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DEWEY
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of economics
ECONOMIC REFORM AND THE OPENING OF THE CHINESE ECONOMY
TO INTERNATIONAL TRADE AND FINANCE
Richard S. Eckaus
95-23
July 1995
massachusetts
institute of
technology
50 memorial drive
Cambridge, mass. 02139
ECONOMIC REFORM AND THE OPENING OF THE CHINESE ECONOMY
TO INTERNATIONAL TRADE AND FINANCE
Richard S. Eckaus
95-23
July 1995
MASSACHUSETTS INSTITUTE
NOV
1 ^ 1995
95-23
ECONOMIC REFORM AND THE OPENING OF THE CHINESE ECONOMY
TO INTERNATIONAL TRADE AND FINANCE
Richard S. Eckaus*
Ford International Professor of Economics
Department of Economics
Massachusetts Institute of Technology
Cambridge, MA. 02146, U.S.A.
July 14, 1995
*The author is indebted to Professor Padma Desai for her useful
suggestions and contructive criticisms and to Anna Sokolinski
and Christiana Stamoulis for their research assistance.
R.S. Eckaus
June 19, 1995
I.
Introduction: Patterns of growth, trade and finance
The expansion of China's participation in international
trade,
since the beginnings of the reform movement in 1978, has
been one of the most remarkable features of its remarkable
It would have been plausible to have expected
transformation.
in 1978 that there would be a strong overall response to reforms
that provided significant incentives for increased efficiency in
production and new investment.
prescience to have predicted the
It would have required unusual
9
per cent average annual rate
of growth of GNP that has been achieved.
Chart
1,
presenting
the levels and annual growth rates in GNP from 1951 to 1993,
shows a highly uneven,
sawtooth pattern of growth before 1978,
with the big declines in 1960 and 1961 associated with the Great
Leap Forward and the effects of the Cultural Revolution in 1967
and 1968.
As the Cultural Revolution faded and the economic
reforms began, the growth rates rose and became less variable. 1
However, Chart
1
also shows the higher inflation rates
associated with the post-reform growth.
It would have been even more difficult to foresee in 1978
the subsequent dynamics of China's foreign trade.
growing at the
9
While GNP was
per cent rate from 1978 to 1994, exports grew
at a rate of about 14 per cent and imports grew only slightly
1
The levels and growth rates before 1978 were based on
estimated, "National income, " which includes only material product.
After 1978, the growth rates are based on GNP estimates.
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slower at the average rate of 13 per cent per year.
The annual
growth rates of exports and imports are shown in Chart
2
.
They
are obviously much more variable than the GNP growth rates.
While the variability persists after 1978, export growth was
monotonic and only once, in 1982, was there a year-to-year
decline in imports.
Chart
3,
which provides quarterly detail on foreign trade
and the trade balance, also shows clearly that, although the
growth in trade has been impressive, the course has not been a
smooth one.
In the late 1980' s, China's trade balance passed
through a difficult period, but the problems did not spin out of
control.
Again in 1993, there were large deficits, which were
quickly and strongly corrected. in 1994 and currently China is
building up large foreign exchange reserves.
These results are so extraordinary as to generate a natural
skepticism, which is nourished by the lack of a detailed
description of national accounting methodology in China and
unavailability of crucial details.
Nonetheless, if the
achievements are only two-thirds or three-quarters of the
official numbers, they would still be astonishing.
The successes contradict several customary generalizations
about transition economies and large developing countries, for
example: that the transition from central planning to market
orientation cannot be made without first passing through a
difficult period of economic disorganization and, perhaps,
decline,
that very large economies have so much inertia that
they cannot transform themselves and grow rapidly, and that the
share of international trade in very large economies cannot grow
quickly due to the difficulties of penetrating foreign markets
on a large scale.
They are, therefore, worthy of close
examination, of which this paper is only a beginning.
There are serious obstacles to the explanation of economic
policies and events in China.
While there has been public
commentary on current economic issues, there has been no public
debate by policymakers or extensive domestic analysis of
alternative policies.
In addition,
the publicly available data
are limited, both with respect to coverage and periodicity.
example,
For
there are annual, but not quarterly estimates of the
major components of the national income and trade and payments
accounts.
Other useful information, for example with respect to
the volumes of trade at different exchange rates, when there
were multiple rates, is not available.
Yet the major features of China's trade and payments
policies can be discerned, even if robust quantitative
behavioral relations cannot always be estimated.
The first step
in the process of explanation will be to provide a brief
overview of Chinese international trade and payments policies
from the successful Communist revolution to the beginning of the
economic reform process in the late 1970'
simply to provide historical background.
s.
The object is not
That is available in
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several excellent surveys. 2
this brief review is
Rather,
intended to help demonstrate that the approach to managing
foreign trade that was followed in the first thirty years of the
People's Republic of China has shaped subsequent decisions in
important ways.
The trade and payments policies followed in the economic
reform period beginning in the late 1970'
up.
s
will then be taken
It will be argued that the direct controls that were
initially employed, which were an inheritance of the pre-reform
period, were an inadequate set of tools in the new environment.
Subsequently, the direct controls have been augmented,
not fully replaced by exchange rate policies.
though
Macroeconomic
policies have also had a role, although it will not be. possible
to determine the extent to which their use has been motivated by
international payments exigencies.
II.
Pre-reform international trade and payments policies
After the success of the Communist revolution and the
founding of the People's Republic of China, its international
economic policies were dominated for at least thirty years by
the goal of self-reliance.
While' this was never interpreted as
complete autarky, the aspiration for self-reliance profoundly
shaped trade policy, especially with the market economies.
In
particular, it was thought that international prices, being
2
See Lardy (1992), (1994) World Bank (1988)
Bell, et al
(1993), W. Tseng, et al
(1994).
,
.
)
.
,
(1994), M.W.
shaped by imperialist and monopolistic forces, should not be
allowed to interfere with rational domestic economic planning. 3
The extreme control exercised over international trade with
market economies was typified by the semi-annual Canton Trade
Fairs.
These provided virtually the only contacts by western
businesses with Chinese trade officials.
China's foreign trade in the pre-reform period was a small
part of the Chinese economy. 4
It has been argued persuasively,
however, that since trade was the source of critical capital
equipment that formed the basis for much of China's growth
through the middle 1960's, it played an important role.
It also
provided some raw materials that were unavailable in China. 5
Imports in the pre-reform period are conventionally
described as having been concentrated in the,
"four waves."
The
first wave is dated from 1956 to I960, when average imports
doubled, as compared to the previous four years.
The imports
were dominantly capital goods, particularly of complete plants,
World Bank (1988), pp. 95-98. This is of some interest,
in view of more recent argument that Chinese exports reflect its
3
international comparative advantage.
4
See H. Harding (1987), p. 22. The interpretation of the
trade/national income ratio is somewhat uncertain, since the
national income concept used omits measures of services, that are
considered unproductive in Marxist ideology and are not included
in the net material product.
In addition, the prices used in the
estimates of all the components are arbitrary in relation to the
real scarcity prices of the economic allocations.
5
See A. Eckstein,
(1966), p.
88 ff.
from the former Soviet Union, but also from the centrally-
planned economies of Eastern Europe.
They were financed by
exports of consumer goods and minerals, as well as by Soviet
credits.
These imports dropped drastically following the
deterioration of Chinese-Soviet relations and the abrupt
withdrawal of Soviet technicians in I960. 6
Subsequently, after the disaster of the Great Leap Forward
was recognized, there were large scale imports of foodgrains in
1961 and 1962, but total imports were at a much lower level than
previously.
Exports held up somewhat better, as China repaid
its loans from the Soviet Union.
Capital equipment, again in the form of complete plants,
dominated the brief second "wave", from 1964 to 1966, with Japan
becoming the primary source.
The end of this phase coincided
with the beginning of the Cultural Revolution.
The beginning of
the next "wave" in 1973, was related to the waning of that
eruption and was called the "four-three programme", related to
the target of spending $4.3 billion over four years, again,
6
Although a number of factors have contributed to
the
deterioration of Chinese-Soviet relations, it is not possible to
assign relative importance to them. The factors usually mentioned
include disagreements over sharing the burden of the Korean War,
disagreement over the sharp policy change in the Great Leap Forward
and the disregard of Soviet advice, competition in third countries
and ideological differences.
