11269 October 1985 Long-Term Development Issues and Options ''' ~,~ WORID BANK COtINTY ECONOMIC REPORT CaCLs,z)r Aida CHINA A World Bank Country Economic Report This report is supplemented by six annex volumes published by the World Bank: I China: Issues and Prospects in Education 2 China: Agriculture to the Year 2000 3 China: The Energy Sector 4 China: Economic Model and Projections 5 China: Economic Structure in International Perspective 6 China: The Transport Sector In addition, nine background papers, numbered here as they are referred to in tbe text, have been prepared in connection witb the report. They are available as World Bank staff working papers. 1 IThe Asian Experience in Rural Nonagricultural Development and Its Relevance for China (Staff Working Paper 7 5 7) 2 International Experience in Urbanization and Its Relevance for China (Staff Working Paper 758) 3 Alternative International Economic Strategies and Their Relevance for China (Staff Working Paper 759) 4 International Experience in Budgetary Trends during Economic Development and Their Relevance for China (Staff Working Paper 760) 5 Productivity Growth and Technological Change in Chinese Industry (Staff Working Paper 761) 6 Issues in the Techniological Developmcnt of China's Electronics Sector (Staff Working Paper 762) 7 'Fhe Environment for Technological Change in Centrally Planned Economies (Staff Working Paper 718) 8 Managing Technological Development: Lessons from the Newly Industrializing Countries (Staff Working Paper 717) 9 Growth and Structural Change in Large Low-Income Countries (Staff Working Paper 763) These supplementary, works may be ordered, by annex or working paper number, from local distributors of World Bank publications andfrom the World Bank Publications Sales Unit, 1818 H Street, N.W, Washington, D.C. 20433, US.A. Long-Term Development Issues and Options The report of a mission sent to Cbina by The World Bank Edwin Lim Adrian Wood Cbief of mission Deputy chief of mission Contributing authors Ian Porter Robert P. Taylor William Byrd Gene Tidrick Timothy King Wouter Tims Gerhard Pohl Publisbedfor The World Bank The Johns Hopkins University Press Baltimore and London Copyright © 1985 by The International Bank for Reconstruction and Development/The World Bank 1818 H Street, N.W., Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First hardcover and paperback printing October 1985 The Johns Hopkins University Press Baltimore, Maryland 21218, U.S.A. 'I'he World Bank does not accept responsibility for the views expressed herein, which are those of the authors and should not be attributed to the World Bank or to its affiliated organizations. The designations employed, the presentation of material, and any maps used in this document are solely for the convenience of the reader and do not imply the expression of any opinion whatsoever on the part of the World Bank or its affiliates concerning the legal status of any country, territory, city, area, or of its authorities, or concerning the delimitation of its boundaries or national affiliation. Library of Congress Cataloging in Publication Data Main entry under title: China, long-term development issues and options. "A World Bank country economic report." 1. China-Economicpolicy-1976- .2. China- Social policy. I. Lim, Edwin. II. InternationalBank for Reconstruction and Development. HC427.92.C46452 1985 338.51 85-22777 ISBN 0-8018-3313-2 ISBN 0-8018-3314-0 (pbk.) Cover photograph by Curt S. Carnemark: Family outing at Tiananmen Square, Beijing Foreword The idea for this study originated during my visit to China in 1983. In Beij- ing, I had the opportunity to meet with Chairman Deng Xiaoping and Pre- mier Zhao Ziyang. Through discussion with them and with other distin- guished Chinese leaders, I learned a great deal about the Government's perspective on development and the long-term goals for the country. We talked about the national aim to raise China's annual per capita income to US$800 by the year 2000, and we contemplated some of the exciting possi- bilities and complex questions that China would encounter in the process of reform and modernization. Out of these discussions in Beijing came the agree- ment that the World Bank would undertake a study of some of the key devel- opment issues that China might face in the next twenty years. In particular, this study would examine, in light of international experience, some of the op- tions for addressing these issues. This report summarizes the conclusions of that study. It is based primarily on the findings of an economic mission led by Edwin Lim and Adrian Wood, which visited China in early 1984. It was presented to the Board of Executive Directors, which represents the 148 member governments of the World Bank, in May 1985. This report, in my view, is a good example of one of the many ways that the World Bank can assist its member countries. Indeed, China's ambitious at- tempt to modernize and reform its economy will shape the future of not only the Chinese people but also people throughout the world. We hope that this report will be a useful contribution to the debate in China about some of the important issues of economic and social development. A. W. Clausen President Tbe World Bank September 6, 1985 Contents SUMMARY AND CONCLUSIONS ....................................................... I Pattern of Growth ................................................................ I Managing the Economy ............................................................ 8 Social Issues and Policies ............................................................ 16 Overview ... ...................................................................... 19 1 GROWTH AND CHANGE .......................................................... 21 Objectives ................... ................................ 21 Macroeconomic Change ............. 22 M icroeconomic Change ............................................................ 26 Inequality . ...................................................................... 29 2 ILLUSTRATIVE PROJECTIONS ..................................................... 3 2 Description of the M odel ............................................................ 3 2 Three Alternative Projections ........................................................ 3 3 Growth and Demand ..... ........................................................ 36 Production and Investment ......................................................... 38 Employment and Income ........................................................... 40 Projections and Predictions ........................... ..... 43 3 AGRICULTURAL PROSPECTS AND POLICIES ........................................ 44 Production Possibilities ............................................................. 44 Potential Demand-Supply Imbalances .................................................. 45 Changing Food Demand ............................................................. S M anaging Household Agriculture ..................................................... 5 3 Agricultural Incomes Policy .......................................................... 5 5 4 ENERGY DEVELOPMENT ......................................................... 58 Demand and Supply: Trends and Balances ............................................... 58 Coal Production, Transport, and Utilization ............................................. 60 Oil and Gas ...................................................................... 65 Electric Power . ................................................................. 67 Rural Energy and Biomass . ........................................................... 68 Investment, Planning, and Prices ...................................................... 69 5 SPATIAL ISSUES ...................................................... 7 3 Specialization and Trade ............................................................ 7 3 Transport, Commerce, and Other Services ............................................... 82 Urban and Rural Development ............... ....................................... 86 Rural Poverty and Regional Inequality ............................................... 91 vii 6 INTERNATIONAL ECONOMIC STRATEGY .......................................... 97 China in the World Economy ....................................... ...... ... 97 Foreign rliade ProspeCtLs and Policies .........................10 External Balance and Finance .107 Regional Issues .109 7 MANAGING INDUSTRIAL TECHNOLOGY .1 10 Technology in Perspective .1 10 Planning for Technological Development . 12 The Make or Buy Decision . 16 Incentives for Innovation and Diffusion. 118 Obsolescence and Scrapping .121 8 HUMAN DEVELOPMENT .123 Education and Training Issues .123 Employment and Productivity .127 Allocating and Motivating Workers. 1 30 Population Issues beyond the Year 2000 .136 9 MOBILIZING FINANCIAL RESOURCES .143 Alternative Sources of Saving .143 Subsidies and Transfers .148 Revenue Needs and Sources. 152 Tax Reform .156 10 DEVELOPMENT MANAGEMENT .160 The State and the Individual .160 The State and Enterprises .164 Investment and Pricc Reform. 171 Economic Planning .177 Overview .181 Tables 1.I Size Distribution of Industrial Enterprises in Selected Countries ............................... 28 1.2 Rural Income Distribution, 1979-82 .................................................... 29 2.1 Average Annual Growth of National Income, Alternative Projections, 1981-2000 ..... ............ 36 2.2 Composition of Final Demand, Alternative Projections, 1981-2000 ............................ 36 2.3 Average Annual Growth of Sectoral Gross Output, Alternative Projections, 1981-2000 .... ........ 38 2.4 Composition of Capital Stock, Alternative Projections, 1981-2000 ............................ 39 2.5 Sectoral Composition of the Labor Force, Alternative Projections, 1981-2000 .................... 40 2.6 Sectoral Composition of National Income, Alternative Projections, 1981-2000 ................... 42 4.1 Energy Supply and Dcmand, Alternative Projections, 1981-2000 .............................. 60 4.2 Share of Solid Fuels in Commercial Energy Use in Selected Countries, 1960, 1980, and 2000 .... .... 62 4.3 Estimated Investment Requirements in the Energy Sector, 1986-2000 .......................... 70 5.1 Dispersion of Production Activities among and within Provinces, 1982 .................... ..... 73 5.2 Gross Output and Profits of State-Owned Industry, by Province and Subsector, 1982 ............... 74 5.3 Industrial Conccntration, by Region and Key City, 1982 .................................... 74 5.4 Extent and Composition of Rural Nonagricultural Activities in Selected Countries ..... ............ 79 5.5 Urbanization and Economic Development in Selected Countries .............. I ................ 87 5.6 Per Capita Income in Urban and Rural Areas, 1982 ........................................ 87 viii 5.7 Distribution of Employment and Population, Alternative Projections, 1981-2000 ................. 89 5.8 Average Annual Growth of Urban and Rural Income, Alternative Projections, 1981-2000 .... ...... 90 5.9 Urban-Rural Income Disparities, Alternative Projections, 1981-2000 . .. ......................... 90 5.10 Rural and Provincial Poverty, 1982 ........ ............................................. 92 5.11 Rural Development in Dingxi County (Gansu) and WvVuxi County (iangsu), 1983 ...... ............ 92 5.12 Wage Levels, by Province and Type of Unit, 1982 ......................................... 94 5.13 State Budget Revenues and Expenditures in Wuxi and Dingxi Counties, 1983 .................... 96 6.1 Total Foreign Trade Ratios, Alternative Projections, 1981-2000 ............................... 102 6.2 Share of Manufactures in Total Merchandise Exports, 1960 and 1981 ........... ............... 103 6.3 Sectoral Foreign Trade Ratios, Alternative Projections, 1981-2000 ............................. 104 6.4 Average Annual Growth of Foreign Trade, Alternative Projections, 1981-2000 ................... 104 6.5 Structure of Foreign Trade, Alternative Projections, 1981-2000 ............................... 105 6.6 Foreign Trade Balance and Debt, Alternative Projections, 1981-2000 ........................... 107 7.1 Index of Total Factor Productivity in State-Owned Industry, 19 52-82 .......111.................... 111 7.2 Sources of Successful Innovations in European Firms ....................................... 118 8.1 Educational Attainment of the Population, by Age and Sex, in Selected Countries ................. 124 8.2 Population Growth, Alternative Projections, 1980-2100 ................................... 137 8.3 Population of Working Age, Alternative Projections, 1980-2100 .............. ............... 139 8.4 Population Sixty-Five Years Old or More, Alternative Projections, 1980-2100 ................... 139 9.1 Gross Domestic Savings in Selected Countries, 1976-80 ..................................... 145 9.2 Subsidies, 1981 . .................................................................... 148 9.3 Subsidies and Transfers as Percentages of Government Revenue in Selected Countries ..... ......... 149 9.4 Subsidies and Transfers, Alternative Projections, 198 1-2000 .................................. 151 9.5 Government Expenditures, Alternative Projections, 1981-2000 ....1.......................... 153 9.6 Illustrative Projections for Figure 9.2 .................................................... 155 9.7 Illustrative Projections for Figure 9.3 ..................................................... 57 Figures 1.1 Composition of Aggregate Demand in China and Other Developing Countries, 1981 ..... .......... 22 1.2 Structure of Production in China and Other Developing Countries, 1981 ........................ 23 1.3 Structure of Employment in China and Other Developing Countries, 1981 ...................... 24 1.4 Enrollment Ratios in Formal Education in China, 1965-83 and Targets for 2000, and in Other Developing Countries, 1965-80 .31 2.1 Share of Agriculture in Total Employment in China, Alternative Projections for 1981-2000, and in Other Selected Countries, 1960-82 .............................................. 41 3.1 Crop Exports and Imports, Alternative Projections, 1981-2000 ...... ........................ 48 3.2 Per Capita Food Intake in China, 1981-2000, and in Other Selected Economies, 1960-80 .... ...... 5 1 3.3 Share of Animal Products in Total Food Intake in China, 1980-2000, and in Other Selected Economies, 1960-80 . .............................................................. 52 5.1 Variations in Per Capita Gross Agricultural and Industrial Output, 1982 ......................... 76 5.2 Distribution of Employment, Capital, and Gross Output, Alternative Projections, 1981-2000 .... .... 88 6.1 Exports of Goods and Nonfactor Services in Selected Countries, 1978-82 ....................... 98 6.2 Trade in Goods and Nonfactor Services, 1978-83 ........................................ 102 6.3 Direction of External Trade, 1983 ...................................................... 105 6.4 ExternalBalance, 1978-84 .............................................. ... 107 7.1 Output and Cost of Production of thejA 1-1 Sewing Machine, by Enterprise, 1980 ................ III 8.1 Population, Alternative Projections, 1980-2 100 ........... 137 9.1 Sources and Uses of Funds,19 81 ......................1................................. 144 9.2 Income Flows and Taxation, Alternative Projections, 1981-2000 ... . .......................... 154 9.3 Sources and Composition of Saving, Alternative Projections, 1981-2000 ........................ 1 56 ix Boxes 1.1 Size and Growth of Enterprises in Market Economies ....................................... 27 2.1 Wages, Profits, and Prices ................................................. ........ 42 3,1 World Grain Trade, Past and Future .................................................... 50 4.1 Cogeneration for Industry and District Heating .6...................................... 63 5.1 The Spatial Distribution of Dairy Production ............................................. 77 5.2 Locational Issues in the Iron and Steel Industry ............................................ 80 5.3 Locational Issues in the Bicycle Industry ................................................. 81 5.4 Trade, Pricing, and Transport of Cement ................................. ............... 84 5.5 Agriculture on the Loess Plateau ....................................................... 93 5.6 The Benefits and Costs of Migration to Communities of Origin ............................... 94 6.1 Contrasting Types of International Economic Strategy ...................................... 99 7.1 Continuous Casting of Steel .......................................................... 113 7.2 Strategic Options in Power Station Boiler Technology ....................................... 114 7.3 A Successful Strategy in Electronics . .................................................... 1 15 8.1 The Second Health Care Revolution .................................................... 140 10.1 Dispersed Social Ownership in the Federal Republic of Germany .............................. 167 10.2 Monetary Control . ................................................................. 174 Maps 5.1 Per Capita Net Material Product, by Province, 1982 ..... ................................. 75 5.2 Provincial Budget Expenditures and Revenues, 1982 ........................................ 95 Relief and Administrative Divisions ..................................................... 183 x Preface This report was prepared principally by members of an tant), and Fred Bentley (consultant on arid agriculture). economic mission that visited China twice in 1984, for . Energy. Roberto Bentjerodt (senior economist, coal four weeks in February-March and for five weeks in projects), Weigong Cao (power engineer), Abdel El- April-May. In addition to visiting Beijing, the mission Mekkawy (engineer, petroleum projects), Robert Taylor went to three provinces: one coastal and relatively high- (energy economist), and Darrel Fallen-Bailey (consultant); income (Jiangsu); one inland and average-income (Hu- D. C. Rao (assistant director, Energy Department) led the bei); and one interior and low-income (Gansu). It re- team in the field. ceived a lot of information, as well as numerous valuable * Industrial tecbnology. Gene Tidrick (team leader), comments and suggestions, from officials and others in Anupam Khanna (industrial economist), Reza Amin (in- these provinces, as well as from those in many central dustrial specialist), and Josephine Woo (research assis- agencies and institutions, including: the State Planning tant). and State Economic Commissions; the Ministries of Fi- * Location and trade. Ian Porter (team leader), Vernon nance, Agriculture, Coal, Communications, Education, Henderson (consultant on urbanization), John Sheahan Foreign Economic Relations and Trade, Labor and Per- (consultant on industrial location and trade), and Samuel sonnel, Petroleum, Railways, Urban and Rural Construc- Ho (consultant on rural nonfarm activities). tion, and Water Resources and Electric Power; the State The following also contributed to the preparation of Statistical Bureau; and various universities and research the report: Wlodzimierz Brus (consultant on socialist institutes of the Chinese Academy of Social Sciences. A economies); Gerhard Pohl (energy and transport); Robert series of seminars was organized by the Technical-Eco- Drysdale (Annex l); Helena Ribe and Nikhil Desai (An- nomic Research Center under the State Council. The nex 3); Shujiro Urata (Annexes 4 and 5); and Lily Uy generous and thoughtful assistance of all these people in (Annex 6). Larry Westphal, Carl Dahlman, and Bruce China contributed greatly to this report. Ross-Larson organized background work on technology. The Bank mission was led by Edwin Lim (mission Behrouz Guerami-N, Tejaswi Raparla, and Kong-Yam chief) and Adrian Wood (deputy mission chief) and also Tan helped with the multisectoral model, the input-out- consisted of William Byrd (economist), Mats Hultin (se- put table, and data for international comparisons. Ann nior education adviser), Erh-Cheng Hwa (senior econo- Orr, Kenneth Hill, Moshe Syrquin, J. V. S. Sarma, Ken- mist), Timothy King (senior economist), Jacques Yenny neth Cochran, Chang Hsin, Liu Ying, and Cai Jinyong (senior transport economist), Umnuay Sae-Hau (research undertook research. Linda Mitchell, Terrice Bassler, and assistant), Betty Ting (interpreter), Luc De Wulf (senior Carol Cole Rosen edited the report; Helen Kung assisted economist, International Monetary Fund), Benjamin in its processing; and Catherine Ann Kocak prepared King (consultant on statistics), Wouter Tims (consultant graphics for the text. on planning and agriculture); and the following teams. The report also benefited from comments of a review * Agriculture. J. Goering (team leader, April-May), panel consisting of Anne 0. Krueger, Luis de Azcarate, Tom Wiens (team leader, February-March), Lang-Seng Kemal Dervis, Janos Kornai (consultant), and managers Tay (irrigation specialist), Lo-Chai Chen (fisheries consul- of the East Asia and Pacific Regional Office. xi Technical Notes Currency equivalents. The Chinese currency is called renminbi (RMB). It is de- nominated in yuan (Y): 1 yuan = 10 jiao = 100 fen. In early 1984 the official exchange rate of the yuan to the U.S. dollar was around Y 2 = US$1. The in- ternal settlement rate (ISR) of Y 2.8 = US$1, however, was used in most mer- chandise transactions. The official exchange rate is now about Y 2,8 US$1. On January 1, 1985, the Government abolished the ISR. W.eigbts and measures. Chinese statistics are usually in metric units; in addition, mu and jin are often used: I mu = 0.1647 acres = 0.066 7 hectares; I jin = 0.5 kilograms. Fiscalyear. The fiscal year is January 1 to December 31. Transliteration. The Pinyin system is used in this report. Terminology. With the recent reorganization of rural administration, "com- munes" have been replaced by "townships,' and "production brigades and teams" by "villages." This report retains the former terminology in one respect, however, by referring to "commune and brigade enterprises." The term "national income" is used in this report to encompass both the Chinese measure (net material product) and the Western measure (gross na- tional product). Where the context makes the distinction between these two measures important, they are more precisely identified. Tables. Individual items may not sum exactly to totals because of rounding er- rors. The following symbols are used: . . indicates data are not available; (.) indi- cates a negligible amount; n.a. indicates not applicable. xiii Summary and Conclusions China's ultimate economic objective is to catch up with higher than in China and will increase in the future by at the developed countries, while maintaining a socialist sys- least 2 percent and perhaps 3 percent per year. To catch tem in which the benefits of prosperity are widely shared. up by 2050, China's per capita income would have to Major, though uneven, progress toward this goal was increase at an average rate of at least 5.5 percent and made in the past three decades. During the next two perhaps 6.5 percent per year. Such rapid progress has decades, there could be substantial further progress. The been rare elsewhere. In 1960-82, excluding small and oil- foundations for rapid and equitable growth in the dominated economies, only two developing countries twenty-first century could also be laid. But this will re- achieved annual per capita income growth above 5 per- quire steering a difficult course, in both development cent: South Korea (6.6 percent) and Greece (5.2 percent). strategy and system reform. More generally, only onc country-Japan-has indisput- This report looks at some of the key issues for China in ably caught up with the developed nations from a posi- the next twenty years, and at some of the options for tion of economic backwardness. addressing them, especially in light of international expe- China's past record, on the other hand, is quite encour- rience. It covers many specific topics, including agricul- aging. From 1952 to 1982, despite relatively rapid popu- ture, energy, technology, transport, industrial location, lation growth and periods of acute economic mismanage- internal and external trade, population, education, em- ment, per capita national income grew at an average ployment, and finance (health was addressed in another annual rate of 4.0 percent, with phases of significantly recent report'). The first section of this summary assem- faster growth. Of particular relevance is China's perfor- bles some of its conclusions in the context of a more mance during the past few years of policy and systcm general discussion of the pattern of economic growth. reforms: from 1979 to 1984, per capita national income Common themes regarding the system of economic man- grew at 6.8 percent per year. agement and planning are pulled together in the second Although the basic objective is to improve living stan- section. A third section covers some related aspects of dards and eliminatc poverty, the Government has set social policy. At the end of the summary there is a brief targets of quadrupling the gross value of industrial and overview. agricultural output (GVIAO) between 1980 and 2000 and The most careful forecasts are often confounded. The increasing per capita national income from about $ 300 to lessons of international experience are often ambiguous $800 (about 5 percent per year). If China's future invest- and controversial. In any event, they are hard to apply to ment efficiency were similar to the average of the past China, a country that in important respects differs from three decades, but allowing for increased investment in all others and is not easy for outsiders to understand. The economic and social infrastructure, quadrupling GVIAO projections of this report are thus not predictions, and its would require an investment rate of about 30 percent of suggestions are tentative. They are no more than an at- national income. This is comparable to the rates in other tempt to contribute to the debate in China about the fast-growing East Asian economies, as well as East Euro- difficult questions that must be confronted during the pean countries, and in line with China's past investment country's unique socialist modernization. rate. With reasonable improvements in energy and mate- Pattern of Growth Per capita national income in the industrial countries is 1. Dean 'T. Jamison and others, Cbina: The Health Sector (Wash- (in terms of purchasing power) approximately ten times ington, D.C: World Bank, 1984). 1 rials use, and provided that the population in 2000 is sector. The pattern in China, however, is characteristic fairly close to the official target of 1.2 billion people, also of the Soviet Union and Eastern Europe. Continued quadrupling GVIAO would allow the Government's per cimphasis uo iii'cicasing the physical volume of produc- cilmta lcome tarect to hc- eAM.... Ltqt.in.g. - (fv,. .. g Of qp VIAO) The target growth rate of per capita income is far might cause this pattern to persist. But China could also above the 2.6-3.6 percent range projected by the World shift to a different pattern of growth, with accelerated Bank for middle-income countries in 1985-95. It seems development of the service sectors. feasible because China's projected population growth is Rapid service sector expansion and reform of the sys- unusually slow (about I percent per year, compared with tem of economic management are closely related options. an expected 2.2 percent in middle-income countries) and Expansion of commerce would go hand in hand with because China's investment rate has consistently been expansion of market regulation and increased specializa- unusually high (the 1982 average for middle-income tion of production units and localities. Expansion of en- countries was 24 percent). But its attainment depends terprise support services, including finance, accounting, crucially on the efficiency with which resources are used. and law, would likewise be a corollary of increased enter- For example, if the overall efficiency of investment were prise autonomy and specialization. And expansion of per- similar not to China's 1952-82 average but to the 1957- sonal services would reflect a change in the relative 77 average-roughly comparable to that of the Soviet weights attached to planners' priorities and people's pref- Union in 1950-75 and India in 1960-82-the growth erences. Moreover, rapid growth of services probably rate of per capita income would he about one percentage could not be accomplished through administrative direc- point lower. tives and centralized resource allocation, but would have If agricultural or energy production (discussed below) to be pulled by demand. Individual and collective enter- increased unexpectedly slowly, or if domestic or intcrna- prises may also be better suited than state enterprises to tional misfortunes adversely affected China's efficiency or providing many types of services. investment rate, growth could be slower still. In any This association with system reform makes it likely event, experience in China and other socialist countries that the benefits of faster service sector growth would strongly suggests the desirability of cautious planning. more than offset its costs (in terms of investment, skilled Unrealistically high growth targets cause fluctuations, labor, and-to a lesser extent-materials). In addition to shortages, and inefficiency, while aiming too low has fcw the direct benefit to households from more convenient adverse consequcnces. Indccd, continuation of China's retail commerce and from more restaurants, tailors, and recent practice of sctting modest annual and medium- so on, there would be indirect contributions to the effi- term targets could greatly facilitate reform of the system ciency of industry and agriculture. A bigger, better- of economic management. equipped, and more responsive commercial sector could reduce requirements for both circulating capital and-by Sectoral Balance permitting greater specialization and realization of econo- Experience elsewhcre also confirms the importance of mies of scale-fixed capital. Enterprise support services striking an appropriate balance among the different broad also make fuller use of specialized equipment and person- sectors of the economy. In particular, favoring industry at nel, while financial institutions can contribute to better the expcnse of other sectors does not seem to generate investment decisions. Larger commerce and enterprise rapid and efficient growth. In China, incentives for agri- support service scctors may also contributc to reducing cultural production have rccently been substantially in- material input requirements, especially by accelerating creased, but additional measures to support agriculture improvements in product quality, which make the cost of (discussed below) will be needed. Moreover, emphasis on materials a smaller fraction of the price. quadrupling GV'IAO should not imply neglect of infra- An alternative devclopment path, involving both structure and serviccs, which are vital for industrial and greater emphasis on serviccs and more cfficient rcsource agricultural efficiency. The adverse consequences of past use, is therefore analyzed in the report. With a level of underinvestment in electricity and transport arc well rec- investment efficiency similar to the average in Japan in ognized in China, but there are still difficulties in divcrt- 1950-80 and in all middle-income countries in 1960-82, ing sufficient funds from directly productive investment it could attain the Government's target national income into infrastructure. And the importance of commcrcc and growth ratc with an investment rate of only 26 percent, other services (including finance and enterprise support and hence faster growth of consumption. (The growth services) has only recentlv come to be appreciated. rate of industry would be 7 percent per year rather than 'I'he share of the service sectors-including com- 8 percent, however, and hence GVIAO would less than merce-in output and employment in China is at present quadruple.) On this path, China would also have the strikingly small by comparison with other developing option of maintaining the investment rate at 30 percent, countries, despite an unusually large education and health which would cause national income to grow one percent- 2 age point faster than the target rate (and GVIAO to slightly target for 2000. Given the growth rate of nonagricultural more than quadruple). output implied by this target, and the present very large agricultural employment share, such a large decline in Human Resources agricultural employment could be achieved only if nonag- Faster service sectof expansion could also make it easier ricultural labor productivity grew slowly. This might well for China to absorb growth in the labor force, averaging be incompatible with efficient industrialization. In the about 10 million workers per year in 1980-2000. In the early decades of the twenty-first century, however, agri- usual pattern of development-even in rapidly industrial- cultural employment is likely to shrink rapidly. izing countries-the main intersectoral employment shift Especially because many of the children of today's is from agriculture into services, with a more moderate farmers will move into nonagricultural employment at increase of employment in industry, which is less labor some point during their working lives, it will be impor- intensive. In China, however, employment has grown tant for China to continue to emphasize the wide diffu- faster in industry than in services. Continued emphasis on sion of basic education and to improve its quality. Inter- increasing the physical volume of production could per- national experience strongly suggests that this could petuate this pattern. This is especially likely because the contribute not only to faster economic growth, but also prospective decline in the primary school age group will to a less unequal distribution of its benefits. In recent cause the number of teachers-now approaching a quar- years, however, there have been problems in maintaining ter of all service sector employment in China-to increase the primary school enrollment ratio (although it remains only modestly. Service sector employment in 2000 might well above the developing country average); and the sec- thus remain as low as 70 percent of industrial employ- ondary school enrollment ratio has dropped below the ment (similar to the ratio in the Soviet Union in 1959). developing country average. Wide variations among lo- On the alternative development path, by contrast, ser- calities in enrollment ratios and school quality also per- vice sector employment in 2000 could be as much as 1 SO sist. These problems are being aggravated by increased percent of industrial employment (similar to the ratio in local financial self-reliance in basic education, as well as Japan in the early 1950s). Such a change in the composi- by key schools (recently modified in name, but less in tion of nonagricultural employment could ease some substance) at primary and secondary levels. Policy problems in China's urban areas, which now suffer from changes, and greater financial support from central and a combination of surpluses of some sorts of labor and provincial authorities, will be needed if the important shortages of other sorts of labor (including competent, target of making nine years of basic education universal able-bodied workers even at relatively low skill levels). A by 2000 is to be attained. much higher ratio of service sector to industrial employ- As regards advanced education and training, the need ment would help to reduce this structural mismatch be- for rapid progress to make up for the damage inflicted by tween labor demand and supply, since service sector jobs the Cultural Revolution is well recognized in China, but tend to be disproportionately filled by the categories of some changes in emphasis seem advisable. University- labor that are now in surplus in urban China-particu- level courses are too specialized, partly because many larly women. educational institutions are subordinate to sectoral minis- Perhaps more important, faster service sector expan- tries and other agencies. The Government's present pol- sion, by raising the overall level of nonagricultural em- icy of vocationalizing secondary education could suffer ployment, could reduce the proportion of China's labor from similar problems. The case for sound general educa- force that must remain in agriculture, where the earnings tion, supplemented by subsequent, briefer training in and contribution to production of most workers are highly specialized skills, is particularly strong in China likely to remain unsatisfactorily low for the next two or over the next few decades. Rapid technical advance and three decades. On the material-production-oriented quad- structural change will require constant alterations in the rupling path, the proportion of the labor force in agricul- skill composition of the labor force. The slow prospective ture-excluding brigade industries-might decline by growth of the labor force in the twenty-first century will 2000 to only slightly under 60 percent. On the alterna- reduce the scope for achieving such alterations through tive development path, though, with the same growth changes in the pattern of training of nrew labor force rate of national income, it could decline to nearer 50 entrants. It will correspondingly increase the required percent, a difference of perhaps 40 million workers. amount of retraininig, which is more difficult for people Even the latter percentage, which implies an absolute whose original education was highly specialized. increase in agricultural employment of 13 million, is much higher than most Chinese projections, which envis- Food and Agrculture age a decline in the agricultural employment share to Despite its long history of food problems, China's per under 40 percent. This would be normal for a country capita consumption of calories and protein is currently with a per capita income roughly double the Chinese similar to the average for middle-income countries. The 3 share of animal products in the diet, however, is that of a Feedgrain imports could make up any conceivable short- low-income country, and a major issue is how far and fast age, probably without an appreciable increase in world this share should inerease. This i'sue is hard to addrcss In itcs, hur it wouid he possibic to export only a part of because oi uncc..;,,- ---r :ultural produc all rtJuat i-ice surpius at economically attractive tion potential: depending on whether the recent remark- prices. Even if overall crop production targets can be able surge in production wanes or persists, the future attained, it may thus be necessary to switch some rice trend growth rate of agricultural output could lie any- land either into coarse grains or into other crops that where between 2- 3 percent and 5-6 percent per year. could be more easily exported. In addition to the successful measures already imple- The future pattern of agricultural production and for- mented in recent years, especially introduction of the eign trade thus depends quite heavily on the rate of in- production responsibility system, the Government could crease in consumption of animal products. The possibility take a number of steps to enhance agricultural growth of a rapid increase cannot be ruled out, but there are prospects. These include improvements in agricultural re- some significant problems and uncertainties, which could search, education, and extension services; irrigation and be greater in the twenty-first century. (Even with a favor- drainage projects; better nutrient balance in fertilizer sup- able feed convcrsion ratio, an incrcase of ten percentage plies, as well as changcs in the pricing and distribution points in the share of animal products in the average diet system so that fertilizer is allocated among crops and is equivalent to the disappearance of 35-40 percent of localities more in accordance with its potential contribu- China's cultivable land, or a 35-40 percent increase in tion to production; increased availability of agricultural population.) Particularly undesirable would be an in- credit; and improvements in rural transport, storage, and crease in per capita consumption of animal products to a marketing facilities. level that could not be sustained-because of a slowdown To permit consumption of animal products to rise from in crop production growth, poor feed-meat conversion 6 percent of total caloric intake in the early I 980s to 1 5 ratios, or unwillingness or inability to sustain large feed- percent by the end of the century, gross agricultural out- grain imports-and therefore had to be reduced. put would have to increase at about 4. 5 percent per year, Although there appears to be little danger of a decline with crop production growing at 3.6 percent per ycar in China's present very satisfactory food intake level, (less than the 1965-83 average) and animal husbandry at caution is accordingly needed in managing food demand. 7.5 percent per year (well above past rates). This agricul- It seems especially important that consumers should pay tural growth rate could simultaneously satisfy the other the full economic cost of animal products, without subsi- demands of cconomic growth at the govcrnment's target dies or administrative restrictions on prices. Japanese ex- rate, with agricultural exports and imports more or less in perience suggests that high prices can bring consumer balance in 2000. But it is very high by international demand for animal products into line with limited sup- standards-well above the 3.0 percent avcrage for mid- plies in a socially acceptable manner. By contrast, the dle-income countries in 1960-80 and surpassed only by experiencc of countries which have subsidized and ra- Thailand and the Philippines, which started with more tioned consumption of animal products has been cx- uncultivated land and lower yields. tremely unfavorable. To achieve such rapid growth of animal production would also not be straightforward. China's pastures arc Energy Production and Use now seriously overgrazed, which makes it unlikely that Because China's initially high consumption of energy per present targets for beef and mutton production growth unit of output offers great scope for conservation, it can be achieved. Much higher priority than at present would be possible to attain the Government's target of would need to be given to improving techniques for the quadrupling GVIAO with a much smaller proportionate production of poultry, a potentially efficient converter of increase in energy production-though probably not as feed into animal protein. The most important issue, how- small as the originally envisaged doubling. Electricity pro- ever, appears to be availability of grain and protein-based duction probably has to quadruple by 2000 to meet de- feeds, on which an increasing proportion of animal hus- mand, which will require a huge amount of investment bandry will have to be based. This is a matter partly of (averaging about 2 percent of national income), although the backwardness of China's feed-processing industry, it is technically feasible and in line with current plans. partly of achieving the required level and pattern of crop Crude oil production in 2000 is hard to predict, since it production. depends heavily on success in replacing the output of With rapid growth of animal husbandry, the Govern- existing ficlds with that of new discoveries, but the 200 ment's present targets for increasing production of spe- million ton target (twice the present level) could be more cific crops would tend to create a large shortage of the than enough to meet the likely level of domestic demand. coarse grains needcd for animal feed and a large surplus of It is coal, however, that will bear most of the burden of rice, whose consumption is likely to grow only slowly. bringing future energy production into line with demand. 4 How much coal will be needed could vary widely, de- in existing large-scale uses such as steel and cement pro- pending on the rate and sectoral pattern of growth, as duction-and to invest heavily in suitable production and well as on the degree of energy conservation achieved distribution facilities. Careful studies will be needed to within individual sectors. With growth of national in- select the least costly of the various alternatives (for exam- come at the Government's target rate, the material-pro- pie, coal gasification versus cogeneration and district heat- duction-oriented quadrupling path would require 1,400 ing) in each case; and their implementation and operation million tons of coal to be produced in 2000 on the most will entail much closer cooperation than at present optimistic assumptions about progress in conservation, among a variety of agencies and organizations. and more probably 1,600 million tons (as compared with 770 million tons in 1984). At the same national income Transport Pnoroties growth rate, the alternative-more service-oriented and There is concern in China that economic growth over the efficient-development path mentioned earlier could re- next decade or two might be held back by transport duce coal demand in 2000 to 1,200 million tons on the shortages, especially given the length of time needed to most optimistic conservation assumptions, and 1,400 construct new railways and roads. But the volume of million tons on intermediate assumptions. freight transport in China is now so high (per unit of Especially because less optimistic, but still plausible, output) by international standards-though lower than in assumptions about progress in conservation could in- the Soviet Union-that it is hard to predict how rapidly it crease the potential demand for coal in 2000 to over will need to increase in the future, given any particular 1,800 million tons, it will be vital to promote economical trend growth rate of national income. This will depend use of all forms of energy. The mixture of administrative on the sectoral pattern of growth (for example, industry controls and financial incentives applied in recent years is more transport-intensive than services) and on its spa- has led to impressive energy savings. But a quota-based tial pattern (which influences average transport distance). energy allocation system is fundamentally unsuited to It will also be affected by system reform, which will on achieving large and economically rational reductions in the one hand tend to increase transport requirements energy intensity over the longer term. It gives enterprises because of increased specialization and exchange, but an incentive to exaggerate their needs and does not take could on the other hand greatly reduce wasteful use of enough account of the widely varying economic costs of transport facilities, for example, through less cross-haul- reducing energy consumption in individual enterprises. It ing, more preliminary processing of materials, and more is very probable that more energy could be saved, with rational location decisions. less waste of other resources, if enterprises were more If national income were to grow at the Government's strongly motivated to reduce all costs and faced with target rate, with continuing strong emphasis on material prices that better reflected the economic values of all their production, and with agriculture and industry using inputs and outputs. transport only moderately more efficiently than in the It should be possible to mine the required quantities of past, freight volume could reach 3,200 billion ton-kilo- coal, given China's ample reserves and the straightfor- meters by 2000 (approaching four times its 1980 level). ward production technology, although this would require But with the same growth of national income achieved some advance planning, substantial investment, and con- through faster expansion of services and slower expansion tinued support for small collective mines. Much more of of industry, and with somewhat greater efficiency in a challenge will be to transport the coal (as discussed transport use, freight volume in 2000 would be 2,400 below) and to use it cleanly and efficiently. The share of billion ton-kilometers. Even in the latter case, China's coal in total commercial energy use is likely to remain at projected frcight intensity would remain high in compari- 70-75 percent (compared with 30-35 percent world- son with other countries, which suggests that the possibil- wide), which will require it to be put to an unusually ity of even slower growth of frcight volume cannot be wide range of uses, including many where backward ruled out. technology and small scale in China today result in waste- Although the overall volume of transport requirements ful and dirty combustion. in the longer term is highly uncertain, there will certainly To prevent further increases in already unacceptably have to be significant changes in the composition of trans- high levels of urban air pollution, as well as to economize port investments, as well as in organization and manage- on fuel, will often require the replacement of decentral- ment. Agricultural and industrial specialization will in- ized and uncontrolled burning of coal in households and volve much movement in fairly small lots of a great enterprises with centralized, large-scale, environmentally variety of goods, often perishablc or fragile, over short to controlled combustion to produce cleaner forms of en- medium distances, to and from dispersed origins and des- ergy (gas, electricity, steam, hot water) for distribution to tinations. This is generally only feasible by road. The final users. This in turn will rcquire China to import and demand for road passenger transport will also increase disseminate new technology-which will also be critical rapidly. However, China now has a rural road network 5 half the size of India's and fewer trucks per rural person sufficiency. This appears to result partly from transport than the impoverished Sahelian countries of West Africa. problems, but also from shortcomings in commerce and Major intercity highwavs. the vehicle fleet, and vehicle material supply, thc nature of th.