For example, while many state-owned companies were privatized, the central government still has considerable powers. The three biggest oil companies are still nationalized, and the state remains the biggest shareholder for the country's six major telecommunications firms. The government still determines interest rates, electricity fees, and the prices of major industrial goods. The legal system is underdeveloped, moreover; government leaders have repeatedly called for legal reforms, but since this would reduce the powers of the bureaucrats, such calls have been fiercely resisted. Other social problems include widening wealth gaps and corruption among public officials.

In the face of these problems, debate on reform picked up again in 2004. Two major arguments have been advanced, one being that the causes for the various problems lie in the fact that reforms are as yet incomplete and that further measures are needed. I belong to this school. The other argument is that efforts toward a market economy are themselves the root causes, and that what is needed is a return to pre-reform conditions. At this point in time, there are a sizable number of people who adhere to the latter view, but the public generally supports the former line, and the government has also clearly indicated its resolve to proceed with further reform and opening up. There is little likelihood, therefore, that the reform process will retreat, and the focus of discussions will be on the concrete methods employed to promote reform.

The Social and Political Impact of Economic Liberalization

Masahiko Aoki: Thank you, Professor Wu. Dr. Wu has played a leading role in promoting China's efforts toward reform and opening up as one of the country's top economists. His writings on China's economic reforms have been translated into Japanese, and one of them, Gendai Chugoku no keizai kaikaku, was chosen as one of the best economic books of the year in Japan last year. Our second speaker is Mr. Toyoo Gyohten, who, incidentally, wrote a recommendation for this book. Now I would like to ask Mr. Gyohten to make his remarks.

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Toyoo Gyohten: I think that China's recent economic growth is one of the most outstanding developments in the history of the modern world economy. I believe three major factors contributed to bringing such growth about. The first is that the entire population ardently desired economic growth. This is a factor that has driven other countries' development as well. The second is that the leadership responded to the people's fervent desires with appropriate policies. And the third is that the reforms were not rushed but implemented in a gradual manner.

Having followed China's evolution over the years, I have come to the following realizations. The first concerns ethical standards. In China today, scandals and corruption involving public officials have become a grave problem. This, I believe, is due to the regression of communist values. When Deng Xiaoping advocated an expedient approach to economic growth, saying "It doesn't matter if a cat is black or white, so long as it catches the mice," he also rejected the ethical standards embraced by communism. This, I believe, was a major factor behind the lowering of moral standards.

Another point that has made an impression on me is the need for structural reforms. China's expansion has been based on manufacturing and export industries thus far, but henceforth shifting to services and domestic consumption will become necessary. There are emerging problems, moreover, regarding the need to promote growth in rural communities, properly manage natural resources, and conserve the natural environment.

A third point concerns the inevitability of political reform. The liberalization of the economy will no doubt advance the process toward greater political freedom. The legal system will have to be reinforced, and the process of weaning the country from the political dictatorship of the CPC and introducing multiparty politics will come under discussion. The question then arises as to whether China will adopt a Western model of democracy or a uniquely distinctive style of democratic government. I am very curious as to which path the country will take.

Wu: As Mr. Gyohten pointed out, the question of ethical standards is probably the Achilles heel of contemporary China. The "good cat" statement by Deng Xiaoping was a domestic strategy aimed at offering the people a foundation for a new economic structure, and so I think the link with ethics is a very pertinent one. Deng's thinking was that before you can start talking about the economy, you need a "cat" that can get the job done, whether black or white.

China had been straitjacketed with ideology for several decades. If an attempt were made to first deal with ideological questions and then to proceed with reform, the process would never have gotten off the ground. Realistically speaking, it would have been impossible. In the initial phases of reform and opening up during the 1980s, when efforts were being made on a trial-and-error basis without clear goals or models, progress would not have been possible had the targets been too lofty or idealistic. What was needed, instead, was a "cat" - a clear target that was easy to understand. And it was important to indicate that using cats entailed adherence to a set of rules.

Introducing a market economy is not an easy task. But at the same time, this does not negate the ethical standards of communist ideology. In China's case, a somewhat distorted version of Marxism entered the country from the Soviet Union. It was already contorted by the time it reached China. In the early years, a great many people joined the party out of their own will and conviction. But later on, the majority joined not so much out of conviction but because they had nowhere else to turn to free themselves of abject poverty and heavy oppression. They turned to communism as a way of changing the circumstances in their lives.

This was particularly true among the rural sector, where there was an innate worship of authority and political power. The Marxism that came to China from the Soviet Union was essentially Stalinism. But this brand of communism collapsed following the Cultural Revolution. This is why Deng Xiaoping embraced the concrete image of a pragmatic "cat" to explain his thinking to the people.