In any case, there was an abrupt
withdrawal of Soviet technicians and Chinese imports from the
Soviet Union dropped sharply; Chinese exports were reduced less
drastically, as the Chinese debts were repaid and Chinese trade was
re-oriented to capitalist economies.
,
10
primarily for capital equipment.
The last "wave", in 1978, was
short-lived, but unique in that it marked a first turning to the
West for capital and technology.
The change in the direction of trade through these various
waves and in the reform period are shown in Table
1.
The abrupt
drop in imports from the former Soviet Union in the early 1960
's
and subsequent growth in imports from Japan and the EEC is quite
clear.
The changes in exports are less abrupt as Chinese
exports to the former Soviet Union were maintained for some
years to repay the credits that had been extended.
It is clear,
from various sources and the manner in which
trade was determined, that trade policy was "import-driven",
with export levels being determined by the import targets. 7
Import and export targets for particular commodities and
manufactured products were determined as part of the overall
planning process by the State Planning Commission and the
Ministry of Foreign Trade.
The imports desired, of capital
equipment and particular commodities, were quite specific, as
were the export targets.
The import and export targets were
then handed to the twelve Foreign Trade Corporations (FTCs)
that were established soon after the formation of the People's
Republic and through which virtually all foreign trade was
"canalized".
These corporations were the sole participants
See A. Eckstein,
(1966)
and N. Lardy,
(1992).
*
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12
allowed in international trade and acted to sell the exports and
buy the imports in types and quantities specified by the plan,
although,
over time the FTCs came to have some leeway with
respect to export composition.
Although the imports targeted by the PRC were quite
specific,
the "airlock" imposed between foreign suppliers and
domestic users appear to have worked against their efficient
procurement.
There are reports of significant inefficiencies
and incompatibilities arising due to the lack of direct contact
between suppliers and users. 8
It is also interesting,
in view of the role of Hong Kong in
China's trade after 1978, that Hong Kong always had a
significant presence in China's trade.
Yet after having a major
role in channeling imports into China in the early 1950'
s,
Hong
Kong's importance in China's trade declined drastically until
the reform period began.
Since domestic prices were distorted and government
subsidies covered the deficits of the FTCs, there is no reason
to believe that the composition of imports or exports was
determined by domestic comparative advantage as revealed by
prices.
In effect, although for somewhat different reasons than
those of other developing countries, China followed an intensive
import substitution policy, which was intensified by the U.S.
See T.D. Gorman (1986) quoted in World Bank (1988)
13
embargo imposed after the Korean War.
In the early 1950
's
foodstuffs and tobacco were by far the most important components
of exports, with the textile shares in exports growing slowly in
this period.
In the agricultural disaster of the late 1950'
and after, the exports of foodstuffs declined and textiles and
footwear took over the leading role.
The FTCs were required to buy goods for export and to sell
imported goods at domestic prices.
Import and export values
were, of course, determined at international prices.
was, by general consensus,
period.
The yuan
overvalued for much of the pre-reform
When foreign prices were converted into domestic
prices, the revenues from exports did not offset the costs of
imports in yuan.
The difference was covered by government
subsidies to the FTCs at levels that implemented the import
targets
As a result between 1948 and 1978 the foreign exchange rate
played no role in equalizing demands and supplies of foreign
exchange.
The balancing mechanism in the foreign trading
process was government subsidies.
Since exports were import
driven and the government subsidies covered any shortfalls,
there was never an apparent balance of payments crisis in the
pre-reform days.
Yet there are no official data on reserves
before 1977, so one cannot be sure.
III. An Overview of the economic reforms since 1978
A great deal has been written about the economic reforms in
14
so that it is neither necessary or appropriate to give a
China,
detailed description of those reforms here. 9
will provide a useful reference.
Yet a brief summary
There was discussion of
economic reform in the early 1970' s, even before the death of
Mao Tse Tung and the arrest of the Gang of Four, but political
uncertainties impeded any substantial changes.
The changes
began, however, as the Cultural Revolution came to a unambiguous
end.
With the ascendancy of Deng Xiaopeng a relatively clear
and consistent line emerged, which, though sometimes questioned
and modified, has never been reversed.
Perhaps it was necessarily so, that the initial major
reform was in the agricultural sector, but in the manner in
which it happened it appears somewhat accidental.
Provincial
officials, trying to improve conditions in a lagging region,
agreed to a departure from collectivized farming and to permit
households to assume responsibility for the cultivation of
particular plots of land.
The households were allowed to retain
the surpluses of their production above a required levy.
The
response to the incentives was immediate and very strong, so
•
much so that the experiments were repeated and the "household
responsibility system" was, subsequently, made into official
policy.
A number of other important reforms were then instituted,
For an excellent perspective see A. Husain,
(1992)
15
often piecemeal, sometimes experimentally, and were extended if
successful.
A dual price system was created for a number of
commodities, with a share of these goods being sold in
uncontrolled markets and a share being transferred at official
prices.
The dual price system has been extended to more and
more commodities and the number of commodities for which there
is a commitment to an official price has been steadily reduced.
It has been estimated that prices of about 65 per cent of goods
were completely market-determined by 1993. 10
Although the devolution of economic power to the provinces
has been an important part of the reform program, this process
started as early as the late 1950'
reversals
.
s
and continued, with some
Important new powers have been granted to these
levels of government during the reform period and include the
establishment of new enterprises and. the undertaking of new
public investments and extension of control over existing state
owned enterprises (SOEs)
.
To a considerable extent, the
"decentralization" of decision making that has been accomplished
is not the transfer of power to market mechanisms, but rather a
shift of responsibilities from the central government to
provincial governments.
This,
itself, was important, however,
because the provincial governments have been more flexible, more
experimental, and more susceptible than the central government
10
World Bank (1994b)
16
to economic pressures originating in markets.
While nothing as successful as the agricultural household
responsibility has worked in the state industrial enterprises, a
responsibility system was also created for most of these
enterprises.
These firms have also been allowed to retain
profits above fixed levies.
That has, however, not resulted in
the elimination of inefficiencies and the SOEs continue to
require large subsidies from government budgets. 11
The most
successful development in the manufacturing and service sectors
have been the township and village enterprises (TVEs)
.
They
have grown from virtually nothing to currently account for an
estimated 40 per cent or more of industrial production and,
perhaps, an even more substantial portion of the service sector.
The TVEs transact in uncontrolled markets with private firms,
with private consumers, with other TVEs, with SOEs and in
international markets.
All of this has been facilitated in the special economic
zones that were created, in which central and, to a considerable
degree, even provincial planning have been completely
eliminated.
In some of these zones there is virtually complete
reliance on market mechanisms for resource allocation and
production of goods and services.
In spite of the major reforms,
11
See Table
3
below.
important rigidities
17
and inefficiencies persist.
For example, the housing, education
and welfare privileges of the employees of state enterprises and
government agencies remain attached to their workplace, rather
than being provided universally by government institutions or
through markets.
This not only reduces labor mobility,
it
creates difficult obstacles to reform of the enterprises, since
they serve as distribution mechanisms for these important
services.
•
From 1978 to the present there have been four waves of
•
expansion that have generated inflationary pressures, with
approximate dating in 1981, 1985, 1988-9 and currently.
In the
first three cases, deflation via overall growth slowdown was
effective, the recovery was quick and growth was resumed
rapidly. 12
The current inflationary surge appears to have not
yet yielded to policy, for reasons that remain to be
investigated. 13
China
'
s
foreign trade began to expand rapidly as the
turmoil created by the Cultural Revolution dissipated and new
leaders came to power.
Though it was not done without
controversy, the argument that opening of the economy to foreign
trade was necessary to obtain new capital equipment and new
12
13
See, R.I. McKinnon,
(1993)
In July of 1995 there seems to have been a slackening in
the inflation rate, although the indicators are still tentative.
18
technology was made official policy.
fact,
This proposition was, in
a feature both of the program of Deng Xiaopeng and of Hua
Guofeng, whom he displaced.