- fia' sNvsrem, distorted fuel nrnoinctinn and distribution are also at p ir ic-, cmpizic;ry'i. h utOkiu iIavc a scli- ingly backward. ous adverse effect on China's overall investment effi- That road transport should play a larger role in the ciency. future is widely recognized in China. Yet there seems to To prevent continued proliferation of industrial plants be no strategic plan to bring this about. Underutilized of suboptimal scale and product quality, there is thus an agricultural labor could, as in the past, be mobilized to urgent need for measures to reduce the present conflict build up an adequate rural road network. But higher between what is rational for a particular locality and what levels of government (central and provincial) will need- is rational for China's whole economy. Of particular im- as in other countries-to play a much more active role in portance would be better transport, fiscal reform, and planning, coordinating, and financing the road develop- changes in the system of economic management (dis- ment schemes implemented at lower levels. In addition, it cussed below), regarding enterprise motivation, competi- will be essential to produce a much larger number and tion, and prices. In addition, the central government wider range of more fuel-cfficient trucks, to improve the might consider legal measures to back up its existing gene- utilization of vehicle fleets, to upgrade the quality of ral prohibition of barriers to interlocality trade, including motor fuels, and to distribute and price these fuels more possibly the establishment of a special regulatory institu- rationally. All this will require improved coordination tion, with the power to levy large fines. among higher-level government ministries and agencies. Suboptimal plant size is not China's only current indus- Railways will remain the most efficient means of trans- trial location problem. There is also too much concentra- porting raw materials and heavy industrial products over tion of industry in large and medium-size cities. Research long distanccs. There will be a large increase in demand and experience in other countries suggest that economic for coal transport, even with more coal washing and efficiency requires weight-reducing hcavy industry (for minemouth power generation. But there is apparently example, iron and steel production) and agroprocessing much scope for economizing on rail transport of all com- to be located near raw material sources, with othcr space- modities through stronger incentives for cost reduction intensive or standardized industrial activities in special- and less administrative intervention in materials alloca- ized small cities. Industries such as petrochemicals and tion and pricing. It also seems physically and financially bicycles benefit from large-scale operation, but not from possible to accommodatc the overall increase in rail trans- proximity to other industries-or at any ratc not enough port demand. This could be accomplished largely by to justify the much highcr economic cost of land and switching from steam to diesel and electric traction, al- labor in large cities. By contrast, industries whose tech- though substantial double tracking and some new lines nology is evolving rapidly or which must respond to will also be necessary. constantly changing demand, as well as many specialized Increased use of water transport could appreciably re- service activities, benefit substantially from mutual prox- duce the load on the railways, expecially if future heavy imity and clustering in large urban areas. Development of industrial investments were appropriately located. And both large and small cities, as well as smaller towns pro- China's entire transport system could benefit from better viding goods and services to rural areas, could thus con- intcrmodal coordination: this is partly a matter of im- tribute to rapid and efficient growth in China; but plan- proving technology and infrastructure (for example, con- ners and prices (discussed below) will need to give better tainers and their handling facilities), but it also depends guidance on what activities should go where. on rationalizing tariffs, increasing competition, and en- How much the overall level of urbanization should couraging new specialized entities to provide an appropri- increase in the decades ahead is a difficult issue, partly ate variety of transport, leasing, storage, and transfer ser- because the distinction between urban and rural is itself vices. blurred in many densely populated parts of China. In any event, substantially increased rural-urban migration Specialization and Urbanization seems probable and desirable. Indeed, without some ru- China's size and past emphasis on local self-sufficiency ral-urban migration, China's overall urbanization rate (as offer opportunities for enormous economic gains through officially measured) would decline from 20 percent in increased specialization and trade among localities. In re- 1981-quite normal for a low-income country-to 19 cent years, agricultural specialization has proceeded rap- percent by 2000, simply because the natural population idly. In industry, by contrast, spccialization does not seem growth rate in existing urban areas over the next two to be increasing, and indeed local planning bureaus are decades is likely to be much lower than in rural areas. still promoting the development of a wide range of indus- 'I'llis could cause the general labor shortages that have trial activities, with continuing emphasis on local self- already appeared in some Chinese cities to become wide- 6 spread within a few years. Increasing urbanization would income country to run foreign trade surpluses, as China probably be a more economically efficient response to has done in recent years, has some obvious disadvantages, such shortages than accelerated automation of urban pro- as compared with a net inflow of foreign capital to sup- duction. An urbanization rate in 2000 of 30 percent plement domestic savings. But experience in other coun- (implying that iore than a third of the urban population tries, including socialist ones, has shown how easy it is to would have come from rural areas) would still involve an slide into excessive or unproductive borrowing, especially unusually large amount of rural nonagricultural employ- when domestic enterprises and planners are not suffi- ment. Lower-middle-income countries today (at a similar ciently conscious of investment costs or responsible for income level) have an average of 34 percent of their bad decisions. population in urban areas. However, China also seems wise to encourage direct Whatever the overall rate of urbanization, efficient de- foreign investment, less for the foreign capital or ad- velopment of towns and cities will require a very large vanced technology it brings than for the demonstration increase in urban infrastructure and services. The admin- effect of modern management techniques. The example istrative responsibilities for their provision, and potential of, and competition from, well-run foreign companies financing and cost recovery mechanisms, need to be care- can help domestic firms identify weak links in manage- fully reviewed. In many countries, efficient and equitable ment, product design, material supply, and so on, and development of urban services has been seriously con- spur them to make changes they might otherwise never strained either by fragmented and unclear allocation of consider. But such examples of the way modern industry responsibility among different administrative levels or by operates in more advanced countries are effective only if inadequate growth of urban revenue sources. In China, contrasted and competing with locally managed firms. moreover, special attention should be given to the poten- This requires foreign and joint ventures to be spread-as tial impact of economic and social reforms on the level is increasingly the case in China-among a wide range of and composition of local government revenues and ex- localities and activities, rather than confined to special penditures. zones or particular sectors. International experience suggests that decentralization Foreign Trade and Capital of foreign trade to the enterprise level can also make an China's recent resumption and expansion of external eco- important contribution to realizing the potential benefits nomic contacts have raised exports to 9-10 percent of of increased external economic contacts. Direct exposure national income, which is well within the normal range of exporting firms to foreign buyers and competitors has for large countries. However, inflows of foreign loans proved elsewhere to be an extremely effective way not and direct investment have remained small, partly be- just of learning in the abstract about new and better cause of foreign trade surpluses. For the future, there products and processes, but also of learning how (and appear to be two large and related issues. The first is how being put under pressure) to introduce them in practice. much, and in what directions, to further increase external Similarly, allowing enterprises-including commercial en- contacts. The second is how best to manage such con- terprises-and consumers to choose directly between im- tacts, and in particular whether to continue the present ported and domestically produced goods could greatly insulation of the domestic economy from the world out- increase competitive pressure on Chinese producers to side by administrative intermediation and separate price introduce new, better, and cheaper products. systems. Such decentralization of foreign trade could have some Over the next two decades, China will need to change potentially serious disadvantages, too, including damage the composition of its manufactured exports. Exports of to promising but newly established industries in China, as textiles and clothing, in particular, are likely to grow well as greater exposure to world price instability and fairly slowly. China will therefore need to make a major unpredictable fluctuations in foreign markets. But skillful effort to expand exports of machinery and metal prod- use of policy instruments-including the exchange rate, ucts. Rapid growth in such exports would permit rapid tariffs, and selective administrative interventions-could growth of intermediate and capital goods imports, as well minimize the costs while securing many of the benefits. as consumer goods imports (which can stimulate impor- China will also always be a large and diverse economy, tant improvements in domestic production). Exports of with a relatively small foreign trade sector, which greatly manufactured goods could also be used to pay for pur- reduces the possible damage that unexpectedly unfavor- chases of licenses and technological assistance, which in able external developments could inflict, even though many advanced as well as developing countries have particular industries and localities might experience quite proved to be very effective ways of upgrading domestic sharp swings in prosperity. technology. Especially following the recent unification of foreign As regards foreign borrowing, the Government's pol- exchange arrangements-and given the current account icy of cautious progress seems well founded. For a low- surpluses of recent years, large reserves, and the ready 7 availability of external capital-China appears to be well not only in bringing together the several elements of placed to move toward a decentralized and mainly indi- market regulation, but also in combining them with an rectlv remglated foreion trade systenm, without the prob- appropriately iniHllilrd system of planning. lerr.s (ot cxtcrna n.!-n-,*r ial inaJnichvor defv tion) that many other countries attempting a similar Enterprise Motivation move have simultaneously had to contend with, To do The unsatisfactory results of direct administrative control this immediately, or at one stroke, would probably be of enterprises-whether by central ministries or local gov- unwise, since most domestic enterprises do not yet have ernments-lead irresistibly to the principle of greater en- appropriate motivation or independence, and since some terprise independence. Yet establishing independent and prior changes of domestic prices would ease the adjust- appropriately motivated enterprises may be the hardest ments required. But it could proceed in parallel with single aspect of reform in a socialist system-and perhaps internal economic reform. also the most fundamental, since an unmotivated enter- prise cannot be expected to motivate its workers, or to Managing the Economy respond to price and tax signals, or to compete. Appropriate enterprise motivation should include a How far China will have risen into the middle-income strong desire to increase profits. Avoidance of losses is an range by 2000 will depend crucially on how successfully important aspect of this, but is insufficient, since China the economy is managed. This is a matter partly of mobi- needs enterprises that not merely pursue a passive strat- lizing financial and human resources, and of importing egy of staying out of trouble, but actively seek to increase and developing modern technology, partly of putting production and sales and to cut costs of all kinds. With these things to effective use. China's past record of eco- rational prices and competition, the best single measure nomic management, for all its unevenness, is superior to of enterprise performance in this regard is usually me- that of other low-income countries, both in promoting dium-term profits (especially after deduction of the cost- growth and in reducing poverty. But maintaining the past depreciation and interest-of the capital employed). The pace of economic progress is likely to require greater active desire of peasant households to increase sales and efficiency. cut costs, because their standard of living depends on it, Efficiency in the relevant sense means ceaseless, intense lies at the heart of China's recent agricultural successes. efforts by producers to reduce costs, to increase produc- Outside agriculture, the same motivation is a natural fea- tivity, to improve product quality, to introduce new ture of individual and family cnterprises, and of small products, and to seek out and respond to changing needs enterprises owned and operated collectively by their and opportunities. It involves bold yet frugal investment workers. In medium-size and large enterprises, however, decisions, increasing specialization, and the constant dis- things are not so simple. placement of more expensive or inferior products and processes by cheaper and better ones. S lATE ENTERPRISES. Some important enterprises These conditions for rapid, sustained growth are at should clearly remain subject to direct government con- present far from fully met in China, except in agriculture, trol and should not primarily pursue profit. At a mini- where outstanding progress has been made in recent mum, this applies to public utilitics (for examplc, electric- years with the introduction of the production responsibil- ity, railways, and telecommunications), large-scale ity system. Recognizing this, the Central Committee of mineral exploitation, and many defense-related indus- the Chinese Communist Party in October 1984 an- tries. Direct control of other key enterprises might also nounced a program of urban economic reforms, with help to achieve specific development objectives, including invigoration of state enterprises as its central theme, to be the tcchnological upgrading of particular sectors. implemented over a period of about five years. Much of What is less clear is the best way to organize and the discussion in the present report is premised on the motivate the remainder-probably the great majority-of Central Committee's decision. state enterprises, which would be relatively independent. To be efficient, enterprises must be motivated to im- Once a suitable economic environment is created through prove their economic performance; they must have some price reform and increased competition, and providcd freedom of maneuver; they must be faced with economi- that indirect levers such as taxes and credits are skillfully cally rational prices; and they must be subjected to com- applied, pursuit of profit should lead most state enter- petition. None of these elements is individually easy to prises in economically appropriate directions. It would establish, and the absence of any one of them reduces or thus no longer be necessary for particular individuals nullifies the benefits of the others. In addition, the state within enterprises to be charged specifically with repre- must retain the ability to direct the overall pace and senting the interests of the state. But cach of the alterna- pattern of development. 'Ihe essence-and the diffi- tive possible internal management arrangements has culty-of a successful and comprehensive reform thus lies strengths and weaknesses. 8 Giving direct control of state-owned enterprises to are banks, pension funds, and insurance companies.) their workers is a socially attractive possibility. Japanese Such a system of socialist joint stock ownership could experience also shows the economic advantages of strong perhaps be created initially by suitable dispersion of the worker commitment to the enterprise. But there are also ownership capital of existing state enterprises. Over time, disadvantages, especially because state enterprises should it could be reinforced by a morc diversified pattern of operate for the benefit of the whole society and not only investment finance (discussed below), with a variety of of those who work in them. Experience in Yugoslavia and state institutions acquiring financial interests in existing elsewhere suggests that worker control could result in and new enterprises. excessive wages and worker benefits, inadequate labor discipline and effort, restriction of employment, and COLI.ECTIVE AND INDIVIDUAL, ENTERPRISES. China's comparative indifference to profitability. policy is to encourage the coexistence of state and other Experience in industrial capitalist economies suggests sorts of enterprises. In small-scale economic activities, that giving control of enterprises, instead, to their man- whose importance will increase with economic develop- agers would increase their propensity to expand, im- ment and reform, individual and collective enterprises are prove, and innovate. But completely independent man- already making a valuable contribution. They could be agers sometimes choose a quiet life or, more commonly, even more productive if given better access to materials, pursue personal power through expansion with insuffi- credit, skilled labor, and technology. Their potential role cient attention to profitability. In socialist countries, in medium- and large-scale activities, however, remains to moreover, managerial control tends to differ only slightly be determined. from worker control, since managers find it hard to resist Experience elsewhere suggests that genuine collectives worker demands for greater benefits or to insist on the flourish only in certain lines of activity and rarely above a often unwelcome changes in work practices that are certain size. Many of the most successful examples else- needed for innovation and increased efficiency. This is where are in commerce and are marketing or purchasing already a problem in China: studies of experimentally cooperatives. There are far fewer examples of medium- reformed enterprises controlled mainly by their managers size genuine worker collectives or of any sort of collec- reveal large increases in worker benefits, but small in- tives in manufacturing. China's numerous township and creases in economic efficiency. village enterprises may appear an exception; however, An alternative approach, common in nonsocialist these are not collectives in the ordinary sense, but com- countries (and now being tried in Hungary), is to give munity enterprises. They have been successful partly be- strategic decisionmaking authority in each enterprise to a cause of restrictions on personal mobility among commu- board of directors. Such a board could contain some nities, which has given local residents a strong common representatives of society at large, as well as of the work- interest in their establishment and profitability. ers. But to impart the necessary motivation, the board Collectives and community enterprises could in the would mainly have to represent institutions with a strong future constitute a significant proportion of China's me- interest in the enterprise's profits. It could insist that the dium-size enterprises. Many individual enterprises could enterprise managers behaved accordingly, partly by ap- also grow rapidly to medium size, if allowed to do so, and pointing and dismissing them, partly by linking their re- could be an important dynamic force in the economy. As muneration to profitability. The managers might in prac- an alternative to the present restrictions on the size of tice make most decisions, but would be greatly influenced individual enterprises, these enterprises might be obliged by their ultimate accountability to the directors. to sell (at a fair price) majority ownership to one or more Such boards should be free from direct government state institutions once they reached a certain size. The intervention. But, precisely because these are state enter- then minority owners could continue as managers, super- prises, this may be difficult to achieve. In China, for vised by a board of directors representing all the owners. instance, even if the boards were to consist of representa- tives of the Ministry of Finance or a new Ministry of ACCOUNIING AND LAW. Fhe best way of motivating State Property, rather than of sectoral ministries or the independent state enterprises, and the best balance governments of the localities in which the enterprises are among state, collective, individual, and mixed enterprises, situated, informal connections and pressures for direct can only emerge from experience and experiment over a administrative control could persist. A possible solution protracted period. But certain necessary conditions for might be to spread the ownership of each state enterprise success can already be identified. among several different institutions, each in some way One is improvement of enterprise accounting and au- representing the whole people, but with an interest diting, which at present leave much to be desired. With- mainly in the enterprise's profits rather than directly in its out accurate accounts, subject to thorough, compulsory, output, purchases, or employment. (Examples of such and independent audits, with severe penalties for non- institutions, in addition to central and local governments, compliance, it is hard to see how any system of indepen- 9 dent enterprises-state or nonstate-could function prop- Another important step toward free entry could be to erly. allow individual and collective enterprises to operate in MoicovrT, a decenrralized economy cannot function more lines of activity, includiie tcclinolo icallv dynamic tlOi~jllly LLIIlUIL d WilllICiUlS1VC sysiem of commercial sectors. Studies in other countries havc shown that small and contract law and institutions and personnel to imple- enterprises are just as innovative as large ones. (Chinese ment it. Laws are also needed to regulate the economic visitors to foreign countries are often given a misleading activities of independent enterprises. Among other impression in this regard, because they are usually taken things, laws or decrees should prohibit specified types of only to well-known, large enterprises.) Particularly be- monopolistic, anticompetitive, or exploitative behavior, cause of the strong incentive that small enterprises have with legal institutions to interpret and implement these to innovate, the overall pace of technological advance prohibitions. At present in China, the situation is unsatis- could very probably be accelerated by letting them com- factorily vague, with enterprises and local officials free to pete for some of China's skilled manpower, technology place their own interpretations on general guidelines imports, and research support. from the center. Lastly, effective competition has to involve the elimina- tion of obsolete or unwanted products and processes. Competition Subsidies or protection for backward technology and in- As the Central Committee's 1984 decision clearly states, efficient enterprises-other than on a temporary basis to competition among enterprises is crucial to efficient permit reorganization-hold back the growth of efficient growth-without it, customer requirements are ne- enterprises and removc a powerful negative stimulus to glected, innovations diffuse slowly, and market-regulated innovation and improved efficiency. At the same time, prices are distorted for monopolistic gain. One key ingre- this aspect of competition can obviously cause hardship, dient of competition is allowing purchasers to buy from especially for displaced workers. Social policies and insti- the best and cheapest source. China has already taken tutions (discussed below), and government retraining some significant steps in this direction, but further schcmes, can alleviate this hardship. But the conflict be- progress is needed. It could probably be assisted by dis- tween the gains of the majority from greater competition mantling the annual production planning and allocation (and faster technological change) and the losses of particu- system, either in one step (as in Hungary) or morc gradu- lar individuals and groups cannot be completely elimi- ally, by reducing each year in each enterprise the propor- nated. tion of material requirements covcred by the state alloca- tion and, in parallel, the obligatory stat production and Prices procurement quota. The Government is well awarc of the need to establish It would also be assisted by dismantling administrative economically rational prices, without which the decisions barriers to internal trade, which would be easier if fewer of independent, profit-oriented enterprises would often enterprises were directly controlled by government or- be inefficient for the whole economy. The Government gans anxious to avoid competition within their "families" also recognizes that this must be accomplished by chang- of enterprises. Consolidation of enterprises into large sec- ing the price-setting system to give market supply and toral corporations, by contrast, would normally tend to demand forces a greater role, and not only by adminis- reduce competition, although this could be offset by in- tered changes in prices set by the state, which tend to lack creased exposure to foreign competition. Equally impor- the flexibility, complexity, and precision needed in a mod- tant would be measures to enlarge, diversify, and ern economy. The prices of many minor items, and of strengthen commerce and related services. Individual and some transactions in more major items, have already collective enterprises might be given a greater role in been successfully decontrolled. wholesaling and material supply and better access to Further progress in this direction is impeded by chronic transport facilities. shortages of many goods. It is feared that these shortages, Another key ingredient of competition is frcc entry of if prices were no longer subject to direct state control, new producers into particular markets. One step in this would cause general price inflation, as well as obstructing direction for China could be to allow larger enterprises to the allocation of materials to key projects. For this rea- diversify more freely out of their existing lines of husi- son, it is often argued in China that further price decon- ness. Provided that prices are rational, such diversifica- trol should be postponed until rising production has elim- tion can transfer profits earned in one line of activity into inated most of the shortages. other lines where the economic returns to investment are Soviet and East European experience suggests, how- greater. And it can permit enterpriscs to transfer workers ever, that chronic shortages are not the temporary result who can no longer be profitably employed in one line to of inadequate production capacity, but an enduring fea- other lines, without having either to discharge them or to ture of administrative economic management, which can keep them idle. be eliminated only by systemic reforms, including price 10 decontrol. This view is supported by China's experience ternative would be to have wholly market-determined in the past few years, especially in agriculture, where prices, but with a price stabilization scheme-Govern- relaxation of direct controls has turned long-standing ment intervention to keep fluctuations at any given time shortages into abundance. The same could happen in within a predetermined range by purchasing for addition industry. increases in specific prices could eliminate spe- to stocks at the lower end and selling from stocks at the cific shortages by stimulating supply and reducing de- upperend. mand. These price increases, moreover, would tend to A third instance concerns the relationship between pro- reduce purchasing power over (and hence the prices of) ducer and retail prices, which needs to be altered not only other goods, provided that the government kept strict to reduce the presently high level of subsidies, but also to control of the budget balance and credit. encourage consumers to buy less of things (such as energy Nonetheless, there is substance to the fear of immedi- or animal products) in short supply or whose production ate and general decontrol of prices in China. The down- costs are increasing and more of things in abundant sup- ward inflexibility of some prices, and of wages, could ply and whose production costs are falling. This could be obstruct the smooth adjustment outlined above. The full achieved by establishing relatively rigid margins between response of demand and supply to price changes may producer and retail prices, sufficient to cover the costs take years. China lacks experience in indirect fiscal and and normal profits of commerce as well as indirect taxes monetary regulation of the general price level, and other (whose rates could vary from commodity to commodity). countries with much greater experience still suffer from In the near term, what is mainly needed are some rising prices. The elimination of shortages, moreover, substantial increases in the retail prices of staple food and would also require increased competition and stronger coal and in rents. T'hese should be as fully and accurately enterprise motivation to hold down costs, including in- compensated as possible, by wage increases and income vestment costs, which cannot be brought about over- supplements to households with high dependency ratios night. For these reasons, price decontrol probably has to (discussed later). Special supplementary interest payments be gradual though steady-perhaps in conjunction with on saving deposits which would otherwise lose part of the gradual dismantling of annual production planning their real value might also be needed (financed perhaps by and allocation mentioned earlier. a corresponding special levy on borrowers, whose loan Some steps, however, could be taken more quickly. repayment burden would otherwise decrease in real Large increases, either administratively imposed or mar- terms). A large-scale program of selling state- and enter- ket-determined, in the prices of most forms of energy- prise-owned housing to its present tenants, who would and some other materials-are a case in point. Without otherwise face increased rents, could soak up a large frac- them, there would be little chance of achieving the essen- tion of existing saving deposits and hence reduce the tial reductions in energy use discussed earlier. There is possible scale of panic buying in anticipation of price concern in China that large energy price increases would increases. have ripple effects, since energy-intensive industries and There is room for disagreement as to whether such a enterprises could not absorb all the increased cost major realignment of retail prices, incomes, and assets through conservation and profit reduction and would should be done in one step, or more gradually. The social therefore have to raise their prices. But most such ripple problems that have sometimes followed large retail price effects should in fact be welcomed (and cushioning increases in other countries seem to have occurred mainly through reduction of taxes and profit remittances because of the absence of compensation-often deliber- avoided): experience elsewhere suggests that increases in ate, because of the need to reduce real consumption in the prices of energy-intensive products, by discouraging the face of economic difficulties. In China, however, their use, can make a vital contribution to raising the there is no need for a cut in household consumption, and economy's overall energy efficiency. full compensation could be provided (although this Agricultural prices are another instance. With the new would mean no net improvement in the state budget system of household agriculture, if production is to be balance). A carefully prepared and well-explained one- efficient and surpluses and shortages of particular com- step adjustment could thus be quite acceptable and would modities avoided, prices must be allowed to respond flex- avoid the protracted uncertainty and delays to other nec- ibly to supply and demand trends. At the same time, it essary reforms associated with gradual adjustment. But it would be desirable to avoid the large short-term price would also obviously increase the cost of errors in prepa- fluctuations-often because of weather-that characterize ration (especially calculating the required changes in unregulated markets for agricultural commodities. The prices, wages, and other forms of compensation) or im- Government's present strategy is to decontrol completely plementation. the prices of minor items and, for major items, to have Following this initial phase of adjustnent, subsequent two-tier pricing (flexible prices for amounts in excess of rises and falls in producer prices could be reflected in official, fixed-price procurement contracts). A possible al- retail prices. Experience in other countries suggests, how- 11 ever, that it would be inadvisable to provide continuing constraining China's growth in the next two decades, automatic compensation for retail price increases in the measures to improve their allocation and motivation fnrm of ge-nera! .wage or incorne indexation, since this SUCIT worth considering. Among the more important ,~ *,,2j ,,-, -ui- t ; -n indcxation (uf huoit cs WUu be IreedOm Of jOb choice, for both state income supplements to poor households, for exam- new graduates and experienced staff, allowing employers ple, or for pensions) should be approached cautiously. to recruit and release freely and competitively, and higher A fourth instance concerns prices that influence the and more flexible salaries. Provided that they were ac- spatial location of economic activities. One is transport: companied by reform of enterprise motivation, competi- prices for each mode should more accurately reflect long- tion, and prices, these measures could help move highly run marginal economic costs, without cross-subsidies skilled labor to where its economic contribution was among different length hauls, to provide incentives to greatest, speed the diffusion of new technology, improve reduce the present waste of rail facilities, to encourage motivation (with better matching of jobs to personal pref- greater use of roads, and to enable proper assessment of erences and skills just as important as more money), and the costs and benefits of locating particular activities in send much clearer signals of needs and priorities to educa- particular places. The other is urban land: for social as tion and training institutions. well as economic reasons, enterprises and planners should More generally, it will be essential to make better use be made to feel the dramatically varying economic useful- of all categories of labor. This is because long-term ness (or opportunity cost) of different sites-higher in growth of average per capita income will be almost en- coastal cities than in more remote regions, higher in large tirely determined by growth of labor productivity, most than in small cities, higher near the center than in the of which must come not from movement of labor out of outskirts (in a city the size of Shanghai, experience in agriculture into other sectors, but from higher productiv- other countries suggests that a central site is worth ap- ity within each sector. Unskilled labor is currently in proximately I S0 times as much as one in the suburbs). surplus, but this will change in the twenty-first century; A differentiated urban land tax reflecting these varia- experience elsewhere shows how hard it is at a late stage tions could be introduced. Alternatively, a competitive to break out of an established pattern of low productivity rental market might be established-which would in prin- and indifference to labor costs. ciple be more efficient and quite consistent with public It might therefore be desirable to give enterprises pro- ownership of all land. (Either or both could provide a gressively more discretion in deciding how many, and useful supplement to municipal revenues.) This would which, less-skilled workers to employ. This should in encourage better use of existing sites and more economi- principle encompass not only the right to dismiss idle or cally efficient location decisions. The presently huge in- negligent workers, but also to release or reject workers centives for rural-urban migration would likewise be re- who are simply not needed for production. Lifetime em- duced to more economically rational proportions, ployment would not necessarily disappear (Japanese expe- especially if differing land values were reflected in house rience confirms its potential advantages in training and rents and wages, and hence in the costs of living and motivation), but would be likely to be limited to larger employing workers in large urban areas. enterprises, which would be highly selective recruiters. Finally, further strengthening of the linkages between Some open unemployment would be an inevitable con- internal and world prices could be beneficial, though sequence of these changes. In addition to its adverse hu- there would need to be some exceptions-for example, man consequences (which could be mitigated by changes rice, where an increase to the present world price could in social policies and institutions, discussed bclow), this aggravate incipient overproduction. For most goods, es- would involve waste of human resources. 'I'he waste of pecially manufactures, enterprises should eventually di- unemployment, however, has to be weighed against the rectly feel the relationship between their value (for cx- waste of human resources associated with the present ports) or cost (for imports) to China in world markets employment system, which transfers unemployment and their domestic prices. Such linkages (which are now from the streets into the factories and discourages man- standard in Hungary and have begun to be introduced in agers from realizing the full productive potential of their China) are essential for the efficient functioning of a de- workers. It is also important to bear in mind the trcmen- centralized foreign trade system. They would also con- dous potential for creation of new jobs in the service and tribute to a much-needed widening of price differentials small enterprise sectors. Nonetheless, movement should between low- and high-quality products, without which be gradual, perhaps with an early end to the obligation of enterprise incentives to innovate and improve quality will enterprises to accept unwanted new workers (usually as remain small. part of a package also containing some useful recruits), and subsequent release of unneeded workers each year up Labor and Wages to a specified percentage of an enterprise's labor force. 'o reduce the risk of shortages of highly skilled workers Greater flexibility of less-skilled wages might smooth 12 this transition, as might stronger linkages between indi- Experience suggests that this would encourage bold and vidual pay and performance. But these changes, too, innovative thinking combined with thorough analysis, could be only gradually introduced, to avoid a sharp drop hard-headed calculation, and the avoidance of waste. in unskilled wages. It will also be necessary for some time Delegating more responsihility for investment decisions to retain administrative control of total and average to independent enterprises might also help in striking a wages (and other benefits) in state enterprises, to prevent better overall balance between infrastructural and other excessive increases in response to pressure from workers, investment. China's local governments have proved dedi- In this regard, the Government is contemplating formal cated and resourceful investors, but are probably unduly linkages between the remuneration of workers and the biased in favor of directly productive industrial invest- performance of their enterprises. But experience else- ment. Making enterprises independent, with more invest- where suggests that this could generate inequities and ment responsibility, could thus give local governments a misrepresentations that might undermine aggregate wage stronger incentive-as in other countries-to improve in- control. It might be preferable to have wage guidelines frastructure in order to attract industrial investment. that were more uniform across enterprises, coupled with China's recent mixed experience with devolution of greater managerial discretion in the distribution of wages investment decisions to enterprises, however, confirms among workers within particular enterprises. that without other systemic changes such an arrangement Gradual wage adjustments could also help remote and can have undesirable results. Inappropriate managerial backward localities. At present, nationally uniform state incentives, irrational prices, lack of competition, and sector wages, and unofficial pressure to tie collective sec- shortcomings in commerce and material supply can lead tor wages to state wages, make it harder for enterprises in enterprises to undertake investments of little economic these localities to compete effectively against enterprises merit, while neglecting other investments of much in more advanced regions or in international trade. Non- greater use to the economy. agricultural employment in backward areas might there- Reforms in enterprise motivation, competition, and fore increase faster if unskilled wages in these areas de- prices could eventually overcome many of these prob- clined in relative terms. At the same time, though, these lems, making it possible to consider devolving a much areas probably need to offer skilled workers higher wages greater proportion of investment decisions to enterprises than elsewhere. and, relatedly, allowing state enterprises to retain a much larger proportion of their profits. More mobility of in- Investment Decisions and Finance vestment funds, through more varied channels, could also In energy, transport, education, health, and defense, the increase the efficiency of decentralized investment deci- Government will undoubtedly retain direct control over sions. most investment decisions, mobilizing the necessary fi- Investment flows in China in the past have been largely nance through the budget. The same will apply to major vertical, with most savings being mobilized upward land and water development projects. Budgetary saving through the budget and dispensed downward through to finance other sorts of investment may also have to sectoral ministries and state banks. In addition, there has remain substantial, if the high aggregate saving rate neces- been some compartmentalized reinvestment of savings sary for rapid growth is to be attained. But households generated within particular sectors and localities. In the and enterprises could contribute a much larger share of future, although vertical flows and compartmentalized aggregate saving than in the past and could make an reinvestment will remain important, they could advanta- increasing proportion of investment decisions. This pat- geously be supplemented and replaced to an increasing tern is already established in agriculture and other small- extent by horizontal investment fund flows of three main scale activities. In larger-scale industry and services, how- types. The first, mentioned earlier, would be allowing ever, the degree to which investment decisions should be existing enterprises to diversify into new lines of activity. devolved to enterprises remains an important issue. The second, which overlaps with the first, is direct invest- Such devolution could have a number of advantages. It ment linkages among economic units: enterprises could would give greater meaning to enterprise independence, increasingly be permitted to invest in other enterprises, especially since the economic performance of an enter- establish new enterprises, or participate in various sorts of prise at any given time depends heavily on previous in- joint ventures. The third sort of horizontal flow is vestment decisions. It would increase the medium and through socially owned financial institutions, acting as long-term responsiveness of production to evolving needs intermediaries between the suppliers and users of re- and demands. It would make fuller use of the detailed sources. knowledge of enterprise managers. It might also provide Such financial institutions, offering interest rates that a way of strengthening incentives for sound investment reflected the scarcity of capital, could mobilize funds decisions, in whose outcome enterprise managers could from households and institutions, including enterpriscs be given a substantial direct personal financial interest. with limited internal investment opportunities. They 13 could make these funds available to potential investors, INDIRECT CONTROL. In the remaining areas of the especially enterprises of all kinds, perhaps mainly in the economy, where decisions will increasingly be made by form of loans, hut also lit thl fOron of ownership capital- households, farrmers, and indepiidcilt cnterprises, there par. a l y bvohw pi,A tj ac to orisky TO wili be a shltt trom direct to indirect control. This, how- be largely loan-financed, partly because directly sharing in ever, need not diminish-and indeed might well in- the risks and benefits would motivate financial institu- crease-the Government's ability to manage the econ- tions to provide more assistance in project design and omy. For up to now in China, what has not been directly implementation, including information on markets and controlled has often not been properly planned. The technology. These institutions could in effect create a broader reach of indirect controls, which shape the envi- socialist market for investment funds. ronment in which all economic units operate, could more For such a market to function well, the financial insti- than compensate for the associated loss of direct control tutions should be numerous and diverse, acting in most over particular economic units. respects as independent state or collective enterprises. Instruments of indirect control fall into two main cate- Nonetheless, government regulation of their activities gories-those connected with credit and those connected would be essential. At a minimum, as in all other coun- with taxes or subsidies. A third category is prices. But tries, rules to protect depositors would need to be de- indirect control through administrative determination of signed and enforced, with other rules and central bank prices has the drawback of being able for any particular intervention in the financial market to regulate the over- commodity to govern either demand or supply, but not all supply of money and credit. In addition, the govern- in general both, and hence having to be supplemented ment could-as for many years in Japan and South Ko- with administrative quotas either on demand (in the case rea-influence the allocation of funds in accordance with of shortages caused by a low price) or on supply (in the strategic economic objectives. This could be done in vari- case of surpluses caused by a high price). Moreover, re- ous ways, including channeling some budgetary savings duction in the scope of administrative price determina- through these institutions and subsidizing or taxing loans tion will gradually change prices-apart from their tax or for particular purposes, as well as by selective direct con- subsidy element-from instruments of government con- trols on interest rates and loan allocation. trol into independent indicators of value, cost, and scar- For China, continued experimentation and exploration city. These both influence and are influenced by the in the area of investment decisionmaking and financing actions of producers and consumers, usually in economi- will be necessary, especially since the experience of other cally appropriate directions. Government intervention, countries providcs no precedent for a socialist financial however, may still be needed in some cases to dampen market. The relative shares and importance of the various fluctuations, as well as to set one very basic price, namely possible elements discussed above-vertical and compart- the exchange rate, which strongly affects exports and mentalized, as well as horizontal-should be allowed to imports in a decentralized economy. evolve with experience and the development of institu- Control of the overall level and growth of credit, which tions. In general terms, however, it seems likely and desir- depends not only on caution in financing budget deficits able that diversified investment arrangements will emerge by note issue or borrowing from banks, but also on as both consequence and cause of a diversified pattern of regulating the whole banking system (according to well- enterprise ownership. established rules), is a fundamental element of indirect macroeconomic management. And, as mentioned earlier, preferential interest rates and repayment terms in certain Planning sectors or regions, as well as direct government interven- Reform of the system of economic management along tion in the allocation of credit, are feasible and effectivc the lines of the Central Committce's 1984 decision will ways of influencing the composition of investment. But reduce the Government's direct involvement in produc- experience elsewhere suggests that they should be used tion, commerce, prices, employment, and so on, hut cautiously, to avoid undesired side effects. Low interest should not diminish its responsibility or capacity to pro- rates on rural credit, for example, can lead to uneconomic mote and steer China's development. The preceding dis- mechanization in areas with surplus agricultural labor. cussion has touched repeatedly on areas in which contin- Personal income taxation, including progressive rates ued, and often enlarged, direct government involvement and selective relief, can influence the proportion of is needed, especially in establishing the physical, educa- household income saved and the composition of con- tional, scientific, institutional, and legal infrastructure es- sumer demand. Above-average indirect taxes on particu- senrial for rapid and efficient growth. The Government lar goods (for example, luxuries) can reduce the amounts will also continuc to intervene directly in some other key purchased and supplied by driving a larger wedge be- sectors and enterprises, though more in investmcnt deci- tween the price paid by the customer and that received sions than in current operations. by the producer; the reverse is true for below-average 14 indirect taxes or subsidies (as on food, children's clothing, government agencies and between the center and local books and the arts in many countries). Taxes on enter- governments (who would still have their own, comple- prise profits, including selective concessions by product mentary, medium-term plans, at least at the provincial or locality, can be designed to regulate the total amount level). Other sorts of planning could also play an impor- of funds available to enterprises, the proportion of profits tant role. reinvested, and the amount of external finance used and One is what is called in other countries "policy plan- can stimulate investment in certain activities or regions ning." This is the design of packages of policies to achieve while discouraging it in others. Similarly, import tariffs specified medium-term objectives-for example, improv- can be used to promote increased production in particu- ing road transport, or increasing machinery exports, or lar sectors through import substitution (although without raising primary school enrollment. It is of particular value complementary export incentives they produce an ineffi- when indirect policy instruments are used, or when sev- cient bias toward the domestic market), and in certain eral different government organizations are involved, or cases it is rational to tax exports. when different objectives and policy instruments are in- This range of instruments can enable planning and mar- terrelated. For this reason, policy planning is generally kets to coexist reasonably harmoniously, though it in- the responsibility of a high-level government agency, with volves greater emphasis than hitherto in China on manag- strong analytical capabilities, which can evaluate alterna- ing demand rather than supply. Direct control of supply tive approaches to an objective, make recommendations will, as mentioned earlier, continue in some important to the political leadership, and monitor implementation. sectors. But in most cases, rather than dictating what Another is location planning. Even with more econom- should be produced, the Government could use taxes and ically rational pricing of transport and urban land, most credits to guide the changing composition of demand and countries have found that zoning plans and regulations to influence the relative profitability of different sorts of arc necessary to preserve urban amenities. Moreover, in production and investment, allowing supply to respond industries where a single optimal-size plant would supply through the decentralized decisions of enterprises and a high proportion of the national market (for cxample, farmers. automobiles or electronic chips), but many alternative Experience in other countries suggests that this indirect sites would be equally attractive in economic terms, the approach can be as effective as direct controls in shaping Government needs to arbitrate among competing locali- the pattern of development and often can be more eco- ties to prevent wasteful duplication. In other industries nomically efficient. But the relationship between objec- (cement and fertilizer, for example), government inter- tives and indirect instruments is much less precise and vention is required because the location and scale of all predictable, especially in the absence (as in China) of the enterprises need to be simultaneously determined to much systematic study of the behavior and responses of minimize transport plus production costs. economic units. This element of unpredictability can be In addition, Japanese experience suggests the potential reduced by research and by flexible and responsive imple- usefulness of long-term sector planning, especially where mentation, with adjustment of policies to achieve desired major technological changes are expected or desired. (In objectives over the medium term. But it can never be China, such plans would provide a particularly useful eliminated, and many countries (including Hungary in framework for establishing industry-specific priorities for recent years) have experienced practical difficulties in in- modernization-a very difficult task because of the com- directly regulating their economies. The increased uncer- prehensiveness as well as the backwardness of the whole tainty associated with greater reliance on indirect controls industrial sector.) However, Japanese experience also sug- thus has to be weighed against the inefficiency of direct gests that such plans should not be designed and imposed controls. from above and must have competitiveness in interna- tional markets as their not-too-distant objective. Through SCOPE OF PLANS. To the extent that direct control of close contact with the enterprises in an industry, sectoral production and allocation was reduced as part of the planners need to create a consensual "vision" of future reforms, annual plans would become less significant in development, which increases the consistency (and re- themselves, although they (and the budget, with which duces the risks) of investment decisions. This vision has to they should be linked) would remain important as a be backed up by, for example, government financial par- means of monitoring and adjusting medium-term plans. ticipation in-or loans to-key investments, including pi- The medium-term plan, by contrast, would become the lot plants, or by temporary restrictions on imports and core of the entire planning process. Although the instru- assistance to exports. But enterprises that wish to pursue ments for its implementation could be different, the gene- a different strategy should often be allowed to do so ral form of the plan document might be much the same as though this may seem wasteful, the flexibility it provides at present. Its preparation could serve even more than has proved valuable, since neither planners nor enter- now as a focus for the exchange of views among different prises can pick technological winners consistently. 