There has been considerable debate in recent years on the need to "reconstruct Chinese values." Advocates include both those seeking to revive ancient Chinese thought and culture as well as those seeking the adoption of such universal human values as freedom, equality, and democratic rule. Some universities now offer specialized degrees in the former. At the same time, the chief executive officer of a state-owned company recently wrote an essay in which he claimed that for China to become a modern state, it must first learn what being a modern country means. He emphasized the importance of maintaining Chinese characteristics but also fostering greater respect for freedom, equality, and other universal values. I agree with his view. There is quite an intense debate over the kind of values the country will eventually adopt.

As for the second point raised by Mr. Gyohten, that of structural reform, there was considerable debate between 2004 and 2006 as to whether the country should proceed with reforms or revert back to its old ways, as I mentioned in my presentation. Accompanying this was another debate on the choice of a growth model.

China continued to make adjustments to the Soviet political system that it had adopted, but it left intact the economic growth model that it had also imported. This was essentially the model employed by Western countries in the nineteenth century, which the Soviet Union had embrace since its founding. Under this model, massive investments were made in heavy industries to promote economic growth. China did likewise, starting with its first five-year plan, and it continues to do today, so even after the decades of reform and opening up. Growing environmental problems led to calls for a reexamination of this approach in 1995, but no concrete studies have yet been conducted on an alternative model. About the only proposals made have been to enhance efficiency and reduce consumption of resources. The tenth five-year plan covering 2000 to 2005 mentions the need for reform, but it has not been achieved. And there has been no change in the active role the government plays in establishing a basic model for the country's growth.

Western industrial nations achieved a new growth model based on investments in technological innovation and improvements in productivity, starting from around the end of the 1950s. The eleventh five-year plan for 2006 to 2010 does chart a course in this direction, but as far as one can tell from the first two years of the plan, there does not appear to be any significant changes.

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Why is this the case? I believe there are four structural obstacles. The first of these is the power still held by the central and local governments in the social distribution of resources. They continue to enjoy discretionary powers over land transactions and allocation of loans. The second is that the government's performance is measured in terms of growth in gross domestic product. Fiscal revenues are linked to material production, and because the government has a large say in resource distribution, expenditures inevitably flow into heavy industries. Great efforts are also made to promote investments from abroad.

The third obstacle is in the country's fiscal and taxation structure. About half of tax revenues come from land-use taxes, and this is directly linked to material production. This is why efforts continue to be made to promote the development of the manufacturing sector. As for expenditures, too much is being forced upon the lower levels of government. Local governments and small administrative units are being called upon to pick up too much of the bill. Responsibility for education and sanitation are now delegated to the prefectural level.

And the fourth obstacle is the unreasonably low prices of factors of production. Because interest, land, and currency have very low values, companies are able to turn a profit with very basic technologies, and they have no need to think about boosting efficiency. Unless this thinking changes, a new growth model will never be achieved, no matter what the economic plan says.

There is an additional factor of luck. Liberalizing the prices of factors of production would push prices higher, so the process must be instated gradually. But if the pace is too slow, then opportunities for reform could be lost. Gasoline and diesel are both too cheap at the moment, and at 16 percent, the fuel tax is the lowest in the world. This is lower than in the United States, Japan, or Europe.

Some economists contend that factor prices should be liberalized and that revenues should be secured from fuel taxes. This might be possible if crude oil prices come down to around 30 dollars per barrel, but at the moment it's too high. If prices are liberalized now, this will breed great discontent among the public. Two years hence may be a better time to do this, but by then, oil prices might be even higher than they are today. The alarming rise in gasoline consumption is also a serious concern.

The foreign exchange rate also needs to be liberalized. Although attempts have been made to liberalize the mechanism for determining the rate since 2003, it was not until 2005 that the renminbi actually started being revalued incrementally. The pace picked up in 2006 but it has again slowed down. The dollar, meanwhile, has been falling of late. This is another unlucky development, but I believe that progress can be made if clear policies are outlined. This is an operational question for the central bank and the Ministry of Finance.

As for the third point Mr. Gyohten raised, that of political reform, I think this was most compelling at around the dawn of the new century. Many people pointed to the rampant corruption and noted that economic growth alone was not enough; it was also important to bolster political governance. Various people have offered various prescriptions.