Exports grew rapidly in the 1970
's,
even before the major domestic economic reforms had started.
Subsequently, participation in foreign trade has been
facilitated.
Exporting firms have been allowed to keep larger
and larger shares of their foreign exchange earnings, which
previously had to be sold to the Bank of China in entirety.
Special tax benefits and relief from other regulations have also
been used to encourage foreign investment.
The purpose is not
only to supplement domestic investment, but also to obtain new
technologies and management skills, which, in a central
proposition of the reform movement, are recognized as essential
to economic progress.
Table
2
sources of foreign investment.
shows the totals, types and
The dominant role of Hong Kong
in direct investment is clear, but this may be somewhat
misleading as investers from other countries may use Hong Kong
as a base.
Hong Kong is also much less important than other
countries as a source of loans.
The foreign trade and investment reforms were extraordinary
departures from Maoist orthodoxy and are conventionally
explained as an ideological shift.
However, they may also have
been the result of short term pressures.
From 1977, the first
year for which the IMF publishes data on China's foreign
reserves, to 1978, those reserves fell by more than one third
19
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20
and the ratio of imports to reserves fell by more than 50 per
cent.
These changes, presumably, were echoes of the internal
disruption created by the Cultural Revolution.
of course,
The facts were,
known to the Chinese leadership and must have been a
source of serious concern.
For purposes of comparison, in 1978,
India's ratio of foreign exchange reserves to imports was almost
six times the Chinese ratio.
IV.
Foreign trade planning in the reform process
The changing scope and intensity
The creation of an "open door" policy did not mean the end
of foreign trade planning.
Although Chinese policy became
committed to the expansion of its international trade, the
decision making processes and international trade mechanisms of
the pre-reform period continued in full force for several years,
to a modified degree for several more years and still continue
to be evident in the licensing controls.
It is impossible to
determine the coverage of these controls, so a precise contrast
with domestic policy cannot be made.
There are frequent
announcements of controls on imports and' foreign investment,
recently, for example, in the automobile and steel sectors.
However, there are similar announcements with respect to
domestic investment in some sectors.
There have, nonetheless, been several major changes in the
procedures established in 1978 and 1979: in 1984-85, in 1988 and
21
1991. 14
There have been several motivations in the planning of
foreign trade.
First,
the composition of trade has been managed
to secure the imports deemed necessary for domestic consumption
and production and to ensure that exports not compete with
domestic demand to the detriment of growth.
Secondly, market
power in particular exports has been used to influence prices.
Finally,
trade management has been used to attain the desired
overall balance.
The continuation of foreign trade planning has meant that,
until recently, at least, the practice was maintained of using
domestic prices for the purchase by the FTCs of the goods bought
for export and for imported goods they sold.
extent,
It may,
still be true, as will be discussed below.
to some
This
practice also meant that international prices have not been
fully translated into the domestic economy and significant state
subsidization in the foreign trade sector has continued, for
some imports and some exports.
At the same time, international
transactions outside of the state planning system has been
growing.
Most obviously, enterprises created by foreign
investors have been exempt from the foreign trade planning and
control mechanisms, although subject to some restrictions on
their transactions in foreign currency.
In addition,
substantial amounts of other types of trade, particularly the
14
This discussion draws heavily on World Bank (1988) and
Mihaljek and D. Burton, (1994)
W. Tseng, H.E. Khor, K. Kochhar, D.
.
22
trade of the township and village enterprises and private firms,
has been relatively free.
The clearest evidence is the
existence of the "swap" markets for foreign exchange, that were
created to facilitate transactions between earners and users of
foreign exchange.
The FTCs have been participants in these
markets, but, if the FTCs had been the sole trade mechanisms,
the markets would not have been necessary. 15
Starting in 1979 the branch offices of the old FTCs were
allowed to operate independently and provincial and ministerial
foreign trading corporations proliferated.
In addition
provinces and enterprises were allowed to retain part of their
foreign exchange earnings.
Nonetheless, it was still true in
1981 that the FTCs under the Ministry of Foreign Economic
Relations and. Trade (MOFERT) carried on 91 per cent of the
export trade and 87 per cent of imports.
These proportions
declined as the foreign trade operations of the provincial and
ministerial FTCs and individual enterprises expanded and by 1984
exports and imports handled by the FTCs under MOFERT hand
declined to 79 per cent and 65 per cent of total trade,
respectively. 16
15
It is understandable that government authorities are
reluctant to be explicit about the scope of the planned trade, the
relative importance of the FTCs and the amounts of the state
subsidies they require.
Such subsidies are likely to be
inconsistent with the rules of GATT and the new World Trade
Organization.
16
World Bank (1988), Annex
1,
p. 9.
23
Major changes in foreign trade control policies were made
Provincial governments were, in general,
in 1984 and 1985.
allowed to hold back 25 per cent of their foreign exchange
earnings, with some provinces permitting a higher retention
ratio to local firms.
Enterprises, which had earned and
retained foreign exchange, were, themselves, allowed to use half
of that amount.
A classification scheme for imports was
published, distinguishing "restricted" and "unrestricted"
imports.
All of the former were under the control of MOFERT,
but goods in the unrestricted category could be imported by FTCs
in other ministries and at the provincial level,
MOFERT'
s
as well as by
The result of
FTCs, without licensing requirements.
these changes was to reduce the importance of the foreign trade
plan, but it still continued to be the major factor in foreign
trade policy and practice.
In the planning process the various FTCs submitted to
MOFERT estimates of the exports they would generate during the
coming year.
In a process of iterative review,
consistent with import plans.
these were made
A distinction was made .between
"command" and "guidance" exports.
On the import side, there
were further distinctions between "command",
"priority
investment" and other "priority" imports and other imports that
require licensing.
The "command plan" exports were specific with respect to
physical quantities of the particular goods.
There was
24
centralized allocation of particular inputs to producers, who
were required to meet quotas for delivery to the designated FTCs
for export.
These mandatory exports have been estimated to have
accounted for 60 per cent of total exports in 1986.
With
respect to exports under the guidance plan, targets were
expressed in value terms and there was greater variety of
practice.
Yet in some provinces guidance plan exports were
converted into command exports.
There also appears to have been
differences in practice among the provinces in the extent to
which contracts were made at official prices or at international
prices
.
In some sectors the FTCs financed export firms and
procured goods at negotiated "internal" prices.
This indicates
the variety of commercial practices that began to flourish
during the reform period and that existed side-by-side with
relationships between official institutions and enterprise that
antedated the reform period.
Exports under the guidance plan
are estimated to have been 20 per cent of total exports in 1986.
In that year, twenty per cent of exports are estimated to have
been "above plan".
Those, presumably, reflect the .buoyancy of
the export system and the difficulties in harnessing it within
the plan framework.
On the import side, seven types of raw materials remained
under centralized control; these were the "command imports".
"Priority investment projects" included centrally financed
projects and imports of major and complete plants that received
25
central recognition.
"Other priority imports" are described as
being determined on an,
"ad hoc," basis.
These three categories
of imports are estimated to account for 70 per cent of total
imports.
Planning for. "other imports" consisted of general
guidelines for licensing, with the convention of approval for
imports for which financing is available.
The foreign trade planning process was, subsequently,
supplemented, implemented by a system of duties and licenses for
both exports and imports.
Export licensing, introduced in 1980,
has been used to manage the prices of primary commodities sold
primarily in Hong Kong and Macao, again to exploit China's
market power in these commodities in the two areas.
Export
taxes are also used for this purpose, as well as to limit the
exports of goods for which there are domestic shortages.
Import
licensing is used to control expansion of production capacity
for certain types of products beyond what is deemed economically
or socially desirable,
luxuries.
smuggling and imports of consumer
Import duties are applied to most goods both to raise
revenue and as a means of domestic protection.
The 1988 reform reduced the importance of the foreign trade
plan with respect to the composition of exports and imports.