15 Long-term (ten- to twenty-year) plans in individual sec- trends, and major changes in the pattern of disease, will tors need not, and probably cannot, be coordinated in also pose new problems. Some changes and innovations de-ail. But thcy coul'd beho.it il(onl a projected long-rerm in social policics and institutions may thus be necessary. frazz.'ol fo. r.c whcAc cckUl 11 IllOSt limited, plausible range. After many experiments, three other countries. have been selected for discussion (some variants will also The division of consumption between public and be mentioned). household consumption was assumed in QUADRUPLE to These three projections-named QUADRUPLE, MODER- stay the same as in 1981, as was the proportionate alloca- ATE, and BALANCE-have no monopoly of merit, but are tion of public consumption among sectors. The share of useful for illustrative purposes. Although all of them lie household consumption allotted to food declines, despite within the range of international (including Chinese) ex- a steep incrcase in expenditure on animal products (see perience, they span a fairly wide range of possibilities, Chapter 3 and Annex 2). The share of clothing in house- both for policy and for factors beyond government con- hold consumption was assumed to rise slightly, and the trol. They also reveal a number of specific questions and shares of other manufactured goods, electricity, transport, problems, which are addressed later in this report. The miscellaneous services, and housing to increase signifi- present section outlines the assumptions of each of the cantly-broadly in line with average international experi- three projections. The rest of the chapter describes their ence. Household consumption of fuel, though, was as- results. sumed to increase more slowly than income, because of improvements in thermal efficiency (see Annex 3). QUADRUPLE Other assumptions of QUADRUPLE include growth of The QUADRUPLE projection attains the Government's crop production at an average annual rate of 3.6 percent, target of quadrupling the gross value of industrial and doubling of crude oil production (in accordance with the agricultural output (GVIAO) between 1980 and 2000. official target), attainment of the Governmcnt's targets Specifically, given a reasonable set of assumptions-de- for hydro and nuclear power, and coal production in scribed below-about the efficiency of investment and 2000 of 1,400 million tons. The present orientation of the forces shaping the structure of the economy, the ag- foreign trade policy is assumed to be broadly maintained, gregate saving rate was varied until the rate that quadru- but the composition of manufactured exports shifts away pled GVIAO was found. from textiles toward machinery and other manufacturcs, As regards the efficiency of investment, sectoral capital- and there is somewhat greater dependence (to save en- output ratios in agriculture and energy were direct ergy) on imports of metals and chemicals. Foreign bor- (though approximate) estimates of the likely investment rowing increases gradually toward a level consistent with cost of increasing gross output in these sectors, drawing a 1 5 percent ratio of debt service (interest and repayment) on World Bank project experience in C(hina and else- to exports. where. In other industrial sectors and in construction, it was assumed that capital-output ratios would be equal to MODERATE the average of the past thirty years in China (based on The MODERATE projection maintains most of the as- estimates of sectoral capital stocks in 1981), with reforms sumptions made in QUADRUPLE, including the same ag- checking their past upward tendency. In transport, the gregate saving rate, hut takes a less optimistic view of the capital-output ratio for new investment was set about 25 future efficiency of China's economy. Sectoral capital- percent above its past level to correct for past underin- output ratios in (nonenergy) industry and construction vestment. In commerce, it was assumcd that greater dis- are assumed to increase gradually, as in the Soviet Union cretion in purchasing would cut circulating capital re- and less efficient developing countries. Specifically, the quirements by 20 percent, and hence that the sector's amount of investment required per additional unit of future capital-output ratio would be lower than in the industrial output is assumed to be 40 percent greater than past. in QUADRUPLE. In addition, crop production is assumed Energy conservation rates in individual sectors in to grow more slowly (an average annual rate of 2.9 per- QUADRUPLE (and also in MODERATE and BALANCE) are cent), because of smaller increases in the efficiency with those regarded as most likely-the consequences of more which investment and industrial inputs are used in agri- optimistic and more pessimistic assumptions are discussed culture. Lower efficiency in converting animal feed into in Chapter 4. Intermediate use of other materials and meat is also assumed. Coal production in 2000 is 1,200 goods was assumed to change in accordance with average million tons. international experience. Specifically, the assumed pat- Lower efficiency was also assumed to be associated tern of change in input-output coefficients includes some with slower growth of labor productivity in nonagricul- substitution of manufactured for agricultural materials, tural sectors, In QUADRUPLE, on the basis of past experi- increased use of chemicals (especially plastics), and re- ence in China and other countries, gross output per 34 worker was assumed to increase at an annual rate of 5 these sectors are indispensable to reducing costs and im- percent in heavy industry (3 percent in coal mining), 4 proving quality in material production through increased percent in light industry, 3 percent in construction, trans- reliance on markets, more specialization and competi- port and commerce, and 2 percent in miscellaneous ser- tion, and greater orientation of production toward cus- vices. in MODERATE all these rates wvrc reduced by one tomer requirements. percentage point. BALANCE CAPITAL. In this broader context, faster expansion of the service sectors could reduce investment requirements The BALANCE projection represents an alternative way of in several ways. A larger, better-equipped, and more re- attaining the same growth rate of per capita national in- sponsive commercial system could require-in light of come as in QUADRUPLE, giving greater weight to the ser- experience elsewhere-smaller amounts of circulating vice sectors-specifically, to commerce and miscellaneous capital, especially within the sector, but also in other business and personal services. This shifts the future struc- sectors, which would be less likely to produce unsalable ture of China's economy away from the Soviet pattern and goods and would have less need to stockpile materials and toward the pattern of Japan and most other countries at semifinished goods (of which it is now difficult for Chi- comparable stages of development (Chapter 1). nese enterprises to get regular supplies of suitable quality In the model, the shift is accomplished partly by chang- and specifications). A larger and better commercial sys- ing the pattern of household consumption. Relative to tem would also permit greater specialization in produc- household income, consumption of miscellaneous ser- tion, and hence larger-scale enterprises with lower capital vices and of commerce (retail trade is treated as part of costs, and a greater payoff to agricultural investment. consumption in the accounting framework used) grows Business service enterprises can also make fuller use of faster in BALANCE than in QUADRUPLE. To compensate, specialized equipment (and personnel). This is obviously the share of household income spent on food declines true of equipment leasing and rental enterprises. But it somewhat faster-although this is partly offset by in- also applies to professional and technical services-such as creased food consumption in restaurants, which are also advertising and market research, law, accounting, design, part of commerce-and the share spent on manufactured engineering, repair and maintenance, and data pro- goods increases somewhat more slowly. There is also cessing-which can often be provided at lower cost and at faster growth of intermediate demand for services. Rela- a higher standard by specialized entities than by an enter- tive to gross output, the volume of intermediate com- prise's own staff. Even mundane business services such as merce and material supply activities is assumed in BAL- catering, cleaning, and trash removal can sometimes be ANCE to increase by 3 percent per year (it remains con- undertaken at lower cost by specialized enterprises. Fi- stant in QUADRUPLE); expenditure on miscellaneous busi- nally, banks and other financial institutions can contrib- ness services is assumed to increase gradually in every ute to better investment decisions (Chapter 10). sector from virtually nothing in 1981 to about 3 percent The potential for reducing invcstment requirements in of gross output in 2000-comparable to other countries. these ways cannot be accurately calculated or appor- Faster expansion of the service sectors involves costs- tioned between fixed and circulating capital. However, investment and use of energy, materials, and labor in on the basis of rough international comparisons, it was those sectors. In BALANCE, these costs are deliberately assumed for illustrative purposes in BALANCE that faster augmented by making the fixed capital required per unit expansion of the service sectors would enable circulating of gross output in commerce three times its QUADRUPLE capital requirements to be reduced (below their QUADRU- level, to reflect improvements in the size and quality of PLE levels) by 30 percent in nonenergy industry, con- warehouses, shops, vehicles, and other equipment, which struction, and miscellaneous services and by about 70 at present in China lag far behind those in other coun- percent in commerce. tries. In addition, to allow for improved staffing of large- scale commercial facilities, a larger share of more labor- MArERIALS. It was also assumed in BALANCE that the intensive smaller facilities, and a shift in the composition increased intermediate purchases of commerce and busi- of miscellaneous services toward more labor-intensive ac- ness services would be offset by reduced purchases of tivities, the growth rates of labor productivity in com- manufactured intermediate goods (and hence indirectly merce and miscellaneous services are reduced in BAL- of agricultural materials and energy, as well as other in- ANCE (to I percent per year in both sectors). dustrial materials). This is the pattern observed in the few Faster expansion of commerce and miscellaneous ser- studies that have been made in other countries-mncrcas- vices would also have economic benefits-in addition to ing service-intensity of production in individual sectors, the gains that consumers would realize directly-espe- but declining materials-intensity, with little systematic cially in association with comprehensive reform of Chi- change (outside agriculture) in total intermcdiate pur- na's system of economic management (Chapter 1). For chases per unit of gross output. Part of the explanation 35 apparently lies in the transfer of particular activities from Table 2.2 Composition of Final Demand, manufacturing entcrprises to more specialized service en- Alternative Projections, 1981-2000 terprses Biitr a nmore imnortant factor appears to bc con- (percent) s1ar ,t, mnt ii, ro{3 vc c!ity tn- +7s2000 materials becoming a smaller part of thc product price, Component 1981 Quadruple Moderate Balance and the value added by processing (including indirect Sbares ofnational income processing, design, packaging, and marketing) a greater (expenditure)a part. Investment 28 (29) 29 (29) 29 (28) 26 (26) Of course, many materials-saving improvements in Public consumption 15 (10) 15 ( 9) 15(10) 16 (10) product quality are unrelated to service sector expansion. Household consumption 56 (61) 56 (62) 56 (62) 59 (64) Independent technological advances, including methods Shares ofbousehold of weight reduction and miniaturization, as well as gen- consumptionr' eral enterprise incentives to reduce waste and improve Food (including processed food) 55 48 49 44 products, are crucial. But the service sectors stimulate and Manufactures 24 29 28 25 facilitate these improvements. Design agencies and tech- Services (including nical consultants provide essential information, while a commerce) 18 20 20 27 good commercial sector, supplemented by advertising Fuel, electricity, and *~~~~~~~~~n transport 3 4 4 4 and market research enterprises, increases the flow of information between customers and producers and a. Figures without parenthcses arc Western miieasures; those within paren- sharpens competition, imiaking it both easier and more thescs are Chinese miieasures. Thc Western measuires may not sumIi to 100 sharpens competition, making ~~~~~~~~because of external tradc imibalances. necessary for cnterprises to improve their products. b. Calculated on a Western basis, at 1981 producer prices, with all comii- mercial margins inclided in services. Source: World Bank projections (Anniiex 4). Growth and Demand For each of the three projections, using both Western and Chinese measurcs, lIable 2.1 presents aggregate growth percent, although the investment rate is closer to 30 per- rates over the period 1981-2000, while Table 2.2 shows cent for most of the pcriod because of foreign borrowing. the composition of both total final demand and house- This is higher than China's average investment rate in hold consumption. (More detailed breakdowns are avail- 1 952-82 (28 percent), but lower than the 1970-82 aver- able in Annex 4. The projections start in 1981 because age (32 perccnt). It is also quite close to Chinese projec- this is the latest year for which all the necessary data exist; tions of the investment rate needed to quadruple GVIAO the projected values for 1982-84 do not conform closely in 1980-2000 (26-29 percent), though somewhat to actual developments in those years.) higher, perhaps because QUADRUPLE assumes more of an In QUADRUPLE, as mentioned earlier, the saving rate increasc-over China's past levels-in capital require- was deliberately chosen so as to attain the target of quad- ments in agriculture, cnergy, and transport. 3 rupling GVIAO in 1980-2000 (annual average growth of National income-as a result of the many othcr specific 7.2 percent). The requircd domestic saving rate is 29 assumptions made, rather than by deliberate choicc-also grows in QUADRUPLE at a rate consistent with the Gov- ernment's targets. Per capita GDP (which in China differs Table 2.1 Average Annual Growth of National only trivially from GNP) grows at 5.5 percent per ycar- Income, Alternative Projections, 1981-2000 from $300 in 1981 to $830 in 2000-which is the mini- (percent, at 1981 prices) mum rate that China would need to sustain to catch up Measure Quadruple Moderate Balance with the industrial countries by the middle of the twenty- _____- - - - first century (Chapter 1). The Chincse measure of per National income GDP 6.6 5.4 6.6 capita national income grows slightly more slowly-5.2 NMP 6. 3 5.1 6.2 percent-because the relative size of the nonmaterial ser- National income per capita vice sectors increases. GDP 5.5 4.3 5.5 In MODERATE, with the same investment rate, the as- NMP 5.2 4.1 5.1 sumption of lower efficiency causes significantly slower Gross value of industrial and agricultural output 7.2 6.0 6.4 Note A Western measure of niational income, GDP (gross domestic product) 3. The Chincse projections are from Liu Guoguang, ed., Zbong- is the net output of all sectors, including all services, plus depreciation. The guo Jing1i Fazban Zbanlue Wenti Yanjiu. (Issues of China's eco- Chinese measure, NMP (net material product) is the net output of the materially productive sectors, nomic development strategy), (Shanghai: Shanghai Renmin Chu- Source: World Bank projectiois (Annex 4). banshe, 1983), pp. 405-406. 36 growth. The growth rates of national income and of is the average amount of investment required to produce GVIAO are reduced by rather more than one percentage an additional unit of output. It can be calculated by point, and per capita GDP rises to only $670 by 2000. lo dividing the average share of investment in national in- attain the same aggregate growth rates as in QUADRUPLE, come in a given period by the growth rate of national the investment rate would have to be increased to about income. 36 percent. (All three projections, incidentally, assume The projected ICOR in MODERATE (calculated using that the Government's target of a population of 1.2 bil- Western national income measures) is about 5.5, much as lion by 2000 is attained. A higher population would in China in the two decades before 1978, and compara- cause a commensurately lower level of per capita in- ble also to the Soviet Union in 1950-75 and India in come.) 1960-82. In QUADRUPLE, the projected lCOR is substan- In BALANCE, with greater weight given to the service tially lower-about 4.5, which is similar to the 1952-82 sectors, the saving rate was deliberately chosen to attain average in China. In BALANCE, it is lower still-about the same growth rate of per capita GDP as in QUADRU- 4.0, which is comparable to the average in Japan during Pl.E, in line with the Government's long-term objectives. 1950-80, but also to the average for all middle-income The Chinese measure of national income in BALANCE developing countries in 1960-82. The assumptions on grows only slightly more slowly than in QUADRUPLE, investment efficiency underlying the three projections because most of the increase is in materially productivc thus seem to span a plausible range of international expe- services (commerce and business services). GVIAO, how- rience.5 ever, grows significantly more slowly, because the greater It should be emphasized, though, that China's experi- share of services means smaller shares for agriculture ence in the next two or three decades-in terms of and-especially-industry. Partly as a result, but also be- growth rate and investment requirements-will not nec- cause of the assumed reductions in use of circulating essarily lie within this range. The possibility of faster capital and materials within individual sectors, the same growth cannot be ruled out. To illustrate this, a variant of growth rate of national income as in QUADRUPLE is at- BALANCE was constructed, with the saving rate increased tained in BALANCE with less investment-26 percent of to the same level as in QUADRUPLE. Per capita GDP in this national income. The increase in consumption that this projection increases at an annual average rate of 6.5 per- makes possible is divided proportionately between public cent (one percentage point higher than in QUADRUPLE consumption and household consumption (which in real and BAI.ANCE, though still slightly below the 6.8 percent per capita terms in 2000 is 9 percent higher than in of 1979-84) and reaches $990 by the year 2000. GVIAO QUADRUPLE). in this variant of BAI.ANCE more than quadruples (growth By most international standards, the growth rates pro- of 7.4 percent per year), with a commensurate increase jected for China are quite high. Even in MODERATE, per also in energy and materials use. capita GDP growth is slightly above the 4.1 percent Equally, if internal or external misfortunes were ad- 1960-82 average for upper-middle-income developing versely to affect China's saving rate or investment effi- countries (3.2 percent for lower-middle-income coun- ciency, growth could be slower than in MODERATE. In tries), and similar to Western estimates of Soviet growth addition, it is possible that all three projections may have in 1950-75. It is well above the 2.6-3.6 percent range underestimated the backlog of past investment needs- projected by the World Bank for middle-income coun- especially in transport and in housing (the estimates for tries in 1985-95.4 Nonetheless, the projected MODERATE electricity are more reliable)-in which case their saving growth rate of national income per capita is almost ex- and investment rates would be too low, or their growth actly what China achieved in 1952-82 (4.0 percent by rates too high, or some combination of the two. In any the Chinese measure), and the rates in QUADRUPLE and BAIANCE are no higher than those attained by China in periods of good economic management. These rates in havebeensurasse bya fe oter cunties,in- 4. World Bank, World Development Report 1984 (New York: turn h s Oxford University Press, 1984), Table 3.2. Most other developing cludingJapan in 1953-73 (8.5 percent). country statistics in this chapter are from the Indicators at the back China's unusually rapid projected per capita income of this World Development Report. growth, as compared with most other developing coun- 5. Total factor productivity (IFP) for the whole economy grows tries, is due mainly to an unusually high investment rate at 1.6 percent per year in QUAI)RUPI.. (contributing 24 percent of (the 1982 average for middle-income countries was 24 output growth), 0.8 percent in MODERAII. (14 percent), and 1.9 percent) and unusually slow population growth (1I per- percent in BAILANCE (29 percent). The average l i p growth rate in a cent per year, as compared with a projected 2.2 percent sample of mainly middle-income developing countries between cent per year, as compared with a projected 2.2percent 1950 and 1980 was 2 percent and contributed 31 percent of in middle-income countries), rather than to unusually output growti (Annex 5, Table 3.16). In these iiiP calculations, efficient investment. This can be seen by looking at the output is meastired by GDP; for China, labor force and capital stock aggregate ICOR (incremental capital-output ratio), which growtl are given eqtial weight. 37 event, experience in China and elsewhere (including East- reflects both lower efficiency in crop production and ern Europe) strongly suggests the need for cautious plan- slower overall growth, which reduces the demand for ning: the fluctuations and inefficiencv caused by sctting m.,eat. (In thcsc prujutiuli-s re ol!tr of nonagricultural I_ __hscp__o(s,ri cwu of nonagVrautuera tuirealisrically bhi lh g.rowth mr-ets are tit ; -nl!v moi.h mort l r icn.priscs iijniu tl 11 ousher sectors, rath er serious than the problems caused by unrealistically low than-as in present Chinese statistics-in agriculture.) growth targets, which can be gradually adjusted upward. The projectcd growth rate of total industrial output in The projected changes in the composition of household QUADRUPLE (about 8 percent) is in line with most Chi- consumption (Table 2.2) are broadly consistcnt with ex- nese projections, as is the slightly faster growth of heavy perience elsewhere. In all three projections the share of than of light industry.6 Within heavy industry, the fastest- food declines: in QUADRUPLE and MODERATE the reduc- growing scctor (9.1 percent) is machinery, pulled along tion is unusually small, mainly because of rapidly increas- mainly by investment demand and by household and ing consumption of animal products; BALANCE is more public consumption, but also by foreign demand (the normal by international standards (Chapter 3). In QUAD- share of machinery output exported rises over the period RUPLE and MODERATE, most additional nonfood con- from 4 percent to 11 percent). Chemicals production- sumption is manufactures, although expcnditure on hous- pulled mainly by intermediate demand-grows almost as ing and miscellancous personal services also grows quite fast (8.8 percent), but metallurgy production grows more rapidly. In BALANCE, consumption of services (including slowly (7.0 percent), partly because of increased effi- retail commerce) grows abnormally fast, to bring China ciency of metal use in the machinery sector, partly be- more into line with the usual pattern. The share of housc- cause of incrcased net imports. Coal and pctroleum are hold income spent on manufactures thus increases slowly, the slowest-growing heavy industrial sectors (on average, but because-as mentioned earlier-aggregate consump- 4.8 percent). Within light industry, the fastest-growing tion incrcases fastcr, real per capita consumption of man- sector is food processing (8.7 percent), followed by ufactures in BALANCE in 2000 is only 5 percent less than wood, paper, and miscellaneous manufacturing (8.4 per- in QUADRUPLE. cent). 'Iextiles and clothing, the biggest light industrial sector, grows more slowly (7.1 percent), partly because Production and Investment consumer demand grows only slightly faster than income, partly because textile exports grow relatively slowly (but Table 2.3 shows gross output growth in the three projec- still by 6.0 percent per year in real terms). tions, broken down among five broad sectors (the In MODERATE, both heavy and light industry grow twenty-sector breakdown is in Annex 4). In all three morc slowly than in QUADRUPLE (because the whole cases, agriculture-discussed further in Chapter 3-is the economy grows less fast), but the difference between slowest growing sector, although its growth rate in their growth rates is somewhat more pronounced, largcly QUADRUPLE and BALANCE is very high by intcrnational because, by assumption, coal production is not much standards, partly because animal husbandry production is lower and petroleum production remains the same. Gross assumed to keep up with rapidly increasing consumer output in other industrial sectors in 2000 in MODERATE demand. Slower agricultural growth in MODERATE thus is about 80 percent of its level in QUADRUPLE-the range is from 84 percent in chemicals to 77 percent in food processing. Table 2.3 Average Annual Growth of Sectoral Gross In BALANCE, the assumed greater efficiency of invest- Output, Alternative Projections, 1981-2000 ment and materials use-and the consequently lower in- (percent, at 1981 prices) vestment rate-enables heavy industry to grow slightly Sector Quadruple Moderate Balance more slowly than light industry and significantly more so ___ _ _ _ __._ _. than in QUADRUPLE (even though national income grows Agriculture 4.5 3.7 4.6 just as fast). Machinery production in 2000 in BALANCE Hieavy industry' 8.1 6.9 7.0 is only 80 percent of the QUADRUPI.E level; metallurgy, l.ight industryl' 7.9 6.5 7.1 Infrastructure' 7. 3 6.1 7.0 percent; building materials, 85 percent; and chemicals, Services' 7. . 05 82 percent. L.ight industryv in BALANCE also grows more Services' ~~~~7.2 6.0 lOS 8 ecet .gt nutyi BLNEasogosmr slowly than in QUADRUPLE, partly because some con- Note 'I'hese broad sectoral definitions correspond only approximately to sumer deand is sitDRom mantufaureso ces, those used in China. sumer demand is shifted from manufactures to services, a. Metallurgy, coal and petroleum (including extraction), chemicals, and building materials and machiriery; excludes electricity. b. Food processing, textiles and clothing, wood, paper, and other manufac- ruring. 6. Most Chinese projections envisage this relationiship for the c Electricity, construction, and transport(f and pssenger). whole period 1980-2000, but with faster growth of light tban of Iealth, public administration, asid defense, heavy industry in the 1980s (see, for example, Liu, ZbongguoJingii Source: World Bank projections (Annex 4). Fazhan Zhanlue Wenti Yanjiu, pp. 146-49). 38 but mainly because of smaller stock building, more effi- Table 2.4 Composition of Capital Stock, Alternative cient intermediate use, and smaller net exports (because Projections, 1981-2000 of less need to generate foreign cxchange to pay for im- (percet) ports of energy, chcmicals, and metals). 2000 T'he infrastructure sectors kelectricity, transpor, and Sector and type !.98! Quadruphe Moderate Balance construction) in all three projections grow nearly as fast as industry, the main user of their outputs and supplier of Sector thi ' . . Agriculture 9.6 8.8 8.4 9.8 their nputs. The link between infrastructure and indus- Heavyindustry' 29 3 3.4 37.3 28.4 try is particularly clear in QUADRUPLE and MODERAIE- Light Industrya 7.9 7.7 8.5 6.4 with slower industrial growth in the latter projection Infrastructure' 14.1 18.1 16.4 18.4 causing an equiproportionate reduction in infrastructure Servicest 38.9 32.0 29.4 37.0 growth. In BALANCE, relative to QUADRUPLE, the reduc- Type of capital stock tion in infrastructure growth is much less pronounced Fixed (net of than the reduction in industrial growth, because of in- depreciation) 65.3 67.5 66.9 74.8 creased use of infrastructure by the service sectors. Elec- Circulating 34.7 32.5 33.1 25.2 tricity projections are discussed further in Chapter 4 (and a. For sectoral definitions, see notes to Table 2.3. Annex 3), transport projections in Chapter 5 (and Annex b. Includes education, health, public administration, anid defense, as well as J ~~~~~~~~~~~~commerce, housing, and miscellaneous services. 6); in both sectors, the plausible range of outcomes in the Source, World Bank projections (Annex 4). year 2000 in each of the three projections is quite wide (depending largely on the degree of success in reducing wasteful use of electricity and transport). The construc- ciency-reflected in the table in the lower ratio of circu- tion industry's output growth is determined mainly by lating to fixed capital. investment demand: it therefore grows more slowly in In QUADRUPLE, industry's share of the capital stock MODERATE (6.1 percent) than in QUADRUPLE (7.2 per- increases over the period-implying that its share of total cent), because of slower overall growth; it also grows investment (about 42 percent) is greater than in the past somewhat more slowly in BALANCE (7.0 percent), be- (about 37 percent).7 This is the result of rapid output cause the investment rate is lower. growth in sectors such as machinery and chemicals Excluding education and health and public administra- (which between them absorb around 20 percent of an- tion and defense, where gross output is a particularly nual investment), coupled with rising capital-output ra- elusive concept (employment in these sectors is discussed tios in slower-growing coal and petroleum. Light indus- below), the service sectors in QUADRUPI.E and MODER- try's small share of the capital stock does not change ATE grow at about the same rate as the infrastructure much. In MODERATE, lower industrial investment effi- sectors and somewhat more slowly than industry. Com- ciency causes the capital stock shares of both heavy and merce grows at almost the same speed as GVIAO, while light industry to be even higher than in QUADRUPLE. In miscellaneous services and housing (both of which are BALANCE, these shares decline slightly, because of slower propelled by above-average growth of consumer demand) industrial output growth and greater industrial invest- grow rather faster. In BALANCE, commerce grows faster ment efficiency. IJndustry's share of total investment (36 (9.1 percent) than GVIAO (6.4 percent), with an increased percent) in BALANCE is still large, however-excluding amount of trade relative to production, while consumer mining and extraction, it is about the same as in Japan in and business demand for miscellaneous services grows 1951-65. rapidly (15.3 percent). The service sectors thus grow In all three projections, the infrastructure sectors in- faster than industry. crease their shares of the economy's capital stock. In Table 2.4 shows broad sectoral shares of the economy's QUADRUPLE, transport absorbs about 10 percent of an- total capital stock (fixed and circulating) in the three pro- jections. These depend, of course, on the sectoral alloca- tion of investment, which in turn is related both to sec- 7. These percentages include all mining (including oil extrac- toral gross output growth and to sectoral capital-output tion), but exclude electricity (included with infrastructure). The ratios (investment requirements per unit of output). In all past estimate is based on the 1981 capital stock data in Annex 5, three projections, agriculture's share of the capital stock which, as wirh the projected estimate, covers all investment in does nor change much over rime, since the sector's be- fixed and circulating capital, including nonstate and nonproductive does ot cange uch ver tme, ince he sctor' be- investment. low-average output growth is largely offset-as in other 8 I he share of light industry declines more than that of heavy countries-by a rising capital-output ratio. Its share in industry partly because coal and petroleum capital requirements BALANCE is higher than in QUADRUPLE simply because are not reduced, partly because greater investment efficiency is the total capital stock is 10 percent smaller, because of the assumed to be reflected in lower circulating capital requirements lower aggregate investment rate permitted by greater effi- (which are more important in light than in heavy industry). 39 Table 2.5 Sectoral Composition of the Labor Force, cause of faster growth of public and household consump- Alternative Projections, 1981-2000 tion. Miscellaneous services absorb thrce times as much (percent, unless otherwise noted) cIt s mvestmcnt as i,, QIUADRUPI F, IDUT still in5s than 2 percent Ser 1 r °,no na ,/ . odera.re Rt..! Agriculture 70 59 61 52 Employment and Income Heavy industry 9 11 11 9 Light industry 6 9 8 7 Table 2.5 shows projected sectoral employment shares Infrastructure 5 7 7 7 (the twenty-sector breakdown is in Annex 4). These de- Services 10 14 13 25 pend in the model on sectoral output growth rates and Laborforce(millions) 452 631 631 631 assumptions about sectoral labor productivity growth Population (millions) 990 1,196 1,196 1,196 (mentioned earlier)-except in agriculture, where em- Note For sectoral definitions, see notes to Table 2.4. ployment is a residual, and in education, health, public Source World Bank projections (Annex 4). administration, and defense, where it is determined by public consumption. In QUADRUPLE, nonagricultural employment increases at 3.5 percent per year. This is somewhat slower than nual investment (excluding purchases of vehicles by over the past thirty years in China-in 1952-82, the rate farmers, households, and nontransport enterprises). was 4.5 percent-because of slower gross nonagricultural Transport and electricity together account for a higher output growth (7.8 percent in QUADRUPLE, excluding proportion (19 percent) of total investment than in the nonmaterial services, versus 8.9 percent in 1952-82). past (12 percent), but about the same proportion as in Average nonagricultural labor productivity in QUADRU- Japan in 1951-65. In MODERATE, these sectors' shares of PLE grows at the same rate as in 1952-82 (about 4 per- the capital stock increase less, mainly because of greater cent), though significantly faster than in 1957-77 (about absorption of investment by industry. In BALANCE, their 3 percent). Labor productivity is assumed to grow fastest capital stock shares are much the same as in QUADRUPLE, in heavy industry, with the result that this sector's em- although in absolute terms somewhat lower (because de- ployment share increases only modestly, despite rapid mand for the output of these sectors grows more slowly). output growth. Conversely, the share of employment in At the outset, the service sectors have a large share (39 services increases more, despite slower output growth, percent) of the economy's capital stock-of which about because labor productivity does not rise so much. one-half is commerce (mainly circulating capital), one- Although faster growth of productivity in industry third housing, and one-sixth education, health, public than in services is the normal international pattern, the administration, and defense. In QUADRUPLE, this share share of employment in services in QUADRUPI.E not only declines, partly because circulating capital requirements remains unusually low, but also increases more slowly in commerce are assumed to be somewhat lower than in than normal (even by comparison with the low service the past, partly because capital-output ratios in other sec- share countries such as the Soviet Union). This is because tors are rising (they rise fastcr in MODERAFE, which of the prospective decline in the primary school age causes the service sectors' capital stock share to decline group, which will cause the number of teachers-now even more). Nonetheless, these sectors absorb substantial approaching a quarter of all service sector employment in amounts of investment. In QUADRUPLE, about 12 per- China-to increase only modestly, even given higher en- cent of annual investment goes into housing and 11 per- rollment rates (Annex 1). Faster growth of employment cent into commerce (still mainly circulating capital), while in health, research, culture, and so on will to some extent education, health, public administration, and defense be- offset this. But the projected increase of 15 million, or 80 tween them absorb about 5 percent (the underlying as- percent, in education and health employment during sumption is a doubling of capital per worker over the 1981-2000 in QUADRUPLE-MODERATE and BALANCE period in these social sectors). Miscellaneous services ab- are similar-may in fact be an overestimate, as may the sorb only 0.5 percent of investment. projected increase of 5 million, or 50 percent, in employ- In BALANCE, the capital stock share of the service sec- ment in Dublic administration and defense (which is cur- tors aiso declines slightly, but is significantly higher than rently approaching a quarter of total service sector in QUADRUPLE, partly because the total capital stock is employment). smaller. In commerce, fastcr output growth and higher Nonagricultural employment in QUADRUPLE increases fixed capital requirements are offset by lower circulating between 1981 and 2000 by rather more than 120 mil- capital requirements, and the sector's capital stock in lion. The total labor force-assuming a slight decline in 2000 is 5 percent smaller than in QUADRUPLE (its share the participation rate of the adult population-increases of annual investment is virtually the same). The social by nearly 180 million. Employment in agriculture thus sectors and housing absorb slightly more investment be- increases by 56 million, even though agriculture's share 40 of employment drops from 70 percent to 59 percent. Figure 2.1 Share of Agriculture in Total Employment This pattern is typical of the low- to middle-income tran- in China, Alternative Projections for 1981-2000, sition elsewhere, with an absolute decline in the agricul- and in Other Selected Countries, 1960-82 tural labor force occurring only at a later stage of develop- ment. But the projected decline in the agricultural Percent,age of ciployment employment share in QUADRUPLE is rather small by in- ternational standards (Figure 2,1). 90 It is also much smaller than in most Chinese projec- Thailand tions, which envisage a decline in the agricultural employ- 80 Tuurkey ment share by 2000 to less than 40 percent.9 This would India Indonesia be normal for a country with a per capita income roughly 70 _ \ double that projected for China in 2000 (Annex 5, Table China Soth Korea 3.8). Given the rates of gross output growth in QUADRU- .akist\ PLE, it could be achieved in China only if nonagricultural 60 Pakistan labor productivity increased at less than 2 percent per Egypt year-half the past rate and probably incompatible with 50 \ Malaysia efficient industrialization. In 1960-82, industrial labor X \\i\ productivity increased on average in all middle-income 40 _hlpie countries at rather more than 2 percent per year; but in Yu \ the faster-growing upper-middle-income group, at 3 per- Yugoslavia cent; in South Korea, at 6 percent; and in Japan in the 30 Brazil 1950s and 1960s, at more than 8 percent. (Productivity and surplus rural labor are discussed in Chapter 8.) 20 I l Sectoral employment shares in MODERAI'E are similar 125 250 500 1,000 2,000 4,000 to those in QUADRUPLE. This is because the assumed Per capita income(I 982 U.S. dollars, logarithmic scale) lower efficiency that causes slower output growth is also QUAI)RUPL E projection associated with slower growth of nonagricultural labor - -BALANCE projection productivity (on average about 3 percent). But the nonag- ricultural labor force grows slightly less than in QUADRU- Source: World Bank, World Development Report 1984 (New York: Oxtord PLE, and hence the share of employment in agriculture University Press, 1984), cable 21; World Bank, World Tables, 3d ed. (Wash- does not decline quite so much. ingtoni, D.C., 1984), vol. 2. In BALANCE, employment in services grows much faster than in QUADRUPLE-partly because the demand ment is 4.3 percent). Agricultural employment in for commerce and miscellaneous services expands faster, BALANCE thus increases between 1981 and 2000 by only partly because improved quality and the changing com- 13 million, and declines to 52 percent of the labor force. position of activities within these sectors are assumed to This would be quite normal for a large lower-middle- entail slower labor productivity growth. By 2000, the income country (Figure 2.1 and Annex 5, Table 3.8). service sectors, which employ 14 percent of the labor Sectoral employment shares largely determine sectoral force in QUADRUPLE, employ 25 percent in BALANCE- shares of national income, although these also depend on almost exactly the 1980 average for lower-middle-income the amount of capital per worker, on wage rates, and on developing countries, with an average per capita income prices-especially in relation to costs. The projections of very similar to that projected for China in 2000. Because sectoral national income shares in Table 2.6 (both West- industrial output grows more slowly in BALANCE, and ern and Chinese measures are presented) assume that industrial labor productivity grows just as fast, industrial sectoral prices change in parallel with sectoral costs, employment does not increase so much as in QUADRU- which means that the relative profitability of different PLE-and indeed increases very little as a proportion of sectors remains constant (Box 2.1). Different assumptions the total labor force (although in absolute terms it rises by about prices-for example, that they do not change or 35 million workers). Employment in the infrastructure that there is movement toward equalization of sectoral sectors, however, increases only slightly less than in QUADRUPLE. The greater increase in service sector emiployment in - - ThLANCE grear ireasehin offservic he sector eemplomen in 9. The most commonly quoted Chinese projection of agricul- tural employment in 2000 is 225 million-S0 percent of a rural industrial employment, so that nonagricultural employ- labor force of 450 million. The projection cited in Annex 2, Table ment increases by over 40 million more than in QUADRU- 5.1, is somewhat higher-250 million, or 39.6 percent of the PLE (the annual growth rate of nonagricultural employ- World Bank's total labor force projection of 631 million. 41 Table 2.6 Sectoral Composition of National Income, profit rates-would somewhat alter the projected shares Alternative Projections, 1981-2000 of national income. ercent) in QtAI)RUPLE, the share of agriculture in national 2000 iuwulnie drops by ten percentage points between 1981 Sector 1981 Quadruple Moderate Balance and 2000, with increases in the shares of other sectors, especially heavy industry and infrastructure. In MODER- Agriculture 3 (40) 26 (30) 27 (32) 23 (29) ATE, the movements are similar, although the share of Ileavy industry 24(26) 28(30) 29(31) 23(28) Light industry 15 (17) 15 (18) 15 (18) 12 (17) agriculture declines less. In BALANCE, there is a much Infrastructure 11 (10) 14 (14) 13 (13) 13 (14) greater increase in the share of services, especially using Services 16 ( 7) 17 ( 7) 16 ( 7) 28(13) the Western measure (partly because some of the increase Note Figures without parentheses are Western measures (shares of GDP); is in nonmaterial services, partly because the material those within parenitheses arc Chinese measures (shares of NMP). In the latter contribution of miscellaneous services is in the Chinese case, infrastructure excludes passenger transport and only commerce is in measure included in the output of the material produc- services; the contribution of business services to material production is incltuded in the net output of other sectors. Other sectoral definitions are as tion sectors rather than of services). The sharc of industry given in Table 2.4. Figure 1.2 differs from the present table mainly because in national income in BALANCE increases less by the Chi- of price adjustments (see Annex 5). and in si ificantleh the Chi- Source World Bank projections (Anniex 4). nese measure and declines significantly by the Western measure (the difference is again due mainly to the treat- ment of business services). Agriculture's share of national incomne declines more in BALANCE than in QUADRUPL.E, Box 2.1 Wages, Profits, and Prices Sectoral relative prices-which are producer (ex factory or mediate inputs (such as agriculture), or where labor pro- farmgate) prices-are determined in the model by sectoral ductivity is rising more slowly than average (such as ser- costs, including intermediate input costs, wage costs, and vices), or where the capital-output ratio is rising faster than capital costs. Intermediate input costs depend on usage average (such as energy), relative prices rise. rates-input-output coefficients-and on input prices. Conversely, in sectors where intermediate-including Wage costs in each sector depend on labor productivity energy-use is reduced, or with above-average labor pro- and on wage rates, which in turn depend on the rate at ductivity growth or below-average capital-output ratio in- which wages in general are rising and on the relationships creases (many industrial sectors), relative prices fall. Some among wage rates in different sectors. In the model, gene- sectors are subject to conflicting cost pressures, which, ral wage increases are tied to household consumption in- moreover, may vary among projections-for example, ag- creases; in these projections, sectoral relative wage rates ricultural prices rise less in BALANCE then in QUADRUPLE (agricultural earnings are included in wages) are assumed to because agricultural labor productivity rises more, as a remain constant in proportionate terms-except in educa- result of greater absorption of labor by other sectors. tion and health, where the initially low wage rises gradu- The assumptions of the present trio of projections thus ally to the same level as in public administration. allow in a simplified way for the most important long-run Capital costs in each sector are governed in the model by tendencies in sectoral relative prices, but not for any modi- the capital-output ratio and the sectoral profit rate (gross of fication of the present relationships in China among wages depreciation), which in turn depends on the economy- in different sectors or among sectoral profit rates. Such wide average profit rate and on the relationships among modifications could easily be incorporated (for example, to profit rates in different sectors. The average rate of profit approximate the results of specified types of wage and (including tax) is determined in the model by the need to price reform), although they would make it harder to generate a large enough surplus to finance the planned interpret the projected structural trends with which this level of saving (net of household saving) and government chapter is mainly concerned. It would also be possible-if consumption. In these projections, it was assumed that complicated-to extend the model to distinguish retail relative sectoral profit rates would remain constant in pro- prices from producer prices, enterprises from government, portionate terms. and urban households from rural households. The deter- In short, prices in these projections adjust over time so as minants of the absolute price level and the rate of inflation, to maintain constant the relative wages of the workers in however, probably could not be handled satisfactorily in each sector and the relative rate of profit on capital in each this model. sector. As a result, in sectors with increasing use of inter- 42 although the difference is more pronounced by the West- culture, energy, transport, urbanization, foreign trade, ern measure. and public finance. It is important, however, to interpret The share of agriculture in national income in 2000 in all these projections appropriately. They are not predic- BALANCE would be normal for a large lower-middle-in- tions, but simply complicated calculations based on many come country (Annex 5, Table 3.6). 'I'he share of ser- assumptions, whose rcsults could be altered considerably vices, however, is almost ten percentage points lower, by different, but still defensible, assumptions. As such, notwithstanding the similarity of the service sector em- they should be taken seriously-as an indication of some ployment share, and the projected income share of indus- future possibilities-but not literally. try and infrastructure is correspondingly higher than in The choice of terminal year (2000) is also quite arbi- these countries-indeed, it exceeds that of almost all trary; the purpose of the projections is to illustrate possi- other countries, including Japan. These discrepancies be- ble long-term trends, most of which would continue into tween employment and income shares partly reflect real the twenty-first century, rather than to assess China's differences in the composition of industry (more heavy position in any particular year. And for planning pur- industry in China) and services (a lower proportion of poses, the process of making projections is often as help- social services elsewhere). But they also reflect the cur- ful as the particular model and numbers selected for pre- rently unusual structure of prices and wages in China, sentation. Cumulatively, the innumerable "unsuccessful" most features of which in these projections are assumed- experiments with different assumptions and model speci- perhaps incorrectly-to persist (Box 2.1). The differences fications are very illuminating, especially in practical judg- between the projected sectoral income shares for China ment of particular plans and policies. in 2000 and the normal shares in large lower-middle- For these reasons, and because there is much scope for income countries are of course even greater in QUADRU- improvement of the model and the underlying data (espe- PLE and MODERATE than in BALANCE. cially the input-output table and sectoral capital require- ments), the projections presented in this report should be Projections and Predictions viewed as no more than a preliminary contribution. Fur- ther work, and better statistics, would be needed to turn Subsequent chapters will further discuss the implications them into a reliable basis for planning. of these three (and some additional) projections for agri- 43 Agricultural Prospects and Policies During the next two or three decades, agricukure will and 1983. Giving adequate incentives to individual remain one of the largest and most important sectors of farmers-the essence of the reforms-will continue to be China's economy.' Even in 2000, food will account for a vital ingredient in expansion of agricultural production about half of household consumption, and about half the over the longer term. But their effectiveness will depend labor force will be engaged in agricultural activities. The on the availability of key inputs such as agricultural land economic linkages between agriculture and other sectors and irrigation, fertilizer, and improved seed. Also impor- will become ever closer. The pace of agricultural progress tant, though less tangible, will be improvements in sup- will depend increasingly on growth of nonagricultural port services, such as research and extension, and trans- demand for food, materials, and labor and on the avail- port and marketing. ability of nonagricultural goods and services. And the Future availability of land will depend heavily on the pace of nonagricultural progress will continue to depend extent to which reclamation can compensate for land lost on growth of agricultural purchasing power and on agri- to nonagricultural uses. Taking account of land quality culture's capacity to supply the right amount and mixture and use by herdsmen, perhaps another 3 million to 5 of produce for industrial processing and nonagricultural million hectares of "wasteland" are suitable for develop- consumption. System reform and government policies, ment in the medium term for sustained production of moreover, will greatly influence these mutually reinforc- annual crops. Losses of land to nonagricultural uses in ing interactions between agriculture and other sectors. 1959-78 were about I million hectares annually; the This chapter, which draws heavily on Annex 2, first current surge of rural housing construction suggests that reviews China's long-term agricultural production poten- these losses will continue to be substantial and are un- tial. It then examines the long-term balance between the likely to be fully offset by increases in the amount of land demand for and supply of agricultural products, with irrigated, which has not increased significantly in recent special emphasis on China's future options regarding the years. level and pattern of food consumption. Finally, the chap- Although organic fertilizer will remain an important ter discusses the choice of policy instruments for manag- source of nutrients (particularly phosphorus, potassium, ing agricultural production under the recently imple- and some trace elements), it is unlikely to meet the Gov- mented responsibility system, and possible ways of ernment's target of half of total nutrient offtake by 2000, narrowing the large gap between agricultural and nonag- if China's fertilizer use patterns follow those of other ricultural incomes. (Rural nonagricultural activities, inter- countries. However, China now has the capacity to de- regional agricultural specialization and trade, and the sign and construct efficient, large-scale plants to produce problems of poor localities are discussed in Chapter 5.) nitrogenous chemical fertilizers; if raw materials are made available, the rather modest future production targets for Production Possibilities nitrogen seem realizable. But achieving the 2000 targets for both phosphorus and potasslum would require an The rural reforms of 1979-80 have stimulated exception- early commitment of substantial resources to develop lo- ally rapid growth of agricultural production, and of rural cal raw materials and introduce new production technol- incomes and food consumption (Chapter 1), based on rapidly rising yields. In grain production, for example, average yields-which were already high by most interna- 1. "Agriculture" is defined throughout to exclude brigade and tional standards-increased by 22 percent between 1979 team industry. 44 ogies. Even so, sizable amounts of phosphorus and potas- the problems of poor seed quality, low fertilizer applica- sium would still need to be imported. Equally important tion rates, and less advanced cultural practices than those will be improvements in the fertilizer distribution system, applied to wheat and rice. to ensure the timely availability of supplies in economi- Among the industrial crops, prospects seem good for cally optimal quantities (discussed later). For seed, how- further yield and production gains in cotton. Increased ever, the basic mechanisms for production and distribu- production of soybeans is essential for meeting livestock tion are already in place, but processing facilities and product targets; there is also a need to improve processing quality assurance procedures need to be improved. of oilseeds to increase supplies of protein meals suitable Experience in other countries suggests that building an for livestock feeding. For industrial crops such as sugar effective national agricultural research capability requires cane and beets, emphasis should be on increasing produc- an annual investment of up to 2 percent of the value of tive efficiency through better cultural practices, improved agricultural output-considerably higher than current ex- planting materials, and careful choice of planting loca- penditure in China. Despite some very notable achieve- tion. Development of the state forestry sector is ham- ments, work at many research institutes is hampered by pered by limited investment and low administered prices, poor facilities and inadequately qualified staff. Good although price and marketing restrictions have recently progress has, however, been made in reorganizing the been abolished for individual and collective forestry. extension service in accordance with the rural reforms, so that it can deliver technical advice to many small pro- Prospectsfor Livestock ducers. Close links need to be maintained between re- The Government expects rapid growth of the livestock search and extension, Moreover, agricultural education sector (tentatively projected to increase its share of gross needs to be strengthened to support these programs: re- agricultural output-excluding brigade industry-from cent studies indicate shortages of appropriately trained about 18 percent in 1982 to over 30 percent in 2000). personnel (at both professional and technical levels), as But achievement of the livestock growth targets could be well as a need to upgrade the qualifications of those constrained by the supplies of grass and feed, the weak- already employed. nesses of the systems of transport, processing, and distri- It will bc essential to improve rural transport, process- bution, and the availability of investment funds. Many of ing, storage, and distribution, whose limited capacity is China's grasslands are overgrazed and probably cannot already an important constraint on the restructuring of provide additional meat and wool in the short to medium China's agricultural sector and increased specialization. term without further degradation. An urgent require- Efforts are needed to both expand the rural marketing ment is therefore to match livestock numbers with the system and increase its efficiency, with simplification of land's carrying capacity, through herd reduction and im- procedures and reduction of administrative barriers to proved range management. The prospects for pigs and internal trade. The Government is currently taking fur- poultry are more favorable, but depend on increased sup- ther important steps in this direction, by switching from plies of high-quality energy and protein feeds, as well as procurement quotas for major crops to contracts, by in- on the price relationship between feed concentrates and creasing price flexibility, and by allowing collective and meat products. Because poultry provide Chinese con- individual enterprises a greater role in marketing. In the sumers with a preferred meat and are, moreover, efficient provision of support services, as in agriculture itself, the converters of feed to high-quality protein, China's poul- economic environment will thus need to be conducive to try industry should be a priority development area. individual and collective investment. Especially because 'fhe prospects for dairy development over the long state investment in agriculture is not expected to increase term will depend largely on the availability of low-cost, significantly, it will be critical to put much of the growing high-quality forage and feed protein and on the establish- volume of rural savings to productive use. ment of efficient milk processing and distribution sys- tems. Milk supplies for some urban consumers might also Prospectsfor Major Crops be increased at lower economic cost by importing pow- The Government's long-term growth target for grain dered milk. Aquatic production will continue to be a production is about 2 percent per year-to be achieved valuable supplementary source of high-quality protein, by raising yields, with the cropped area declining. Rice and good potential exists for increasing the output of production is projected to grow at 1 .8 percent per year- fresh and marine fish. a target that appears readily attainable. The projected 2.6 percent annual growth in wheat yields would require Potential Demand-Supply Imbalances continued attention to wheat diseases, good water con- trol in irrigated areas, and improved nutrient balance in Projecting China's long-term agricultural demand-supply fertilizer use. Similarly, the projected growth in corn balance is peculiarly difficult. This is partly because of the yields (2.8 percent per year) would require attention to dramatic difference between the sector's performance in 45 the past five years (gross output up by over 7 percent per of 3.6 percent. This particular growth rate was chosen year) and in the preceding twenty years (average under because it approximately balances agricultural demand 2.5 percnt. cpIiujng oii wvhat pasr period is regarded and producLion In 2000-net cron imports equal to 0.5 an.1 aZ ULhC untries as reievant percent ot crop production. Though well above the long- comparators, the future trend growth rate could be pre- term trend increase in China prior to 1979, this projected dicted at anything between 2-3 percent and 5-6 percent crop production growth rate is close to the 1965-83 per year-which, over twenty years, is the difference average (3.7 percent per year). between less than doubling and tripling. Moreover, even Given the underlying assumptions about agricultural given a particular view of potential production growth, efficiency, this crop production growth rate requires use most projected imbalances between agricultural demand of chemical and other industrial inputs to increase at and supply will not actually materialize-or at least not to about 6 percent per year, and investment in fixed and the extent indicated-simply because producers or con- circulating capital averaging about Y 6 billion (or 2-3 sumers or the Government will automatically react in percent of total investment) per year. Production of ani- ways that reduce them. The following analysis (which is mal products-responding to the assumed steep increase based partly on the economywide model and projections in consumer demand-grows at 7.5 percent per year, presented in the previous chapter, partly on the more which requires, in addition to rapid growth of animal detailcd agricultural projections in Annex 2) is thus not feed consumption, investment averaging about Y 15 bil- an exercise in prediction, hut an exploration of possible lion (or 5-6 percent of total investment) per year. In tendencies and problems-some of which could he total, gross agricultural output grows at an average annual avoided if anticipated sufficiently early.2 rate of 4.5 percent, and the sector absorbs 8 percent of A starting point for the analysis was the assumption- total annual investment. based partly on Chinese planning targets-that over the This agricultural growth rate lies within the fairly wide next two decades there would be a rapid increase in the range (under 4 percent to over 5 percent) contemplated share of meat, poultry, fish, eggs, and dairy products in by most Chinese economists.3 Though well below the the average Chinese diet, with a corresponding decrease growth rate of the past five years, it is higher than any in the share of direct grain consumption. Specifically, it past long-term trend rate in China (in 1965-8 3, the aver- was assumed that, if the Government's targets for na- age was 4.1 percent). This is because of the high pro- tional income and population growth were attained, per jected growth rate of animal husbandry production (in capita consumption of animal products would approxi- 1965-83, growth of livestock and fishery production av- mately quadruple (by weight), raising their share of a eraged 5.4 percent and 3.6 percent per year, respec- slightly increascd total caloric intake from 6 percent in tively). By international standards, it is a very high long- the early 1980s to about 15 percent by the end of the term growth rate-double the 2.3 percent average for century. (In the next section, somc possiblc alternative low-income countries in 1960-80, well above the 3.0 food consumption patterns are considered.) The economywide model also assumes that investment - will he allocated-and hence production will respond to 2. 