This involves a number of issues, including reinforcement of the legal system, democratization, the election system, and the locus of power. People must be granted basic rights, but at the same time the government also needs basic authority. A line must be drawn so that government authority does not infringe on people's rights. China does not have much experience drawing such lines, so it would probably be unrealistic to expect a perfect demarcation from the outset. Personally, I think this can be accomplished while the legal system is being more fully developed.

The political system also needs to be rebuilt around core values. The extent to which people have access to such universal values as freedom, democracy, and equality is an important consideration. People of my generation have been taught for decades that such values are those of the propertied classes, but I am heartened by recent moves to put aside such influence and embrace liberal thinking. People are talking about freeing themselves from the binding ideologies of the past. The essay by the CEO I mentioned earlier placed great emphasis on such universal values as freedom, even while giving importance to China's unique characteristics. Premier Wen Jiabao also recognized in a press conference that democracy and freedom have universal value. So there has been a greater openness to rebuilding China's philosophical foundations on such values.

Breaking Up Interest Groups and Promoting Privatization

Aoki: We in Japan tend to see China in a monolithic light, but from Professor Wu's remarks, we can see that the country is actually undertaking active debate on its future. Now I would like to invite questions from the floor.

Question: Professor Wu, you have long contended that interest groups within the CPC are hampering economic reform efforts. Is the present leadership succeeding in breaking such groups apart?

Wu: I'm afraid it isn't. Breaking up interest groups requires fundamental structural reforms that would limit the authority of political forces, but the reforms have not advanced that far.

Question: How is the privatization of state enterprises proceeding? The National Development and Reform Commission has been exerting a strong influence on China's economic policy, but it has been targeted for an overhaul in the most recent series of reforms. Has there been any change in the commission's influence?

Wu: The privatization of state enterprises made considerable progress from 1999 to 2001. During this time, reforms were undertaken to break existing monopolies by separating them from the government, launching new companies, and diversifying shareholders by taking the companies public. But there has been a slowdown since then, and the government continues to hold the vast majority of shares in the country's six major telecommunications companies. There is still considerable room for further reform.

As for the NDRC, this commission functioned much like the former Ministry of International Trade and Industry in Japan, which exerted a powerful influence. Precisely because its powers were extensive, the NDRC came under criticism, and its supervisory role over individual companies was separated. Nonetheless, it still has great say over macroeconomic policy. Macroeconomic management has been the focus of much debate in China for more than a decade. Personally speaking, I think the best approach is macroeconomic management by fiscal and monetary authorities. Some contend that the NDRC should also have a say, and others also seek a four-party management team that includes the China Council for the Promotion of International Trade. The strength of the NDRC is sustained by such views.

Sino-Japanese Dialogue for a Sustainable Economy

Question: I have a question about China's response to global warming. Japan employs a sectoral approach whereby the reduction targets for greenhouse gas emissions are allocated to each industrial sector. What is the method being used in China? What are your views regarding an emissions trading scheme for greenhouse gases?

Wu: China, like Japan, has set targets for carbon dioxide emissions and energy consumption for each industry and region. But as I referred to earlier, GDP growth is used as the chief measure of a local government's success, so emission reductions have not made much headway. As for trading in emission rights, I think it's an effective approach, and Chinese companies are attracted to the idea. But before we can set up a trading scheme, fundamental issues must be resolved, such as methods of accurately measuring the volume of greenhouse gases.

Aoki: I'll take one final question from the audience.

Question: Mention was made of the East Asian versus Western model of growth, but it appears that the latter has gained ascendancy in China since the mid-1990s.

Wu: In the 1980s, bureaucrats in China supported the East Asian model, while scholars pushed the Western model. The government's role in economic planning began to dwindle and became more indirect from the period of reform and opening up in 1994, and this was partly responsible for policies that follow the Western line. But as I mentioned, the debate on macroeconomic management is still ongoing, and bureaucrats are fiercely resisting attempts to reduce their authority. So the question remains as to how closely China's economy will come to approximating the Western model.

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Aoki: I have recently been giving great emphasis to the concept of global commons. This is an idea that views air and natural resources as being the common assets of all humankind. Ensuring their effective use by establishing an environmentally sustainable economy has become a global priority. To create such an economy, I believe that China and Japan, as Asia's two biggest economic powers, need to promote greater dialogue. And it is hoped that this symposium will contribute to promoting such dialogue.

Wu Jinglian

  • Member, Development Research Centre, State Council of the People's Republic of China

Toyoo Gyohten

  • President, Institute for International Monetary Affairs; Senior Advisor, The Bank of Tokyo-Mitsubishi UFJ, Ltd.

Masahiko Aoki

  • DISTINGUISHED FELLOW
    Professor Emeritus, Stanford University