The coverage of both mandatory plan and priority plan exports
was reduced, the former by about half, to 21 commodities, and
the latter by about a quarter,
However,
from 120 to 91 commodities.
foreign trade planning continued in a different
26
A system of three
framework and with different instruments.
year foreign trade contracts was introduced in which targets
were established by MOFERT, the Ministry of Finance and the
State Planning Commission for each of the provincial level
administrative units and the national FTCs.
These units then
entered into agreements with MOFERT which, except for command
imports, specified in value terms their export targets,
the
share of their foreign exchange earnings to be channeled to the
central government and the central government's commitment to
cover losses on export sales with subsidies.
Another major modification of the trading system occurred
in 1991, when the contracts were converted to annual agreements
and the terms of the contracts were to be developed in
negotiations, based on proposals by provincial authorities and
enterprises.
Currently, while increasing amounts of trade are
uncontrolled, a system of overlapping direct controls has
evolved for some types of imports that continues the
canalization and regulation through specific FTCs and licensing.
Specific import controls were also used for protection of
domestic industry.
Of the 32 per cent of total imports subject
to canalization in 1992,
two thirds were mandatory imports and
one-third in the other import category. 17
General import
licensing is managed by the Ministry of Foreign Trade and
17
World Bank,
(1994), p.
64
27
Economic Cooperation (MOFTEC)
,
the successor to MOFERT.
This
licensing applied to about a quarter of total imports in 1992. 18
China's tariffs have become a sophisticated system of
protection with rates that are among the highest among
developing countries, but which are also distinguished by their
relatively high variance, indicating the specificity of their
targets.
Tariff exemptions and exceptions are so extensive that
tariff collections were only 5.6 per cent of the value of
imports in 1991, although, in 1992, with roughly the same tariff
the trade weighted mean tariff was 31.9 per cent. 19
rate,
Overall, it is clear that for much of the period since
reform, China has managed its foreign trade system actively,
rather than leaving it to internal and external enterprise
initiatives, although in the last
3
to 5 years the extent of
that management seems to have declined.
Since we do not know
the degree of the government's commitments to its targets,
impossible to know how successful the management has been.
it is
If
targets have been missed, we cannot identify and give relative
weights to the contributing factors.
Without more information
with respect to domestic supply conditions, it is impossible to
know whether foreign trade created or avoided bottlenecks
Domestic prices do not give clear signals.
18
World Bank (1994), p. 65.
19
World Bank (1994), p. 56.
28
It has been argued that trade policy in China after 1979
was,
"driven more by export possibilities than import
requirements.
It was a top-down process until 1979, but became
more of a bottom-up process, with estimates of export
availability and import needs made at the local level." 20
This
assessment suggests a mercantilist policy designed to accumulate
foreign exchange reserves.
While there have been periods of
substantial reserve accumulation, these have usually been
followed by reserve decumulation.
long record, as,
for example,
There is, consequently, no
in Japan and Taiwan,
to support
the diagnosis.
Without knowing details of the planning process, it is
difficult to assign priorities to the either the- export or the
import plan.
We do not know to what extent provincial
authorities assigned priority to exports to earn foreign
exchange in order to import or made import plans relying on
central determined allocations of foreign exchange to make
payments.
In particular,
it is hard to believe that the central
authorities thought that the export plans of enterprises, which
have relatively little knowledge of international economic
conditions, foreign exchange rate pressures and domestic
macroeconomic policy, would provide a secure basis for export
projections and, therefore, for centrally determined import
20
World Bank (1988), pp. 21-22.
29
policies.
The breakdown of foreign trade management in the late 1980
The large trade deficits of the late 1980'
's
are evidence
s
that trade management system did not avoid very severe balance
of payments difficulties in that period.
Chart
4
supplements
the previous evidence and shows that the ratio of China's non-
gold international reserves to imports fell drastically from
1984 to 1985 and 1986, before they began to recover slowly.
ha.c
It
been asserted and is plausible that the trade deficits were,
to some extent,
the result of the intentional reduction of
foreign exchange reserves
.
This was reinforced by the increased
freedom that was given to provincial authorities to borrow
abroad.
However, the urgent actions in 1985 to reduce the
deficits suggest strongly that intentional international reserve
reduction cannot account fully for the very rapid increase in
the trade deficits.
What did go wrong then?
Either imports
grew more rapidly than expected or exports grew more slowly.
Chart
2
shows that imports, measured in yuan, more than
doubled from 1984 to 1985. 21
While part of this reflects yuan
depreciation and inflation, it
21
is,
clearly not a sustainable
There is a puzzle in the data for exports in the mid1980' s. As noted in the text, exports grew by 40 per cent in yuan
terms as reported in the Chinese Statistical Yearbook and according
to IMF statistics.
However, the growth rate of exports measured
in US dollars was about 5 per cent.
Again, using IMF data, about
15 percentage points is due to depreciation of the yuan, leaving
to price inflation a rate that seems on the high side.
30
CO
Ratio of Reserves to Imports, Percent
o
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3.
31
pattern.
To some degree the growth in imports reflects the
expansion of the domestic economy, yet it is also true that,
starting in 1985, there was a long term change in import ratios.
Although the growth in imports virtually stopped in 1985 and
1986,
import levels did not decline.
The import/GDP ratio moved
to a distinctly higher level and has not,
to the pre-1985 ratios.
subsequently, returned
In fact, after some reduction of the
trade deficits in 1987, they expanded rapidly again in 1988 and
1989, before being brought under control in 1991 and early 1992.
Subsequently, in 1993 and 1994 imports have again risen rapidly.
Some more light is thrown on the matter by an examination
of the composition of imports during the surge of 1985.
While
there was general growth, imports of three types, grew much more
rapidly than other types: tobacco, clothing and machinery.
Tobacco imports are a small part of total imports, so their
growth is not responsible for the big increase in the trade
deficit.
Still their growth is puzzling.
These imports did not
substitute for domestic tobacco, because, in the same year, its
production also expanded strongly.
It appears that the Chinese
government simply made it possible for the population to begin
smoking more.
It is somewhat easier to explain the growth in clothing
imports and that growth does, in fact, help explain a puzzle.
In the mid-1980
's
the Chinese people were changing their clothes
rapidly: from the conventional blue jackets and trousers to
32
varied colorful individual attire.
There was a small mystery as
to how it was accomplished so quickly.
The import numbers help
clear this up.
It is the third category of machinery imports that is most
revealing with respect to the sources of the breakdown of the
foreign trade management system.
rapidly
These imports grew most
in 1984 and 1985 and maintained their relative position
in 1986.
decisions.
Machinery imports are not spur-of-the-moment
Either as new capacity or replacement of old
capacity, the use of new machinery requires planning which
requires time.
In addition, while some types of machinery can
be purchased "off the shelf", much of it is built to order.
Machinery is relatively heavy and shipment by air is expensive,
so that, more than most other types of goods,
shipped by sea.
it tends to be
All of this means that the rapid growth in
machinery imports in 1985 should not have been a surprise.
It is also possible that the growth of exports was
overestimated, since exports did grow more slowly from 1984 to
1985 than from 1983 to 1984.
It seems implausible that the
authorities would have accepted a projection of a roughly 60 per
cent growth in exports in one year, from 1984 to 1985, which
would have matched the actual increase in imports.
Although the
mid-1980' s were a period of economic expansion in China's major
markets, China's exports were becoming less attractive because
of its domestic inflation.
Alternatively, the use of resources
33
for domestic production and consumption in China became more
attractive than exports.
explanations.
There is evidence for both of these
As indicated in Chart
1,
overall growth of real
national income accelerated in 1985 to over 13 per cent from 10
per cent in 1984.
Price inflation also accelerated to almost 12
per cent, as measured by the consumer price index, from 2.7 per
cent in 1984.
It is most plausible that the extraordinary expansion of
imports occurred as a result of the changes that were made in
1984 in the foreign trade management system that eliminated
quantitative controls for about 35 per cent of imports. 22
That
contributed to the rapid expansion of imports, especially
machinery imports, in 1985 and the consequent large deficits.
This appears to be the kind of mistake that the system should
have been most able to avoid.
system failed.
In this sense,
therefore, the
Moreover, the trade management system was not
able to bring the deficits under control until 1987 and then for
only one year, before they expanded again in 1989 and 1990.