'Ihe strength of the economywide model lies in relating demand-in such a way as to maintain approximate na- agricultural production, input use, and eiployment, as well as tional self-sufficiency in animal products and processed demand for food and agricultural materials and agricultural exports tXnat self-suficienc in animalprdand imports, to corresponding developments in other sectors (in- food. Agricultural demand-supply imbalances thus show cluding food processing) and in macroeconomic aggregates. Its up mainly in projected net crop exports or imports weakness is that-to avoid unmanageable complexity-it distin- (though these are powerfully influenced by the rate of guishes only two agricultural subsectors, crops (including forestry growth of animal husbandry production, since animal and sidelines) and animal husbandry (including fishing. Annex 2, feed is an important component of crop demand). The conversely, contains projections for more detailed subsectors and potential size of these imbalances, given the overall pace some specific agricutural commodities, but without full consider- and patenofecnmigothcnccrinlyhi ation of all the linkages with other sectors. 'I'hese two sets of and pattern of economic growth, can accordingly he in- projections, though they cannot be precisely reconciled, were vestigated by varying the assumed future rate of growth made in a coordinated way and are fundamentally consistent in of crop production (which, as already mentioned, cannot their assumptions and implications. be predicted with any accuracy). 3. Some Chinese estimates of future agricultural growth ap- The QQUADRUPILF. projection introduced in the previous pear significantly higher because they include rapidly expanding chapter is a convenient point of reference. It incorporates brigade and team industries. For agriculture proper, the Ministry the assumption of a rapidly changing diet, as well as of Agriculture's preliminary targets imply a growth rate of 3.8 attainingthsother main long-term targets, percent (Annex 2, 'lable 5.3). 1ligher estimates are given in li[u attaining the government's othcr main long-ternitargets,' Guoguang, ed., ZhongZguo Jingii Fazhan Zhanlue Wenti Yanjiu (Is- but allows for some substitution of industrial for agricul- sues of China's economic development strategy), (Shanghai tural raw materials in manufacturing. Crop production is Shanghai Renmin Chubanshe, 1983), p. 155 (4.7-5.7 percent) assumed to grow in 1981-2000 at an average annual rate and p. 404 (4.4-4.5 percent, perhaps 5 percent). 46 percent average for middle-income countries, and sur- If aggregate income growth were slower still, the pro- passed only by Thailand and the Philippines, which jected crop deficit could disappear, even with crop pro- started with more uncultivated land and lower yields. duction growth at 2.9 percent. This is so in the MODER- ATE projection (introduced in the previous chapter), in Alternative Outcomes in 2000 which lower efficiency in industrial investment causes the China's strict birth planning policies are motivated partly whole economy to grow at an annual rate about one by concern about food availability. A projection was thus percentage point lower than in QUADRUPLE, while lower made with the economywide model that maintained the agricultural efficiency manifests itself in slower growth of assumptions of QUADRUPLE, except that the population crop production. Though crop production in 2000 in rises to 1.3 billion in 2000 (rather than 1.2 billion). This MODERATE is 12 percent lower than in QUADRUPLE, causes a larger foreign trade deficit in crops. But the there is a significant trade surplus in crops (about 2 per- projected deficit is surprisingly small-about 2 percent of cent of domestic crop demand), because slower growth of total crop production in 2000, which is similar to that in incomes reduces demand by even more. Direct human the early 1980s. This is because the higher population consumption of crops is only 6 percent less, mainly be- causes per capita income to be lower, which, given the cause grain remains a larger proportion of the diet at the assumptions linking consumer demand to income, causes lower per capita income level (indeed, direct grain con- lower per capita consumption of crops and of commodi- sumption might be higher in absolute terms if incomes ties whose production directly and indirectly requires were lower; see Annex 2, Table 2.1). But indirect con- crops.4 If per capita food consumption were unchanged, sumption-mainly animal feed-and other uses of crops the impact of a larger population would be much together are 17 percent lower. greater-an increase in direct and indirect grain require- ments in 2000 of about 40 million tons, or 8 percent of Cbanging Imbalances over Time projected requirements (Annex 2, Table 2.3). Moreover, In considering the long-term agricultural demand-supply the possible range of alternative population sizes for balance, it may be misleading to look simply at projected China becomes far wider in the twenty-first century (see values for 2000. Although the present model is not de- Chapter 8). signed to analyze medium-term movements, the projec- Projections were also made under somewhat more pes- tions suggest some changes in the pattern of imbalances simistic assumptions about agricultural efficiency, both in during 1981-2000, with possible implications for policy crop production (given the same resource inputs, gross in the rest of this century and beyond. output was assumed to grow about 0.7 percent per year Figure 3. 1 a illustrates this for the QUADRUPLE projec- more slowly) and in animal husbandry (feed requirements tion, by showing what happens to crop exports and im- per unit of product in 2000 up by about 15 percent).5 ports. Up to the mid-1990s, domestic demand for crops Retaining all the other assumptions of QUADRUPLE, falls short of production, causing a projected foreign trade lower agricultural efficiency pulls down the aggregate surplus and-not shown in the figure-abnormally high growth rate (GDP grows at about 6.4 percent per year, accumulation of stocks because of an assumed upper limit rather than 6.6 percent). Its impact on the agricultural on crop exports imposed by world market conditions demand-supply balance depends, however, on whether it (discussed further below). This represents a continuation is assumed to cause more resources to flow into agricul- of the actual situation of abundance in the early 1980s as ture (to maintain production) or to cause slower agricul- a result of the surge in production induced by the rural tural production growth. reforms. This initial surge is assumed eventually to dimin- In the former case, with growth of crop production ish, with somewhat slower growth of crop production in maintained at 3.6 percent per year, exports and imports the 1990s (3.4 percent per year) than in the 1980s (3.8 of crops are almost unaffected. This is because lower percent per year). In consequence, and despite an as- efficiency in converting feed to livestock products, which sumed reduction also in the rate of increase of food con- would tend to increase the crop deficit, is almost exactly sumption, the demand-supply balance begins to change in cancelled out by slower growth of total and per capita income, which reduces crop consumption both directly and indirectly (through lower consumption of meat and 4. In the model, faster population growth has almost no effect other commodities). In the latter case, with growth in on total national income in 2000, partly because it would not crop production reduced to 2.9 percent per year, lower significantly alter the size of the labor force until later, partly agricultural efficiency causes a substantial crop deficit by because of the assumption of surplus agricultural labor. 2000-net imports equal to nearly 9 percent of domestic bys. The assumed increase in animal feed requirments is substan- nal. But the difference between low and high efficiency in conver- demand for crops (and nearly 20 percent of total im- sion of animal feed to meat could in fact add as much as 50 ports). Were it not for the slower overall growth of in- percent, or 60 million tons, to feedgrain requirments in 2000 come and demand, the deficit would be even larger. (Annex 2, Table 2.2). 47 Figure 3.1 Crop Exports and Imports, Alternative Projections, 1981-2000 ikn 0t 19 I 4 1 I.;. '"Y j 14 1 a DLAI)RUPLE projection h QLJADRUPI.i projectioni, / / higher population variant 12 l 12 - /~~~~~~~~~~ 10 I10 / 8 _ 8 6 6 - 4 4 2 2 0 I I I . . I I o II0 I I 1981 1985 1990 1995 2000 1981 1985 1990 1995 2000 Billions of 1981 yuan d Billions of 1981 yIsan 14 14 QUADRUPLE projectiono, ld MDERAYE projection 48- low crop production variant 10- M 10 8 8 6 6 4 /-4 2 2 1981 1985 1990 1995 2000 1981 1985 1990 1995 2000 ---Upper and low,er bounds oni exports 'Irade surplus M Imports* Trddeit X ExportsTaddeit Source- World Baiik projectionis. 48 the early 1 990s, with an absolute decline in crop exports the substantial projected imbalances within the crop sec- and, in the last years of the century, the emergence of a tor would have to be resolved through international trade crop trade deficit. Though the deficit in 2000 is very or by altering production patterns, both of which would small, it is growing: if the projected demand and produc- be feasible up to a point, but not without problems. tion trends of the late i990s were to continue, it would increase to 5 percent of domestic demand by 2020. INTERNATIONAI TRADE. It would generally be more Most of the other projections discussed above follow a economic to import feedgrains rather than an equivalent similar time path, with crop surpluses in the earlier part amount of animal products, simply because wages in Chi- of the period diminishing or disappearing in the later na's agriculture are likely to remain far below those of the part, although the speed of the transition varies (Figures main animal product-exporting countries. It also appears 3.1b and 3.1c). In the variant on QUADRUPLE with that China could purchase a large amount of feedgrains slower crop production growth, for example, the surplus on the world market without much effect on prices, becomes a deficit before 1990 and thus becomes large by mainly because of the large unexploited production po- 2000. MODERATE, however, is an exception (Figure tential in grain-supplying countries. World trade in coarse 3. Id): despite slower crop production growth, the slow grains, on the basis of past trends, could increase by 7 overall growth of the economy causes projected crop million to 8 million tons per year, and prices could con- exports to exceed imports throughout the period (though tinue to decline in real terms (Box 3. 1, and Annex 2, abnormal stock accumulation ceases in the 1990s); even paras. 5.17-5.19). Even if the whole of the large feed- in the last few years of the century, there is no tendency grain shortfall identified above were to be met through for a deficit to emerge. imports, these would not exceed 15-20 percent of world market growth, and by the end of the century China's Product Mix witbin Agriculture imports would be unlikely to exceed 10 percent of world Expansion of animal husbandry at the high rate (7.5 trade in grain. Diversification of suppliers in recent years percent per year) entailed by demand growth in the has also reduced the ability of any single large supplier to QUADRUPLE projection might be technically feasible, but use grain embargoes or restrictions for political ends. would require attention to some curent problems and Nonetheless, it might be unacceptably risky for a country weaknesses in the livestock sector (as discussed earlier and of China's vast size to become heavily import-dependent in Annex 2, paras. 4.41-4.88 and 5.28-5.38). It would (60 million tons would be about a third of China's pro- also require substantial diversion of crop output to animal jected feedgrain requirements in 2000). feed, which could cause problems of demand-supply im- There is also the necessity of earning sufficient foreign balance within the crop sector. exchange to pay for these imports. This need not be Even with an overall crop balance, as in QUADRUPLE earned by agricultural exports: indeed, in some of the and in a more detailed alternative projection with lower projections mentioned above, in which there is an overall animal husbandry production (see Annex 2, Table 5.2), agricultural deficit, some of it would have to be covered the Government's present targets for increasing produc- by exports of manufactures and services (conversely, an tion of specific crops could well lead to sizable surpluses overall agricultural surplus could be a net source of fi- of rice (possibly 30 million tons, unprocessed, by 2000), nance for nonagricultural imports). But the projected co- and of tubers and pulses, with a large shortage of feed- existence of shortages of feedgrains and surpluses of other grains (perhaps 60 million tons, or 12 percent of total crops obviously suggests the possibility of exporting the grain production, by 2000). Though the magnitudes latter. vary, a broadly similar pattern of imbalances arises in all Here a major question arises. Thle surpluses are mainly the other projections described above. It occurs partly in rice, and world trade in rice is comparatively small. because direct consumption of fine grains by humans is Indeed, the potential rice surplus for 2000 mentioned unlikely to increase on a per capita basis if income growth above (some 20 million tons on a milled basis) is about as and dietary change proceed according to Government large as most estimates of total world rice trade at that targets (the projected surplus of rice would be even time (the total is now about 12 million tons and is ex- greater if China were assumed to experience the shift of pected to grow at about 2.5 percent per year), which consumption from rice to wheat that has occurred in would imply a doubling of total trade and an increase in other Asian countries in response to higher incomes- China's share from the present 10 percent to around 50 Annex 2, para. 2.11 and Table 2.3). These imbalances percent. It is unlikely that world trade in ricc could be arise also because of the projected rapid growth of de- doubled without depressing the world market price of mand and production in animal husbandry and the need rice to uneconomic levels. Ilowever, the present relativc for such production to be increasingly based on grain and level of the world rice price-2.5-3.0 times that of protein-based feeds, rather than pasture or forage. wheat-has little foundation in nutritional content. And Taking the projected pattern of food demand as given, in China, the cost of rice production is probably lower 49 Box 3.1 World Grain Trade. Past and Future Over the past twenty years, and indeed since the 1 930s, more than half their grain imports for animal feed. world trade in cereals-wheat, rice, and coarse grains-has Most projections (see Annex 2, paras. 5.17-5.20) sug- increased in volume by about 4 percent per year. Grain gest slower growth of world grain trade in the 1980s. This production has grown more slowly, so that trade has in- is because of slower demand growth, due to increased creased its share of output from about 4 percent in the production in India and China, and economic difficulties 1930s to 10 percent around 1960 and more than 14 per- for some other large grain importers. As a result, and cent at present. Trade in coarse grains has grown the fast- because world production potential will still greatly exceed est, at 5 percent per year, and rice the slowest, at 2.5 demand (in the United States alone, 50 million hectares of percent per year. Although prices have fluctuated, their unutilized land could produce an additional 200 million trend has been downward in real terms (for wheat and tons per year), grain prices are expected to continue to corn a decline of about 50 percent between 1925-29 and decline in real terms. Recent World Bank projections 1981, for rice a decline of more than 25 percent over the (made before the analysis of demand and production past twenty years). Developing countries have accounted trends in China discussed in this chapter) suggest reduc- for two-thirds of the increase in world grain imports over tions of II percent, 13 percent, and 7 percent in the prices the past fifteen to twenty years; in particular, their coarse of rice, wheat, and corn respectively by 1995, as compared grain imports have increased tenfold, mainly because of with their 1976-82 averages. dietary changes in middle-income countries, which use than that of wheat production (Annex 2, Table 1. 3). It fcedgrains are grown in the North, while most pork and could therefore be in China's economic interests to ex- poultry are produced and consumed in the South. In the pand rice exports substantially-but gradually, for future, there will thereforc have to be either more North- smooth adjustment-and to reduce the world ricc price South movement of feedgrains or an increase in livestock to a level much nearcr that of wheat.6 production in the North for transportation to the South (which would involve a smaller volume of transport, but PRODUC'I'ION PAYl ERN. In addition, or as an altcrna- more expensive refrigerated equipment). tive, to using international trade to match demand and supply for particular crops, there is scope for altering the Changing Food Demand domestic production mix. This would involvc switching The preceding discussion of potential agricultural de- rice land either into coarse grain production or into the mand-supply imbalances has assumed a rapid increasc in production of other crops that could be more easily ex- the share of animal products in a gradually rising total ported to pay for coarse grain imports. 'I'he cxtent to food intake. Because animal products are relatively ex- which either of these switches would be economic, let pensive, this implies an income elasticity of dcmand for alone the economically optimal combination, cannot be food (0.85) that is rather high by international standards determined on the basis of presently available informa- (0.70 would be normal for a country at about China's tion on China's soil and water resources. Muchi of the income level).7 Clearly, however, adjustment of the level presently irrigated rice land would not be as well suited to other crops, but in rainfed upland, rice yields are much lower in relation to those of corn and oilseeds. Major 6. To maximize China's economic gains, the pricc should he expansion of some of China's traditional export crops (tea reduced to the point where the increase in foreign exchange earn- expand iomushrooms, ofo example)' woulds diffitional tcustcas ings from adiditional rice exports-taking account of the loss of an inushrooins, for example) would bc as difficult as revenue on existing exports caused by the price reduction, as well expanding ricc exports; Iajor expansion of alternativc- as the increase in volume at the new price-is approximately equal and potentially promising-export crops would require to the cost of additional rice producton, measured in foreign tremendous improvements in storage, transport, and exchange. 'The price level in question could be roughly identified in packaging facilities, advance on the basis of information on the price elasticity of world Since these changes in the production pattern would demand, but its attainment wouild require gradual adjustment and require certain areas to become more specialized il pro- careful monitoring of demand and cost development. require ofraniared o ecort moditied th Go- 7. 'I'he income elasticity of demand for food is defined as the duction of animal feed or export comnmodities, the Gov- growth rate of r-eal per capita expenditure onofood divided by the erminent would have to furthier relax local food self-suffi- growth rate of real per capita househlold income. 'Ihe figure of cieney requirements (see Chapter 5). In addition, the 0.85, for example, implies that each 10 percent increase in income present regional pattern of production is such that most leads to an 8.5 percent increase in food expenditure. 50 and pattern of food consumption is an additional possible Figure 3.2 Per Capita Food Intake in China, response to these imbalances. 1981-2000, and in Other Selected Economies, The present food situation in China is very unusual, in 1960-80 two senses. First, by comparison with other countries: total food intake, in terms of protein as well as calories, is Food intake (ktiocalories per day) above the average for middle-income countries; yet the 3,600 Germany, Fed. Rep proportion of animal products in the Chinese diet is simi- .raw lar to the low-income country average. This limits the 3,400 France relevance of international experience, since a "normal" - diet at the Government's target income level for 2000 would involve significantly less food (though more ani- 3,200 Spain mal products) consumption than at present. Second, by Turkey comparison with the past: for much of China's history, 3,000 Egypt Japan feeding the population at a level-at best-Just above / subsistence has been a major problem; yet in just five 2,800 Hong Kon years a remarkable surge of agricultural production has / transformed the situation. Even looking a long way 26 ahead, agricultural production seems likely to grow at 2,600 China B least twice as fast as population, which implies that there -Brazil should be no difficulty in maintaining or improving on 2,400 Indonesia Nigeria China's present satisfactory average per capita calorie and Pakistan I hailand protein intake. 2,200 - The projections discussed above also allow the possibil- ity of an increase in animal product consumption over India the next two decades as rapid as present targets imply. 2,000 - But this would require crop production to grow at a high rate, international trade or changes in production pat- 1,800l terns to balance supply and demand for particular crops, 125 250 500 i.000 2,000 4,000 8,000 16,000 and feed-meat conversion ratios to improve substantially. Per capita income (1982 U.S. dollars, logarithmic scale) There is no guarantee that any or all of these conditions .Relationship in abo. t 1960' will be fulfilled, especially over the longer term. There are Relationsitip in about 1980; some difficult technical and economic obstacles to over- Q ULADRUPIT projection, 2000 come, as well as the possible risks of dependence on feedgrain imports. The meager scale of China's cultivable a. Based on 1960 per capita income and the 1961-65 average for food land resources and the possibility of substantial popula- ieitake. tion growth in the twenty-first century are also reasons b Based on 1982 per capita income andl the 1978-80 average for food for caution. Even with a favorable feed conversion ratio, Source. World Bank data. an increase of ten percentage points in the share of animal products in the average diet is equivalent (other things being equal) to the disappearance of 35-40 percent of being's equltvabl) e landisappearance 35-40 percent fc e i figure shows that it would lead to roughly the food con- China's coulativ nd, sumption level of Japan (under 3,000 kilocalories), rather China's population.5 than to the substantially higher levels (around 3,500 kilo- One possibility of particular concern would be an in- caois ofWsenErp n teUie tts I calories) of Western Europe and the United States. (In crease in per capita consumption of animal products to a the U.S.S.R., the corresponding figure is 3,300 kilocalo- level that could not be sustained, because of a future E i r f , slowdown in crop production growth, inefficient meat kioar is ) ' production, or inability or unwillingness to import feed- kBlocaloraes.) ' . . . ~~~~~~~~~By contrast, China's target increase in consumption of grains on a sufficient scale. International experience sug- r s ~~animal products, relative to the target increase In pcr gests that the cutback in meat consumption that would capita income, is high by international standards (Figure then be required could cause acute social problems. Alternative Food Consumption Patterns 8. This is because more than four kilograms of grain are rc- China's target Increase In total food Intake IS modest by quired to prodLuce a kilogram of meat, which contains only thrce- international standards (Figure 3.2). If the 1981-2000 quarters as many calories as one kilogram of grain consumed di- trend were continued to a much higher income level, the rectly. 51 3.3). Over similar low- to lower-middle-income ranges, Japan's food consumption pattern is of special rele- the share of animal products in the diet in most other vance to China's future development, largely because the countries either increased only slighrl, (Fgypt and Nor- two countries have in com-mlon a vcrv sm.all amoount of r!a) or dedMied 'Indcliesia. Palks ...........n .,!..,dJ.]T,_... il; ' ''' !trra 'I'h;-s is morc thlan, key). Moreover, if this Chinese trend were continued, it double Japan's). Japan's pattern differs from that of other would lead to West European levels, rather than to the industrial market economies not only in its substantially much lower level of Japan. Indeed, China at an income lower caloric intake and far lower animal products intake level of $800 would have a share of animal products in (although the latter increased from 300 kilocalories per food consumption similar to Brazil at a comparable in- day in 1961-65 to 550 in 1977), but also in the composi- come level, but 50 percent higher than Japan had at an tion of the animal products intake, with an unusually income level of $2,500, and only 25 percent lower than high share of aquatic products and unusually low shares at Japan's present income level of $1 0,000. of meat-especially beef-and dairy products. This di- etary pattern, moreover, has been achieved through rela- tively high food prices, with the result that expenditure Figure 3.3 Share of Animal Products in Total Food on food is actually a higher proportion of consumer ex- Intake in China, 1980-2000, and in Other Selected penditure in Japan (around 30 percent) than in Western Economies, 1960-80 Europe and the United States (around 20 percent). Prices for Japanese farmers that are well above world market levels-enforced by restrictions on most agricultural im- Perc40tage of food intake ports-have been passed on to consumers. Germany, Fed Rep Variants on the QUADRUPLE projection were con- /~ structed to illustrate the impact that changes in the food 36 France consumption pattern in 2000 could have on agricultural demand-supply Imbalances. For example, reducing con- 321 / sumption of animal products by about 6 percent, but increasing direct crop consumption by a roughly equiva- lent number of calories, transforms the slight overall crop 28 Hong Kong deficit into a small surplus. The impact of this change is Spain greater for individual crop subsectors: the potential rice 24 surplus is reduced from about 20 million tons to 15 4 / Japan million tons, and the coarse grain deficit from about 60 /apan million tons to 40 million tons. 20 Another variant assumed a lower income elasticity of demand for food (0.70, as mentioned earlier), with signif- icant reductions in both meat consumption (about 12 16 Pakistan China razil percent in 2000) and direct crop consumption (about 8 percent). This transforms a projected crop deficit of 0.5 12 percetnt of production into a 2 percent crop surplus. The change would be larger, except that the reduction in 8 Turkey consumer expenditure on food is matched by an increasc Inhailand in expenditure on other things, especially light manufac- -India EgPt tures, whose production requires considerable amounts 4 - Nigeria of cotton and other industrial crops. The BALANCE pro- Indonesia jection introduced in the previous chapter also assumes o5 l 0 Indonesia l an income elasticity of demand for food (0.80) lower 125 250 500 1,000 2,000 4,000 8,000 16,000 than in QUADRUPLE, but attains almost the same level of Per capita income (1982 U.S. dollars, logarithmic scale) food consumption in 2000 because of faster growth of total household income and consumption. However, do- * Relationship in about 1960' mestic demand for crops in 2000 is 2 percent lower * Relationiship in about 19801 because of the increase in the weight of services in the * QUADRUPlE projection, 2000 eas ftl nraeI h egto cvcsI h QUADRUPLE__________projection,____________2000____ economy relative to that of industry. a. Based on 1960 per capita inconme and the 1961-65 average for food ManagingFood Demand intake. b. Based on 1982 per capita income and the 1978-80 average for food As the preceding discussioni suggests, the long-term capac- Sontre. World Bank data. ity of China's agriculture to provide its people with, in 52 particular, a higher level of consumption of animal prod- adjusts to the changing pattern of demand, thus minimiz- ucts cannot be accurately predicted. The uncertainties are ing the costs of the potential imbalances discussed earlier. especially great in the twenty-first century-although past These issues all raise the question of how prices and other long-term predictions of food production potential (in economic levers should be used in managing household other countries and worldwide) have anliost always been agriculture and of the appropriate roles of the state and unduly pessimistic, because they have underestimated the collective in the new system. technological progress in agriculture. Recent changes in government policies will substan- These uncertainties, and the adverse social conse- tially increase the regulatory role of the market. From quences of possible future reductions in per capita con- 1985, compulsory procurement and production quotas sumption of animal products (or food in general), suggest for grain and cotton have been abolished. This is to be the need for caution in managing food demand in China. extended gradually to all agricultural products, with an One essential policy objective will be to continue to guar- accompanying loosening of price controls. However, the antee a minimum supply of food to everyone, and espe- state will continue to fix the price at which it procures cially to people in poor rural areas. Indeed, some of the agricultural products under contracts that will account for present grain surpluses could he used to increase the guar- a large proportion of the total marketed by farmers. Im- anteed minimum. This would not only reduce the gap portant inputs to agriculture are still administratively allo- between the minimum and the average level of food cated. The state also remains significantly involved in intake, which has probably increased in the past five agricultural production-including the state farm sys- years, but it could also help to eliminate the stunting due tem-and directly productive investment, and it is appar- tomild chronic malnutrition that persists among a signifi- ently envisaged that large-scale state-owned units will cant proportion of China's rural children (Annex 2, para. play an important role in the rapid growth of meat and 2.05). dairy production. At the other end of the social spectrum, considerations of efficiency and equity suggest that consumers should Output Pricing and Marketing pay the full economic cost of animal products (including The discussion of imbalances in earlier sections, and addi- the opportunity cost of divcrting scarce agricultural re- tional analysis in Annex 2 (paras. 3.30-3.39), suggest sources and foreign exchange from other uses). A long- some general directions in which agricultural producer term food trade strategy, especially with regard to tariffs prices may need to move during the next few years. or quotas on imports of animal products and feedgrains, Potential shortages of animal feed and surpluses of rice has to be established in advance. Given this, it would could be alleviated by increases in the price of coarse probably be inadvisable to subsidize or administratively grains (and possibly soybeans, the most useful source of restrict either the retail prices of animal products or the animal feed protein-Annex 2, para. 4.75) relative to the prices of inputs into animal husbandry and aquaculturc, price of rice. Pork and fish prices will need to he higher particularly feedgrain. The experience of Japan suggests than in the past to make it financially attractive for pro- that high prices can bring consumer demand for animal ducers to invest in the more feed-intensive systems neces- products into line with limited supplies in a socially ac- sary for rapid output expansion-and of course the re- ceptable manner. By contrast, the experience of other quired animal product price increases will be made countries with subsidized and rationed consumption of greater by the increases in animal feed prices. Fligher animal products has been extremely unfavorable, both timber prices also seem necessary to stimulate produc- economically and politically, notwithstanding its short- tion, although some other tree crop products (such as tea term social appeal. and rubber) at present appear overpriced. More important than these possible specific pricc changes, however, is the issue of whether necessary price adjustments should be administratively imposed or gener- The production responsibility system has been extraordi- ated by the market. With the ncw system of household narily successful. Yet there may be substantial scope for agriculture, and with increasing reform of the nonagricul- further improvement of agricultural management, in light tural economy, it will not be possible, let alone efficient, of China's own experience with the new system, as well to have an administered structure of agricultural prices as experience in the many other developing countries that ignores or fundamentally contradicts the forces of whcre households are the basic agTicultural production demand and supply. Yet it would also be impossible to units. The major issues include: how best to stimulate calculate and apply an economically efficient set of ad- growth of household agricultural production; how to im- ministered agricultural prices, especially because they prove its economic efficiency, which is essential to in- would constantly be altering. Even at a very aggregated creases in both national and rural incomes; and how to level, the projections discussed earlier suggest the possibil- ensure that the composition of agricultural production ity of changes in agricultural imbalances over tirie. T'hc 53 point is strengthened when specific categories and quality the price limits could be as significant as those of altering subdivisions of agricultural products are considered: the purely administered prices. Nonetheless, it could have detailed pattern of demand is hound to change in innu- certain advantagcs over tii iw-lirr (mtnlract and above- merghI& e .x,th- tke added co irirn that deni.A '"'.au) pric ......svsctci. ci IltpwllitciU in for particular products is affected by the prices and avail- China, especially in terms of administrative simplicity and ability of other products; the detailed pattern of produc- responsiveness to changing circumstanccs. tion costs will also change, again with the complication 'I'hough a price stabilization scheme could not be used that the willingness of farmers to supply particular crops directly to redistribute income, as is possible with two- at particular prices is affected by the prices and produc- tier pricing (discussed later), it could contribute indirectly tion potential of the alternative crops they might grow. to raising rural incomes by enabling the state to reduce its Nonetheless, experience in other countries and interna- present heavy direct involvement in agricultural com- tional markets suggests that market forces alone may pro- merce. Indeed, the Government would need to purchase duce undesirably unstable agricultural prices. Actual or and sell agricultural products only as required for stabili- anticipated changes In production-often weather-re- zation purposes and to secure emergency stocks and sup- lated-and diemand can cause large short-term price fluc- plies for poor areas. Scarce state resources could thus be tuations that inflict needless hardship on producers or released from commerce for other, more vital, agricul- consumers, increase the cost of adjustmcnt to fundamen- tural support activities. And allowing collective and indi- tal changes in economic circumstances, and create risks vidual enterprises a large share of (at least) the incremcnt that can discourage farmers from specialized production in agricultural commerce over the next two decades could for the market rathcr than subsistence. For these reasons, make an important contribution to boosting rural non- there are few countries in which governments do not in farm incomes-as expcrience in other countries confirms. some way intervene in agricultural price formation. Simi- The same applies to food processing, whose volume is larly, the Chinese government intends to limit the influ- projected to increase nearly fivefold between 1981 and cnce of market forces on agricultural prices: although the 2000, and to the proccssing of other agricultural prod- prices of minor products will be allowed to float frecly, ucts. for major products market-determined prices will apply only to above-contract sales (that is, sales in exccss of Input Pricing and Allocation contracted state procurement) and even then will be sub- Under the production responsibility systcm, farmers have ject to a statc-set floor price. a strong incentive to make more efficient usc of industrial A possible alternative approach for major agricultural and other inputs to agricultural production, applying products would be for the Government to let prices be them just up to the point where lheir contribution to determined by demand and supply, hut to intervene in increased output value is balanced by their cost. How- the market to prevent excessive fluctuations. At any ever, to ensure that farmers use inputs in a way that is given timc, prices would be allowed to move only within optimal for the economy as a whole, it is necessary that a range established by the Government's willingness to output prices and input prices be economically rational, purchase for addition to its stocks at the lower end and to and that farmers be able to obtain sufficient quantities of sell from its stocks at the upper cnd. The range could be inputs at these prices. At present in China these condi- narrow, which would require frequent interventions at tions are not always fulfilled. both ends and comparatively large stocks. Alternativcly, Chemical fertilizer is a good example (Annex 2, paras. as in most schemes of this sort elsewhere, the range could 3.17-3.25, 3.35-3.36). Although its price seems quite be wider, with price volatility reduced by starting inter- rational by international standards, especially in relation vention on a modcst scale before prices rcach the estab- to the price of wheat, it is allocated to farmers through a lished limits. Over time, if a price persistently remains at cumbersome administrative procedure. 'l'he allocation its upper or lower limit, with the Government's stocks criteria are not at all clear and are not always followed, becoming very small or very large, the Government grad- although they appear to include priority for food crops ually alters the two limits, shifting the whole rangc in the over feedgrains and compensation for state procurement direction required by demand and supply trends. at low prices. In any event, the present systerm does not To operate such a price stabilization scheme would not allocate fertilizer among farmers or localities in a way that be simple. It would be technically quite complicated, maximizes its contribution to production (which would cspecially given the likcly need for coordination with involve equalizing the marginal output response to a kilo- export and import policies and for interregional price gram of fertilizer in all uses). variations within China. It would involve financial costs, Nor, more importantly, could any administrative sys- especially because it is possible to be wrong about market tem of fertilizer allocation in practice achieve this desir- trends (and hence to adjust price limits too sooni or too able result: the yield response to fertilizer varies not only late); and the political and social repercussions of altering among crops and localities, but also among individual 54 plots of land within a given locality. Individual farmers needed to improve rural transport, storage, and market- are usually better informed about such variations than ing facilities (Annex 2, paras. 3.61-3.70). At present, government officials and could use their knowledge in China's rural road network is less than half the size of deciding how much fertilizer to purchase in a competitive India's; there are fewer trucks per capita in rural China market. China shouuld thus consider moving toward mar- than in the impoverished Sahelian countries of West Af- ket allocation of fertilizer, although this would make it rica; and there is less cold storage capacity in the whole of even more necessary to maintain economically rational rural China than in northwest India (with a population of agricultural product prices. The immediate impact of 50 million). Improvements in these aspects of China's market regulation on the general level of fertilizer prices agricultural infrastructure would almost certainly be a cannot be predicted, but could be cushioned by suitable better use of Government resources than, for example, changes in imports. The level of imports, in conjunction direct state investment in animal husbandry, which in with economic calculations of the relative cost of imports most countries is inefficient compared with household and domestic production, would then provide a guide to production (Annex 2, para. 4.70). investment needs in the domestic fertilizer industry. Expansion of collective activities in certain areas-espe- Similar arguments for moving, in the context of a sys- cially marketing and input supply-could also make an tem of household agriculture, away from administrative important indirect contribution to the development of measures and toward market allocation of inputs (with household agriculture. The original collective principles market-regulated prices) can be made for pesticides, ani- of China's supply and marketing cooperatives are being mal feed, farm machinery, fuel, and so on. They also revived, but they could be given a much larger role in the apply to credit, which, together with the farmer's own commercial system. Both in perishable crops and in ani- saving, is in household agriculture the main source of mal husbandry, including dairying, cooperative market- finance for fixed investment and of circulating capital. ing facilities in other countries have very effectively stim- Extensive experience with rural credit in other developing ulated and facilitated production, as well as increasing countries has made clear the disadvantages of subsidizing farmers' incomes. interest rates and of the administrative rationing conse- quently required by excess demand for available funds. China's farmers, including the poorer farmers, will proba- bly be able to get more credit, and hence to increase their Increased state and collective activity in these various production and incomes more, if the interest rates areas, by helping farmers to increase production, to re- charged reflect the scarcity of credit and repayment is duce costs, and to market their output, could make a vital strictly enforced. These conditions would also make it contribution to raising agricultural incomes over the next harder for China's rural credit institutions to discriminate two decades. So could more economically rational alloca- against loans to households and in favor of loans to col- tion and pricing of agricultural inputs. But are there other lective or state-sponsored activities (Annex 2, paras. measures that could help to close the large gap between 3.45-3.46). And they would discourage uneconomic agricultural and nonagricultural incomes? (Policies to- mechanization.9 ward very low and very high incomes within agriculture are considered in Chapters 5 and 9, respectively.) Areas for Increased State and Collective Activity Economic forces are, by themselves, unlikely to lead to The preceding discussion has identified a number of ar- an early reduction in this gap. Indeed, experience from eas-pricing, marketing, input allocation-in which less other countries suggests that the gap is more likely to extensive or direct government involvement in managing widen-even in proportional terms-during the low- to China's household agricultural system could be advanta- middle-income transition. The basic problem-in China geous. At the same time, there are a number of areas as in other countries at a similar stage of development-is (identified in Annex 2) where increased government ac- that agricultural labor productivity does not increase fast tivity would be highly desirable. Given overall limitations enough to close the gap, even when agricultural output on government resources for agriculture, moreover, it grows quite rapidly, unless or until agricultural employ- may in fact be essential to curtail some activities in order ment starts to shrink absolutely. In the QUADRUPLE pro- to expand others with larger economic benefits. Among the areas for increased state activity identified in Annex 2 are agricultural research, education, and ex- 9. Especially in poorer localities, where it would aggravate the tension services (paras. 3.48-3.58), range management labor surplus, with (as in other countries) potentially unfortunate (paras. 4.48-4.5 1), fertilizer utilization studies (para. social and economic consequences. In richer localities, shrinking agricultural labor surpluses will make mechanization more attrac- 3.25), and seed testing and certification (para. 3.27). tive to farmers, but the alternative of permitting more movement Equally important, state support-both directly and by of labor from poorer to richer areas may be beneficial to the encouraging collective and individual provision-is national economy (this issue is discussed in Chapter 5). 55 jection, for example, although gross agricultural output products, which-as emphasized earlier-will be very im- increases at 4.5 percent per year, agricultural employ- portant in managing China's new system of household me__t also rises (at 0-9 percent per year). Thus, Alth,ouvSl agrilullrure lDemand and Supply forces, coupled with for- tv'v giY.v .Msiig!--- f . . ' ."'t', . ag,l.. attl7-cV5t t1§14[LId[IC POIRtiCS, may require agricuitural price in- doubles over the period 1981-2000, it increases more creascs-as for example in Japan, where high agricultural slowly than in other sectors. Even in the BALANCE pro- prices are a concomitant of the Government's policy of jection, where faster growth of employment in services limiting agricultural imports. But this will not necessarily causes slower growth of agricultural employment (0.2 be so, or not to a sufficiently great extent. And the percent per year), agricultural labor productivity-net of experience of Western Europe, where artificially high ag- increased outlays on inputs such as fertilizer-increases ricultural prices are maintained specifically to boost farm slightly more slowly than in other sectors. incomes, has not been favorable, bccause of the financial Agricultural employment tends to continue to expand cost of stocking the resulting surpluses or exporting them in the early phases of development fundamentally be- at a loss. cause it constitutes such a large initial share of total em- In China, however, additional room for maneuver is ployment. The absolute number of farmers can therefore provided by the two-tier agricultural pricing system. Even be reduced only by extraordinarily rapid growth of non- following the recent decision to unify the state procure- agricultural output (as in South Korea in 1960-80, with mnent prices for grain, cotton, and oilseeds (based on industry growing at around 1 5 percent per year) or by weighted averages of the former quota and above-quota unacceptably slow growth of nonagricultural labor pro- prices), procurement prices will generally differ from the ductivity (Chapter 2). But in the twenty-first century, the market prices for above-contract sales and purchases. situation in China will become more favorable, mainly These market prices will strongly influence farm house- because agriculture's share of the total labor force will hold decisions to incrcase or decrease production of par- have shrunk. In 2000-2020, for example, if the total ticular commodities, and hence are the prices relevant to labor force were to grow at I percent per year,'° and balancing demand and supply. But the state procurement nonagricultural employment were to continue to grow at prices will powerfully affect the average price that farmers the same rate as in QUADRUPI.E (3.5 percent per year, receive and hence their incomes. In the past, state pro- from a share of 41 percent in 2000), the agricultural labor curement prices have generally been below market force would decline from 370 million to 255 million, or prices-the differcnce being an implicit tax on agriculturc. 33 percent of the total labor force. The corresponding But the Government apparently envisages that the new extrapolation for BALANCE, with faster growth of nonag- unified procurement prices for major crops will be above ricultural employment, would be from 330 million to 85 their market prices (otherwise it would not be possible to million, or 11 percent of the labor force (similar to Japan replace compulsory procurement quotas with voluntary in 1980). contracts). For the remainder of this century, however, the Gov- 'I'he immediate impact of the latest price and procure- ernment may need to intervene actively to prevent the ment reforms on farm incomes will depcnd on whcther gap between agricultural and nonagricultural incomes the market prices for the crops concerned turn out to be from becoming (or remaining) unacceptably wide. Price above or below their unified procurement prices. But in adjustments are one obvious mechanism for transferring the longer term, regardless of whether market priccs are the benefits of nonagricultural productivity growth (in initially above or bclow procurement prices, the Govern- both rural and urban areas) to agricultural workers, ment could in principlc boost the incomes of farmers by rather than giving them mainly to nonagricultural work- increasing procurement priccs, while allowing market- crs in the form of higher wages. To illustrate this, the determincd above-contract prices to equate supply and macroeconomic projections specifically assume that the demand for the various agricultural commodities. To fi- relative pricc of agricultural output adjusts so that agricul- nance its increased expenditures on procurement, the tural earnings per worker remain a constant proportion- govcrnment would of course have to raisc additional rev- about one-half-of nonagricultural wages. In QUADRU- enues (or reduce other expenditures or subsidies), largcly PLE, for example, the relative price of croDs has to at the expensc of the nonagricultural population. But the increase by 17 percent ovcr the period 1981-2000 to same would be true of any rcdistributive scheme to nar- prevent the earnings gap from widening. In BALANCE the row the agriculture-nonagriculture income gap by a given required relative price increase for crops is 6 percent. amount. The key issues are rather (a) how much redis- Larger increases in agricultural prices could in principle tribution from the nonagricultural to the agricultural reduce the gap in earnings between agriculture and non- agriculture. But they might conflict with other objectives of China's agricultural price policy, including the need to 10. This is similar to the fastest of thc three labor force projec- balance demand and supply for particular agricultural tions in Table 83. 56 population is desired; and (b) whether increasing procure- farm households-an administratively costly process, ment prices within a two-tier system is the best of the with wide scopc for abuse, especially since considerable various alternative redistributive schemes available. discretion would have to be given to local officials. Direct Although the first of these issues is fundamentally a income supplements to broad categories of farm house- political matter, it is complicated by the fact that the holds would be an alternative means of redistrihution incomes of suburban farmers-who are in close proxim- that might pose fewer administrative problems, because ity to the urban population-are generally substantially of its greater simplicity and transparency. higher than those of the majority of farmers in more Another means of redistributing nonagricultural pro- distant rural areas. Redistributive schemes that raise the ductivity gains to farmers that would probably pose even incomes of all farmers across the board are thus more fewer administrative problems is increased government likely to provoke an unfavorable response from the non- expenditure on development of agricultural infrastructure agricultural population than schemes whose benefits are and support services. Greater budget expenditure on ru- concentrated on farmers with average and below-average ral social services, particularly education and health, incomes. This could be a disadvantage of redistribution would constitute yet another approach, as would subsi- through two-tier pricing-although it could be minimized dies to a rural social insurance scheme that provided pen- (as appears to be the Government's intention) by exclud- sions and other welfare benefits (discussed in Chapters 8 ing the most important suburban agricultural products, and 10). All these approaches naturally have some limita- such as meat and vegetables. tions, especially as to the amount of money that could Redistribution through two-tier pricing would also be usefully be spent and the possibility of spreading it equita- technically quite complicated, especially if it were to be bly within the agricultural population. But, in conjunc- done on a large scale and if serious inequities among tion with two-tier pricing or otherwise, they offer sub- farmers in different places and situations were to be stantial scope for economically efficient government avoided. This is because its impact depends crucially on action to raise agricultural incomes. the allocation of procurement contracts among individual 57 Energy Development Energy, though a much smaller sector than agriculturc, is most important energy source (more than 25 percent of just as critical to China's future growth and subject to primary consumption). Oil-all domestically produced- similar uncertainties. There is uncertainty about cnergy accounts for approximately one-fifth, and natural gas for supply prospects, particularly for oil and gas, but also for less than 3 percent, of primary commercial energy con- coal and electricity, whose successful development will sumption. Electricity in 1980 accounted for just 18 per- require much investment and planning. Uncertainty also cent of final commercial energy consumption, a far lower surrounds both the magnitude of potential economies in share than in most countries.' energy use (by reducing waste, modernizing technology, Industry-especially metallurgy, chemicals, and build- and changing industrial structure), and how much of this ing materials-accounts for at least half of the final con- potential China will be able to realize without compro- sumption of coal, oil, and gas, and three-quarters of elcc- mising standards of living. Equally important, coal is tricity consumption. Households and commerce together likely to rcmain in Chinia-unlike almost all other coun- accounted for only 20 percent of final commercial energy tries-the overwhelmingly predominant source of energy. consumption in 1980-but, including biomass, for ap- To harness it cleanly and efficiently in an unusually wide proximately 43 percent of final energy use (the same range of uses will be a major challenge. share as for industry). The transport sector's share of final This chapter, which is based largely on Annex 3, first commercial energy consumption (8 percent) is low com- reviews overall energy demand and supply prospects and pared with other largc developing countries, because of targets to the year 2000. It thcn looks at issues and the small role of road transport. policies in specific energy subsectors, with special refer- ence to the production, transport, and use of coal. Fi- Energy Intensity nally, it reviews possible investment requirements in the Cross-country comparisons suggest cxceptionally high sector and the fuiture role of planning and demand man- consumption of both commercial and total primary en- agement. Two common themes-which will echo ergy per unit of GDP in China. This can be explained through subsequent chaptcrs-are the importance of partly by C.hina's high share of industrial output in GDP more general improvements in the efficiency of rcsource and by space heating requirements. But energy consump- use in China and the need for economic as well as techni- tion per unit of gross output value in Chinese industry is cal analysis in choosing among options. Both will require also exceptionally high compared with most other coun- the strcngthening of economic planning and intersectoral tries. Although the share of energy-intensive subsectors in coordination as wcll as incrcased reliance on market regu- industry is not significantly different from other coun- lation. tries, Chinese industrial output is weighted toward en- ergy-intensive goods. High energy consumption in indus- Demand and Supply: Trends and Balances trial production is also cxplained by relatively backward Coal already dominates energy consumption in China. In 1980, it accounted for about three-quarters of primary - Final ener consumption excludes transformation losses in commcrcial energy consumption and one-half of total electric power donutioneg sctors trab"o rcet of in primary energy consumption (incluiding biomass), the mary cotmmtiercial energy use in 1980), commercial energy excludes highest share for coal in any major country. Biomass hionlass fuels (about 27 percent of total primary cienrgy use in ftuels-uscd mainly in rural households-are the second 1980). 58 technology, the small scale of industrial plant, and the resource use), energy demand grows significantly more type of fuel used (particularly coal). Low energy prices slowly-by 3.8-5.0 percent per year from 1980 to 2000. and insufficient cost consciousness among enterprises and In the MODERATE scenario (with GDP growing at 5.4 planners also appear to have contributed substantially to percent per year, as compared with 6.6 percent in QUAD- the low efficiency of energy use in China. RUPLE and BALANCE, and with thc same emphasis on In recent years, steps have been taken to reduce both expansion of manufacturing output as in QUADRUPLE), the growth of overall energy consumption and energy use energy demand grows more slowly still-by 3.4-4.6 per- per unit of output. These steps have so far consisted cent per year. mainly of regulations concerning the amount of energy The Government's original tentative target was to use per unit of output, reductions in energy supply quo- quadruple GVIAO between 1980 and 2000 while only tas, and bonuses for energy use below established quotas. doubling the production and use of energy (to somewhat Conservation centers have been established to provide less than 1 ,300 million tons of coal equivalent of primary technical assistance. A larger share of investment funds commercial energy). This was to involve doubling the has recently been allocated for technical transformation production of coal, oil, and natural gas (output levels of of existing enterprises and in particular energy conserva- 1,200 million tons for coal, 200 million tons for oil, and tion measures. Financial incentives are now receiving 25 billion cubic meters for gas by 2000). Preliminary greater emplasis, and there has been some movement forecasts by the Ministry of Water Resources and Electric toward rationalizing the energy price structure. Power (MWREP) suggested that electricity generation As a result, during the past five years an impressive would increase from 301 terawatt-hours in 1980 to reduction in energy use in relation to economic activity 1,000-1,200 terawatt-hours by 2000-with some 230- has taken place. Energy consumption per unit of gross 280 terawatt-hours from hydro and nuclear power. value of industrial and agricultural output (GVIAO) was The energy demand projections discussed above, and reduced by 7 percent per year during 1979-81 and by 3 more recent government estimates, suggest that it will percent per year during 1982-83. Preliminary data indi- probably be necessary to increase the production of en- cate a further reduction of almost 7 percent in 1984. ergy somewhat faster than originally envisaged (Table Technical and operational improvements are estimated to 4. 1). For example, even under optimistic assumptions have accounted for about 40 percent of these energy about improvements in energy efficiency, the estimated savings. The other 60 percent came initially from a de- growth in energy demand resulting from quadrupling cline in the relative importance of heavy industry and the GVIAO (4.2-5.5 percent per year) would be more than closure of some inefficient small-scale plants, but since could be accommodated by doubling energy production 1981 mainly from structural changes within major indus- (which implies a growth rate of about 3.5 percent per trial subsectors. year). Increasing oil and gas production substantially above the original targets is a possibility that cannot be Demand and Supply Prospects relied on, and it would be extremely difficult to increase To investigate the future growth of demand for various primary electricity production much faster than already types of energy in China, the projections made with the planned. For these reasons, and because the need for multisectoral economic model (discussed in Chapter 2) more than the originally anticipated amount of energy were combined with a plausible range of assumptions production is concentrated on fuel, the burden of bring- about changes in unit energy consumption in particular ing energy production into line with demand is likely to sectors. The resulting estimated annual average growth fall mainly on coal (oil distillate and total electricity pro- rates of primary commercial energy demand between duction plans conform reasonably well with the demand 1980 and 2000 range from 3.4 percent to 5.5 percent. projections). Projected elasticities of growth in energy demand relative In the QUJADRUPLE and BALANCE projections discussed to growth in GiDP range from 0.6 to 0.85, which is far in Chapter 2, it is assumed that coal production in 2000 lower than the past trend in China (1.5 in 1965-78), will reach 1,400 million tons-a figure regarded as feasi- though higher than the elasticities realized during the past ble by relevant agencies in China, even allowing for the few years (0.2 in 1978-81 and 0.5 in 1981-84). need to develop additional transport facilities and other In the QUADRUPLE scenario (which involves the quad- infrastructure. How much coal will in fact need to be rupling of GVIAO), the projections indicate that total pri- produced, however, will depend heavily on the rate of mary commercial energy demand could be expected to economic growth, on the sectoral structure of the econ- grow at 4.2-5.5 percent per year, depending on the de- omy, and on the degree of success in reducing energy gree of success in reducing unit energy consumption. In intensity within individual sectors. the BALANCE scenario (which has the same rate of In QUADRUPLE, production of 1,400 million tons growth of GDP, but with slower growth in manufacturing would meet coal demand only on the most optimistic output, faster growth of services, and greater efficiency in assumptions about reductions in energy consumption per 59 Table 4.1 Energy Supply and Demand, Alternative Projections, 1981-2000 Totalprimary Fvr! Odldl,,j,. ;.--, cneigy Co#npuonenr (millions of TCE,) (millions qf tons) (terawatt-hours) (millions of TCEM Projections of demand QUADRUPLE 1,135-1,455 100-140 1,060-1,285 1,385-1,765 MODERATE 955-1,225 8 5-115 885-1,070 1,180-1,500 BALANCE 1,030-1,315 90-130 955-1,150 1,270-1,610 Production levels in line with original targets 1,020 112 1,000-1,200 1,275-1,295 a. Fuel includes coal, fuel oil, and natural gas for power generation, for other energy industrics, and for final consumption. irci indicates tons of coal equivalents. Sources Annex 3, Chapter 2. unit of output in each sector. On the least optimistic (but together contain only 10 percent of the economically not implausible) assumptions about unit energy consump- recoverable reserves, but by international standards are tion, coal demand in QUADRUPLE in 2000 would exceed comparatively well endowed; recoverable reserves in 1,800 million tons. Even in MODERA'IE, with signifi- these two regions are sufficient to sustain 1980 produc- cantly slower economic growth, coal demand in 2000 tion levels (210 million tons) for more than 300 years. would on these less optimistic assumptions approach Production costs are low by international standards. 1,500 million tons. In BALANCE, with slower growth of Operating costs are typically less than Y 20 per ton, while industry compensated by faster growth of services, and capital costs average about Y 110 per ton of capacity.2 higher overall economic efficiency, projected coal de- But geological conditions and mining costs vary widely mand is substantially lower than in QUADRUPLE-1,400 among different coal producing areas. For example, costs3 million tons on intermediate assumptions about unit en- are as low as Y 30 per ton for extracting the few deposits ergy consumption, and 1,200 million tons on the most amenable to open-cast mining in remote areas of Nei optimistic assumptions. Monggol and Shanxi and are approximately Y 40 per ton for the huge underground reserves at moderate depth in ~oal Production, Transport, and Utilization Shanxi province. But smaller and less favorable deposits Coal Production, Transport, and Utilization close to major consumption centers in the South and East In any cvent, the share of coal in commercial energy use might have production costs of up to twice those in the by 2000 is likely to remain exceptionally large-some North. 70-75 percent (compared with 30-35 percent world- Between 1965 and 1979, coal production grew at an wide). Even if oil production reaches 200 million tons by average rate of almost 30 million tons per year. Coal 2000, it would still account for less than one-quarter of production fell by 15 million tons in 1980, however, and commercial energy production. If the target of doubling remained at the same level in 198 1, because of insuffi- gas production by 2000 is achieved, natural gas would cient attention to mine development during the 1970s continue to account for only 2-3 percent of primary and the economic adjustment program of 1980 which energy consumption. Even if the gas production target sharply reduced investment allocations. Production has were exceeded, which is quite possible, it is extremely since picked up, increasing by about 45 million tons per unlikely that its share of energy consumption in 2000 year during 1982-84. would exceed 5 percent. (By contrast, natural gas pro- An average increase of about 40 million tons per year vides close to 20 percent of primary energy in most major would be required to reach an annual production level of industrial countries, and 30 percent or more in the 1,400 million tons by the year 2000. 1o achieve this will United States and the U.S.S.R.) China thus inevitably require further strengthening of production incentives, a faces somne unusually substantial challenges in coal pro- stepped up program of project preparation (including duction, transport, and utilization. Coal Mining 2. Y 140-1 SO per ton for large-scale central mines and Y 75 per China has abundant reserves of good-quality coal that can ton for small and less mechanized local mines (excluding social be mined at relativelv low cost. Economically recoverable Infrastructure). 2 , , , ,, 3. Including an appropriate charge for capital recovery, for ex- reserves are concentrated in the North, which accounts ample, 15 percent of invested capital per year (based on an interest for two-thirds (Shanxi province alone for one-third) of rate of 12 percent, reflecting the opportunity cost of capital aind an the total. The populous southern and eastern regions ccononoic life of fifteen years). 60 mine infrastructure), and coordination between the Min- transfers (for example, rail to ship to rail to road) are istry of Coal Industry (MoCI) and the transportation min- required to transport coal, say, from Shanxi to an inland istries to increase coal transportation capacity more city in the South, total transport costs could be Y 40-60 quickly than originally planned. Organizational changes per ton, justifying coal production in the South even for central mines could also help to speed project imple- under unfavorable conditions and at high costs (up to Y mentation. State-imposed design norms leave little flexi- 80-100 per ton-or 2 to 2.5 times the production costs bility for taking account of geological conditions in the at the more favorable deposits in Shanxi province). design of specific coal mining projects, which can lower Nonetheless, the concentration of China's coal reserves the cost effectiveness of some projects. Time required for in the North requires increasing large-scale, interregional mine construction is currently longer than in other coun- coal transportation. At present, railway transport is prob- tries for similar work (construction time is more than six ably more of a constraint on energy supplies than coal years for central mines) and could be shortened by better mine development, because of insufficient railway invest- coordination among the many government entities in- ments in the past and the slow replacement of inefficient volved in project execution. steam locomotives by electric or diesel traction. It will Equally important is the balanced development of cen- take several years to complete the railway projects that tral and local mines. Central mines, primarily operated by were recently initiated to alleviate critical bottlenecks be- MOCI, and local state and collective mines each accounted tween major mining areas and the coast. If coal produc- in 1984 for about one-half of production. Because local tion were to reach 1,400 million tons in the year 2000, as mines are smaller and less mechanized they require only much as 450 million tons might need to be transported about half as much capital spending per unit of output as out of Shanxi and adjacent areas in Nei Monggol and large-scale central mines. And because they are more Shaanxi, even if current plans for developing mine-mouth widely scattered across the country they put less pressure power generation were implemented. To handle this traf- on transport infrastructure than the large-scale mines in fic, it would probably be necessary to construct an addi- the major coal basins (one-third of the coal produced by tional new double-tracked electrified line for heavy unit local mines comes from south of the Chang Jiang, as trains (similar to the new Datong-Qinhuangdao line cur- compared with only 3 percent of coal produced by MOCI rently planned) in a southeastern direction and to in- mines), In recent years, the existence of a market for coal crease capacity on existing lines through double tracking supplies beyond plan allocations has contributed to the and electrification. Slurry pipelines might ease the pres- development of local mines, which accounted for most of sure on the railways, but water shortages in Shanxi could the overall increase in coal production in 1979-84. If, in constrain their widespread use. addition, access to investment funds and transport facili- Since a considerable part of incremental coal produc- ties were improved, local mines could continue to play an tion (an additional 2 50 million to 3 50 million tons) will important role in meeting energy demand, especially in be for electric power generation, coal-fired power genera- areas with less favorable coal deposits and in supplying tion in mining areas in conjunction with long-distance local needs. There is also considerable scope for improv- transmission of electric power to load centers represents ing mining techniques in local mines, with selective intro- one alternative to transporting large quantities of coal. duction of mechanization and greater attention to mine Current preliminary plans are to locate roughly half of safety. However, large coal deposits are often more suit- thermal power capacity additions during 1986-2000 in able to large-scale development with higher mechaniza- coal mining areas. The relative economics of electricity tion, lower costs, and better safety and resource recovery. transmission compared with rail transportation of coal are project-specific, as costs vary substantially. Howevcr, Coal Transport in most cases, rail transport of coal would be less expen- Transport costs greatly affect the optimal spatial pattern sive than long-distance transmission of electric power (see of coal production and utilization. Just as coal mining Annex 3, Appendix E). The optimal mix of mine-mouth costs vary considerably in China, depending on the type power generation and load-center-based power plants of deposit, coal transport costs also vary widely depend- will therefore be determined mainly by other factors such ing on factors such as the available transport mode (rail, as the availability of low-quality coals or middlings from ship, road), degree of capacity utilization, and topogra- coal preparation plants (discussed later), the availability of phy. For example, long-run marginal costs (LRMC)4 for water for mine-mouth power plants, and the potential for transport over a 1,000 kilometer distance by double- cogeneration of electric power and heat or steam for track railway may be some Y 20 pcr ton, but about Y 30 per ton on a single-track railway line. Coastal shipping over several thousand kilometers may be Y 20-30 per 4. Total costs including capital construction, operating, and ton, but road transport costs might be as high for a maintenance costs, calculated by using an appropriate factor to distance of only 200-300 kilometers. If several modal reflect the opportunity cost of capital. 61 most industrial countries coal accounts today for only Table 4.2 Share of Solid Fuels in Commercial Energy 20-40 percent of energy consumption (Table 4.2), and Use in Selected Countries, 1960, 1980, and 2000 even iess n .most developing countrics. Coal usc in othcrf Cou7ntry 1960 1980 2000 such as electric power generation, the steel and cement United States 24industries, and large industrial boilcrs, where environ- Japan 54 19 mental control measures can be more easily implemented Germany, Fed. Rep. 78 3 3 and are less costly than in small-scale uses in industry or South Korea 79 36 . the residential and commercial sectors. U.S S. R. 64 3 3 . . In some respects, energy utilization patterns will have China 96 77 70-75 to remain quite different in China from those prevailing in most other countries today. But a number of industrial Source United Nations, Energy Statistics Yearbook (New York, 1982); An- nex 3. countries used to have a similarly high share of coal use twenty to thirty years ago and are now again increasing the role of coal, albeit not to the high levels that are likely to prevail in China. The main issue in China will be how industrial or space heating uses in the case of power to use coal in environmentally acceptable and affordable plants located near load centers. These economic choices ways, especially in urban areas where air pollution has in need to be thoroughly studied before long-term plans can many cases already reached very high levels. Making coal be finalized. use environmentally acceptable will require many things, While railway transport of coal is likely to remain a but will often involve replacing decentralized and uncon- constraint on energy supplics for some years to come, it trolled combustion of coal with combustion in large facil- nevertheless remains one of the most economical means ities with better environmental controls, and distribution of energy transport in China, as other technologies (water of clean energies (for example, steam and hot water) from transport, slurry pipelines, power transmission) are either these facilities to final consumers. H owever, these distri- not as widely applicable or more costly. Lead times for bution networks are usually very costly, and careful stud- railway investments need not be longer than for other ies need to be carried out to minimize costs and to avoid alternatives. But long-term investment plans for railways duplication (for example, between district heating and gas and other transport facilities need to be closely integrated distribution). Particularly uncertain is the extent to which with coal mining development, and sufficient resources coal conversion (coal gasification and liquefaction) tech- will have to he allocated, especially to ease critical bottle- nologies can be justified at present, given the cost and necks. An optimal coal development and transportation availability of alternative clean fuels or alternative ways to strategy must also incorporate measures to reduce trans- make direct coal combustion cleaner and more efficient port requiremcnts, for example, through balanced devel- (for example, cogeneration and district heating. opment of large-scale coal mines in major coal basins High priority will have to be given to the transfer, remote from demand centers and mining under less favo- development, and introduction of coal utilization tech- rable conditions and at higher costs in smaller deposits nologies including coal preparation and cleaning, im- closer to consumption centers. Other means to reduce proved boiler systems, heat recovery equipment, process transport requirements include optimal location of raw controls, cogeneration systems, district heating tcchnol- material processing industries and more extensive use of ogy, coal briquetting technology, and emission control coal preparation to reduce transport of inert material, devices such as electrostatic precipitators and bag filters. possibly in conjunction with mine-mouth power genera- Improved coal utilization also will requirc greater coordi- tion. Realignment of coal and transport prices to reflect nation throughout the entire coal production, beneficia- economic costs and greater enterprise autonomy in ar- tion, distribution, and consumption chain, calling for ranging supply could greatly facilitatc development of greater interaction between the many agents involved least-cost solutions for coal production and transport. (for example, coal producers, transportation ministries, the power sector, commercial departments, municiDal Coal Uti-lization governments, and industrial entcrprises). Many of the Improving the efficiency of coal use could much reduce options for improving the utili7.ation of coal (for example, the amount of coal that will need to be mined and trans- cogeneration, district heating, coal gasification) cut across ported. Even so, projected increases in coal consumption the rcsponsibilitics of many different institutions. In- will have serious implications for environmental pollu- creased cogeneration could result in major energy savings tion-and hence high welfare and health costs-unless (see Box 4.1), but would require institutional arrange- improved environmental protection measures are ments for power generation to be more flexible. adopted. This is particularly important in China because Coal beneficiation through washing has been slow to coal is expected to remain the dominant fuel, whereas in develop in China (about 18 percent of China's coal was 62 Box 4 1 Cogeneranon for Industuy and Dsstnct Heating Cogeneration, or combined heat and power (CHP), is the ably more attractive, especially if environmental benefits combined production of two forms of energy-electricity are considered, and could justify construction of large c HP or mechanical power plus useful thermal energy-in one plants in industrial estates to supply steam within a radius technological process The total amount of fuel needed to of, say, five kilometers produce both electricity and thermal energy in a cogenera- District Heating District heating has recently received tion plant is less than would be needed to produce the renewed interest in view of sharply increasing prices of same amount of electric and thermal energy scparately clean fuels such as distillate oil or natural gas District Cogeneranon is used intensively in Western and Eastern heating is also a way to increase the use of coal and other Europe, accounting for up to 30 percent of installed elec- lower-grade fuels to meet residential and commercial en- tric power capacity, and is about evenly split between ergy requirements in an environmentally acceptable way industrial and district heating uses, but its use for district Although network costs for district heating are high (de- heating has recently expanded In West Germany, for ex- pending mostly on urban density), the superior efficiency ample, cogeneration for district heating doubled over the of heat extraction from large CHP plants usually more than past ten years while industrial cogeneration stagnated, as compensates Improved materials and network construc- industrial restructuring and improved energy conservation tion techniques have reduced the cost of heat distribution reduced industrial heat requirements In the United States, At the low temperatures required for district heating (70- the role of cogeneration is small and limited to industry In 1400C), cogeneration is particularly efficient, with incre- China, the iole of cogeneration is relatively small (Box mental fuel requirements for heat extraction equrkalent to Table 4 IA), and its technology not very advanced by only about one-fifth of conventional boiler fuel require- international standards ments In Europe, a large share of new coal-fired electric power plants are now being built as CHP plants New CHP plant designs have been aimed at increasing efficiency of Box Table 4 1 A Estimates of Installed Cogeneration heat extraction and maximizing flexibility bctween electric Capacities in Selected Countnes power and heat dispatch Perecntagt a] electn power Market penetratiot of distiict heating has reached very gen,grney apt,ty _r_ high levels in Eastern Europe and Scandinavia (up to 50 Country (gigawatts) Total Industrial beating percent of total space heating requirements) Apart from climate, market penetration of district heating is related to Wired rtates 14 9 2 3 2 3 ( availability and costs of alternative clean fuels, particularly West Germany 16 o 17 9 9 6 a 3 Utnited King- natural gas Countries that rely mostly on market mecha- dom 2 5 3 6 3 6 () nisms in energy supply hake found that the most impor- Finland 3 2 29 4 16 5 12 8 tant obstacles to wider use of district heating are existing U S S R 76 6 27 3 natural gas distribution networks that make market pene- Chma 4 9 7 1 tration for a new and costly distribution system very diffi- Source Uno nera kdcirb eChlu uh e- cult But district heating is often the lower cost alternative Source Union Internazionakt drs Drutriblcuru de Choeu (Lunth)lInter- if natural gas is scarce and gas distribution networks do not naaonal Dmrict Heating ConferelLCe Kis 1982 World Bank saatt Cstl- inat s yet exist, and if urban densities and space hcating require- ments are sufficiently high I hese conditions appear to be fulfilled in northern Chinese cities Induwtrtal Cogeneration The pulp and paper, steel, and Cogeneration and district hieating require close coordi- chemical industries typically account for a very large share nation between electric power generation, urban planning, (up to 80 percent) of industrial cogeneration In tht pulp and industrial location decisions Transfer pricing mecha- and paper industry, large amounts of burnable wastes are nisms between electric power utilities, cogenerators, and generated and used to fuel combined heat and power district heating utilities are trucial and should reflect the plants, as are blast furnace gases in the steel industry In costs and benefits of cogeneration as accurately as possible other industnes, a lack of waste fuels has limited cogenera- Otherwise, potential industrial cogenerators will not find tion With increased fuel priLes, many industries have cogeneration a profitable investment In market econo- found it more profitable to invest in energy-saving inea- mies, large (HP plants are often owned and opcrated sures, rather than in cogeneration schemes However, if jointly by the electric power and district heating utilities to clean fuels are not available (as in China) cogeneration of facilitate coordination and render transfer pricing arrange- electricity and steam for industrial uses might be consider- ments more transparent 63 washed in 1983) and needs to be expanded. Increased some cities, air pollution has already reached a multiple coal washing can substantially improve end-use efficien- of internationally accepted standards. The largest and cics incc ,r-lbst)Ii and reduce the amount of inert matc- most noticeable smurce o! street-levelnn o!hurion krhe *li- -6iz ual 1 1daPU1 . iTe optimai role ot coal rect burning of coal in household stoves and numerous washing must be carefully evaluated, however, because industrial and commercial boilers without even simple capital costs are high and energy losses are significant, environmental control equipment. In Beijing, for exam- depending on coal characteristics. In the United States, pie, average dust (total suspended particulate) levels were though, some electric utilities have found that the cost of reported at 0.5 milligrams per cubic meter, or about coal preparation and coal cleaning is compensated by seven times greater than U.S. air quality standards. De- higher utilization rates and lower maintenance costs of spite large reserves of low-sulfur coal in North China, electric power plants. Whether this would also apply to sulfur dioxide levels in Beijing are also very high, as coals China will depend among other things on the combus- of unusually high sulfur content are used by households tion characteristics of the particular coal being used and for space-heating and cooking. would need to be studied further. The development of There are several options for making the use of coal in local uses for washery tailings from coal preparation the residential and commercial sectors cleaner and more plants is of particular importance, to minimize energy efficient. Over the long run, these include greater devel- waste and hence reduce the cost of coal beneficiation. In opment of district heating, elcctric cooking, and possibly countries where large proportions of coal output are coal gasification. Over the short- and medium-term, pol- washed (for example, West Germany), washery develop- lution problems associated with small-scale combustion of ment is closely linked with thermal power development coal in urban areas could be alleviated by greater use of and production of coal briquettes. China's planned ther- higher-quality coals, in particular anthracite, and dissemi- mal power development in coal mining areas such as nation of improved coal stoves. Under the present coal Shanxi should be well integrated with washery develop- allocation system, some of the least desirable coals (for ment-washery throughputs of 300 million to 400 mil- example, briquettes from coal fines with high volatile lion tons in 2000 would produce tailings that could fuel matter and high sulfur content) end up in urban areas. 20-30 gigawatts of power generating capacity. This could be remedied by allocating high-quality coals Further development of fluidized bed combustion (FBC) (anthracite) to urban areas and restricting the use of less is of particular importance if coal mining and coal wash- desirable grades of coal. ery wastes are to be used in mine-mouth power plants. Urban air pollution could also be alleviated by locating While China has a larger number of FBC boilers operating energy-intensive heavy industries outside densely popu- than any other country, most are small industrial FBC lated areas. The construction of large cogeneration plants boilers using low grade coals, and only a few mine-mouth can be justified in urban areas, however, provided ade- power plants with somewhat larger FBC boilers (25 mcga- quate environmental protection measures (dust and noise watts, electric) are in operation, using coal mining wastes. control) are adopted. As low-sulfur coal is available in One of the reasons that larger units are not used more substantial quantities, expensive flue-gas desulfurization widely is that transfer prices for electric power are not equipment may continue to be unnecessary, but much sufficiently attractive for sales to the power grid and limit more attention will need to be given to installing im- power generation by coal mines to internal use. Again, proved particulate removal systems. Installation of such institutional changes for electric power generation, and in equipment in new coal-fired plants is now standard prac- particular appropriate transfer pricing arrangements, tice in most countries. Fly ash collected from power would be required to improve the efficiency of coal utili- plants and industrial enterprises can be used profitably as zation. Mine-mouth power planits using coal wastes could an input in cement manufacturing (up to 40 percent of be operated by the the power grids, the coal mines, or the raw material requircd) or as a substitute binder for jointly. Appropriate economic incentives will be required building materials, as is already done to some extent in to make cogeneration attractive. Chiina. In a number of industrial countries that have experi- enced environmental damage from acid depositions China fortunately has very substantial resources of rela- ("acid rain") it is now believed that these effects are tively high-quality (low-sulfur) coals,' and total emissions probably due to a complex interaction of different pollu- of sulfur dioxide and nitrogen oxides are still low, compa- tants, involving not only sulfur and nitrogen oxides but, rable to, for example, the United States around 1920-30 (or one-half and one-quarter, respectively, of present U.S. levels). Nonetheless, air pollution from coal burning, cs- 5. Most Chinese coals have a sulfur content of 0 4-2 percent, pecially particulates (dust and soot) is already a serious probably averaging less than I percenit, but a few. deposits have problem in urban China, particularly in the North. In higli sulfur conitent (3-5 percent). 64 in a key role, ozone and other photochemical oxidants mine the most promising areas for immediate explora- formed by reactive hydrocarbon compounds, emitted tion, establish priorities for future exploration, and for- primarily by petroleum refineries and other chemical mulate policies on the use of foreign technology and plants. Although there are still large scientific uncertain- capital. Moreover, although exploration, development, ties about the mechanisms and effects of acid depositions, and production practices have been imiproved consider- these deserve attention in the choice of energy utilization ably in recent years, China's techniques and practices will technologies. Large-scale coal gasification is of particular need to be brought closer to international standards. In concern because pollutant emissions from coal gasifica- the recent past, petroleum exploration and development tion plants are similar to those from refineries. Some of have been characterized by too much attention to short- the most serious environmental effects of air pollution in term production targets. Reservoir management has Eastern Europe are believed to be related to large-scale sometimes also been less than optimal, with many fields coal gasification. producing at rates that reduce ultimate total recovery of The experience of other countries indicates that enter- oil from the reservoirs. prises are often unwilling to make substantial investments To meet its petroleum production targets, China must in pollution control equipment without direct govern- upgrade equipment, technology, and management at all ment intervention in the form of financial incentives or stages of exploration and development. Current opera- administrative measures, such as a system of enforced tion and maintenance practices, particularly for field penalties for exceeding specific industry-by-industry stan- equipment, need to be improved substantially. Future dards. In China, the development of adequate pollution discoveries of the magnitude envisaged probably can only regulations and enforcement provisions is necessary and be located by drilling in the deeper parts of sedimentary will become even more important as state enterprises gain basins, in more complex geological structures, and in more autonomy and independence. Lack of attention to more remote locations where access is difficult. All this pollution control at the time of installing new plants may will require, in addition to imports or joint venture man- ultimately result in higher costs. Investments required to ufacturing of equipment, more intensive personnel train- rectify the situation could be higher than if adequate ing, both on the job through service contracts and abroad measures had been taken at the time of plant construc- in accredited institutions and with operating companies. tion. In view of rapidly increasing energy use and remain- International oil companies (lOCs) are already involved in ing uncertainties about causes and effects of environmen- China's offshore oil activities and recently the Govern- tal damage, it would also be highly desirable to sharply ment decided to expand Ioc activities to limited onshore increase the extent and quality of environmental moni- areas through joint venture contracts. Appropriate legisla- toring. This could be instrumental in determining cost- tion needs to be prepared before contracts can be final- effective environmental pollution control measures in the ized. Such involvement would allow the Government to future. share the risks of development and exploration with for- eign investors and might facilitate technology transfer. Oil and Gas The transportation of crude oil, petroleum products, and natural gas does not appear to face major bottlcnecks Oil Production at present, but the options and costs of future transport China's largest oil fields have already passed their peak systems should be analyzed. Increased use of pipelines productivity. The extent of their natural rate of decline is could help to reduce the burden on the railways and being reduced somewhat by a program of infill drilling, improve refinery utilization. Transport will be an impor- well stimulation, and secondary recovery. China's success tant factor in developing the hydrocarbon reserves that in meeting its goals for petroleum production in 2000, may be discovered in the western basins, as transporta- however, will be largely determined by the extent of new tion costs will be critical in determining the econormic discoveries and the speed with which they can be devel- viability of such efforts. oped. By 2000, most of the fields producing today will be twenty-five to forty-five years old, and it is unlikely that Natural Gas they will provide more than a small share of the produc- Natural gas production is targeted to increase to 25 bil- tion target of 200 million tons. A large share of total lion cubic meters by the year 2000-roughly double the production by the year 2000 will have to come from new current level. A significant part of this increase is expected reserve additions during the next eight to ten years. to be achieved by doubling production from the Sichuan China's prospective oil areas onshore and offshore are Basin to 10 billion cubic meters and through develop- extensive, geologically complex, and largely unexplored. ment of new onshore and offshore finds such as the To achieve the 200 million tons per year production recent Zhongyuan and Hainan Island discoveries. Nonas- target by the year 2000, China will have to develop a sociated gas production by 2000 could be as much as four long-term strategy for exploration, which could deter- times greater than the current level of 5 billion cubic 65 meters. If, in addition, the oil production target is tween 30 million and 50 million tons in 2000, even with reached, total gas production could reach 3 5 billion to 40 major improvements in energy efficiency. 'fransport fuel c mtcrs, or thircc timucs cOt wiir levels. if ex- requiremcnts thus would acouiuni for one-fourth of tar- iers f'^-r. nonassoc,acd rnaidull gds aiC sLCUped geted oii production, or more if oil production falls short up, production could be even higher, and some estimates of the target. Policics to restrain the growth of road indicate that it could reach as much as 5 percent of total transport could of course reduce growth in distillate de- commercial energy requirements. There is also an urgent mand, but at high costs in terms of the efficiency and need to increase gas exploration in older producing areas dynamism of economic development, especially outside where production declines are leading to shortages of gas large cities (see Chapter 5). for existing plants. While the projected high share of transport fuels in In many feedstock and fuel applications, natural gas has total petroleum product demand is not unusual by inter- a relatively high value per unit of energy compared with national standards, the bulk of Chinese crude oil is rela- other energy sources. Evaluating its optimal use, how- tively heavy with, on average, more than 70 percent ever, is highly complex and needs to be pursued on a site- residuals in primary distillation. Chinese crude oils are by-site basis, taking into account regional variations in particularly deficient in very light fractions (naphtha and demand, in the opportunity cost of alternative fuels or gasoline). Consequently, about 35 million tons per year feedstocks, and in the costs of gas transmission and distri- of secondary conversion capacity has been installed, pri- bution. Given the characteristics of natural gas, it is nec- marily catalytic cracking (24 million tons per year) and essary to make a comprehensive plan that includes re- thermal cracking. Refinery complexity in China (second- quirements for exploration and development as well as ary conversion equivalent to 3 5 percent of primary distil- transport and use. To accommodate uncertainties about lation capacity) is thus already high in comparison to gas reserves, production rates, and the size of the market, most other countries, except the United States (48 per- this plan should be flexible, with staged construction to cent). Refinery throughput is about 80 million tons per permit continuous revisions as new information becomes year (80 percent capacity utilization), and refinery losses available. 'I'he value and use of natural gas is likely to be have been reduced from 8 percent in 1980 to about 6 very location specific. Given the projected small share of percent in 1984. Exports of crude oil have increased to natural gas in commercial energy production and use, over 20 million tons in 1984, and product exports have natural gas is likely to be used primarily for high-value averaged some 5 million tons in recent years. industrial uses such as feedstocks. Nonetheless, some uses 'I'he major issue for China's refinery industry in the of natural gas which may be regarded as "low value"- future is how to match domestic demand, geared toward electric power generation, for examplc-should not be transport fuels and other distillate products, with China's excluded as they could bc instrumental as initial uses to domestic resources of heavy, high-wax (but low-sulfur) develop gas production and pipeline networks. House- crude oils. While some degree of flexibility regarding hold use for cooking and heating could be rational In domestic burning of residual fuel oil appears justified, some areas. given the high costs of converting plants originally de- signed to burn oil to use coal or the high costs of coal Petroleum Refining handling equipment for small boilers, there is little doubt The demand for oil distillates6 is projected to grow from that it will be more economical in most cases to increase 34 million tons in 1980 to between 90 million and 140 coal supplies to meet boiler fuel demand and to either million tons in 2000. The attaimnent of both oil produc- export or further refine much of China's residual fuel oil. tion and economic growth targets might result in a bal- While it is technically feasible to convert Chinesc crude ance betwcen oil distillate supply and demeand around the oils to transport fuels and other distillate products by midpoint of the projected demand rangc with approxi- secondary conversion, yielding virtually no residual fuel mately the same refinery complexity as today (Table 4.1). oil, these processes are inherently very capital intcnsive If crude oil production levels were to reach only 150 and expensive. Considerable savings from the present million tons in 2000, either major imports would be strategy of self-sufficiency in petroleum products for do- rcquired to satisfy domestic demand for distillates or re- mestic consumption could be achieved by greater integra- finery distillate yields would have to be incrcased to their tion into the international oil market. Other countries in technical maximum by installing more sophisticated (and the region and elsewhere have a different dcmand struc- expensive) secondary conversion facilities. ture, and other crude oils are available with very different If road freight and passenger transportation both grow at close to 10 percent per year during 1980-2000 (imply- ing significant increases in the share of road transporta- 6. Defined to include gasoline, diesel, keroscne, luhricants, light tion In total transport), the deinand for transport fuels petrochemical fccdstocks, and liquefied petroleum gas (0.P(). See would grow from about 10 million tons in 1980 to be- Annex 3. 66 characteristics. Refineries elsewhere are meeting product 84, and the power sector has been unable to meet de- demand not only by installing conversion facilities, but mand fully. also by optimizing the mix of crude oil feedstock and by trading some refined products in international markets. Demand Projections Some of the options that should be considered before Eiectricity demand growth could average 6.0-7.5 percent investments in further secondary conversion facilities are per year during 1980-2000, with the projected range finalized include: (a) importing foreign crude oils in ex- depending to a large extent on the rate of growth of change for increased exports of Chinese crude oils to manufacturing industry (Table 4.1). Generation require- increase the yield and quality of products (for example, ments in 2000 would be 960-1,290 terawatt-hours, transport fuels or asphalt) in which Chinese crude oils are which is quite consistent with MWREP's preliminary esti- deficient; (b) importing (or exporting) deficient (or sur- mates of 1,000-1,200 terawatt-hours. 