In
order to understand the changes that did occur and the control
policies that came to be used, it is necessary to consider
macroeconomic and foreign exchange rate experience in China.
V.
Macroeconomic and exchange rate policy
We cannot know the economic decision making process within
22
World Bank (1988), p. 102
34
the Chinese government, but it is clear that the period starting
in 1984 or 1985 was a period of new departures in policy, whose
lack of coordination, as suggested above, had some adverse
effects.
The new policies implemented in late 1984 reduced the
range and power of the direct controls over foreign trade as
well as direct economic management of the economy in general.
Existing foreign trade enterprises were made into independent
entities, provincial authorities and provincial enterprises were
given new authority to engage in foreign trade and the agency
system was adopted with users of imports responsible for their
own accounts.
For many types of goods and in some regions, the
guidance provided by the central government seems only to have
been indicative and not compulsory.
For other types of goods
and situations, specific targets were maintained.
While the
huge trade deficits of 1985, led to a partial reversal of these
policy changes, their essence remained and they were
subsequently extended.
The policy changes of 1984, of course, necessitated new
emphasis on and use of indirect macroeconomic instruments of
both domestic and foreign trade policy.
The fact that the trade
balance deteriorated so quickly and to such an extent in 1985
and could not be substantially reversed quickly suggests that
effective macroeconomic policy instruments were not in place
when the quantitative controls were reduced, if not eliminated.
However, under the pressure of events, there was rapid recourse
35
to such instruments.
Public finance and fiscal policy
This is not the place to explore all of the issues of
public finance and fiscal policy in China, rather, the emphasis
will be on their use to affect China's foreign economic policy.
There is evidence that Chinese authorities, while not
Keynesians,
have been aware that tax and expenditure policies
have macroeconomic effects, but there is something paradoxical
in the fact that fiscal policy is not a readily available tool
of macroeconomic policy in China.
It might be thought that in a
one-party state, this could be a relatively flexible policy
instrument.
Yet,
although China is a one-party state, it is a
many-province-power country, and the political power of the
provinces has always been substantial.
While the devolution of power from the center to the
provinces began in the 1950'
s,
it remained true until 1980 that
all tax revenues were forwarded to the central government before
being reallocated to the provinces.
Starting in 1980 the
provinces were allowed to retain all of certain types. of tax
revenues and a part of other types, while a third type was
remitted to the central government.
That resulted in a
substantial redistribution of revenues among the provinces, with
the wealthy provinces being the major beneficiaries, but with
the center maintaining considerable control over the revenues of
some provinces, such as Shanghai.
36
This system was revised in 1985 and a new one that provided
different schedules of remittances for different provinces was
created.
In 1988 a system of three-year "contracts" was
instituted with separately negotiated agreements between the
central government and the provinces for the collection and
return of funds.
These procedures have subsequently been
revised again with the central government regaining more control
of revenues.
Nonetheless, since 1980, the ability of the
central government to exercise macroeconomic fiscal policy, if
it so desired, has been substantially reduced.
The government expenditure budget has all the components
that one might expect, but there are significantly different
relative magnitudes as compared to market economies.
Many
expenditures relating to social services appear directly in
relatively Small amounts in the central and provincial
government budgets, as many of these services are provided by
enterprises or local governments.
That includes housing,
education, and medical and other social services.
hand,
the economic ministries,
On the other
though much reduced in their
.
responsibilities, as compared to the pre-reform period, still
have much greater scope than in market economies.
In addition
the government investment budget includes a larger share of
total investment than in market economies.
In any case, as shown in Chart 5,
it is difficult to make a
prima facie case that the government budget has been used for
37
countercyclical economic policy.
Prior to 1978 the government
usually ran a small surplus overall.
large government direct investments,
Taking into account the
there was, in fact, an
important contribution to national savings.
For most of the
years since 1978, the government has run deficits, but these
have remained in the range of slightly more than
It is possible that 1985 is an exception,
GNP.
the year with the smallest government deficit. 23
2
per cent of
since that was
In the Chinese
official statistics the swing from deficit in 1984 to surplus in
1985 was almost one per cent,
large enough to have a perceptible
effect on total aggregate demand.
The deficits in 1991, 1992
and, budgeted for 1994, were noticeably above the average
levels.
In particular,
in 1993,
there was a 20 per cent
difference between the budgeted and actual deficits, indicating
in another way that government attempts to control expenditures
were ineffective at the same time that its public stance was
strongly anti-inflationary.
Interestingly, over the period
during which government savings have been falling, private
savings have been rising rapidly, thus becoming the major source
23
The percentages are taken from IMF calculations, which
have consolidated budgets at all levels and revised them to the
definitions of the IMF's Government Financial Statistics
The
IMF's estimates of deficits are generally about twice the deficits
reported in official Chinese statistics.
The differences are
mainly due to revision of the Chinese government practice of
treating some borrowing as revenues, debt repayment as a current
expenditure and shifting of revenues and subsidies of state
enterprises among government accounts.
.
38
w
o
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to
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Government Budget Surpluses or
Millions. of Yuan
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1951
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Deficits,
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Growth of Real GNP, Percent
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39
24
of support for the high rates of investment.
The financing of the government deficit has changed
substantially over time.
Foreign borrowing has emerged as a
major source of funds since the early 1980's, accounting,
subsequently,
for a fifth to a third of all borrowed funds.
Borrowing from the People's Bank of China has usually been the
major source of debt finance.
In the late 1980's the government
started selling bonds directly to the banking system, some of
which were resold to the households and enterprises, who also
purchased some bonds directly from the government.
The indirect macroeconomic effects of the government debt
would be expected to occur through the monetization of the
deficit.
Although this undoubtedly occurred, the direct
connection has not been a consistent one, in part because of the
increasing resort of the government to bank and public placement
of its bonds.
Chart
6
shows the annual government deficits and
changes in the money supply, money velocity and inflations
rates, using both the definitions of the Chinese government and
the IMF definitions.
The eye can pick out the closeness of the
relationship between government deficits and changes in the
money supply until the mid-1980'
s,
after which the direct
correlation no longer exists.
But government current deficits are not the only source of
24
See
explanation.
F.
Modigliani
and
L.S.
Cao
(1993)
for
an
40
increases in the money supply.
As noted above,
the PBC has had
difficulty in imposing credit controls and reserve requirements
on the banking system, which has operated with substantial
excess reserves.
Thus,
the banking system,
itself,
in
responding to the demand for loans, has had ample opportunity
for money creation.
Monetary policy
In such circumstances,
it would have been natural for the
central government to have relied more heavily on monetary
policy, but this,
too, has been a blunt instrument.
The
People's Bank of China (PBC) has not been a true central bank;
only in March, 1994 was a bill passed, giving it a central bank
structure.
In particular,
the power at the center has been
sharply circumscribed by the principle of "dual leadership",
which links the provincial banks to the provincial governments.
That,
and the close links between the provincial Communist Party
organizations and the provincial governments, have given those
governments substantial power over operations of the PBC within
the province.
Only in 1988 was the headquarters of the PBC
given the power to appoint the presidents of its provincial
branches.
It might be inferred that such appointments were
subject to political interactions of the center and the
province
It is interesting to note that, after the appointment of
Zhu Rongji to vice-prime minister in 1993, with the announced
41
responsibility of bringing inflation under control, one of the
first actions was a reorganization of the PBC,
control to the center.
to give more
The fact that the process of
implementation has been a long one suggests the difficulty that
the center has had in actually exercising control in this arena.
Monetary policy was intended to be implemented through the
annual credit plan, which, first, applied only to the universal
and specialized banks in China, but which, since 1988 has been
ex-tend to direct financing by enterprises and
financial institutions.
non-banking
This annual credit plan is part of an
overall macroeconomic program, which is subject to central
monitoring.
The major instrument for its implementation has
been credit ceilings set quarterly as well as annually and for
specific types of credit, e.g. fixed investment and working
capital, as well as the totals.
Since the late 1980
's,
reserve
requirements and administered interest rates have also become
monetary policy tools, though both have limited effectiveness.