'lThe share of elec- plus) products to meet domestic demand; and (c) con- tricity in final commercial energy consumption is pro- tracting for the processing of a marginal share of China's jected to continue to rise from 18 percent in 1980 to crude oil in international refining centers with excess ca- 26-27 percent in 2000 (excluding cogeneration in indus- pacity. try), but the elasticity of growth in electricity demand Institutional changes would be necessary for more ra- relative to growth in GDP is expected to decline to 0.9- tional investment and production decisionmaking in the 1 .15. Electricity use in transportation and households is refining industry. While distillate prices are more or less expected to grow particularly fast (14-15 percent per in line with international prices, crude oil prices are low, year and 11-13 percent per year, respectively, from 1980 making oil refining a very profitable industry. This has led to 2000); though this is from a low base in both sectors, to duplication of investments in the past, as different it may result in increased peak load generating require- localities and organizations tried to maximize their reve- ments. The manufacturing sector is projected to continue nue from oil refining. The consolidation of virtually all to account for at least three-quarters of final power con- refining and basic petrochemical production in one state sumption, although electricity use per unit of gross manu- corporation (SINOPEC) in 1983 has helped to rationalize facturing output value is likely to fall slightly, because of the refining and petrochemical sector and has made trans- changes in the structure of manufacturing output. fer pricing of petroleum products and petrochemical feed- stocks less cumbersome and controversial. However, Investment Planning some problems remain. For example, the present prefer- No official long-term development program for electric- ence for product rather than crude oil exports is appar- ity development for the remainder of the century has yet ently mainly related to the allocation mechanism for for- been prepared. The present mix of generating capacity, eign exchange. Less than optimal export patterns (and however, is not expected to change much over the next resulting revenue losses) could be avoided if domestic two decades. By the end of the century, nuclear power prices for crude oil and products were set at international would supply less than 4 percent of total generation, prices and if foreign exchange allocation mechanisms while hydropower would stabilize its share of supply at were improved. Decentralization of the petroleum indus- 18-19 percent (or 22-23 percent if small plants are in- try would become possible only after price reform. cluded). Thermal power will account for the balance, and under current plans all new capacity will be based on Electric Power coal. The bulk of additional hydropower is expected to come from four large-scale river basin development Electric power development in China has proceeded rap- schemes, which have already been the subject of substan- idly during the past three decades. By the end of 1983, tial study. total installed capacity reached 76,000 megawatts, com- China's exploitable hydropower resources are among pared with less than 2000 megawatts in 1949. Approxi- the largest in the world, but the bulk of undeveloped mately one-third of generating capacity in 1983 was hy- potential is in the Southwest and Northwest, where dro, while the remaining two-thirds was thermal. No large-scale development would require transmission of nuclear power plants have been commissioned. There electricity over distances of 1,200-1,500 kilometers to were thirteen power grids with capacities of more than major industrial load centers. Gestation periods for the 1,000 megawatts each; four of these had capacities ex- large-scale projects are relatively long (eight to ten years ceeding 10,000 megawatts. The combined installed ca- from project approval even under ideal conditions) and pacity of the thirteen largest grids accounted for more have been further extended in some recent projects be- than 80 percent of the national total. Between 1965 and cause of unexpected geotechnical problems, shortages of 1979, total generation increased at an average rate of funds, and other unanticipated problems. Higher infra- 10.7 percent per year, but has slowed down in recent structure costs and rising costs due to inundation are also years, increasing by 5.8 percent per year during 1979- increasing the costs of large-scale hydro projects, and 67 careful economic analyses will need to be carried out in and power transmission, environmental implications, and selecting sites and timing of large-scale hydro projects, other external factors such as increased use of cogenera- talkii ;jiii(f ilhifutnT cconomic effects on agricultural pro- tioIl. d' ""dI,alllllt; WdtIl iI u1sport, and other users ot water I'he demanid for power currcntly exceeds supply in all resources. of China's major grids, and the cost of interconnecting MWREP's preliminary power production profiles for most regional grids, which requires transmission lines of 1985-2000 suggest a commissioning of 5,000-8,000 1,000 kilometers or longer, may not be justified by re- megawatts of nuclear capacity by the end of the century. ductions in reserve requirements and load diversification Because of relatively low-cost coal and competing de- alone. IHowever, with large-scale hydropower develop- mands for financial resources, it is unlikely that a nuclear ment and construction of some mine-mouth power power program beyond MWREP's targets could be justi- plants, greater interconnection will become more com- fied, at least in the medium term. I'he high capital costs, pelling and eventually imperative, because large amounts long lead times, and uneven performance of nuclear of power will have to be transmitted from West to East. plants in some countries underscore the importance of In addition, integration will allow wider use of modern, evaluating the parameters that determine the economics large-scale generating equipment with improved technical of nuclear generation in relation to the costs of other and economic results. Currently, China has adopted a alternatives (particularly coal, but possibly also natural step-by-step approach to grid expansion and integration, gas). Commissioning of a few nuclear units in China with plans to establish a national integrated power grid could be justified in certain circumstances, for examplc, by the end of the century. in locations far from low-cost coal mines and on the basis Increased efforts to optimize investment planning by of the continuing need to develop technical expertise and focusing on long-term, least-cost development programs operating skills. The competitiveness of large-scale nu- will be essential. Of particular importance is the need to clear power development could probably be enhanced by consider the full economic costs of large-scale projects the experience gained from a modest-size program and by with long lead times (for example, nuclear or large hydro careful planning-foreign experience shows that a well- projects). Such projccts clearly can provide major bene- designed and well-paced program could reduce capital fits, hut the opportunity costs of money invested and the costs. costs of sacrificing flexibility need to be more carefully Nuclear power requires a major long-term commit- evaluated. The adoption of up-to-date system planning ment to developing manpower and infrastructure. It in- techniques also will help in the evaluation of broad strate- volves technically complcx plants, severe economic conse- gic decisions about the generating plant mix, power plant quences in case of operational failures, and strict safety location, and grid architecture. Modern computer requirements, all of which are unique to this type of models allow planners to look beyond the unit cost of power. Major investments of effort, time, and resources energy in determining least-cost sequences; they take into are necded to develop the technology and standards for account such factors as demand patterns, variation in equipment manufacturing in the early stages of the pro- hydrology, and random outages of generation and trans- gram, as well as autonomous safety and regulatory insti- mission facilities. These models are not without their tutions to provide essential oversight functions. Particu- limitations, however, and much training is required to larly important over the long term is that plants be based use them appropriately. on a standard design that has been carefully selccted and developed. Rural Energy and Biomass Under current plans, conventional thermal power gen- eration based on coal will continue to provide at least According to Chinese estimates, the consumption of bio- three-quarters of total generation at the end of the cen- mass fuels (that is, fuelwood, crop byproducts, and dung) tury. Probably the most important issues are those of by rural households was about 220 million tons of coal plant location and transmission network planning. For equivalent in 1980, thus accounting for more than 25 example, the location of many plants will have to be percent of total primary energy use. Crop byproducts determined by the relative advan age of development at and fuelwood each account for roughly one-half of con- coal mine sites-requiring high-voltage transmission to sumption, while dung contributes an almost negligible major load centers-versus devclopment near load cen- share. Biomass fuels provide some 85 percent of the total ters and port areas where large quantities of coal would energy consumed by rural households. In many areas, he transported by rail or water. Decisionmaking should biomass fuel supplies fall short of demand, but supply include consideration of factors such as the regional distri- even at current levels no longer can be sustained by the bution of coal resources, availability of low-grade fuels agricultural system and local environment through tradi- from coal preparation plants, regional differences in coal tional means without serious adverse consequences. development costs, relative costs of coal transportation While the production of crop byproducts has probably 68 doubled since the first half of this century, the proportion Given the importance of local conditions, central poli- used as fuel has increased from about 50 percent during cies should be highly flexible and should emphasize con- the early 1930s to 60-80 percent today, inhibiting their tinued strengthening of local capabilities for both techni- use as animal fodder, organic input for soil improvement, cal development and economic evaluation of alternatives. and construction material. Increased demand on local All options should be considered, including increased reli- nonagricultural land to produce other types of biomass ance on supplying energy to households from outside a fuel has exacerbated long-standing water and soil conser- given locality. vation problems, as traditional fuel collection methods have often gone unchecked and immediate fuel needs Investment, Planning, and Prices have impeded efforts to reforest local areas. Hence, China faces major challenges in developing alternatives to Investmnent Requirements traditional supply and use practices. Continued reliance The energy sector is one of the most capital-intensive on traditional patterns of biomass supply and use to mcet sectors in any country, and efficient use of existing and rural household fuel needs will result not only in greater new plants is of utmost importance for the efficiency of disparity between supply and demand, but also in greater the sector and the economy at large. The average annual disruption of local agricultural and ecological systems. investment requirements for developing the coa!, petro- Current rural energy policies emphasize the develop- leum, and electric power industries are estimated on the ment of local energy resources for local needs and im- basis of current government goals to increase from about provements in the efficiency of energy use. In 1980, an Y 11 billion in the Sixth Five-Year Plan (1981-85) to Y initiative was launched to promote the production of 30 billion to 40 billion during 1986-2000. If petroleum fuelwood in private woodlots in areas that have suitable production targets are to be achieved, a significant in- uncultivated land. By 1984, small plots had been allo- crease in investment for exploration and production de- cated to almost one-half of China's rural households for velopment will be required. Investments in the power this purpose. The developmcnt of local coal resources sector will need to be sharply increased if electric generat- continues, for use by local households and industrics and ing capacity is to be installed to meet forecast demand. for sale to consumers in other areas. Solar cookers have While the power sector accounted for less than 40 per- been popularized in a few areas and, where conditions for cent of original energy sector investment allocations for small-scale hydropower development are particularly fa- the Sixth Five-Year Plan, power will need to account for vorable, the use of electricity for cooking is beginning to two-thirds of energy investments according to Western be promoted. Despite past setbacks in the biogas pro- definitions, or 60 percent according to Chinese defini- gram,' the promotion of family-size digestors continues, tions of capital construction (Table 4.3). Actual spending with greater emphasis on quality construction. In some for electric power during the Sixth Plan has been consid- areas, larger, community-size digestors are now being erably higher than originally planned. promoted to supply gas for household use. A major pro- gram to develop and disseminate more efficient rural PETROLEUM. On the basis of knowledge of some Chi- cooking stoves was started rccently, and by early 1984 nese fields and using some international yardsticks, the had put into use more than 40 million improved stoves. minimum investment required to discover and develop The potential and the economic viability of the differ- the additional reserves required to meet China's produc- ent options vary dramatically from area to area, depend- tion targets can be estimated at Y 30 billion and Y 70 ing on local conditions. Moreover, even the implementa- billion for exploration and development, respectively, tion of seemingly simple solutions can be quite complex. over the next twelve to fifteen years. Considering the In the case of biogas generation, for example, the eco- risks and uncertainties associated with petroleum invest- nomic viability of the higher-quality but more expensive ments, this estimate simply provides a benchmark. Major digestors currently being promoted hinges on a wide adjustments in investments targeted for the sector may be range of local direct and indirect factors (for example, required as risk assessments and cstimates of development local slaughtering rates, winter temperatures, sanitation needs change. Petroleum sector investment targcted un- problems). Experience in other developing countries sug- der the Sixth Five-Year Plan amounted to Y 15.5 billion gests that, while the benefit of energy conservation de- (an annual average of Y 3 .1 billion), 70 percent of which rived from improved stoves appears attractive relative to was for petroleum developmcnt and 30 percent for explo- the costs involved, dissemination can be difficult. For ration. Thus a future average investment figure of Y 6 example, acceptance can be hindered because the new stoves may compromise convenience in cooking or may prove inappropriate for preparing certain traditional 7. Of the 5 million family-size biogas digestors constructed in foods. In China, household hcating nceds, which are of- Sicltian during the 1970s, only about one-third are reported to be ten met by traditional stoves, must also be considered. in operation. 69 Table 4.3 Estimated Investment Requirements been about I percent of GDP or less, mailnly because of in the Energy Sector, 1986-2000 lower growtb rates of electric nowe'r demand.) (bwillioni eZnergy sector (AI. 'I'he avcrage yearly financial requirements for Component of Yuan) inivestmenit capital expenditures to produce 1,400 million tons by Coal mining' 50-70 12-13 2000 (also in 1983 prices) are expccted to rise to about Y Pctroleum 80-120 20-21 4 billion to 5 billion for mine development plus Y 2 Exploration 20-40 5-7 billion to 3 billion for social infrastructure. This may be Development 60-80 1415 comparcd witli, for example, the 1983 statc budget for Electric power 280-370 66-68 Generation 200-270 48-49 capital expenditures in coal for MOCI mines (Y 3.6 billion Other 80-100 18-20 including social infrastructure, or about Y 2.2 billion cx- Total 410-560 100 cluding social infrastructure). I'he Government's pro- gram for coal price increases should provide more inccn- Energy-related investments tives and financial resources to increase coal production in industry and transport Coal transport 40-50 particularly In mincs operated by local governments and Refinerics 20-40 - collcctives. Rcsources made available to MOCI are being increased under the Seventh Five-Ycar Plan (1986-90) to a. Assuming coal production of 1 2 Ibillion to 1.4 billion tons bly 2(100. more than Y 6 billion a year social infrastruc- Includes only dircct production-related investment Asocitlcd social ifra- (includig structure (houLsilg, scho0ols, Ctc.), which is included in Chlncsc cstimates, ture). ro supplcment domestic funds, efforts are also be- wouild add at least Y 20 billion to 30 billion. ing mlade to mobilize foreign investment resources in the Source; Data provided to th economic mission form of foreign loans as well as direct forcign invcstment. Planning and Coordination billion to 8 billion a year represents about two or three To achieve optimal energy production and cfficient use of times the recent level of expenditure. The foreign ex- energy, deccntralization of dccisionmaking and greatcr change requirements for substantial imports of sophisti- use of prices and other economic levers will be essential. cated tools, material, and equipment, along with the pro- At the same time, however, long-term planning and inter- posed involvement of foreign contractors, would likely sectoral coordination will need to be improved. In partic- amount to USS 15 billion to 20 billion over the next ular, economic evaluation of specific developmenit alter- twelve to fifteen years. natives to rcflect all relevant costs and benefits could help to avoid serious economic distortions. For examplc, eco- ELECTRIC POWER. Preliminary estimates of the invest- nomic evaluation of a coal gasification schemc for urban ment rcquired for capacity and grid expansion to gener- cooking should take into consideration all economic ate 1,000-1,200 tcrawatt-hours in the year 2000 have costs, including gasification, gas distribution and con- been made by MWREP. Given the increasing unit costs sumer hook-ups, and the relative costs and benefits of expected in the sector, a dramatic increase in average other alternativcs, for which different institutions may be annual investments will be required if capacity is to be responsible. expanded not only to relieve current supply constraints, Beyond specific project analysis, long-term energy plan- but also to provide the additional power rcquired to meet ning slhould consider explicitly thc impact of broad as- the necds for rapid economic growth. Undcr the Sixth pects of economlic development strategy on energy (lc- Fivc-Year Plan, the average annual invcstment for the mand, as well as long-term programs for cncrgy power sector has so far been about Y 4.2 billion. Average production and distribution and improvement in energy annual investment requirements are estimated to grow to efficicncy. Potential tradcoffs betwecn the achicvcment somc Y 13 billion to 15 billion during 1986-90 and Y 22 of short-tcrm gains and attainment of long-term goals billion to 29 billion during 1991-2000. This implies a may exist, for examplc, in cases where cmphasis on in- major increase in the share of the power sector in total creasing short-term energy production compromiscs ul- domestic investmenit compared witht recent years. timatc reserve recovery or overlooks preparationi for 'I'hc share of power sector investment hias been lower long-term needs. 'Iradeoffs may also arise where the de- in China than in many other developing countries. 'I'he ployment of outdated technology in ncw industrial ca- increased share estimated for the future (about 2 percent pacity provides an easier and f:aster way to mect pressing of u;I)I) is not unusual by interniationial standards. 'I'he currenit demands, but tiltimatclv may comiipromiiise goals World Bank cstimates that power sector investment rc- to improve energy efficielcy. quiremnents in all developing countrics together will rcprc- Becausc cffectivc long-term planning for encergy pro- sent about 2 pcrcent of (;l)P from 1982 to 1992. (Electric duction, distribution, and utilization involves so many power investments of industrial countries have generally interrelated and interscctoral issues, an integrated ap- 70 proach to energy planning is essential. The development Demand Management and Pricing of markets in various sectors and regions must be consid- Energy in China has been-and still is, despite recent ered along with the development of energy production, reforms-largely allocated administratively, with market transportation, and distribution. Major imbalances may forces playing only a minor role. Financial constraints be avoided througlh review and coordination of long-term have not been a critical consideration for mnost enter- plans for specific projects in the various economic sectors. prises, whose overriding objective has been to meet phys- Better energy planning also requires an improvement in ical output quotas. Energy prices in China likewise have the quality and quantity of statistics relating to energy been primarily determined by administrative decisions, production and consumption. some made decades ago. As a result, most energy prices Intersectoral coordination has been difficult in the past, today reflect neither scarcity nor production costs-pe- for example, in relation to the location of large coal mines troleum refining is very profitable, for example, while and power plants and to the distribution of natural gas official prices for coal barely cover operating costs. Some and the development of its market. To meet even greater improvements have recently been made by permitting needs for such coordination in the future, institutional market-related prices for above-quota supplies. This two- mechanisms at both central and regional levels must be tier pricing system has spurred production (for example, strengthened. Prices that fully reflect production costs from small coal mines under local control) and may also and scarcity are the most important tool for ensuring have helped to reduce energy consumption. intersectoral coordination, but market research by pro- Overall, administered energy prices are low in relation ducers and interagency coordination at all levels are also to economic costs, with the exception of some petroleum important. products and electricity for residential consumers. Com- pared with the structure of international prices, the prices Tecinology Transfer and Development of coal, crude oil, and fuel oil are particularly low. Aver- The rapid transfer and development of energy-efficient age electricity tariffs are much lower for nonresidential technologies will also be crucial because the power plants than for residential consumers. Centrally allocated coal is and energy-using industrial equipment that are now being priced at about 60 percent of long-run marginal costs, built will last for several decades and will determine the and heavy fuel oil at only one-third of international efficiency and environmental effects of energy use into prices. There is little information on the level and struc- the next century. With rapid economic growth, the de- ture of natural gas prices, although they appear to be low gree of energy efficiency of new plants will be more in relation to the economic costs of competitive fuels. important for energy conservation over the long term Although recent measures (mentioned earlier) have than energy savings in existing plants. Moreover, the been effective in promoting energy savings, a quota-based most energy-efficient technologies available abroad are energy allocation system is fundamentally unsuited to not necessarily more costly, particularly if attributes such achieving large and economically rational reductions in as better reliability, product quality, and environmental energy intensity over the longer term. Enterprises are controls are considered. discouraged from reducing energy consumption because Technology transfer is critical for thermal power plants, quotas are related to past consumption levels, and unnec- combined heat and power plants and district heating, essarily large quotas are sought for security or stockpiling, small- and medium-scale industrial boilers, heat recovery or for sale or exchange for other commodities. The in- equipment, industrial process controls, transport equip- flexibility of the administrative allocation system also ment, and a long list of other industrial equipment. At makes enterprises reluctant to introduce new products least as important is the transfer of disembodied technol- and processes, including energy-saving measures, where ogy, for example, modern management and organiza- these would involve changes in the required level or pat- tional techniques (see also Chapter 7). Importation of tern of energy supply. Enforced reductions in energy quo- disembodied technology through manufacturing licensing tas, for lack of information, have to be imposed too agreements, service contracts, joint ventures, and other uniformly on all enterprises, with insufficient regard to procedures is one of the most economical means of trans- the widely varying economic costs of reducing energy ferring technology, as is job training in conjunction with consumption. technology service imports. An important example of the The two-tier pricing system now in operation for some need to import disembodied technology through service forms of cnergy, and under consideration for others, is a contracts in the energy sector is the transfer of petroleum considerable improvement on the pure quota system, exploration, development, and reservoir management since the market-determined prices of above-quota sup- techniques that could considerably enhance the efficiency plies give more appropriate signals to producers and users of China's petroleum sector (Annex 3, Chapter 5)-a of energy. But for the two-tier system to operate effec- critical element if petroleum production targets are to be tively, quotas need to be set and regularly revised so that reached. all producers and users are obliged to make significant use 71 of the above-quota market. I'his is difficult, especially ally tradable fuels, such as petroleum, prices should be set because production potential and energy consumption at world prices plus or minus transport margins, unless reqairements change constantly and often canniiot be di- rhere ire limits teo imorts or expcrts (n.- nossilyv, in the reetvy and reiiabiy ascertained. Indeed, the two-tier pric- case of coal), in which case domestic prices should float to ing system itself increases the incentives for energy pro- clear the market, especially if there are many producers ducers and users to supply misleading information to the and markets that could be competitive. For electric authorities responsible for setting quotas. power, tariffs should on average at least cover long-run There would thus be clear advantages to phasing out marginal costs that fully reflect investment costs and the the whole quota system gradually, with more autonomy opportunity cost of capital. Lower tariffs may be set at for individual enterprises, and the establishment of a uni- off-peak periods, and higher tariffs are needed to bring fied energy price structure that reflects the relative scar- demand efficiently into line with supply in periods when city of competing fuels (see Chapter 10). Two key advan- generating capacity is insufficient. An appropriate electric tages of higher energy prices as compared with power tariff would make physical rationing of electric administrative regulation are: (a) that they are passed on power unnecessary, as users would restrict their demand in higher product prices and hence reduce consumption if the costs of electricity consumption exceeded the bene- of energy-intensive products; and (b) that reductions in fits, particularly in peak-load periods. An appropriate energy use occur automatically where the economic cost electric power tariff would also promote dcvelopment of reductions is least, provided that other prices are ra- of efficient cogeneration schemes and mine-nmouth power tional and enterprises are profit sensitive. For internation- generation. 72 Spatial Issues Spatial aspects of development will play a critical role in Table 5.1 Dispersion of Production Activities how efficiently and equitably China makes the transition among and within Provinces, 1982 from a low- to a middle-income country. First, China's Numher Number ofprefectu municipalities sheer size and past emphasis on local self-sufficiency offer of provinces involred iectu iity opportunities for large gains in national economic effi- involvedm _in- ciency through increased specialization and trade among Production activity Jiangsu Hubei Gansu activity (out of 29) (out of 1 4) (out of 1 4) (out of 1 3) regions and between urban and rural areas. Second, re- maining poverty and inequities have a major spatial di- Foodgrains 29 14 14 13 Cotton 2 1 1 1 1 2 3 mension-personal incomes are much higher in urban Coal 217 9 7 3 than in rural areas, and poverty is concentrated in specific Cement 29 14 14 13 rural localities. Pig iron 2 7 9 3 2 To increase internal specialization and trade and to fur- Steel 28 13 8 4 ther reduce rural poverty will require a lot of invest- Steel products 28 14 7 ment-and some basic changes of orientation-in trans- Fertiliters 28 134 1 2 port and commerce. It will also require changes in the Cloth 28 14 14 4 system of economic management and in the roles of dif- Bicycles 26 12 6 1 ferent levels of government. For example, to ensure that Sewing machines 24 . . 8 0 the spatial decisions of households, farmers, and (increas- Watches 24 11 . . 0 ingly) autonomous enterprises are efficient, special atten- Source: State Statistical Bureau, Statistical Yearbook of Cbina, 1983 (Hong tion will need to be given to economic levers such as Kong; Economic Information and Agency, 1983); data provided to the transport tariffs and land use charges, as well as to remov- ecoDomic mission ing barriers to competition and trade among localities. Direct government intervention in some spatial deci- sions-and of course in infrastructural development-will Specialization and Trade continue to be necessary. But the appropriate degree and formof irec inervetio, an th levl (r leels of China's past emphasis on local self-sufficiency rather than that shouldect interven e, w nd t o berels- specialization has resulted in all twenty-nine provinces, government that should mtervene, will need to be reas- and hundreds of prefectures, being involved in a wide sessed. range of production activities (see Table 5. 1). In fact, This chapter-which unavoidably deals more with ge- almost all provinces and many areas within provinces neral principles than with geographical specifics-looks first at policies and instruments to guide specialization j and trade in agriculture and industry. It then considers cement-whose production is dispersed in most coun- and radem arlcutur andmdusry.It ten onslers tries-but also iron and steel products and coDsuimer du- associated changes in the volume, pattern, and efficiency of transport, and in commerce and related services. Next, it discusses some implications of structural change and h .~~~~~~~~~~~~~~~~~~ . . This chapter draws on the fuller discussion of transport in specialization for the pace and pattern of urban and rural Annex 6 and on Background Papers 1-3, which cover rural nonag- development. It concludes with a review of measures to ricultural development, urbanization, and international economic reduce rural poverty and regional inequality. ' strategy. 73 rables, whose production in other countries tends to be provinces (see Map 5.1 and Figure 5. 1). Both per capita much more concentrated because of large economies of agricultural and industrial output tend to be much higher scale. In i-taisvy sireais of Chilna, production is small scalc, Oil Lthc coast tlhan in the interlor,2 lhe difference. for h-igh,; cz, ar.U II, JUCIILIy oi such iow quaiity that com- instancc, between Jiangsu, a prosperous coastal province, mercial bureaus can sell the output only by restricting and Gansu, a poor province in the interior, is substantial: imports from other localities. Partly as a result, there is per capita gross agricultural output is Y 390 in Jiangsu wide variation among provinces in the profitability of and Y 160 in Gansu; per capita gross industrial output is enterprises in particular industrial subsectors (Table 5.2). Y 820 in Jiangsu and Y 410 in Gansu; and per capita net The diversity of production in most localities in China does not imply an even distribution of output. In fact, industrial output is quite concentrated, especially in 2. The interior is defined to include the provinces of Shaanxi, Shanghai (Table 5.3). And there are large differences in Gansu, Qinghai, Ningxia, Xinjiang, Sichuan, Guizhou, Yunnan, per capita output between, and also within, regions and and Xizang. Table 5.2 Gross Output and Profits of State-Owned Industry, by Province and Subsector, 1982 (percent) Gross output Profit rate National National Subsector Jiangsu Hubei Gansu average Jiangsu Hubei Gansu average Metallurgy 3 17 16 11 22 17 10 23 Power 6 5 9 5 38 19 24 23 Coal 2 . 3 4 -4 -10 1 3 Petroleum 4 6 17 7 137 36 Sl 74 Chemicals 15 10 13 12 37 20 18 38 Machine building 18 22 20 19 34 14 14 21 Building materials 3 3 3 3 33 20 17 21 Forest industry . . I 1 2 48 36 1 5 22 Foodstuffs 1 5 11 .. 13 88 101 . . 93 Textiles 28 19 5 16 100 58 54 81 Paper making I I . . 1 50 17 7 33 Other 5 5 13 7 49 29 25 37 Total 100 100 100 100 45 23 19 32 a. Defined as profits plus taxes divided by net value of fixed assets. Sources Data provided to the economic mission. Table 5.3 Industrial Concentration, by Region and Key City, 1982 (percent) Gross industrial Population Ratio oJfoutput output sbares shares to population Region Total Heavy Light Total Urban Total Urban and city (1) (2) (3) (4) (5) (l)(4) (1)(5) Three municipalities' 19.3 17.8 20.8 2.8 8.8 6.91" 2.2' Beijinge 3.9 4.3 3.4 0.5 2.7 7.8 1.4 Tianjind 3.7 3.2 4.2 0.5 2.5 7.4 1.5 Shanghai" 9.0 8.0 10.0 0.6 3.0 15.0 3.0 Other provinces 80.7 82.2 79.2 97.2 91.2 0.8 0.9 Otherkeycitics' 15.9 170 14.7 3.1 15.1 5.1 1.1 Total, all provinces 100.0 100.0 100.0 100.0 100.( 1.0 1.0 Total, all key cities 32.5 32.5 32.3 4.7 23.3 6.9 1.4 a. Includes some rural counties surrounding the cities of Beijing, Tiansjin, and Shanghai. bs. The equisalent ratios for scme major cities in other couistries are: Chicago 2.6 in 1914 and 1.4 in 1977, Bangkok 3 7 in 1978. c. Theequivalent ratios for some major cities in othercountries are Chicago 1.2 in 1914 and 1.1 in 1977; BangkokO.6 ini 1978. d. Excluding the rural counties. e. Includes Shenyang, Dalian, Clsangchun, arld Hlaribin in the Northeast, liiyuan in rhe North; Jitsan, Qingdao, and Nanijing in the East; Wilian and Guangzhou in the Central Sooth; Xian and LanzhouL in the Northwest; aitd Chengciii and Chongqing in the Southwest. Source State Statistical Burcasi, Statistical Yearbook of China, 1983. 74 Map 5. 1 Per Capita Net Material Product, by Province, 19 82 U S S R. 7~~~~~~~~~~~~~~~~5 AFGHANISTA~~~~~~~~~~~~~~~~~~N ~~~~~44- ~ ~ ~ ~ WRO MONGOLIA4 ...... AoHNSAMO 300 m O'N -f ~ ~ ~ - -IOM~O KILOMETER4.SVE T NA 0~ ~ ~ ~ ~ ~~~~~~~~~POL Soo MILES~~~~~~~~~~~~HILN E Z~~~~~~~~~~~~~~~~~~~~SPEBR18 Figure S.1 Variations in Per Capita Gross material product is Y 550 in Jiangsu and Y 320 in Agricultural and Industrial Output, 1982 Gansu.3 Differences in per capita output within individ- ual provinles (whilic ditneselves are. as large as most mid- die-size countries) are cven more substantial. In Gansu, _ 2% for example, per capita gross output ranges from Y 94 in National , 8 the county of Qinan to Y 2,685 in the city of Lanzhou, while in Jiangsu even some rural areas have per capita gross output levels of nearly Y 3,000. ,, \ Despite fiscal and other redistributive measures, these 41% inequalities in per capita output result in substantial, Regional though smaller, interregional variations in personal in- Y 900 y 5 16 comes. The gap in personal incomes between Jiangsu and (:oast Interior Gansu, for example, is 1.4 to 1; between Wuxi County, I | Jiangsu, and Dingxi County, Gansu, it is 2.8 to 1; and i_ between Qianzhou Township, Wuxi, and Dongye Town- 3 32 % + 28% ship, Dingxi, it is over 10 to 1.4 The challenge will thus Provincial be to increase efficiency through greater internal speciali- y 571 zation and trade, while simultaneously reducing the pov- Y 1,211 erty associated with these substantial income inequalities. Gansu Province Jiangsu Province | Agnicultural Specialization In recent years, rapidly increasing agricultural specializa- tion in China has contributed to both growth and pov- 41% erty reduction. The specialization has mainly involved Prefectural y 199 5 353% changes in the location of nongrain agriculture (with con- tinuing, though diminishing, emphasis on local self-suffi- Y 1,548 _Dingxi PrefctCLre, ciency in foodgrains). In the case of industrial crops, pro- Gansu vincial specialization according to comparative advantage SuzlioLt Prefec n' IiisIItu e dcveioped a simiiar machine, main parts produced by the Suzhiou plant, as well as of which was then made available to other foundries. In this several small components made by other manufacturers. case, diffusion occurred from the research institute, but This should expand the market share of the superior not from the enterprise. In general, innovations have Forever brand at the expense of the lower-quality Suzhou sometimes been successfully diffused to subordinate bicycle, but without loss to the workers in the Suzhou units, but they are rarely diffused horizontally (there is factory. little communication with other ministries or regions pro- Examples I and 11 show that enterprises that innovate ducing similar products). successfully need incentives to diffuse new technology to other producers. A change in the right direction now EXAMPLE 11. The Shanghai Bicycle Company (SBC) is being made is the introduction of patents, internal licens- not only one of the leading bicycle producers in China,"' ing of technology, and fees for technical assistance. but also a producer of bicycle machinery that is advanced Examples II and III suggest that greater labor mobility by world standards. However, SBC is not interested in would enhance diffusion. Hiring of experienced techni- producing bicycle machinery either for other plants in cians and managers is perhaps the most important source China or for export. The Shanghai Light Industry Bureau of new knowledge for enterprises in most countries. (Ex- has set up a specialized factory to produce bicycle ma- cessive labor mobility, however, can create a disincentive chinery, which may use SBC designs but will have only for enterprises to invest in training.) Japan is a notable minimal access to SBC specialists. Since much technologi- exception to this general rule, at least in the large-scale cal knowledge cannot be explained in manuals, but rather manufacturing sector. Japan apparently substitutes for is embodied in people, the bureau's factory is unlikely to this means of diffusion partly through Mrri's efforts to be as proficient as SBC and is certainly less likely to havc bring industry experts together to share experience and to the export potential of SBC. In other countries, SBC develop a consensus on future development and partly would spin off a specialized company to produce machin- through informal contacts among people who went to ery, or its engineers would set up their own company or the same school or university but now work in different be hired by the new producer, thus diffusing the technol- companies. Even so, Japanese enterprises have far more ogy of machinery production. flexibility in hiring than Chinese enterprises, so that a textile enterprise, for example, can hire electronics engi- EXAMPLE 1Il. The Shanghai Number 6 'lextile Mill neering graduates. China is now introducing some flexi- achieved national recognition for its success in developing bility in its hiring procedures, though far more is needed computer monitoring of looms. About fifty othcr textile (Chapter 8). Professional associations based on individual producers in China have built or will build a similar membership have also been revived, thus encouraging system, many with the assistance of the Number 6 mill. engineers and scientists in different industries and fields to Thus diffusion is occurring because of the organization make contact. and communications within the Ministry of Textiles. The These examples also show that China needs to encour- Number 6 mill now proposes to develop, in cooperation age specialization. Special agents can mediate between with a research institutc, an online microprocessor con- producers and users of technology or provide missing trol system, but neither unit has any staff specially trained technological elemcnts. In Example III above, consultants in microprocessors. Since it is difficult for the textile in- with expertise in electronics and some familiarity with dustry to hire an electronics enginecr or to get support textiles could probably have provided a fast and cost- from the Ministry of Electronics, the two units will effective alternative to staff training or interministerial mostly rely on training their own staff through seminars coordination. Consultants and othcr specialized agents, given by the city. moreover, have an incentive to speed diffusion whereas competing enterprises may wish to limit it (for instance, CONCLUSIONS. Several improvcments could be made in Example iI, SBC might not wish to assist other bicycle to rcmove the barriers to technology diffusion in these manufacturers by selling them improved machinery, but a examples. Examples I and III illustrate the problem of specialized enterprise spun off from SBC would have a poor communications between ministrics, regions, and strong interest in selling better equipment). enterprises. I'hough this problem can never be wholly overcome in an administratively regulated economy, joint ventures across administrative boundaries could diminish it. For example, as part of the plans for cooperation 10. Its Forever brand bicycles are in very high demand and must within the Yangtze Delta zone (established to break down he rationed in the domestic market. sBC also exports bicycles to provincial barriers to development), SBC has formed a Sears, Roebuck & Co. in the United States. 120 China has recently begun to encourage the formation Obsolescence and Scrapping of consulting companies, using experts from research and design institutes, universities, and ministries. But much Old and new processes and products coexist in all coun- more needs to be done to facilitate the creation of new tries, since it is rarely economic to scrap and replace enterprises and organizations that specialize in production recently acquired equipment or recently introduced prod- of technology-related goods and services, and indeed also ucts the moment new proccsses and products become of other things. In other countries, units providing ser- available. Thus, although China has deliberately chosen vices such as repair and maintenance often spin off from to use old and new technology simultaneously as one their parent firm to provide services on a contract basis to aspect of the strategy of "walking on two legs," it could both the parent and other firms, which helps make firms also be said that the typical economy walks on far more in most industrial capitalist countries less comprehensive than two legs: it is like a centipede, with the newest than Chinese firms." Large Japanese firms likewise often products and techniques at the front, the oldest at the help set up trusted employees in business as subcontrac- back. The creature moves forward steadily, innovating at tors. The specialization that results from spinoffs is one of the head, abandoning old products and processes at the the main vehicles of productivity growth. tail. But it always remains quite long: the vintages of equipment in use may span two decades or so, with The Role of Small Enterprises corresponding variations in enterprise profitability, while Greater reliance on small enterprises for innovation could outputs of widely varying quality are sold at different also contribute more generally to China's technical prices to different segments of the market. progress. Studies in other countries have shown that What is unusual about China is the length of the tech- small industrial enterprises are just as innovative as large nological centipede, and indeed its tendency to get longer ones, especially in sectors such as specialized machinery, and longer. As new processes and products are intro- electrical and other consumer goods, and in small com- duced, the head moves forward, but the tail does not puters and related software. Even in sectors where large- move. There is very little scrapping of equipment and scale production is optimal, such as basic chemicals and abandoning of old products, even when it makes good metallurgy (and, in electronics, semiconductors), small economic sense to do so. Antique vintages of equipment specialized firms have contributed many useful innova- are not merely used, but continue to be reproduced and tions, sometimes in the role of subcontractors to the embodied in new investment on an enormous scale by larger firms. (Chinese visitors to foreign countries are China's machine-making industry."2 Equally remarkable often given a misleading impression in this regard, be- is the coexistence of high- and low-quality products sell- cause they are usually taken only to well-known, large ing at the same price, with the result that, for example, enterprises.) inferior bicycles accumulate in inventory while "famous In China, by contrast, it is generally assumed that small name" brands continue to be rationed. firms are necessarily technologically backward, while There are various reasons for this unusual pattern. large firms must be the technological leaders. As a result, Some of them are connected with aspects of China's collective and individual enterprises, which already have system of economic management mentioned in earlier strong incentives to innovate, are denied access to the sections of this chapter-few incentives for innovation, skilled manpower, modern equipment, and foreign ex- littlc competition, chronic shortages, irrational prices. change they need to innovate. State enterprises, which There is also a widcspread, dcep-rooted aversion to the have far less incentive to innovate, have exclusive access "wastc" involved in scrapping equipment that still func- to the necessary resources. tions, or any product that might still serve some purpose. Diverting a substantial fraction of China's skilled man- This is coupled with intense reluctancc to displace work- power, technology imports, and research support to small ers, largely because of fear that they would become un- enterprises on a coimpetitive basis would unquestionably employed. These apprehensions have some foundation, speed China's technical advance. Moreover, the social but are in important respects misconceived and exaggcr- problems posed by strong incentives for innovation could be less serious in the context of small than of large enter- prises. High individual or collective earnings from suc- cessful innovation may sometimes be more acceptable than large payments to managers and researchers insu- I1. In Switzerland, watch companies do not have thei own lated from risk in big organizations. Similarly, the failure machine shops or provide all of their components as in China. In of a small enterprise (in other countries, most small enter- Japan, steel companies contract out manay services, suclh as chang- pofe faisal withinriaeyear othr souofntartingsu, motsallethoug ing refractory linings in fuirnaces, that are providedi withini Chinese prises fall within a year or so of starting up, although ienterprises. Some steel companies in less developed countries even those involved often try again) affects only a few workers contract for this difficult operation internationally. and a small amount of capital and has little effect on the 12. An eminent Chinese economist, Sun Yefang, was the first to prosperity of its locality, describe China's machinery industries as reproducers of antiques. 121 ated; they will need to be dispelled if China is to make problems with consumer goods, where the higher cost of rapid technological progress. the new item has ro be weighed agninst irs benefit to l'he Govcrnmenr1, rccognizini, the outmoded .stare of conslinjers. W.,ifn!hn.ess to pay. rctlect-d in the price Jif- much ot (hina's industry, is at prcscnt stressing technical ferential between new and old products, is the measure of transformation of existing enterprises rather than wholly consumer benefit in a market economy. But at present in new construction. In line with this approach, it needs to China, consunmer prices are not allowed to move freely be more widely understood in China that the economic enough to serve this purpose. Even if they were, the life of equipment is usually shorter than its physical life.'3 Government, like others in developing countrics worried It would also seem worth disseminating certain well-cs- about the spread of costly Western consumerism, might tablished rules for deciding whether an old process is still not see them as an appropriate guide to the allocation of economically viable, or whether it should be upgraded or technological resources. scrapped, with or without replacement. Specifically, an The possible adverse effects of scrapping on employ- old process should in principle be scrapped and replaced if ment should also be put in perspective. Much of the the total cost of production using new equipment (includ- replacement process can occur within existing enterprises: ing interest and depreciation on the new capital em- in Japan, for example, lifetime employmcnt in large firms ployed) would be less than present operating costs (mate- has proved compatible with high rates of product and rials, energy, and wages). It should be upgraded if the process innovation, and much the same has been true in saving in operating costs would be greatcr than the capital other countries. At the same time, the experience of cost of the upgrading investment. And it should be smaller firms in Japan and elsewhcre makes clcar that scrapped without replacement if both the operating cost cvolutionary competition bctween old and new products with existing equipment and the prospective total cost and processes would inevitably lead to the closure of with new or upgraded equipment exceed the product enterprises, with consequent loss of jobs. In general, how- price. ever, the closure of old enterprises actively stimulates the These principles are logically powerful and could assist expansion of technologically more advanced enterprises, in choosing technical transformation projects, many of creating new jobs to absorb the displaced workers. This is which are now selected more on the basis of engineering because the continued existence of backward enter- enthusiasm than economic calculation. But they are not prises-as in China-acts as a drag on progressive cnter- easy to apply in present Chinese circumstances, mainly prises, by depriving them of materials, skilled labor, capi- because prices, wages, and charges for the use of capital tal, and markets that they could put to more productive do not reflect the true value to the economy of the items use. concerned. Cheap fuel, for example, would on the princi- Over time, and looking at the economy in aggregate, ples outlined above encourage uneconomically slow re- both economic logic and the expericnce of other coun- placement of energy-intensive equipment, while capital tries suggest that high rates of scrapping and replacement grants, cheap loans, and unduly high wages for unskilled cause faster, rather than slower, growth of modern indus- labor would all lead enterprises to scrap and replace trial employment. This may require many workers to equipment sooner than economically desirable. Nor is change jobs more frequently, sometimes with transitory there an adequate market in used equipment, which periods of unemployment; it may also, more seriously, could allocate items abandoned by one enterprise either cause certain workers and localities to experience pro- to other enterprises that could use them economically or tracted unemploymcnt. 'I'here are policies and institu- to the scrapheap. In this situation, in the near term, tions that could alleviate the economic hardship of dis- enterprises and their supervisory bureaus might be placed workers and assist in their retraining and obliged to use shadow prices set by some central agency reemployment. But, as in any society undergoing rapid to make economic audits of their equipment and dcci- change, the losses of particular individuals and groups sions about replacement and other technical transforma- from technical advance would still have to be weighed tion. In the longer term, price reform and related mca- against the gains of the majority. sures would help enterprises spontaneously to make appropriate decisions on old equipment. 13. It is sometimes argued in China that raising the depreciation Similar principles exist for scrapping and replacement rate, which is at present only 3-4 percent per year, would bring of products, but are also not easy to apply in present about a more appropriate pace of scrapping. Such a step might Chinese circumstances. In the case of producer goods, the indeed help to overcome some irrational resistance to abandoning test is whether the higher cost (because of the additional things beforc the end of their physical life. But, as explained in the investment required) of supplying a new and better item text, the magnitude of accumulated accountinlg depreciation does wouldvestm onterethan offet blya thewcost reductterions ~ not enter into an economically sound calculation of whether or would be more than offset by the cost reductions it not a particular item should be scrapped at a particular time. Only would permit users to realize. Again, though, the test is the operating costs of installed equipment are relevant to decisions valid only if prices are rational. And there are additional regarding its future use. 122 Human Development People are both the means and the ends of economic position (Table 8.1). The proportion of the population development. T heir numbers, health and nutrition, edu- with primary education is exceptionally high. But, largely cation and training, allocation among economic activities, because of the Cultural Revolution, which stopped or effort, and initiative will largely determine the pace and hampered higher, upper secondary, vocational, and tech- pattern of China's development. People's well-being, nical education for ten years, the number of people with however, is the whole object of development-to enable advanced educational qualifications is small-smaller, in- them to enjoy greater consumption of material goods and deed, in the twenty-five to thirty-four age group than services, improved health, increased opportunities to among those over thirty-five. China's many years of iso- shape their own lives, and a greater sense of security and lation have also contributed to the smallness of the stock social worth. of people equipped to apply or teach the up-to-date skills China's future human development policies-especially essential for modernization. in education, employment, and wages-must take ac- count of the need for structural change. At the macroeco- Basic Educational Priorities nomic level, rapid growth will require and bring about These deficiencies in advanced, high-quality education substantial changes in the sectoral pattern of employ- have-rightly-been the focus of China's educational ment. At the microeconomic level, as discussed in Chap- strategy in the past few years, when great efforts have ters 1 and 7, structural change should be even more been made to restore academic standards, to expand both rapid, as newer and better processes and products displace formal and informal higher education, and to plan for its older ones, causing constant shifts in the relative effi- further substantial enlargement over the next two de- ciency of different enterprises and in the pattern of de- cades. These efforts should not, however, divert attention mand for labor. A central theme of this chapter is that from basic education, where problems have emerged in China's presently rigid, compartmentalized approach to recent years. the development and use of human skills could prove a major obstacle to rapid and equitable growth. INTERNATIONAI. EXPERIENCE China's long-standing The first part of the chapter addresses some key issues commitment to widespread basic education has a sound in education and training, including the role of man- economic, as well as social, foundation. Some other power planning.' The discussion then turns to employ- countries, such as Mexico or Brazil, have industrialized ment, productivity, and wages, with special reference to quite rapidly with relatively low levels of basic education. labor surpluses and shortages, allocation of workers, and But their development has been characterized by much payment systems. The final section deals with some po- inequality of incomes, partly due to the high earnings of tential problems of the twenty-first century arising from the educated minority, and has been unduly oriented changes in the size and composition of China's popula- toward capital-intensive, not very efficient, industry. By tion, whose solution would require action within the contrast, widespread basic education in some East Asian next decade or so. Education and Training Issues I. Annex I contains a fuller discussion of recent educational developments and of issues in primary and secondary education, By comparison with other low-income countries, China's technical and vocational education, teacher training, and education present stock of educated manpower has an unusual com- costs and financing. 123 Table 8.1 Educational Attainment of the Population, by Age and Sex, in Selected Countries Percentage oa/persons who have completed at least: Countrv Pri marv scbool 1 "se endary school Uiss., T UU,; J,,,1' P,,'r, ""t'tC2Cvl and age group Male F'emale Male Female Male Female Male Female China, 1982 Total,l5years ormore 79.1 51.1 42.9 26.0 13.3 8.3 1.( 0.3 15-24years 95.1 82.2 71.0 53.6 23.5 17.8 0.1 0.1 25-34 years 88.8 61.9 48.0 26.4 13.4 7.6 0.8 0.4 35yearsormore 63.2 24.6 21.5 7.5 6.4 2.4 1.6 0.5 Other low-income countries India, 1971 rotal,15 years ormore 37.2 14.7 21.3 7.1 10.3 3.0 1.6 0.4 15-24 years 53.6 27.4 3 55 15.1 15.6 6.4 1.2 0.7 25-34 years 39.4 14.4 23.4 6.5 13.1 3.1 2 7 0.7 35 years ormore 26.4 7.1 12.0 2.4 5.9 0.9 1.3 0.2 Pakistan, 1973 Fotal,15 years or more 30.8 9.5 . . . 12.5' 3.91' 1 9 0.5 15-24 years 44.8 18.0 17.0' 7.3" 1.5 0.9 25-34 years 34.8 8.8 . 5.2' 3.71" 3 4 0(8 35yearsormore 20.8 4.8 .. .. 8.7' 2.1' 1.5 0.2 Sri Lanka, 19 71 Total, 15 years or more 59.6 44.8 7.7' 6.61' 0.7 0.3 15-24 years 69.8 65.0 7.5' 7.71" 0.1 0.1 25-34 years 66.5 53.6 12.2' 10.81" 1.6 0.9 35 years or more 49.1 30.8 5.7' 3.61' (.8 0.2 Middle-income countries Brazil, 1970 Total, 15 years ormore 33.6 31.7 9.9' 9.I1 1.5 0.5 15-24 years 41.5 41.6. 10.8' 11.60' 0.1 0.1 25-34 years 35.0 31.8 I 1 8' 1(0.6" 2.1 1 0 35 years or more 26.7 23.5 8 2' 6.31' 2.3 0.6 Colomblia, 1973 lotal, 15 years or more 80.7 79.0 26.0'" 23.7" 4 1 1.6 15 19 years 87.5 89.8 36.0' 36.2" (1.7 0.7 20-29 years 86.4 86.5 34.4' 3 0.7") 7.4 3.6 30-39years 81.4 78.2 . .. 22.4' 18.2" 5.2 1.5 40 years or morc 71.1 65.6 . . . 14.6' 12 3" 2 8 0.4 Mexico, 1970 lotal. 15 years or more 31.3 27.7 10.8 7.0 6.4 4.1 3.8 1 5 15-24 years 44.4 39.7 15.1 10.4 6.8 5.1 3.2 1.7 25-34 years 3 1.5 27.5 11.6 7.1 8.5 5.O 5.6 2.0 35yearsormore 20(5 17.8 6.9 42 5.0 2.8 3.3 1.2 South Korea Trtal, 15years or morc 82.3 66.3 44.5 22.4 23.7 8.9 6.2 1.6 15-24 years 97.5 95.9 55.9 39.3 23 2 13.1 1.6 1.5 25-34years 94,9 85.7 57 9 29.6 37.2 14.2 11.7 3.4 35yearsormorc 63.7 37.7 28.2 8.2 16 3 3 6 6.6 0.7 a All secoridary school, rnale. b. All seconinlary school, tfnisalc Source. Ten Percent Sanples oCbina Populatiooz Census (Beijing, Statc St.ittical 13ureau, 198 3); Country Denograpbic Pro/ilcs (WSahi)glo, D) C .I s Burcau of the C'enstis, (.cnter for Internationaml Research l)ivtision), selectc(l issucs. economies has helped achieve both uniusually higlh outptut and efficiency.' Failure to achieve basic literacy is a con- per unit of physical capital and an unusually equal sharing demnation to utter poverty; strong evidence links pri- of the benefits of rapid development. Western specialists now believe that developing couIn- tries may have overemplhasized higher education at the 2. See World Bank, World Development Report 1980 (Washing- expense of primary education and in some cases also ton, D.C., 1980; reprinted liy the World Bank in 1982 as Poverty secondary education, from the viewpoint of hoth equity and Human Development) for references to detailed studies. 124 mary education and the ability to earn an income, in unless parents actually enroll their children in school and both rural and urban settings. Economic rates of return encourage their continued attendance. on educational expenditure, viewed as an investment, The campaign to publicize the benefits of basic educa- appear to compare favorably with rates of return on tion should clearly be continued. But the Government physical capital; they are generally higher for primary should also direct more financial suDDort to schools in than for secondary education, and for secondary than for poorer areas. This money could be used to reduce some tertiary education. Furthermore, educating women en- of the obstacles to school attendance, including fees, dis- courages and assists them to have fewer children and tance (by building more schools or providing free trans- contributes to their children's health and educational at- portation), and the quality of staff and buildings. Finally, tainments. and especially insofar as there is a conflict between the interests of parents and children, serious consideration PROBLEMS IN CHINA. International experience should should be given to making attendance compulsory, as is thus reinforce concern about the drop (discussed in Chap- normal in industrial countries and already practiced in a ter 1) in primary and secondary school enrollment rates few places in China. This is not a simple solution, since it in China's rural areas in the early 1980s, mainly as a creates administratively (and often morally) difficult, and consequence of the production responsibility system costly, enforcement problems. But China's relatively high (PRS). The declines have been most marked in secondary degree of social organization would make it less difficult education and for girls in poor areas; this is apparently than for most other developing countries. related to employment opportunities. Thus school atten- dance in the richer parts of Jiangsu has not been much KEY SCIIOOLS. Education defines subsequent opportu- affected, although the productivity of additional child nities to an unusual degree in China. Examinations deter- labor on a family holding might be quite high, because a mine whether a child will attend senior high school, and junior secondary education is necessary for a job in a local thus whether he may take the unified national university commune or brigade enterprise. Furthermore, education examination. This examination determines the institution can contribute more to raisingagricultural output in areas to be attended, if any, and the course of study to be such asJiangsu where technological advance is rapid. followed, which in turn has normally determined the In the poorer parts of China, however, where there is graduate's life-long job assignment. Examination results little technological advance in agriculture or opportunity are thus of momentous individual significance; and they for nonagricultural employment, the economic return to may be grcatly affected by the quality of the school a education must seem very low. Peasant households in child attends. It may therefore be questioned whether these areas tend to have large families, so a twelve-year- China's key-school policy, which deliberately increases old daughter can help around the house or look after quality differences among schools by concentrating re- younger siblings without seeming to jeopardize hcr pros- sources in the better schools, is desirable, or whether it pects. But taking a longer-term view, the same daughter unnecessarily increases inequity and widens the gap in may be in the labor force forty years from now, when educational access between rural and urban areas. economic opportunities will be very different. Moreover, Research has shown that the educational system has an if there is to be significant migration out of the poorest inherent tendency to perpetuate the economic advan- parts of China (Chapter 5), a good basic education will be tages and disadvantages of particular families from gener- essential to enable migrants to adapt to a new economic ation to gcneration, which is unlikely to be absent in and social environment. China, even though differences in family background The Government has taken steps to revcrse the enroll- may be smaller. This tendency is aggravated by the une- ment decline, apparently with more success in primary ven quality of secondary, as well as higher, education than in secondary education. But increased local financial even in the richest countries. Schools with the highcst self-reliance in basic education seems to have aggravated achievement rates are located in cities and hence are more the already substantial problems of poorer areas (see accessible to children from urban families. All countries Chapters 5 and 10). Moreover, the factors that caused also eventually abandon the principle of equality in the enrollment decline could be a serious obstacle to higher education in order to concentrate students, staff, attaining the Government's target of making nine years and facilities in centers of excellence, because of the costs of basic education universal by the end of the century. involved in scattering them among all institutions of This is an important target-essential if China's full po- higher learning. tential for growth is to be realized, and its benefits equita- Given the low enrollment ratios, poorly qualified or bly distributed between town and country and between over-age staff, shortage of library facilities, and obsolete backward and more advanced localities, It is also an af- equipment in China's higher education, somc scarce re- fordable target, because of the prospective decline in the sources should probably be concentrated in a few "key" primary school age group. But it will not be achieved universities. But the gains in educational quality or cost- 125 effectiveness from such a policy at the secondary and attcmpt to provide all their own manpower; for example, especially at the primary level are questionable. Concen- the Ministry of Railways has a medical sclhool to train tration ol reso.ut-cs im certain priviieged schools encour- physicianis for employment in i It ics. ages thc cducati6i_al Ay L Oii J classily cniidiren too nastily I his "small but comprehensive" approach, even where it as high or low achievers, whiclh leaves much potcntial does not result in ovcrspecialized courses, is wasteful be- ability untapped. Many countries, capitalist as well as cause it passes up potential economies of scale. socialist, have rejected such policies in basic education as Given the apparent shortage of skills, the recent fall in contrary to both equity and economic efficiency. enrollments at-the mainly enterprise-run-schools train- ing skilled workers is surprising, especially because the Specialized versus General Education disincentive to enterprise training that worker mobility The Government's present policy is to reduce opportuni- creates in other countries is much less in China (an entcr- ties to go to general senior secondary schools and to prise can select the best trainees from its own schools). promote vocational education, by adding vocational The causes of this decline, which could be related to the courses at some general secondary schools and wholly new emphasis on profitability (although some enterprises converting others into vocational secondary schools. This are using part of their retained profits to supplement the policy is a reaction to the heavy pressures on univcrsity 1.5 percent of the wage bill thcy may use for training), entrance and the general difficulties of absorbing ncw should be investigated, as should its consequences. This is labor forcc entrants into productive jobs. However, en- partly bccause upgrading and relearning of skills will con- rollment in general upper secondary education is not high tinue to be badly necded (the state of China's impres- in Clhina compared with other rapidly growing develop- sively large and capable, but outmoded, stock of human ing countries, and its contribution to raising the produc- resources strongly resembles that of its physical capital tivity cven of pupils who do not go on to univcrsity stock and requires just as much "teclhnical transforma- should not he undercstimated. tion"). It is also because enterprise-sponsored vocational Vocational secondary education, moreover, has been training, despite the danger of excessivc narrowness, can controversial in many countries since the beginning of ensure close contact between the trainers and users of this century. In the I 920s, for instance, Strumilin argued trained manpower and provide opportunities for training that sound general education supplemented by brief voca- on the latest equipment, thus overcoming problems of tional training was the most efficient form of training for irrclevance and obsolescence that have plagucd vocational skilled workers.' For China, this argument is reinforced training elsewhere. by the need for rapid structural change over the next few 1'his advantage of enterprise-sponsored training can decades, which will requirc constant alterations in the also be captured by schools in closc touch with enter- skill composition of the labor force, and by the slow prises, but funded by local governments, several of which prospective growth of the labor force in the twenty-first alrcady exist in (China. Representatives of local enter- century (discussed later), which will reduce the scope for prises can be on the boards of directors for the schools changing skill composition simply by changing the pat- and can arrange for on-the-job training using relcvant tern of training of new labor force entrants. Providing equipment.4 These schools can provide broadcr training workers with good general cducation, which is the best -- c foundation for retraining as circumstances change, is thus L .dS.aGio Str ininsin tbe EconomicS of E ation, t a X k~~~dLcation,' in Readings in tbe Economics of Etlucation, e(iitcd by likely to yield large economic benefits. Mary Jean Bowman and others (Paris: Unesco-IIEP, 1968), pp. Any vocational training should be in skills adaptable to 413-50. Despite Strumilin's opposition, the Soviet Union did a wide range of occupations, but vocational training in eventually develop formal vocational educationi. Various attempts C.hina suffers from one of the acknowledged weaknesses were also made to integrate vocational and general education, but of the Soviet system on which it is imodcled: overspecial- none was successful. See Irenc Blumenthal and Charles Benson, ization. China now offers 700-800 training programs Educational Re/irrm in the Soviet Union: Implicationsfor Developing (zthe Soviet Unionwintheearly offered700800t ng Pagrt Countries, Staff Working Paper 288, (Washington, D C.: World (the Soviet Union in the early 1970s offered about Bank, 1978), pp. 32-0. 1I,100). Most vocational training, and even higher educa- 4. In Romania, after several reforms of education and training. tion, is carried out by enterprises or under the auspices of a reportedly cost-effective, successful system has been developed sectoral ministries and tends to be excessively narrow and All vocational schools arc jointly administered and operated by a job specific. nearby enterprise and a govcrnment institutioni. 'Ihe enterprise The administrative compartmentalization of training subcontracts the mnanufascture of product componenits to school also reduces quality and raises costs. Enterprises or sec- workshops. However, these must fit into the training programs toral agencies now seek self-sufficiency In key skills be- .d modles prepared by the Ministry of Education, which en- sures that training is not narrowly specialized. See Andreas C. cause trained manpower has been scarce, the assignment Tsantis and Roy Peppcr, Roniania: The Industrialization of an process does not meet their needs, and they cannot hire Agrarian Economy undler Socialist Planning (Washington, D.C.: employees away from other enterprises. 'I'hey may even World Bank, 1979), pp. 151-64. 126 than enterprises normally do and are less likely to lose doctors would find medical employment, while the oth- economies of scale. They could also fill the void created ers sought retraining or jobs requiring more general skills. by the proposed phasing out of apprenticeship programs By contrast, with administrative allocation, the forecast- (now involving more than 2 million young workers). ing error would be less conspicuous, but enterprises that Other countries, however, in particular both East and reaily needed a doctor and an engineer would find them- West Germany, have found apprenticeship schemes, with selves with two doctors and no engineer. a minority of time spent in the classroom, to be an effec- Recognizing the difficulties of manpower forecasting, it tive way of training skilled workers. would be desirable for postsecondary schooling to offer several routes to any given educational qualification. For The Role of Manpower Planning example, rather than having an indivisible four-year uni- Planning of both the level and the composition of ex- versity course for engineers, an individual might become penditures on (especially advanced) education and train- a "technician" in, say, two years and an engineer in ing in China is linked to manpower forecasting. How- another two. Under this system, the requirements for ever, manpower forecasting elsewhere has proved very both technicians and engineers need be forecast only two unreliable (though less so in projecting needs for teachers years ahead. Revising forecasts annually or biannually and doctors than in other areas). Manpower forecasts in could steer the educational system in line with labor re- countries particularly active in the field some time ago- quirements. Canada, France, India, Italy, Nigeria, Sweden, the The considerable flexibility of higher education in United Kingdom, the United States, and Zambia-were China, achieved for example through correspondence especially inaccurate more than two or three years ahead. colleges and television universities, is offset to some ex- Forecasts were usually based on estimates provided by tent by excessively specialized fields of study. It is less enterprises of the numbers of workers with particular difficult, forexample, to forecast the demand forchemists skills (especially in scientific and technical areas) they than for organic chemists, inorganic chemists, and indus- would require. But only very large firms regularly fore- trial chemists. The difficulties of manpower forecasting cast personnel requirements; moreover, they can only thus strengthen the case for broad curricula, with highly guess at their individual relative shares of the total mar- specialized skills acquired after, not during, formal study. ket, so that the forecasts of individual firms may be quite inconsistent and cannot be aggregated into a forecast for the whole economy. ~~~~~~Employment and Productivity the whole economy. More complex manpower planning methods-which The preceding discussion revolved mainly around short- attempt to calculate labor requirements (by occupation, ages. Just as much thinking in China, however, has re- sector, and industry) based on output and productivity volved around surpluses, especially of less-skilled labor. forecasts and to convert them into an educational struc- China's labor force will continue to grow, though less ture through estimates of the level of formal education rapidly in the 1990s than in the 1980s. In absolute terms, required for each occupation-have been no more suc- the numbers are staggering: an increase between 1981 cessful. Converting information about occupations into and 2000 of about 250 million in the population of educational needs is difficult partly because it involves working age, and perhaps 180 million in the labor force, aggregating varying amounts and kinds of formal and requiring on average nearly 10 million additional jobs nonformal education. But the main problem of this ap- each year. proach is its neglect of the possibilities for substitution: Faced with these statistics, and with evidence of exist- depending on prices, wages, and availability, enterprises ing labor surpluses, many people in China are worried produce given amounts of output with widely varying that there could be-also partly because of the PRS- mixes of labor and machinery, of different occupational widespread open unemployment in the countryside, with skills, and (within occupations) of different educational serious social and political consequences. There is like- qualifications. As a consequence, extensive research has wise fear of urban unemployment, which, for example, been unable to relate output forecasts (which are them- has led the Government in the past five years to cram selves problematical) to educational needs. many young people (especially those who returned from Manpower planning in China is likely to suffer from all the countryside) into enterprises that were already grossly these problems, but the consequences of error could be overmanned-and whose labor productivity has deterio- much more serious, at least if skilled labor continues to be rated as a result. More generally, a strong desire to pre- administratively allocated (discussed later). In other coun- serve and multiply jobs is reflected in reluctance to take tries, inaccurate manpower forecasts are less worrisome, steps that would raise productivity. These legitimate and because both individuals and enterprises can respond important concerns raise many policy issues requiring more flexibly to errors: for example, if 1,000 doctors had careful analysis of both the facts and the principles in- been trained while only 500 were needed, the 500 best volved. 127 Productivity and Growth manager may complain that he is obliged to employ far Economic growth is, overwhelmingly, productivity too many veterans, females (especially in heavy industry), growth. Since the ratio of the lahor force to the total and children. of cuurentr or former empioyees, but also population will change little. growth of --verXge a pita tha- 'c s SI;h..- Vi c, il)LCIIL,t wcii-trained, abie-bodied income will be almost entirely determined by growth of workers even at relatively low skill levels. Shortages and average output per worker. And, as in other countries surpluses of specific types of labor coexist in other coun- (chapter 1), although part of the increase in average labor tries, too, but, as with goods, the degree to which this is productivity will come from movement of labor out of so in China is unusual. agriculture into other sectors, most of it must come from The acuteness of the mismatch between labor demand higher productivity within each sector. For these basic and supply in China is partly due to rigid labor allocation reasons, measures that restrict labor productivity growth and wage policies (possible implications for these policies will slow China's overall economic growth. Slower are discussed later in this chapter). But it, and the general growth, moreover, means slower accumulation of capital predominance of labor surpluses in urban areas, also owes and expansion of demand in the modern sectors, and much to the unbalanced sectoral and institutional struc- hence over the longer term less of precisely the sorts of ture of production. cmployment that the Government is seeking to provide The smallness of employment in the service sectors in by holding down labor productivity. China, especially commerce and miscellaneous business This is not to deny that increases in productivity may and personal services, and the possible economic advan- lead to the loss of particular jobs. Indeed, as discussed in tages of its much faster expansion in the future, have been Chapter 7, rapid and intensive growth depends on this discussed in earlier chapters. The range of future possibili- happening on a large scale, with obsolete or uneconomic ties may be illustrated by comparing Chapter 2's QUA- activities and products being replaced by new and better DRUPLE projection, in which service sector employment ones. Displacement of old jobs by new jobs can take place increases by the year 2000 to 14 percent of the labor largely within existing enterprises-in other countries, force (90 million workers), with the BALANCE projection, employment tends to grow faster rather than slower in in which-with the same growth rate of GDP-it increases enterprises with above-average rates of innovation and to 25 percent of the labor force (155 million workers), productivity growth. But part of it must involve move- most of the increment being in commerce and miscellane- ment of workers from one enterprise to another (raising ous services. Service sector employmcnt in QUADRUPLE possible issues of unemployment, discussed below). in 2000 is only 70 percent of industrial (manufacturing Nor is productivity growth incompatible with the "la- and mining) employment, which is similar to the Soviet bor-intensive" development path that some successful de- Union in 1959 (80 percent). In BALANCE, service sector veloping countries havc followed. High labor intensity in employment is 150 percent of industrial employment, the relevant sense is not low output per worker. It is which is the same asJapan in the early 1950s, though less making the best use of scarce capital, land, materials, and than in the average lower-middle-income country today skills by using them in conjunction with large amounts of (200 percent, which is the product of a similar-size service unskilled labor, thereby achieving the highest level of sector but less industrial employment). output (and hence average labor productivity) that avail- Service sector activities, being more labor intensive able resources permit. In countries that have, like China, (combining more workers with a given amount of capital concentrated scarce resources in capital-intensive enter- and materials), could create more jobs and hence reduce prises, labor productivity in those enterprises has some- the overall urban labor surplus. These jobs would, more- times been high, but average labor productivity in the over, disproportionately employ the categories of labor economy has been reduced. that are now in surplus in urban China. In the United Kingdom in 1970, for example, women made up 52 percent of the labor force in commerce, finance, business, The situation regarding current and prospcctive urban and miscellaneous services (as compared with 30 percent labor surpluses and shortages in China seems to be re- in manufacturing), partly because of the greater scopc for markably varied. Despite general concern about surpluses part-tirne employment.5 The service sectors in other there is rapid absorption of labor into small rural towns. countries also absorb many males who lack the skills, Some larger towns and cities-for example, Changzhou physical strength, or tolerance of monotony needed for in Jiangsu and Shashi in Hubei-arc also cxperiencing manual work in modern industry. Expansion of the ser- gcneral labor shortages. And the projections discussed in Chapter 5 imply that this will happen more frequently unless greater migration is permitted. 5. In the U.K. data, 36 percent of the womrne in the service Within enterprises, in localities of general surplus and sectors worked part time, as compared with 22 percent in manu- general shortage alike, the picture is even more mixed. A facturing. 128 vice sectors could thus permit many people who now nonagricultural enterprise activities is of course not con- contribute little or nothing to output in China's factories fined to urban areas. The degree to which such activities to move to more productive work. So could expansion of expand will also have a powerful effect-probably as transport (see Chapter 5), especially road transport, great an effect as the overall pace of growth-on the which is much more labor intensive than rail transpor-L. number of workers in agriculture; which is likely to re- Closely associated with China's presently unbalanced main the residual employer of labor over the next few production structure is the smallness of the individual decades. sector-including self-employment, partnerships, and sole In the QUAI)RUPLE projection, with continuing rather proprietorships with a few workers-which in other slow growth of the service sectors, the proportion of the countries plays a dominant role in commerce and miscel- labor force in agriculture declines from 70 percent in laneous services, although it is important also in industry, 1981 to 59 percent in 2000; the number of agricultural construction, and transport. In China in 1984, this sector workers increases by 56 million. In the BALANCE projec- employed about 2.5 percent of the urban labor force. By tion, with faster growth of the service sectors, employ- comparison, to take some representative examples of cit- ment in agriculture drops to 52 percent of the total, but ies in other developing countries, the equivalent "infor- the number of agricultural workers still rises by 13 mil- mal sector" is estimated in the early 1970s to have em- lion. This is a normal pattern by international standards. ployed 31 percent of the urban labor force in Abidjan, 40 A marked decline in China's agricultural labor force over percent in Jakarta, and 30-40 percent in Lima.6 Even in the next two decades could be achieved only if nonagri- other socialist countries, the proportion is much higher cultural labor productivity grew unsatisfactorily slowly than in China: for example, the proportion of the indus- (Chapter 2). trial and industrial-handicraft labor force employed in Thus although the agricultural labor force could shrink private, semiprivate, and cooperative enterprises in the rapidly in the twenty-first century (Chapter 3), surplus early 1970s was 8 percent in Romania, 11 percent in East rural labor in the next twenty years is probably unavoid- Germany, 17 percent in Hungary, and (in 1980, with able. The ratio of farmworkers to cropland in China is services included) 29 percent in Yugoslavia.7 very high indeed by international standards, with Chi- It is increasingly recognized in China that many ser- nese sources generally estimating that about one-third of vices and specialized products are more efficiently pro- the agricultural labor force is superfluous.9 In considering vided by small, flexible enterprises and that such eco- nomic activity complements, rather than threatens, the state sector. Since 1980, young job-seekers have been 6. leatlher Joshi, Harold Lubell, and Jean Mouly, Abidjan: officially encouraged to organize small collective enter- Urban Development and Employment in the Ivory Coast (Geneva: prises. Self-employment and the development of family International Labour Office, 1976); S. V Sethurainan, 't'he Ur- enterprises have been promoted, and the taking of ap- ban Informal Sector: Concept, Measurement and Policy,' Interna- prentices and hiring of labor (up to eight employees) have tional Labour Review, vol. 1 14, no. 1 (July-August 1976), pp. 69- been permitted. Although still very small, the individual 81; C. Wendorff, "El Sector Informal Urbano en el Peru: sector has grown rapidly. In 1984, privately owned in- Interpretacion y Perspectivas" (paper presented at a seminar on dustrial and commercial undertakings employed moe ,employment problems in Peru, Catholic University, LIima, Peru). dustria . and commercial undertakings employed more 7. TIhe figure for Romania excludes small-scale private firmiis than 13 million people, of whom about 3 million were in and is therefore an understatement. The figure for Yugoslavia urban areas, a twentyfold increase over 1978. The major- inicludes transport, communications, catering, tourismii, construc- ity are in commerce, where the Y 28.8 billion turnover tion, and artisan work. David Granick, Enterprise Guidance in East- was 8.6 percent of total retail sales.8 ern Europe (Princeton, N.J.: Princeton University Press, 1975), p. Further expansion seems desirable. Indeed, to take 486; Harold Lydall, Yugoslav Socialism (Oxford: Clarendon Press, fuller advantage of the employment-creating and produc- 1984), p. 268. .. . . ~~~~~~~~~~8. China Daily, March 16, 19 85. tive potential of individual and small collective activity in8.CiaDlyMrc1619. 9. Labor use in China is very high, even compared withs other China would require few positive actions, since the sector parts of East Asia, which in turn is usually greater than elsewhere tends to grow spontaneously to meet demand once re- in the world. For example, Japanese agriculture used nearly 525 strictions are removed. It would bc necessary, however, man-days per hectare in 1956, and well over 600 man-days in to further improve its access to premises, materials, some areas. See K. N. Raj, "Preface," iri Labor Absorption in Asian skilled labor, and credit and to make sure that the work- Agriculture, by Shigeru Ishikawa (Bangkok: International labour ers involved have access to public services such as hous- Office-Asian Regional Team for Employment Promotion, Asian ing, health care, and pensions. (Policy toward the individ- Employment Programme, 1978), p.v. A recent study of thirty ual sector is discussed further in Chapter 10.) production teams in Nantong County, Jiangsu, suggeste(i that a ualsecor siscssefuthriChptr 10wheat-cotton rotation required 92.3 labor-days per mu ( 1, 3 84 per Underutilized Rural Labor hectare) and that a wheat-rice rotation needed 77 labor-days per mu (1,155 per hectare). See Song Linfei, "Village Labor Surplus The scope for expansion of service sector and individual (continued) 129 what to do about this, it may be unhelpful to think of organizational problems of public works. The difficulties somc specified proportion of agricultural workers as sur- encountered with extensive rural mobilization during the plus, the rest as necessary. Instcad, the problem could be Great Le2n Forward demonstrated the limits to this ap- vlcwcd as iost auxicultural workers making a small fere- pro2ch. mainivh.'.-. fror agri mcntal contribution to production-or, as Western econ- cultural production. During the Cultural Revolution, ex- omists would say, generally low marginal productivity. cessive emphasis on large projects that did not justify the Because farmers are poor and ingenious, this contribution effort involved also led to a reaction against labor-inten- is rarely zero-if it were, parents would not (as they are sive construction methods. But aside from these two pe- now doing in China, and have always done in other riods, China has effectively used rural labor in the slack developing countries) keep their children out of school to season for such things as the maintenance and upgrading work on the land. Marginal productivity may even have of irrigation facilities and terracing. The obligation to been increased in recent years by the PRS-for example, perform "social labor" is a tradition that preceded the cotton uscd to be picked only once, but is now picked People's Republic and has not been ended by the PRS, repeatedly. And the continuing reorientation of the sec- although it can now often be commuted into a tax pay- tor away from grain toward other crops and animal hus- ment. bandry may raise the marginal productivity of agricul- Neither seasonal public works nor the general utiliza- tural labor over the decades ahead. But it will in most tion of very labor-intensive methods in rural construction places and activities rcmain exceedingly small. is likely to be a panacea for underutilized rural labor. But This does not necessarily mean low or stagnant agricul- China could, over the next two decades, use labor-inten- tural incomes. For although in other countries low mar- sivc public works to improve rural infrastructure, espe- ginal productivity would mean low wages for landless cially roads. Even the roads linking substantial towns and laborers, peasant incomes in Clhina depend instead cities are often poor, and the even lower quality of the mainly on average productivity-the amount produced rural road network poses a serious obstacle to economnic on the household plot dividcd by the number of house- development (Chapter 5). The abundance of underuti- hold members. In some localities, and for some house- lized agricultural labor could, with proper management holds, average productivity also will be very low. But for and planning, provide an opportunity to tackle this prob- the agricultural sector as a whole, average productivity is lem, while contributing directly and indirectly to increas- likely to incrcase quite substantially over the next two ing rural incomes. decades (Chapter 3). From the viewpoint of efficiency, though, agricultural Allocating and Motivating Workers labor with very low marginal productivity is an underuti- lized resource. It has often been argued in other develop- To realize the full potential of China's human resources, ing countries that utilizing such labor for rural public it will be essential not only to provide appropriate educa- works could increase output and investment, as well as tion and training and to create the right jobs, but also to raising the incomes of somc of the poorest mcmbers of society. There has also been much skepticism about this possi- bility. Although a fcw rural construction projects could and Its Outlet," Chinese Social Science, no. 5 (1982), pp. 121-33. use unskilled labor and need very simple tools, most rural Even with this intensity, however, and with a significant amount of investment needs other equipment. Using labor-intensive sideline and collective enterprise activity, this particular county had methods can also be very slow, especially if the work is a great dcal of surplus labor. Ihere were only 1.6 mu per head of only done in the off season. Partly finished projects are the agricultural labor force; the study argued that about 4 mu per like unutilized capital assets-it may be worth using worker would be needed to avoid surplus labor. This is actually a higher-cost methods to complete them quickly. Some substantially higher estimate of labor requirements than many oth- projectsmight be completed by using very large amounts ers used in China. For example, forecasts of national agricultural projects might manpower requirements by the Ministry of Agriculture, Animal of labor at once, but this requires considerable organiza- Husbandry and Fisheries use an average cropping intensity of 9 mu tional skills, which are not costless. Furthermore, labor (0.6 hectare) per worker in crop production as an estimate of full participation in public works projects requires the pay- employment. On official estimates of the cultivable area, this ment of reasonable wages, at least to justify the travel and would suggest that crop production itself could fully employ only work effort involved. If this is not to be inflationary, about 160 million workers. additional taxes need to be collected. In short, these pro- 10. See Shahid J. Burki and others, Public Works Programs in posals for using surplus labor require investment decisions Developing Countries: A Co-mparative Anaysis, Staff Working Paper 224 (Washington, D.C.: World Bank, 1976); and Basil Coukis and based on careful evaluation of the benefits and costs In- others, Labor-based Construction Programs: A Piactical Guide for volved. ) Planning and Management (New York: Oxford University Press, China has made considerable progress in solving the 1982). 130 be successful in matching workers to jobs and getting able; they are still obliged by the labor bureaus to accept them to perform well in those jobs. China's traditional "packages" containing both wanted and unwanted re- system of allocating and motivating workers has serious cruits; they cannot discharge redundant workers; and shortcomings, but changes to achieve greater economic they have been allowed to dismiss unsatisfactory workers efficiency wvill raise d.ffiuit issues, especiallv of ecuitv. In only in a few instances, involving extreme absenteeism or agriculture, fundamental and highly beneficial changes in malfeasance. It appears imperative to consider further, the system of motivation have already tied household more radical, changes. earnings to household effort and initiative. This section will thus focus on labor allocation and motivation in INDIVIDUAL CIIOICE OF JOBS. A fundamental weak- nonagricultural and urban activities, which will predomi- ness of the present assignment system is its failure to take nate over the longer term. account of the the fact that individual job performance is as much a matter of individual interest and motivation as Employment Cboices of Enterprises and Workers of qualifications. Nor is monetary reward the only China's system of labor allocation allows individual em- motivator of effort and initiative. Freedom of choice ployers and employees uniquely little freedom of about where to work not only increases individual satis- choice-far less even than in the Soviet Union and East- faction, but also productivity, since people are likely to be ern Europe. Until recently, all young people were admin- more enthusiastic in a job they have chosen to do. 'Fhere istratively assigned to particular jobs-college graduates are therefore many advantages to allowing all workers, by the central government, secondary school graduates skilled and unskilled, new graduates and experienced peo- by local labor bureaus-with little attention to their pref- ple, to choose and change jobs freely. erences or the preferences of employers. The assignment Most governments assign graduates only for compel- was typically for life: with few exceptions (generally dic- ling reasons. For example, a few with training in much- tated from above rather than a result of individual or needed skills might be asked to work in remote areas for employer preferences), workers could not move from a fixed period. Centrally planned countries assign some one enterprise to another. Enterprises, moreover, were graduates to their first job: for example, Hungary assigns not permitted to dischargc workers, even if they had doctors and teachers; its chief manpower planner found more employees than they needed, and even if particular the idea of extending this procedure to all graduates "in- employees were habitually absent, lazy, or negligent. conceivable." " Hungary, Romania, and the Soviet In the last few years, there have been some changes. Union all allow some choice of assignment, at least to the The system of unified assignment has been dropped for best students, which provides an incentive for good per- youths with limited training, and enterprises may now formance at school. Furthermore, these assignments usu- examine prospective employees assigned to them by labor ally last only three years. Many workers then choose bureaus. Some jobs are now advertised. It was recently another job (perhaps because they were poorly assigned, announced that the best graduates of two universities or perhaps because the assignment process is used to fill (Qinghua and Jiaotong) may choose their own employ- inherently unattractive positions). In the Soviet Union, ers. From mid-1984, an experimental "job invitation" the first year of assignmcnt became a probationary pe- scheme has allowed a few organizations to offer jobs riod. The enforcement of assignments, which was once which they may later terminate to particular individuals, very strict, is now rather lax. the individual also having the right to refuse the offer or Allowing experienced workers to change employers subsequently to withdraw. Another experiment, covering also has advantages. It diffuses technological knowledge 300,000 workers in early 1984, involves "job contracts" (Chapter 7) and reduces overspecialization. Workers can between enterprises and new employees, often for three move to jobs where their particular skills will contribute to five years, specifying mutual obligations in regard to more to production than in their present jobs. Further- wages, performance standards, contract renewal, and sev- more, people like variety and are often challenged and erance. Enterprises are now in principle allowed to dis- stimulated by new situations. (At present in China, the miss unsatisfactory cmployees. Finally, there has been employing unit has to give permission for an cmployec to rapid growth of the commune and brigade and individual move: it will obviously consider its own necds more than enterprise sectors, where employment decisions are sub- those of other enterprises or the whole economy and is ject to little administrative regulation. likely to deny permission to those with the greatest en- These and other reforms, though beneficial, have not ergy and aptitude for tackling a new job.) Besides, work- basically changed the system. The unified assignment ers forced to remain in jobs whcre they are bored or schcme is still used for virtually all those with any postse- condary training and for some skilled manual workers. Enterprises can seldom hire badly needed skilled workers 11. Jainos Timar, Planning the Labor Force in Hungary (White from other enterprises where their skills may be less valu- Plains, N.Y: International Arts and Sciences Press, 1 966), p. 137. 131 unhappy are generally unproductivc. Even large Japanese of workers threatened with dismissal. But the virtual im- enterprises, which typically provide lifetime employ- inunity of employees from dismissal in China is unique, ment, though only to about a quarter of Japan's labor ind the comparative cxpericncc of Ilonig Kong and for- -.-. H #''t- O"''' t7" r er { s.n..ns diullelciu eign businessmen who have established enterprises in departments. Thcy also oblige their workers to "re- China abundantly confirms that it substanrially reduces tire -usually to other jobs-at about age fifty-five. worker effort and initiative. Positive incentives that kin- A possible disadvantage of individual freedom in job dle enthusiasm for work and reward diligence are essen- choice could be that the resulting pattern of employment tial. But it is vital to complement them with the threat of was not in accordance with national economic priorities, dismissal for poor (and not merely atrocious) perfor- particularly because many skills are now extremely mance. scarce. This is indeed a real danger in China's present Inevitably, some dismissals will be unfair. Because of circumstances, but mainly because enterprises are not yet mistaken perceptions or personal dislike, employers subject to appropriate motivation and cconomic signals. sometimes dismiss satisfactory workers unless they have Without enterprise responsibility for profit and loss, to go through a prohibitively elaborate administrative or product market competition, or rational prices, employer judicial review process. Moderate safeguards, such as the willingness to pay to secure or retain particular employ- right to appeal to a tribunal containing some worker ees would be a poor guide to their potential economic representatives, would be essential, but could not avoid contribution (the changes in the wage system that might all injustice. be required are discussed below). But these problems Dismissal will also often cause economic hardship- should be corrected through wider system reform, which, unemployment and loss of income-which, though fair except for a few projects of great scientific or strategic for the idle or negligent worker, is not so for his children. significance, could make it unnecessary and inefficient for For if dismissal involves no hardship, it loses most of its the Government to intervene directly in the allocation of force, as, for example, in the Soviet Union, where labor. chronic labor shortages mean that dismissed workers The other possible disadvantage of giving individuals have littlc difficulty in getting other jobs. Even in indus- more frecdom to choose and changc jobs is excessive trial capitalist countries, where a dismissed worker risks labor turnovcr, which could disrupt production and pre- protracted unemployment and may be ineligible for un- vent cmployees from acquiring enough expericnce in par- employment insurance benefits (which are commonly ticular jobs, as well as deterring employers from offering confined to those who lose their jobs through no fault of training (unless subsidized or obliged to do so). Though their own), he would usually be eligible for some form of there is controversy about its extcnt and causes, labor public assistance, especially if he had dependent children. turnover in the Soviet Union is generally believcd to be Some such compromise between making dismissal a high by international standards and to impose substantial toothless sanction, and making it distressingly onerous, economic costs. By contrast, the Japanese model of mu- would have to be struck also in China. tual lifetime commitment between worker and employer Policy toward workers an enterprise would like to dis- in large enterprises is widely believcd to have contributed charge (or reject), not because they are idle or negligent, to the country's economic success. Nevcrtheless, substan- but because they are simply not needed for production, tial labor turnover in most countries does not seem to involves yet harder choices. Indeed, even the principle have bcen particularly disruptive. Even in Japan, 13 per- that enterprises should be allowed to do this (or, more cent of all workers leave their enterprises each year, and drastically, to close down altogether) is not generally ac- South Korea has been economically successful despitc cepted in China, mainly because it would inevitably lead very high rates of turnover, cspecially in the labor-inten- to open unemployment. This is seen as wasteful of hu- sivc export scctors. man resources, and also inequitable because thosc who lose their jobs may have been conscientious workers E"NIERPRISF. CHOICE OF WORKERS. The possible ad- (though clearly employers will let the least diligent go vantages of allowing entcrprises to compete for workers first). It would also inflict unusual hardship in China, (new graduates or workers in other enterprises) have al- where there is at present not only no unemployment ready been mentioned. 'Ihere would also seem to be insurance, but also workers dcpend on their enterprises advantages in allowing cnterprises frcely to reject poten- for housing, pensions, much education and medical care, tial recruits they do not want, to release redundant work- and so on. Thcse objections deserve careful consider- ers, and to dismiss unsatisfactory workers. ation. Dismissal of unsatisfactory workcrs is alrcady an ac- Long-term, large-scale unemployment is unquestiona- cepted principle in China. The issue is, rather, what con- bly wastcful, espccially where, as at present in the indus- stitutes unsatisfactory performance. This varies from trial capitalist countries, large numbcrs of young people country to country, as do the legal and procedural rights are affected, In China, moreover, where the actual wages 132 of many urban workers may be above their potential The arguments for and against allowing enterprises to contribution to production in alternative employment, release or reject redundant labor hinge ultimately on the employers might on the basis of profitability calculations probability of released workers finding new jobs, paying want to release more workers than would be rational acceptable wages, within a short time. T his probability- from the viewpoint of economic efficiency. For example, which, if high, would make unemployment much more if the wage were Y 100 per month, profit-oriented enter- acceptable-should not be underestimated in China. prises would release all workers contributing less than Y Many workers released by one enterprise would be able 100 to monthly production, even though the alternative to find work in other enterprises simply because em- jobs for these workers might raise production by only Y ployer needs for particular types of labor are now poorly 50-thus clearly lowering total national production. (The matched with labor allocations. Other released workers implications of this for China's wage policy are discussed would find work after retraining in accordance with the below.) revealed pattern of shortages and surpluses of particular Nonetheless, the waste associated with unemployment skills (which is at present hard to ascertain). The elimina- has to be weighed against the waste associated with the tion of old jobs and inefficient enterprises actively con- present employment system. To some extent, this system tributes to the creation of new jobs and the expansion of simply transfers unemployment from the streets into the employment in efficient enterprises (Chapter 7). There is factories, which is no less wasteful. The resulting sense of great potential for creating productive jobs in the service labor surplus in many enterprises, moreover, discourages sectors and the individual economy. managers from improving work habits and increasing the But even under the most optimistic assumptions, free pace of work. The rigidity of the system is also an obsta- release of labor would cause an appreciable number of cle to long-term technological advance and productivity unlucky individuals-and localities-to suffer long-term growth, both by impeding the replacement of old prod- unemployment, or (as is more usual in developing coun- ucts and processes with new ones (Chapter 7) and by tries without unemployment insurance schemes, and con- obstructing the movement of particular workers to jobs sequently with little open unemployment) to experience in which they could be more productive. For these rea- sharp wage reductions. The increases in unemployment sons, allowing enterprises to release or reject redundant in industrial countries since about 1970 are not encourag- workers could on balance lead to fuller use of China's ing: although unemployment rates are still only 2-4 per- human potential, despite transitory unemployment. This cent in Austria, Japan, Norway, and Sweden, they are would be particularly likely if the state provided displaced over 13 percent in Belgium, the Netherlands, Spain, and workers with retraining and assistance in finding suitable the United Kingdom (where 5 percent of the labor force new jobs. has now been without jobs for more than one year). There are also ways of reducing the hardship that un- There is also appalling urban poverty in some developing employment would otherwise impose on workers re- countries. Thus, even though most unemployment in leased or rejected by Chinese enterprises. These, which other countries is in fact temporary, freedom for Chinese are discussed in Chapter 10, include establishing a system enterprises to release or rcject redundant-as distinct of unemployment insurance and transferring much re- from idle or negligent-labor would have both advan- sponsibility for housing, pensions, and social services tages and risks and should probably be approached from enterprises to the Government. However, setting tiously and gradually. the level of unemployment benefits (including housing and social services for unemployed workers) involvcs an Efficiency, Fairness, and Stability in Wage Deternination insoluble dilemma. If these benefits are set low, relative For most of the past three decades, China's wage system to wages, then people who become unemployed through has been just as rigid as its labor allocation system- no fault of their own, and their families, suffer unaccepta- though more similar to the Soviet and East European ble hardship. But if they are set high, people have little systems. There are centrally determined basic wage incentive to work and may even prefer to be unemployed scales, varying among occupations, industries, and locali- rather than take, to gain a little extra money, a monoto- ties. Enterprise managers have had virtually no discretion nous or arduous job. The strength of this disincentive to over where to place individual workers on, or how fast to work remains controversial. But most economists agree move them up, these scales-indeed, individual wages that generous unemployment benefits, both by providing might be frozen for a dccade or so, causing, for instance, a disincentive to work and by raising wages in low-skill a rapidly promoted minister to be paid less than a longer- jobs, have contributed significantly to the high levels of serving junior official. Bonuses, piecework, and other long-term unemployment that now afflict, in particular, forms of payment by results were for many years prohib- some West European countries. T hese benefits have thus ited. Moreover, a large fraction of worker remuneration also changed unemployment from a problem of poverty has been provided in kind (housing, social services, subsi- into one mainly of wasted human resources. dies), more or less equally to all employees. 