That is true of reserve requirements because of high levels of
excess reserves in the banking system.
Interest rates have
modest effectiveness for several, reasons: soft budget
constraints of state enterprises and difficulties in supervising
their administration.
It is common among western economists to complain about the
lack of sophisticated tools at the service of monetary policy in
China.
However, the tool of direct control of the volume of
42
Government
Deficit, Billions of
Yuan
O
>
z
o
m
CI
o
<
0)
(0
—
3
Q
O
<
m
lo!
a
m
t
o
m
ISI
TJ
a
^ Q
u> H
-<
2
CD
o
00 "
i.
fi)
3
Si
-<
(A
C
o
I
0)
TJ
I
!!!
I
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m
rO
o
:
!*:
i
I
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l£!
i
<D
w
\l
a
Changes
in
Money,
Inflation,
Changes
in Velocity,
Percent
o
01
a.
43
credit can be an effective instrument.
Direct credit controls
have been a powerful and flexible tool of monetary policy in
many countries.
In Latin America,
they were the most common
monetary instrument for many years until the 1980
no doubt,
'
s.
There are,
inefficiencies in their use, as compared to monetary
instruments that operate through the interest rate, but there is
little doubt as to their potential effectiveness.
It cannot be presumed, however,
that the effects of
additions to the money supply in China correspond to analogous
changes in market economies.
There are no national financial
markets through which changes in the money supply would affect
interest rates.
While there are local markets, which are
increasingly interconnected, those are relatively recent
developments, and are limited in scope and intensity.
while
Moreover,
the ventures of private and cooperative enterprises might
be affected by the interest charges on their bank loans,
it is
less obvious that this is true for state owned enterprises.
Their bank loans may be negotiated through the intermediation of
the central government or provincial government ministries.
This may be also true in practice' of some loans to private and
cooperative enterprises
The problem in the use of direct credit controls in China
has been the difficulty of enforcing them.
The provincial
branches of the NBC have not, perhaps until recently, been
willing or able to resist the pressures of local enterprises,
44
backed by the provincial governments, for credit, even when that
meant breaking through their credit ceilings.
The substantial
bank excess reserves facilitates their lending and the
difficulties of controlling credit advanced by the rapidly
growing non-bank financial institutions have compounded the
problem of credit controls. 25
Exchange rate policy
Exchange rate policy in China has also been complicated by
special administrative and political conditions.
Before the
reforms, all foreign exchange earnings were collected by the
central government and reallocated through the NBC.
Although
there was, nominally, one exchange rate until 1981, the
multitude of special provisions for balancing trade, in effect,
created many different rates.
For example, as noted above, the
Foreign Trade Corporations were required to procure goods for
export at domestic prices and sell imported goods also at
domestic prices.
Since their losses on these transactions would
be covered by subsidies from the government budget, the
effective exchange rate was different from the nominal rate.
As
the reform program progressed and the FTCs were made
25
See W. Tseng, et al
for discussion of the constraints
use of credit controls and assignment of the problems of
monetary policy to the lack of market-based instruments of monetary
policy.
An unconventional rationale for the development of those
instruments is that they would not be subject to the local
political pressures that now constrain the use of direct controls.
.
on
45
individually responsible for their own losses, the importance of
this source of subsidies declined.
for foreign trade, that,
in effect,
Other sources of subsidies
create a wedge between the
actual and the effective exhange rate remain.
For example, as
noted above, provincial officials have been influential in
gaining loans for local enterprises, bypassing credit rationing
and interest rate constraints.
Nonetheless, the foreign exchange rate is unique among
macroeconomic and foreign economic policy tools in China in that
it appears to be entirely under the administrative control of
the central government.
tool, which,
That should make it a more flexible
as will be shown, has sometimes been the case.
At the beginning of 1981 a single exchange rate, below the
official rate, was created for the internal settlement of
foreign trade transactions.
That still left a multiple exchange
rate system for external transactions until 1984, when a single
rate was established.
This did not last long in the face of
rapidly growing deficits and, in 1986, a dual exchange rate was
created, with an "official" rate being pegged to the dollar.
Starting in 1985, some enterprises, particularly those created
with foreign funds, and some provincial governments were allowed
to retain a part of their foreign exchange earnings.
This
system was gradually extended and Foreign Exchange Adjustment
Centers (FEACs) were established in 1986 in which these
retentions could, initially, be purchased by foreign funded
46
enterprises, at prices set within the FEACs.
This created an
"unofficial" flexible exchange mechanism, although we do not
know the extent to which the government intervened in this
market.
The exchange rate determined in the FEACs was always at
a premium in relation to the official rate, with the premium
sometimes quite large.
After 1986, there were a number of minor
adjustments in the official exchange rate with a major
devaluation in December, 1989, when the value was reduced by 21
per cent and again in November, 1990, when there was a
9
per
cent devaluation.
Access to the FEACs was extended in 1988 to all firms with
foreign exchange earnings or retention quotas and extended still
further in 1990 and 1991, with individuals being allowed to buy
and sell in computerized trading.
On January 1,1994 a single exchange rate was established at
the rate then prevailing on the swap market and the retention
system was eliminated except for foreign enterprises.
Foreign-
funded enterprises operate under special rules that permit them
to retain all of their foreign exchange earnings but require
them to obtain approval from the State Administration for
Exchange Control (SAEC) for purchases and sales of foreign
exchange.
The role of the SAEC in approving transactions by
domestic enterprises has been eliminated.
It is still true that
receipts of foreign exchange from sales abroad by domestic
enterprises must be sold to designated financial institutions.
47
For trade not subject to quotas,
registration,
licensing or automatic
foreign exchange can be purchased by importers
presenting commercial invoices or bills.
by-
Purchases of foreign
exchange for controlled imports requires the appropriate
approvals
Exchange rate determination is now a managed float.
People
'
s
The
Bank of China announces a rate at the beginning of each
trading day and intervenes in the market to keep the rate within
0.3 per cent of that rate.
Since the unification of the
exchange rates, the yuan/dollar rate has remained virtually
stable at about 8.7 yuan per dollar until the present.
Chart
7
shows the time pattern of the real exchange rate since 1981.
The present system for the determination of the exchange
rate is similar to that in a number of market economies.
A
significant difference remains because important amounts of
foreign exchange continue to be allocated by licensing and
permits.
That,
too,
is to be reduced in importance by an
agreement with the United States in October, 1994 in which China
will eliminate most of its quota and license controls .over a
five year period.
Assessment of China's trade policy
China has become a much more open system over the last
twenty years and much more is known about it than previously by
outsiders.
Nonetheless, there are still features of its economy
and its economic policy that remain somewhat opaque.
In
48
CO
Real
o
c
o
_k
CD
CD
ro
o
b
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o
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Index
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49
particular, with respect to foreign economic policy,
it is
impossible for outsiders to know the extent to which direct
interventions and indirect policies of various types remain
important.
So assessments must remain tentative.
The composition of exports and imports
There have been great changes in China
'
s
foreign trade
policy since the economic reform programs began, from its
original character as a planned, managed, canalized and
Yet it would not be accurate to describe the
controlled system.
current system as completely free.
A substantial amount of
trade continues to be canalized through the FTCs and subject to
supervision.
A number of centrally imposed licensing and quota
requirements for particular goods persist. 26
In addition there
are trade restrictions imposed by provincial officials, which
are acknowledged, but not completely codified and, therefore,
difficult to assess
.
It is still not uncommon to read that some
Ministry has decided that imports or exports of a particular
good must rise or fall or reach a specified target.
Presumably
this is not wishful thinking and actually represents a policy
which the Ministry is able to implement.
Licensing continues for a large share of China's imports,
estimated to be 30 per cent in 1993, to provide protection to
26
The goods subject to export licensing has been estimated
to account for 48 per cent of total exports in 1993.
See W. Tseng,
et al (1994), p. 5.
.
50
domestic sectors, for overall plan implementation and as a means
27
of achieving overall balance.
There is also a comprehensive
tariff system, with an average unweighted tariff of 40 per cent,
with an elaborate system of duty exemptions, which provide a
mechanism of control.
The central and provincial governments
have a direct role in the import of certain products such as
staple foods and petroleum.
Charts
and exports.
8
and
9
indicate the composition of China's imports
Clearly "heavy manufactures", which are mainly
capital equipment, have dominated imports, except during the
drought and famine years of the Great Leap Forward in the early
1960's, when food imports became of greater importance.
It is
also striking that the capital; imports from the former Soviet
Union and Eastern Europe were replaced quickly by imports from
non-Communist countries.
On the expert side,
food exports were
the most important single component until 1978, again,
for the Great Leap Forward period.
except
Since then light
manufactures have become the leading export.
It has been argued that China's international trade has
reflected, although perhaps not completely determined by its
comparative advantage in labor intensive products.
apparent transparency in this argument.
There is an
Much of the growth of
exports has been facilitated by Hong Kong, whose enterprises,
27
W.
Tseng, et al
.
p.
5,
51
one would expect to be quite sensitive to international prices.
Moreover, a careful investigation of the labor intensity of its
28
exports supports the inference.
The argument poses a puzzle, however.
As noted earlier,
the distorted prices of the pre-reform period could not have
guided exports along lines of comparative advantage.
reforms,
After the
the liberalization of prices has been gradual and their
relationship to real costs must remain doubtful, especially in
the state owned enterprises
.
While it is true that wages have
been freed from most controls in the Special Economic Zones and
in some sectors, wages in state owned enterprises are still not
market-determined.
The scope for market pricing has steadily
expanded, but for most of the reform period, and even now,
important inputs are still subject to price controls.
Moreover,
we know that, although to a decreasing extent, trade has been
canalized through the FTCs and their trade losses have been
covered by the government budget.
How is it possible, then, that China's real comparative
advantage could have become manifest and determined trade
patterns, when most prices have been distorted for most of the
reform period and trade has been subject to somewhat arbitrary
practices?
But,
It is hard to explain this,
except by denying it.
if it is denied, how then can one explain the composition
28
World Bank (1994), Annex 7.2
52
U o
r a>
o O
in
d
(f>
Share, Percent
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o
(T>
>
m
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Q.
Q.
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D
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CD
D
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1955
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1958
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54
of Chinese exports?
The answer is relatively simple.
What else could China
have exported in quantity except petroleum, foods, particularly
to Hong Kong,
textiles and simple manufactures?
The petroleum
exports of the early reform period based on the crude oil
reserves, were among the most immediately marketable of China's
products.
China has only recently developed the expertise and
capacity to sell some capital goods in foreign markets.
That is
true also of sophisticated consumer goods, such as electrical
consumer durables.
In addition, because of its high rate of
investment, China has chosen not to export any of the capital
goods which might find a foreign market, but rather has kept
those at home.
There is a sense, however, in which real relative factor
scarcities have determined Chinese exports.
Its manufacturing
capacities reflect its relative scarcities.
Because of its
relative capital scarcity and relatively low levels of skill,
much of its productive capacity is relatively labor intensive.
This is particularly true of the township and village
enterprises (TVEs) that have grown extremely rapidly since the
beginnings of the reform and are now estimated to account for
roughly 40 per cent of industrial production.
Table
3
presents
estimates of the share of the exports of the TVEs in total
exports.
and 1990.
As shown, the share increased five times between 1985
55
Table
3
Township and Village Enterpr ise Exports
Year
Exports
($ billion)
Share of Total
1.20
2.67
4.35
8.03
10.00
12.50
4.4
8.6
11.0
16.9
1985
1986
1987
1988
1989
1990
*Tr?ken from
(per cent)
19.1
20.2
World Bank (1994), p. 14.
The role of comparative advantage in determining exports
is,
no doubt, increasing as the scope of market determined
prices increases.
And, with the help of foreign investors,
effective capacities in other types of goods are emerging and
making their way into export markets.
Overall balance, macroeconomic and foreign exchange policy
Although a number of important direct and indirect
interventions in international trade persist, there is no doubt
that,
as a result of the reforms,
there is now a much greater
reliance on macroeconomic and foreign exchange rate adjustments
in China's foreign trade policy.
The interventions and exchange
rate adjustments appear to be used together, however, not always
with full consistency.
It does not appear to be the case that
China has ever made a major internal macroeconomic adjustment,
56
motivated primarily by the need to correct a payments
imbalance. 29
On the other hand,
international payments issues
may have been a contributing influence in some macroeconomic
adjustments,
for example in 1988 and 1989.
the late 1980'
s
As noted above, in
the foreign trade management system did not
prevent a succession of years of substantial trade and payments
deficits.
Those were reversed in the 1990 and 1991, in spite of
the considerable liberalization of trade practices.
Chart
3
,
As shown in
the trade and services account swung into deficit again
in 1993, but that deficit was eliminated in 1994.
The primary motivation for changes in Chinese macroeconomic
policy seems to have been domestic inflation.
While domestic
economic restraint or stimulation created through monetary
policy has undoubtedly affected trade, it appears that greater
reliance has been placed on the foreign exchange rate as an
instrument of policy.
Estimated changes in the real exchange rate from 1981 to
1994 are presented in Chart 7, using the Chinese and the U.S.
consumer price indices for the deflation.
There was an
effective real depreciation from 1981 to mid-1993, but,
subsequently, as Chinese prices rose relatively rapidly, there
has been a significant real appreciation in the yuan.
As yet,
that has not elicited an adjustment in the nominal rate,
29
See Tseng et al
.
(1994), p.
8
57
presumably because of the excellent recent performance of
Chinese exports.
The monthly data in Chart
7
on Chinese exports poses
As the estimated real exchange rate has
another puzzle.
appreciated, exports have grown.
apparent paradox?
What can account for this
The puzzle is interesting, because the answer
might throw some light on trade conditions and exchange rate
policy.
There are not many possible explanations of the puzzle:
(1)
there may be a delayed reaction of exports to
relative prices;
(2)
there may be some offsets to import and export
prices subsidies, that have made it possible for
Chinese enterprises to continue to export at higher
prices;
(3)
the statistics may be incorrect.
Unfortunately, it will not be possible to make a definitive
distinction among these alternatives, but some judgment can be
applied.
The first answer is not implausible.
The "J-curve"
response to currency depreciations has been observed in other
countries at other times.
It seems unlikely in this case,
because such a large proportion of Chinese exports, textiles and
toys,
for example,
faces strenuous competition and the demands
for these goods must be very elastic and respond quickly to
price changes.
A second rationale for the first answer is that
58
domestic costs have not risen so much that Chinese exporters
cannot still cover the variable costs of their exports
selling abroad.
by-
Finally, the first answer could be correct if
the profit margins on Chinese exports have been very large.
That would have made it possible to maintain the foreign
exchange price, absorbing the incrases in domestic costs.
That
pattern has also been observed, for example, in the past for
other countries.
Taking up the second possibility, it is possible that
enterprises have expanded exports, even at a loss, because of
domestic offsets to the loss.
For example, state owned
enterprises and the Foreign Trade Corporations might have been
exporting at losses, with the expectation that those would be
covered by government subsidies.
It is somewhat less likely
that SOE managers would have done this in 1994, as compared to
previous years, since, to an increasing extent, their own
bonuses have been tied to their firms' profits.
Nonetheless, it
is possible to imagine a conjunction of circumstances that would
have resulted in an increase in such practices.
Since the
allocation of foreign exchange is, to some extent, still
restricted, there may be a scarcity value for foreign exchange
which is above the official rate.
That,
temptation which was not fully resisted.
be made with respect to the FTCs.
in turn,
could create a
The same argument can
Another type of export
incentive might have arisen from a liquidity shortage, created
59
by monetary stringency.
Export earnings, even at losses, could
have been used to offset this monetary tightness.
Finally, there are at least two ways in which the Chinese
statistics could be incorrect.
First,
there may just be
mistakes as the result of incomplete coverage or errors in
measurement of of exports and imports, although it is not clear
A
why mistakes should take just the pattern shown in the data.
systematic type of error could have its source in the
underinvoicing by exporting firms in 1993.
Then, when the
profits were repatriated in 1994, they would be reported as
exports.
That is made more plausible by the recognition that
the unification of exchange rates on January 1,1994 was an
effective devaluation, which had been proceeded by speculation
that some type of depreciation would take place.
It would have
been rational in such circumstances for exporters to have
thought of taking advantage of a prospective depreciation by
postponing repatriation of profits.
In any case,
it is clear that Chinese authorities now
consider the foreign exchange rate an important policy tool
which is used with discretion, but strategically.
Implications of China's trade policy for participation in the
World Trade Organization
This is not the place to attempt a review of the all of the
issues related to China's potential role in the World Trade
Organization (WTO)
,
but some brief implications of the previous
60
discussion can be made explicit.
Briefly put, questions about
China's entry into the WTO have arisen because its management of
trade in the past has raised questions as to its adherence to
the non-discrimination principles of GATT.
As has been pointed out,
some aspects of the trading
arrangements in China are quite complex, with a number of
different participants.
The interactions of these different institutions provide
opportunities for the granting and for the concealment of
subsidies that can support discriminatory treatment.
Table
4
presents data on the magnitude of the losses of the FTCs from
1986 to 1987.
To put these losses into perspective,
the values
of China's total exports in corresponding years are added in a
final line.
It
can be seen that, although the losses of the FTCs
declined from 1986 to 1991, they remained, in that year, at
about
5
per cent of the total value of exports.
Since the
losses were, most likely, concentrated in certain types of
trade, rather than being spread evenly across all trading
categories, the losses were, most likely, a larger fraction of
trade of particular types.
It should also be pointed out that
the table does not include any losses of the FTCs
of the provincial governments that might have been borne by
those governments.
61
Table
4 30
LOSSES OF FOREIGN TRADE CORPORATIONS
FINANCED BY CENTRAL GOVERNMENT BUDGET
(Y billion)
1986
1987
1988
1989
1990
1991
Losses
24.96
28.21
26.85
33.64
22.44
17.61
Total Losses of
of SOEs within
budget
41.71
48.17
52.06
74.96
'93.26
93.11
108.58
147.18
176.95
195.25
293.06
375.04
Year
Exports
Tcjral
Table
4
proves nothing with respect to government support
of exports by China,
since some, unknown portion of the losses
may have arisen in the subsidization of imports.
suggest, however,
The table does
the difficulties that arise for outsiders in
coming to a judgment as to the extent to which the central and
provincial Chinese governments still do play a direct role in
trade
Economic reform and political reform
It is natural to look for generalizations from the Chinese
experience on the relation between economic and political
reforms.
In particular,
compared to the former Soviet Union, it
is tempting to say that the Chinese policy demonstrates the
success of giving priority to economic reform (perestroika) over
30
26
This table is taken directly from World Bank (1994a)
,
p,
62
openness and political reform (glasnost').
The temptation has
not been resisted by many commentators.
The history of the reforms in China, the former Soviet
Union and Eastern Europe provides us with only a small sample of
possibilities, however.
historian,
Thus,
the art of the political
rather than the techniques of the econometrician, is
required to produce generalizations.
Since the experiences with
economic reform have been so dissimilar, it is plausible that
they are due to differences in the societies, their economies
and the political conditions which prevailed at the outset of
the reform programs.
of these aspects,
There are important dissimilarities in all
of course, but the differences in the
conditions when the reforms first started seem especially
important
In particular,
the political and economic events in China
just before the reforms primed the country for the subsequent
economic changes.
The Cultural Revolution had thoroughly
disrupted ordinary life in both urban areas and the countryside
and even led to small scale civil war in some cities.
There had
been extensive disruptions in the government bureaucracies and
in the professional classes, as well in the political leadership
groups.
As the Cultural Revolution faded, many, if not most, of
the displaced persons returned to their previous, or similar,
positions.
It seems a reasonable presumption, nonetheless,
that
there was a residue of resentment among all classes against a
63
This would have created an
system that had treated them badly.
openness to reforms that promised not only economic improvements
but a reduction in the pervasiveness of government supervision
and an expansion of the scope for personal activity.
Moreover,
the reinstated bureaucrats and political leadership did not have
entrenched positions and privileges to defend against new ideas.
However, the personalization in the Gang of Four of the
excesses of the Cultural Revolution helped to maintain the image
and authority of the Communist Party.
In addition,
since the
source of the reforms was the new leadership of the Communist
Party, accepting and supporting the reforms did not require
rejection of the political system.
Thus,
the Party and the
government retained legitimacy, in the sense that its
announcements had credibility.
In addition,
the turmoil at the
center of government in Beijing must, certainly have strengthened
the provincial leaders and bureaucracies.
Much of the original
'decentralization of economic power' was not a replacement of
government by market control, but rather a transfer of power
from the central government to the provincial governments,
creating opportunities for local officials to strike out and
make their reputations
on their own initiatives.
Yet skepticism about the proposed reforms would have been
natural, given the history of repeated tacks and turns and
changes in direction and consequent disruptions.
However, there
was a substantial and immediate payoff to the reforms that were
64
The increase in
initially made in the agricultural sector.
productivity increased agricultural incomes and improved the
quantity and variety of foodstuffs available in the cities.
So,
unlike previous reforms, this one seemed really to work.
This story offers some strong contrasts with the former
Soviet Union and Eastern European countries.
While their
economies were virtually stagnant prior to the reforms, they
were not in disarray and confusion.
Thus,
there were still
established positions and privileges at all levels to defend
against the threats of new policies.
Moreover, the new policies
were announced by governments that had admitted any number of
political, personal and economic crimes
in the past.
Finally, the reforms in the former Soviet Union and Eastern
Europe did not pay off quickly in significant economic
improvements.
Rather,
another act of faith:
the populace were asked to engage in
that, with sacrifice and forebearance,
their lives would continually improve.
With differences in
content, that, of course, was the promise of the Bolshevik
Revolution.
It was a promise that had not been fullfilled and
the same old gang was asking it of them again.
It is slight
wonder that it could not generate general support.
This reasoning about the still early experiences with
economic reform of the former Soviet Union, Eastern Europe and
China argues that they are not differentiated by the contrast
65
between the consequences of the timing of glasnost
perestroika.
'
and
Rather the different experiences reflect the
histories, mainly recent, with which the different countries
entered on their new economic adventures.
Conclusions
It is striking that,
as a transition economy, China has
managed its international trade and payments as an effective
adjunct to its development policy and without persistent
Though there have been difficulties, they have not
prcblems.
been persistent, and have not become major obstacles to its
economic growth.
To achieve this, China has moved away from the
completely planned and managed international trade and payments
policy with which it entered its reform period in 1978 and which
it maintained for several years afterward.
Increasing freedom
has been given to exporters and importers.
A dual price system
for foreign exchange was created to facilitate trade without
imposing all the costs of a full devaluation.
Subsequently the
exchange rates were unified.
Yet,
it would be mistaken, as noted above,
to -consider
Chinese foreign trade and payments now as completely market
determined.
There still is a substantial amount of planning and
control, but, without more information than is available to
outsiders, it is impossible to evaluate its relative importance.
The obstacles to the transformation of China's
international economic relations have been formidable.
The
66
attitude of irrelevance with which international trade must have
been regarded by many enterprises had to be supplanted with
trade incentives.
The independent attitudes and ventures of
provincial leaders had to be tamed.
The multiple temptations of
international markets had to be both resisted and exploited.
None of this has been done perfectly, to be sure.
There
are enough imperfections and holes in the policies to have sunk
the ship,
except for one thing.
The expansion of the domestic
economy and of exports has been so strong as to overcome any
defects without major crises.
For this some credit must be
given to the foreign trade and exchange rate policymakers and
policy executers, who have managed to steer an unwieldy, if fast
moving ship.
To some extent also the successes of the economic
reforms are reactions to the economic and political failures of
the Cultural Revolution.
The political excesses and economic
turmoil of that period the prepared the ground for economic
reforms.
The injection of some degree of market economics then
quickly produced substantial improvments by reducing the
profound inefficiencies that had previously prevailed in foreign
trade practices and production.
The initial successes have been
a strong validation of subsequent policies.
MIT LIBRARIES
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67
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