133 In recent years, there have been some changes, most ther steps toward a more flexible, less egalitarian wage notably the reintroduction of piecework and bonuses, system, in which demand and supply, as well as individual whicil now have no uppcr limit for individual workers. contributions to production. would pnlay greater role in t;itougil cnterprises making payments above specified lev- determining the earnings of particular employees and oc- els are in principle subject to stiff taxes. Under various cupations. It must be stressed that in few other countries "floating wage" schemes, most or all of the basic wage are wages freely determined by market forces: even in follows the standard eight-grade scale, but bonuses and a capitalist nations, there is usually some mixture of market part (usually 20-30 percent) of the basic wage are linked forces, collective bargaining by trade unions, minimum to the profit or output of the firm or to performance wage legislation, and-within large organizations-ad- targets for the individual job.'2 A related scheme is the ministered wage scales influenced by considerations of "floating wages and grade system,' under which a hierarchy and fairness. (The rigidity that these nonmarket worker is promoted for good performance but can only elements introduce into the wage structure is widely retain the higher grade after three years of sustained good thought to have contributed to both unemployment and performance. Some state enterprises set aside up to 1.5 inflation in the industrial countries.) Moreover, for percent of the wage bill for "labor emulation" or "labor China, the economic benefits of a more flexible wage competition" awards, and honorific titles and privileges system would be relatively limited without more general are offered for good work performance or innovation. In reforms of enterprise motivation and prices, which would addition, there has been rapid expansion of commune align the financial interests of enterprises more closely and brigade and individual enterprises, which have con- with the economic interests of the nation. siderable freedom to set their own wages. Objections to more wage flexibility-which could be As with labor allocation, however, these reforms have accomplished partly by reform of the state enterprise not basically changed the system. Bonuses have become wage system, partly by relative expansion of the less regu- general wage supplements, distributed to workers and lated nonstate enterprise sector-are mainly connected staff in almost all organizations, often with little regard to with equity. Although the Communist Party's Central the performance of either the organization or the individ- Committee has recently stressed that China needs more ual. Managers still have little discretion regarding promo- than the present degree of wage inequality, 3 both very tion (or demotion). Floating wages apply to a tiny minor- high and very low earnings may be considered contrary ity-inJiangsu in early 1984, only 1.4 percent of workers to socialist principles. Another concern is that more flexi- were covered by such schemes. Moreover, even with bility might lead to wage inflation, with adverse conse- floating wages, the main determinant of earnings remains quences for the budget or the overall price level. These the centrally prescribed wage scales, which have changed possible disadvantages of further substantial reform of very little and are most egalitarian by the standards of China's wage system merit careful consideration. other countries, especially as regards the smallness of the differentials between manual workers and technical, man- HIGII WAGES. It is essential to distinguish between agerial, and professional staff. two quite different forces that would tend, with a greater These continuing characteristics of China's wage sys- role for market regulation, to increase the relative pay of tem cause serious economic problems. It is hard for enter- certain individuals and occupations. The first is the na- prises to reward good work-including, very importantly, ture and magnitude of their work: jobs that are particu- that of their managers-with higher pay or promotion, or larly arduous or unpleasant, or involve disagreeable risks to penalize poor work with lower pay. The low, fixed or responsibilities or long training, must be better paid pay of skilled or other scarce labor contributes to misallo- than other jobs requiring comparable skills to persuade cation and waste, because employers who need such la- enough people to work in them (this is true even now in bor cannot attract it, and because wages that do not China, where mining and remote or hazardous jobs com- reflect its economic value offer no disincentive against mand a wage premium); and people who work longer employing such labor unnecessarily. Conversely, the rela- hours, or faster, or more conscientiously will tend to be tively high wages that must be paid to unskilled workers paid more. These causes of high earnings seem fully com- are a deterrent to their employmcnt and would become ____ even more so if employers were given more freedom of 12 See, for example, Qiu Yang, "On the Basic Direction for the choice in hiring and firing. More generally, the rigidity of Reform of the Wage System of Enterprises,' Jingji Guanli, no. 9 the wage structure is an important cause of the striking (September 5, 1983), pp. 20-23 Uoint Publications Rescarch Ser- coex*stence, mentioned earlier, of labor shortages and vice 84603, October 24, 1983). Also Zhuang Qidong. "Com- in urbn China. (ea po .ble s ments on Floating Wages Being Tried Out in China," Renmin surpluses in urban Chma. (The problems caused by Ilm- Ribao, December 9, 1 983. ited interregional diffcrences in wage levels and structure 13. Communique of the Third Plenary Session of the Twelfth were discussed in Chapter 5.) Central Committee of the Chinese Communiist Party, October 20, The Government is therefore actively considering fur- 1984, Decision on Reform of the Economic Structure, Article VII. 134 patible with the socialist principle of payment according ary burden of subsidies to overmanned loss-making enter- to work. prises is also a disadvantage. The second source of high wages in a market setting is If unskilled wages were allowed to float downward, the scarcity. This may arise from a limited supply of innate problems of employment associated with a more flexible talent-outstanding artists, sportsmen, and businessmen system of allocating labor, discussed earlier, would be being examples. Or it may arise from bottlenecks in the reduced: profit-oriented employers would want to release education and training system, which cause shortages of fewer unskilled workers than at the present, higher, certain sorts of labor-at least for a while-even though wages; and it would be easier for those released to find more than enough people would be willing to undergo employment elsewhere. But this gain, and other associ- the necessary training. Unexpected changes in demand ated increases in economic efficiency, could involve a and supply-including those associated with other aspects socially and politically unacceptable drop in unskilled of system reform-can also cause temporary shortages of wage levels. There are various ways of easing this prob- particular types of labor in particular places. These sorts lem; none offers a perfect solution. of scarcity tend to generate high earnings, which, while One is to move gradually, so that there is little or no they may be economically efficient, are much harder to absolute reduction of unskilled wages even though they defend as fair. However, progressive personal income tax- decline in relative terms. This could be done on an indi- ation can help to reconcile efficiency with equity by driv- vidual basis, with the guarantee that workers' wages will ing an increasingly large wedge between the wage paid by not be reduced, even though new recruits will be paid the employer (whose high level encourages efficient use less. This would, however, create tension between "old" of scarce skills) and the wage received by the employee. and "new" workers. Another approach would be to es- China already has a progressive personal income tax, tablish a legal minimum wage at the present unskilled aimed primarily at resident foreigners; this could be more level, and then (this would be the vital but difficult part) widely applied as greater wage flexibility is introduced. (A not to raise it in real terms for perhaps twenty years, even progressive payroll tax paid by the employer on wages though average earnings-especially those of skilled above a certain level could achieve similar results.) But workers-were increasing. For example, if the unskilled the progressive tax would have to be levied on high earn- wage were initially three-quarters of the average wage, ings due to effort as well as on those due to scarcity, since and the average wage increased at 4 percent per year (as there is no administratively feasible way of discriminating in the QUADRUPLE projection in Chapter 2), a constant between them, and could thus deter hard work and initia- absolute unskilled wage would, after twenty years, have tive. For this and other reasons (discussed in Chapter 9), declined to one-third of the average wage. the personal income tax rate structure in China, as in all A related strategy would be to increase the cost to countries, would have to be a compromise between con- employers of other inputs to production, thus making use flicting objectives. of unskilled labor relatively more attractive. Obvious ex- amples are increases in the cost of capital (higher profits LOW WAGES. The conflict between principles of effi- or taxes on machinery, higher interest rates, fewer ciency and of equity is generally sharper, and harder to grants), energy, raw materials, and of course skilled labor. resolve, for low relative wages than for high relative But beyond a certain point, such increases might be eco- wages. In China, as in other developing countries, un- nomically irrational, although they could perhaps be skilled labor is in such abundant supply that profit-orn- complemented with targeted payroll subsidies to employ- ented employers may only be willing to pay a wage ers of low-wage labor. (Payroll taxes or employer social below the minimum necessary for a decent existence. insurance contributions on unskilled wages would of China's approach to this problem thus far has consisted course have the opposite effect.) mainly of keeping unskilled wages above their economic T he association between low-wages and household level while obliging employers to take on more unskilled poverty is weakened by varying labor force participation. (and other categories of surplus) labor than they want. Some low-wage earners are members of households with This approach is not altogether inefficient, since many of reasonable average incomes, citlher because there are few the "unwanted" workers in state enterprises are engaged dependents or because other family members earn higher in low productivity activities, much as if they had been wages. Conversely, some households are poor even voluntarily hired at a lower wage. But it has some serious though their working members earn reasonable wages, disadvantages in the context of wider economic rcform: it because they have many dependents. Rather than at- runs counter to the spirit of making enterprises manage tempting to boost or supplement low wages as such, it their own affairs and cut costs; and it makes it hard for may thus be more equitable-and more efficient-to pro- state enterprises to compete effectively in product mar- vide direct state income supplements to poor households. kets with nonstate enterprises, which in turn encourages This possibility-and some of its other advantages and administrative restrictions on competition. Thc budget- disadvantages-are discussed in subsequent chapters. 135 WAGE STABILITY. Recent experience in China, as well reduced by poor accounting and managerial indifference as in other socialist and capitalist countries, substantiates to financial results. the concern that a more fliucxjbk wage system might cause In addition, formal liilkace.s betwecn worker remunera- ev¢_t9 C rnctear n auu u.iu L wagcs-and hence tion and enterprise (as disti:ct from individual or group) budgetary or macroeconomic management problems. In performance should be approached with caution. This is capitalist countries, the main sources of wage-push infla- partly because irrational prices and limited competition tion have apparently not bcen market pressures, but insti- make profitability a poor measure of economic perfor- tutions such as collective wage bargaining and legal mini- mance at present in China, partly because alternatives mum wages. These can not only push up wage rates measures such as labor productivity are fraught with am- despite balance or surplus in labor markets, they also biguities of definition and calculation. But it is mainly make it difficult for any wage rate to fall in money terms, because there is no way to determine how much of the so that relative wage adjustments can be achieved only variation among enterprises in the level or growth of through wage increases. In socialist countries, workers profits or productivity is due to variation in worker effort also exert pressure on managers to raise wages, and man- and initiative, as opposed to variation in technology or agers are often disinclined to resist, partly for ideological managerial skill, which are generally more important. reasons, partly because they are not concerned to hold Some improvements in enterprise performance, more- costs down. As a result, there has always been some form over, are simply a reflection of unacceptably poor prior of wage control from above in the Soviet Union and performance. Larger wage increases for workers in enter- Eastern Europe, although its form has varied. priscs whose profits or productivity increase more rapidly If China were to move toward a more flexible, market- are thus often (and justifiably) perceived as unfair by regulated, wage system, control of wages in the individ- workers in other entcrprises, who then exert pressure on ual and collective sectors would probably not be needed their employers to securc similar increases by manipulat- for overall wage stability (although wagc bargaining by ing the statistics and bending the rulcs. (For example, trade unions is a potential problem). But in the state rules relating wage increases to enterprise productivity sector, unless or until managers are made highly profit- increases seriously undermined an overall policy of in- conscious (see Chapter 10), wage control from above will come restraint in the United Kingdom in the late I 960s.) still be necessary. This is partly because workers in large Current government proposals to establish formal link- organizations can exert collective pressurc for wage in- ages between average remuneration and financial perfor- creases, partly because, as the Hungarians have discov- mance (tax or profit remittances) in individual state cnter- ered, it may be politically inexpedient to encourage con- prises could thcrefore cause problems. An alternative flict over wages between the managers and workcrs of approach might be to have rather uniform guidelines for statc enterprises. In China, the case for continuing state average wage increases in state enterprises, related to an sector wage control is further strcngthencd by the large overall strategy regarding wage differentials between the sizc of the present gaps between wages (and benefits) in statc sector and other sectors (including agriculturc-see statc and nonstate enterprises and between urban and Chapter 3), as well as to econoimiywidc labor prodtictivity rural incomes, which should probably be gradually nar- increases. T'hese overall limits should as far as possible be rowed. combined with stronger linkages within enterprises be- Thle precise form of wage control is itself a difficult tween the remunerationi and performance of particular issue. 'l[e Soviet Union and Eastern Europe have moved individuals and groups, and with greater flexibility in increasingly toward limits on the enterprise's total wage setting the pay of scarce, skilled categories of staff and bill, leaving managers considerable discretion over how workers. But there will inevitably have to be compro- many workers of particular types to employ and how tmises between the need for contintiing administrative much to pay them, and toward linking the overall wage restraint of total wage bills and the need for more micro- bill to measures of the enterprise's economic perfor- economic flexibility and incentives, Morcover, the mana- mance, such as growth of net output. Such an approach gerial indifference to profitability that makes administra- could have advantages for China, too. But it would be tive restraint of total wages necessary is obviously also an desirable to retain limits on growth of average (per impediment to establishing an economically efficient and worker) earnings in each enterprise, as well as on the total nonegalitarian distribution of the wage bill within partic- wage bill. Workers and miianiagers may. otherwise, find it ular enterprises. in their intcrests to restrict or reduce employment to an economically undesirable levcl, which would have more Population Issues beyond the Year 2000 serious consequences in China than in the labor-short Sovict Union. These limits on earnings increases should, China's low rate of population growth, by comparison moreovcr, be enforced administratively, and not merely with most other developing countries, is onc important through tax penalties, whose efficacy in China is much reason for China's uLlusually favorable per capita income 136 growth prospects (Chapter 2). It has been achieved Figure 8.1 Population, Alternative Projections, through widespread female literacy and primary health 1980-2100 care (see footnote 2 in this chapter), as well as strong birth planning policies. The Government's target for the Millions of people year 2000 is a population of 1,200 million. This will 1,800- require a substantial drop in rural fertility from its present A level, which will not be easy to achieve. But the target 1,600- seems broadly feasible, as well as desirable, and its attain- B ment has been assumed in the various economic projec- 1,400- tions presented in earlier chapters. The focus of the present section, however, is on demo- i,200 graphic and related issues in the twenty-first century. Its objective is not to offer predictions or prescriptions, nor even a comprehensive account of possible outcomes and their determinants and implications, but rather to draw 800- attention to certain issues that may need to be considcred 1980 2000 2020 2040 2060 2080 2100 and acted on within the next few years. Figure 8.1 and Table 8.2 present and extend to the year Source World Bank projectionis. 2100 a demographic projection (B) which almost exactly attains the Government's population target for the year 2000, as well as two alternative projections (A and C).14 Projection C reaches the same low fertility rate as Projec- In Projection B, fertility falls below the replacement level tion B in the early 1990s and maintains it until the year during 1985-90, reaches a low point in the first half of 2040, when it returns to replacement level. Its popula- the 1 990s, and rising again, remains at replacement after tion is 1, 180 million in the year 2000, falling to about the year 2000. Its population of 1,196 million in the year 800 million by the time it stabilizes. (There are no good 2000 stabilizes by the year 2100 at an unchanging level historical precedents for such a decline, except in condi- of about 1,500 million. Projection A assumes a rather tions of acute economic distress, as in nineteenth century slower decline of fertility, never falling below replacement level; but it, too, assumes that replacement fertility will be achieved in the year 2000 and then maintained indefi- 14. These projections follow the World Bank's standard meth- nitely. Its population of 1,273 million in the year 2000 odology. See My T Vu, World Population Projections 1984 (Wash- eventually stabilizes at about 1,700 million. In contrast, ington, D.C World Bank, 1984). Table 8.2 Population Growth, Alternative Projections, 1980-2100 Projection A Projection B Projection C Average Average Average annual annual annual Population growth Population growth Population growth Year ('millions) TFR' (percent)" (millions) TFRf (percent)` (millions) TFR' (percent)" 1980 980.3 - - 980. 3 - - 98(.3 - 1990 1,112.4 2.3 1.3 1,093.8 2.1 1.1 1,093.8 2.0 1.1 2000 1,273.0 2.2 1.4 1,196.3 1.7 0.9 1,179.7 1.5 0.8 2010 1,392.1 2.2 0.9 1,312.2 2.2 0.9 1,232.7 1.5 0.4 2020 1,495.0 2.2 0.7 1,379.4 2.2 0.5 1,245.9 1.5 (0.1 2030 1,583.4 2.1 0.6 1,436.8 2.1 0.4 1,224.8 1.5 -0.2 2040 1,626.3 2.1 0.3 1,461.1 2.1 0.2 1,158.1 1.5 -0.6 2050 1,646.8 2.1 0.1 1,449.7 2.1 -0.1 1,085.6 2.1 --0.6 2060 1,663.8 2.1 0.1 1,446.7 2.1 -0.( 1,()02.6 2.1 -0.8 2070 1,679.3 2.1 (.1 1,454.8 2.1 0.1 938.4 2.1 -0.7 2080 1,682.6 2.1 0.0 1,461.0 2.1 0.( 893.9 2.1 -(0. 2090 1,685.7 2.1 0.0 1,459.9 2.1 -0.0 859.3 2.1 -0.4 2100 1,68 7.8 2.1 0.) 1,462.1 2.1 (.0 843.0 2.1 -(0.2 a. lotal fertility rate; i.e., the average number of children born to wroiren who experience the prevailing pattern of fcitility dtirinig their childic-)aring years. b. Growth rates alrc averages over the preceding teil years. Source: World Bank projections. 137 Ireland, but some Chincse demographers have suggested smaller agc cohort would offcr an opportunity for fm- an ultimate population target as low as 700 million, to be proving enrollment ratios, but recent falls in enrollment rcached ac iapdivy as plusildc) ig sugest that capacit) Is not currently the main constraint In zhc.cx tzwV6 Uc .auu.r oLIe e.iUHiiL iII1piLatioiis oi on enroiiment. these alternative projections are quite limited. The differ- ence in population of about 93 million between Projec- POPULArION OF WORKING ACGE All three projcctions tions A and C in the year 2000 is of course striking, show growth in the population of working age (here especially since neither projection is based on extreme taken as age fifteen to sixty-four) until after the year 2010 assumptions. But, though very large in absolute terms ('lable 8.3). The anticipated growth of the labor force is and by the standards of other countries, it is a difference slower under Projections B and C, but even under Pro- of less than 10 percent, and the differcnce in the average jection A, the rate is not high by past Chinese or develop- annual growth rate of the population during 1985-2000 ing country standards. is only 0.5 percent. The higher figure would cause per Eventually fewer people enter the labor force than re- capita incomc in the year 2000 to he somewhat lower, tire from it. In Projection C, the population of working and probably also the pattern of food consumption and age (and hencc presumably the labor force) begins to agricultural trade to differ (Chapter 3), but not to a large shrink after the year 2010. Under the other projections, extent. this drop comes somewhat later and is less marked. The In contrasting Projections A and C over the longer problem is especially acute in 2030-40 when the large term, however, the differences in population size are as- cohorts of the mid to late 1960s and early 1970s retire, tounding. A nation of 1.7 billion people would differ in and all three projections show declines in the working age very many ways-physical and social, as well as eco- population. Negative labor forcc growth might have noinic-from one less than half that size. 'lo assess the some economic advantages. It could cause rapid increases long-run optimal size of China's population would be in productivity through faster abandoning of old plants, difficult and pcrhaps impossible, since there is no basis for and stronger inccntives for employcrs to economize on predicting the statc of technology more than a century the use of labor. In agriculture, the opportunities for ahead. But it is possible to examine the more predictable consolidating landholdings and mechanization, and more consequences of alternative population growth paths for generally the elimination of the rural labor stirplus, would the age structure of the population and some of their be welcome. economic and social implications. 'I'hese will probably be Howevcr, a shrinking labor force also inevitably causes quite small in the next fifteen ycars, but could be very problems of adjustment. To introduce new products and large in the twenty-first century. processcs would require more than equal reductions of employment in older activities, which would not bc eco- Changes in the Age Structure nomically or socially costless: the closure of some plants to prescrve economies of scale in other plants might, for l'OPUI.AI'ION OF S(.l 10OO. A(.F. TIhe differcnce be- example, requirc substantial geographical movement of tween Projections A and C in the number of children age labor. There would be a rise in the average age of the five to fourteen is 29 million at the end of this century; labor force, with shortages especially of younger, more thiereafter, the gap widens until by the year 2040 there recently trained, more adaptable workers, and possibly are 106 million five- to fourteen-year-olds in Projection A surpluses of older workers, who find it harder to ad'just to and only SO million in Projection C. new production possibilities requiring substantially differ- A smaller number of children would offer the potential cnt skills. These problems-whose solution would be im- for significant savings or quality improvements in educa- possible without a flexible and responsive systcm of labor tion. But the cost reductions would not be proportionate training and allocation, far removed from China's present to the difference in population size, since there could not system-wotld occur under all three projections, but he a proportionate elimination of classrooms and schools would be most serious and prolonged under Projection C. or dismissal of teachers. Even in industrial countries, with much more urbanization, better public transport, and a T1 IE ELDERLY'. Because all three populationi projections stronger tradition of dismissing redundant employees, it assume the same ultimate fertility and mortality rates, has proved difficult to consolidate educational facilities in the facc of declining educational needs. China already has fairly modest primary student-teacher ratios (averaging I SongJian. ''Population Developicnt-Goals and Plans," in 25:1 in 1983) and average class sizes (thirtv-four pupils China's Population. Problems and Prospects, by LRiuZheng and others I our (Beijing New World Press, 1981), pp. 25-31; llu Baosheng and per class in 1983), with an average of about five classes others, "Setting a Tirget for Our Country's Total Population," per school, which, with a five-year currictIlum, gives little Renkou Yu Jingji (Population and economilics), no. 5 (198 1), p). opportunity for consolidation. At the secondary level, a 15-18, 64. 138 Table 8.3 Population of Working Age, Alternative Projections, 1980-2 100 Projection A Projection B Projection C Percentage A verage annual Percentage Average annual Percentage Average annual Population of total growth Population of total growth Popuiation of total growth Year (millions) population (percent)' (millions) population (percent) (millions) population (percent) 1980 584.8 59.7 - 584.8 59.7 - 584.8 S9.7 - 1990 761.4 68.4 2.7 761.4 69.6 2.7 761.4 69.6 2.7 2000 850.3 66.8 1.1 850.3 71.1 1.1 850.3 72.1 1.1 2010 956.8 68.7 1.2 901.0 68.7 0.6 901.0 73.1 0.6 2020 1,020.1 68.2 0.6 944.0 68.4 0.5 894.2 71.8 -0.1 2030 1,027.6 64.9 0.1 935.2 65.1 -0.1 829.7 67.7 0.7 2040 1,000.6 61.5 -0.3 866.2 59.3 -0.8 698.7 60.3 -1.7 2050 1,029.0 62.5 0.3 877.6 60.5 (.1 620.8 57.2 -1.2 2060 1,025.4 61.6 -0.0 899.6 62.2 0.2 570.7 56.9 -0.8 2070 1,021.4 60.8 -0.0 883.8 60.8 -0.2 532.3 56.7 -0.7 2080 1,030.0 61.4 0.1 888.8 60.8 0.1 50)8.6 56.9 -0.5 2090 1,024.8 60.9 0.0 894.6 61.3 0.1 505.7 58.8 -0.1 2100 1,029.4 60.9 0.0 887.2 61.7 -0.1 510.5 60(.6 0. Note: Data are for the population fifteeni to sixty-four years old. a. Growth rates are averages over the preceding tcin years. Source World Bank proicctiois. Table 8.4 Population Sixty-Five Years Old or More, Alternative Projections, 1980-2100 Projection A Projection B Pr(sjection C Percentage Working- Percentage Working- Percentage Workinig- Population of total age pop. Population of total age pop. Population (Yjtotal age pop. Year (millions) population -65 + pop. (millions) population -65+ pop. (millions) population - 651+ pop. 1980 45.1 4.6 13.0 45.1 4.6 1 3.0 45.1 4.6 13.0 1990 67.2 6.0 11.3 67.2 6.1 11.3 67.2 6.1 11.3 2000 94.5 7.4 9.0 94.5 7.9 9.0 94.6 8.0 9.() 2010 118.5 8.5 8.1 118.5 9.0 7.6 118.5 9.6 7.6 2020 172.9 11.6 5.9 172.9 12.5 5.5 172.9 13.9 5.2 2030 234.8 14.8 4.4 234.8 16.3 4.0 234.8 19.2 3.5 2040 316.7 19.5 3.2 316.7 21.7 2.7 316.7 27.4 2.2 2050 307.7 18.7 3.3 307.7 21.2 2.9 3107.7 28.3 2.0 2060 323.6 19.4 3.2 275.8 19.1 3 .3 275.8 27.5 2.1 2070 348.8 20.8 2.9 299.7 20.6 2.9 256.4 27.3 2.1 2080 338.3 20.1 3.0 304.6 20.8 2.9 227.4 25.4 2.2 2090 347.7 20.6 3.0 294.0 20.1 3.0 200.1 23.3 2.5 2100 350.2 20.8 2.9 305.3 20.9 2.9 179.1 21.2 2.9 Source: World Bank projections. they all eventually converge-in the twenty-second cen- is likely to find aging issues more serious, because the rise tury-to the same, unchanging age structure ('Fable 8.4). in the proportion of elderly people will begin at a com- People age sixty-five and over constitutc about 2 1 per- paratively low income level. In addition, with an irregular cent of the "stationary" population in each case. The decline in fertility, the proportion of the elderly may even population of working age is about 61 percent of the temporarily rise above its long-term stationary lcvcl. In total, only slightly greater than the 60 percent of 1980. Projections A and B, the proportion of the elderly in- The ultimate ratio of dependents to the labor force is thus creases slowly to its ultimate size with little fluctuation. not very different from today. But the demographic struc- By contrast, in Projection C, the elderly become an ex- ture of depcndency is very different: in 1980 only about tremely large proportion (27-28 percent) of the popula- one out of ten dependents (excluding those age fifteen to tion for several decades after the year 2040. sixty-four) was sixty-five or more; ultimately, it will be How financial support of China's prospectively large about one out of two. elderly population might be organized-an issue that may Though all countries will probably eventually have a require important steps to be taken soon-is considered similarly substantial proportion of elderly people, China below. The other major problem posed by the aging of 139 1 Th- ,nd Htalth C-are Re- olution The pattern of Ifese health problems has already ment holds promise of results and can he afforded, they changed from that of a low-income developing country, must pay careful attention to affordable plans for rehabili- where typically over 10 percent of (leaths result from in- tation of individuals partially or wholly incapacitated by fectious, parasitic, .-intl respiratory causes and mortality is noncommunicable disease, and they must be concerned particularly high .sousmi|g infants and young children, to one with humane care for the terminally ill (an area in which where the leading *.uscs of death are heart disease, there have been major and quite affordable advances in strokes, and cancer, :kathey are in high-income countries Western medical practice) China noA faces the slifficult challenge of preventing and "A third ingredient of the second health care revolution treating these chronic * seases The conclusions of a recent will be that of designing an insurance and financing strut- World Bank study of hina's health sector are summarized ture that encourages prevention and discourages current in the following MWphs tendencies toward overuse of facilities Such an insurance "While there are important steps [to prevention of structure shiould both provide stiong disincentives for in- chronic diseases] that eWn be taken with little further analy- troduction of the high-cost procedures that would neces- sis-particularly 4 mmlei of salt intake and tobacco con- sarily be available to only a fraction of the population, and sumption- much work needs to be done to identify it should (through inclusion of substantial deductibles and and field test .iumu ate preventive strategies The task is co-insurance rates) create incentives for both patient and inherently far more o*ficult than is that of prevention of doctor to utilize health resources prudently communicable disease An essential ingredient of a second 'Assembling the above three ingredients will, inevitably, health care vijeiRRM, [to tackle emerging problems of prove to be a major challenge, but, to the extent that chronic disease] in Eliula will be to recognize the difficulty success is achieved, China will have become a world leader and importance of Mt task and to ommnit substantial in the effective and humane handling of the burden of resources in a iutwols I way to its solution chronic disease without succumbing, as other countries "Another Important ingredient of the second health care have, to endlessly costly investments in medical technolo- revolution wvill be sZMopmenit and widespread implemen- gies of limited efficacy"' tation of strategies M1 dealing with the large number of cases of chronic *11 that will, inevitably, occur rhese I Dean r Jamison and nihers China The Ilealtb Sector (Wishing strategies must include capacity tor treatment where treat- ton, D C World Bank, 1984), paras s 13-5 16 China's population will be health care in the Unitcd trol the level of fertility precisely Though couples arc States, mcdical expenditure per elderly pcrson is roughly urged to have one child, some will have more Despite th ree times that of working-age people Changing age substantial cconomic incentives, the one-child policy is structure is in fact only one of the components of China's not popular in a family-oriented culture, which has impcnding second health care revolution (see Box 8 1), greatly prl7ed sons rather than daughters but it providcs the clearest illustrations of the terrible There are no official population targets beyond the choices that will hlavc to he made ahout the-usually year 2000 But the preccding analysis suggests that while extremely cxpensive-treatment of chronic and terminal the achievement of replacement lexel fertility (2 1 chil- diseases Britain, for cxample, has held down costs by dren per women) is clearly desirable, there could be dis- dcnying those above a certain age acccss to treatments advantages in trying to hold fertility well below this level, suchi as renal dialysis Other countrics, such as the United especially after the year 2000 Beyond a certain point, as States, have not donc this, with the result that thcir illustrated by Projection C, the gains from achieving a health carc costs have risen dramatically as a share of smaller population in the twenty-first century could be G,NP-and the proportion of the elderly in C hina in the more than cancelled out by the ad)ustment and transfcr ncxt century will be far higher than the prcscnt propor- problems posed by the population's changing age tion in the United States structure In any event, an important issue is how eventually to Bzrtb-Planning Polcy achieve an orderly transition out of the one-child policy In the past decade, the Governmisent has shown a remark- Abandoning the policy suddenly would probably lead to able ability to control individual fertility decisions Clhina an undesirable new baby boom One mcasure already is in a good position to determine its demographic des- adopted, which is designed to cmphasize that the one- tiny Nevertheless, even the Chinese system cannot con- child policy is only a temporary measure, is to allow 140 children from one-child families who marry each other to reduces mobility of workers among enterprises, partly have two children. Another policy modification now ap- because it increases the difficulty and social cost of closing plied in rural areas is to permit parents whose first child is down or drastically reorganizing inefficient enterprises. a girl to have a second child. A possible extension of this Other approaches to supporting the elderly include would be to permit every family to have one son, but no having the elderly support themselves, through work and further children: average family size would then be about through personal saving; the establishment by the state or two children. Whatever route the transition takes, the employers of funded pension schemes; and state noncon- present generous level of economic incentives to parents tributory (or nonfunded) pension schemes, Other coun- who have only one child should be maintained, at least tries have adopted varying mixtures of these approaches, until their removal would not excessively stimulate fertil- each of which has some advantages and disadvantages. ity. Indeed, the core positive incentive-a monthly pay- Except for household agriculture, the degree to which ment to one-child families-might well remain, even if the elderly support themselves through work depends on some of the negative incentives, which discriminate the age of retirement. In China, this is now normally against children from families with more than one child, sixty for men, fifty-five for women cadres, and fifty for were removed. women workers-a pattern that is not unusual by inter- national standards, and indeed has been shapcd by similar Supporting the Elderly pressures, including a desire to move workers (especially Providing financial support to a large elderly population women, who actually tend to live longer than men) out poses two sorts of problems. One is its economic cost. of the labor market at times of general unemployment. While the ultimate overall dependency ratio may be Official retirement ages are not closely related to ability much the same as at present, elderly people have higher to work; despite increasing longevity and improving material consumption needs than children, especially for health, the retirement age was raised in only two out of food and housing space. The economic cost of supporting fourteen industrial countries between 1949 and 1977 the elderly could in principle be reduced by cutting their (nine countries lowered it). Moreover, forcing people living standards, but China, like other societies, will want with the capacity and desire to make a contribution to its older people to share in the increasing prosperity that stop work at a certain age can be bad for their health and they have helped to bring about. The costs involved are self-respect. In the longer term, and especially when Chi- already causing difficulties in rich countries, even though na's labor force is stagnating or shrinking in the twenty- they have a smaller proportion of elderly people than first century, providing more-especially part-time-em- China will have in a few decades. ployment for people above the retirement age, or raising The other problem is how to organize and provide this the retirement age, would be an option worth considcr- support. Traditionally, in China as in other developing ing. countries, elderly parents have lived with, and been sup- Greater personal saving for retirement also has certain ported by, their children; China's 1980 marriage law advantages (governments elsewhere sometimes provide reiterates this filial duty. But in all countries, economic tax concessions to long-term saving schemes), including modernization-with more urbanization and mobility, smaller administrative costs and a greater sense of inde- rising incomes, and changing social attitudes-has re- pendence and responsibility for the beneficiary. But be- duced the number of multigeneration households. In cause many people are either too poor, or insufficiently China, the difficulty children have in supporting parents farsighted, or without access to appropriate financial in- will be further increased by the one-child family policy. vestments, to save enough to support themselves decently China already provides some support for the elderly, in old age, personal saving will problably in China (as in but existing institutions will not be able to cope with the most other countries) be confined to a supplementary problems of the twenty-first century. In the countryside, role. the Five Guarantees provide food and clothing, shelter, Fully funded (FF) pension schemes, sponsored by the medical care, and burial expenses. But the level is mini- Government or by employers, are similar to personal mal, and people are sometimes reluctant to accept these savings in that they receive and invest contributions dur- benefits, because of the shame of indigency or because ing the employee's working life, with the resulting pen- they want to retain the right to bequeath family property. sion strictly dependent on the amount contributed and In the cities, and in a few rural areas, enterprises and the returns earned from its investment. They may differ other employers now provide pensions for retired work- from personal savings, however, in receiving contribu- ers; the coverage of such schemes will increase as industri- tions from employers as well as from employees, or in alization and urbanization proceed. However, continued making employee contributions obligatory. heavy reliance on pensions paid directly by employers EEmployer-sponsored FF pension schemes would be su- would be an obstacle to intensive growth, partly be- perior to the present Chinese system of pensions paid cause-as experience in other countries has shown-this directly by the employer (sometimes called pay-as-you- 141 go), because the fund could and should be legally sepa- der government schemes), or by raising the contributions rated from the enterprise's general finances and could of current employees or their employers. The principle tusI SU, ViVe a!( meer irs pension responsibilities even if that beneficiaries should havc earndc their pensions .hc citcjiiL J.u"c Luw ii. Slwit ilarly, if employees were through contributions remains important, if only because allowed to retain or transfer their share of the pension the elderly thus seem (and feel) less of a burden on cur- fund to a new employer (which employers elsewhere rent workers. have been reluctant to permit, partly to encourage long There is increasing concern, however, that collecting service, partly because of the administrative costs in- these contributions through-in effect-a substantial tax volved), the employees could move more easily among levied on wages may have an adverse effect on employ- enterprises. But, clearly, government-sponsored pension ment. (This could also be a problem in China, especially schemes (whether funded or not) would also offer inde- as regards unskilled workers.) For this reason, but also pendence from entcrprise finances and greater worker because the contributory principle is now often a matter mobility. of appearance more than substance, state pension FF pension schemes have the additional advantage of schemes financed straightforwardly through general taxa- providing pensions as a right, with less sense of burdcn tion arc sometimes advocated, and have been imple- for both the recipient and the working-age gencration. In mented in the Soviet Union and, on a supplementary other countries, moreover, pension funds play an impor- basis, in Japan and the United Kingdom. China's Fivc tant role in financial markets and could perhaps also do so Guarantees system is similar in principle to thcse pension in China, as well as providing a means for indirect worker schemes. ownership of enterprises (these possibilitics are discussed Noncontributory pension schemes are sometimes criti- further in Chapter 10). cized as being exccssively costly and as imposing an unjust flowever, FF pension schemes also have certain short- burden on current workers. Ibhis is fundamentally incor- comings. They provide little or nothing for those who rect, since, whatever the specific institutional arrange- retire within a decade or two after their introduction and ments, the elderly are ultimately always supported by the indeed become fully opcrational only after forty years or productive activities of current workers-the real issue so. Moreover, the pensions they provide are uncertain being at what relative level. Raising the substantial reve- and variable in relation to the wages of current workers. nues required through general taxation may, however, as T his is partly because wages go on rising, while the pen- with payroll taxation, have adverse economic effects or sion depends largely on contributions from earlicr-and be politically difficult. much lower-wages, partly because the return on finan- For China, a central issue would be whether, when, cial and other investments is somewhat unpredictable, and how to include peasant households in any pension especially when corrected for price inflation (which some- scheme. Reform of the urban pension system would be times makes real returns negative). comparatively straightforward. In rural areas, however, For these reasons, which would be relevant also in there would be not only more administrative difficulties, China, governments and employers have often supple- hut also, and more findamentally, the problems of an mented or modified FF pension schemes. To mect the initially large gap between average urban and averagc needs of those retiring before the schemes are filly opera- rural incomes and of widely varying rural incomes. In tional, some govcrnments have-as in Japan-cstablished thesc circumstanccs, should the contributory principlc be parallel noncontributory pension schemes, while others- applied, should contributions be compulsory and related as in the United States shortly after the introduction of to income, and should pensions be related to contribu- the social security system-have waived or reduced con- tions-all of which would make pensions as unequally tribution requirements for these age groups. 16 ensure distributed as incomes and, in some eases, very low? Or that pensions maintain a stable and equitable relationship should a large and fiscally expensive noncontributory cle- with current wages, many government and enterprise ment, or cross subsidies, be used to make pensions less pension schemes have made pensions dependent on the unequally distributed than-or even unrelated to- number of years during which contributions were made, contributions? the individual's terminal salary, subsequent price infla- In planning for the support of the elderly in the tion, current wage lcvels, and so on-rather than on the twenty-first century, China has a wide range of options. individual's accumulated contributions. The choice among them is not simple, and none (and no Although bcnefits have increasingly been divorced mixture of them) is ideal. But it will be important to from individual contributions, the principle of an indc- consider them, to choose a system, and to put it into pendent, financially viable fund has generally been pre- operation, within the next fcw years. Other countries served, either through supplementary contributions from have found that the problems of an aging population can employcrs (under enterprise sclhemes) or the budget (un- he compounded by failure to look sufficiently far ahead. 142 Mobilizing Financial Resources In China, as in other countries, rapid economic and social ing. Conversely, total domestic saving comes partly from development will require (though not automatically fol- the government, partly from enterprises (state, collective, low from) high rates of both saving and government and individual), and partly from households. Of this sav- revenue raising. To mobilize the huge amounts of money ing, part is used for self-financed investment-enterprises involved, and to do so in ways that promote efficicncy, ploughing back retained profits into expansion and peo- improve the distribution of income, and maintain macro- ple building houses. The rest is channeled into investment economic stability, will require much political will and indirectly, through government grants or loans to enter- administrative skill. The economic and institutional prises, through bank deposits being relent to enterprises, changes associated with system reform, moreover, will through bond sales, and so on. require constant adaptation of old financial instruments and policies, as well as experimentation with new ones. Alternative Sources of Saving This chapter discusses some interrelated long-term is- sues and options in government finance and national sav- The macroeconomic projections discussed in Chapter 2 ing-financial intermediation and investment decision- suggest that to attain its long-run growth targets China making are discussed in Chapter 10. After reviewing will need to save something like 30 percent of national alternative sources of saving, it looks at subsidies and income (the numbers mentioned in that chapter range transfer payments, then at overall government revenue from 26 percent to 3 6 percent, depending on the assump- needs and sources, and finally at tax reform." (Though tions made about investment efficiency, foreign borrow- local public finance was addressed in Chapter 5, this re- ing, and the growth rate). This is a high saving rate by port does not deal fully with the complex and difficult most international standards, though similar to those of financial relationships among different levels of govern- Japan and the East European socialist countries (Annex 5, ment in China. And it touches only very briefly-in Table 3.2), and comparable to the rates achieved by Chapter 1 0-on short-term fiscal stabilization policies.) China over the past three decades (Chapter 2). It is thus The various topics and projections discussed in this important to consider, especially in relation to proposals chapter share a common macroeconomic accounting for further fundamental reform of China's system of eco- framework, summarized in Figure 9.1 (which includes nomic management, how this high saving rate might he estimates of the relevant magnitudes for China in 1981). achieved, and in particular what might be the contribu- The economy is divided into three institutional sectors tions of different institutions and sectors. (the government, enterprises, and households), each of Up to now in China, the Government has been the which has a distinct source of income (taxes and remitted main saver, which has meant a large overlap between profits, retained profits, and wages and other earnings, saving and public finance. This pattern of saving is proba- respectively). The diagram divides the uses of national income into three main categories: household consump- tion, public consumption, and saving. It then shows how each of the three institutional sectors contributes to each I. International experience in public finance and its implica- nons for China are discussed in Background Paper 4. of the three uses of national income. Government reve- 2. Government finance of household consumption throughi nues, for example, finance some household consumption subsidies is not explicitly shown in the figure, since uses of national (through transfers and subsidies2), as well as public con- income are measured at purchaser prices (which already include sumption (to which enterprises also contribute), and sav- the price-reducing effect of subsidies). 143 Figure 9.1 Sources and Uses of Funds, 1981 (billions ofyuan) National income at producer prices (442) Profitsa ( 160) T Wages and earnings (282) Indirect Direct taxes Net profits after taxes' and levies' taxes and levies (60) (118) (46) Wages and earnings Income generation and distribution Government revenue (178) Retained Divi- after taxes Government Other uses of government profits dends1( subsidies revenue ( 1 3 4) (45) (I) (44) National income at purchaser prices (458) Institutions Government' Enterprises H 2ouseholds Government Enterprise Household tranisfers to transfers and self-financed Household consumption (2 5 3) households subsidies to consumption households (4) (8) (241) Government- Enterprise- Household- financed financed financed public public public Uses of incomne Public consumption (7 3) E consumption consumption consumptiong 0 (65) (8) (0) 0 Saving ( 13 2) (65) 5 4 Net finance of investment through grants, loans, banks, bonids, and so forth Note'I This acctunting framework can le applied to aniy country, hut the numbers in each box arc tentative estimatcs for China, 198 I Ihe diagramimiiatic intcgration of the national accounts svith governmcnt, citerprise, and household accouinits is based on the United Natitns System of Natiooial Accounts 'I hus, national incomc" includes not only net material product, buI also nonimaterial scrvices (which compose a largc fraction of "public consumiiption - ind depe-eciation (which composes a largc fraction of "saving"). National income (or gross domcstic product, cjv) can be measured at producer prices, rcflccting thte incomes actUally received Iby the producers in the economy, or at purchaser pr ices, reflecting the amounts paiu i),' houscholds, cnterprisce, and the (Govertment for the goods and services they buy. -I'hc difference betsveen the two is indirect taxes, net of governnent subsidies. 'The sum of incoiies received by the Go(vernment, enterprises, and households is cqual To (.I)P at producer priccs plus total indircct taxes (which form part of go'ernmcnt revenue) a. Gross of depreciation and govcrniincnt subsidies, but net of in(iirect taxes h. All taxes and levies on goods and services. c Itllcudes income and profit taxes, asset taxes, agriculitiral tax, profit remittances to thic budget and to govcrnciens organizationis, remittances if fepreclation funds, and social Insuirance contributions. d. Workers' bonuscs paid out of enterprise profits are considcrecd part if wagcs and earnings c Includes extrabudgctary income and expenditurcs of government organizations, as well as the government budget f. State, collective, and individual entrciprises are treatedi as a single sector. g. Is the convcitional nationial accounting framnivork, houLseehlsl CxjeiMlditures oni edUcation, health, and other forms of pubhlic consumption iare defincd as private consumptioni and therefore are included in the box above. Source: Annriex 5, Appeindixj. 144 Table 9.1 Gross Domestic Savings in Selected Countries, 1976-80 (percent) China, Cbina, United United South Measure 1978' 1981' States Kingdom Japan Korea India Share of total saving Government 7 3 49 7 0 9 26 1 3 Enterprisesb 12 22 58 56 37 35 22 Households" 15 29' 35 43 54 38 65 Tlbtal 100 100 100 100 100 100 100 Aggregate saving rated 37 29 19 19 32 25 23 Note: Data include depreciation funds. a. For China, government saving includes both the consolidated budget surplus of revenues over current expenditures and the nonbudgetary saving of government organizations. Enterprise saving includes state and urban and rural collective enterprises. b. Rough adjustments have been made to the niational accounts statistics in order to include the saving of unincorporated enterprises with that of other enterprises (rather than with that of households). c, In 198 1 personal saving appears to have been unusually high in China, because of large stock increases in rural areas. d. Total savinig as share of oDP at purchaser prices. Source Estimates based on State Statistical Bureau, Statistical Yearbook oj'Cbina, 1981 (Hong Kong: Economic Ilformation anid Agency, 1981), sec Annex 5, AppendixJ; United Nations, Yearbook of National Accounts (New York, 1981). bly similar to that of the Soviet Union and Eastern Eu- heavy reliance on government saving has actually been rope (though detailed data are not available), but is quite associated with underinvestment in economic and social different from those of most other countries. In Table 9.1 infrastructure; in other countries a significant fraction of for example, despite a significant change between 1978 such investment is financed by the savings of enterprises and 1981, government saving in China is far more impor- and households through the issuance of government tant than in any of the other countries. Correspondingly, bonds. Moreover, government finance of other invest- the shares of both enterprise and household saving in ment does not always imply close control: recent experi- China are the lowest in the table-although the division ence in China suggests that it may in fact be difficult for of saving between enterprises and households varies the central authorities to regulate the level and composi- widely among the other countries (enterprise saving being tion of local government investment, especially when it is substantially larger than household saving in the United financed from extrabudgetary funds. States, for example, but substantially smaller in Japan). One clear disadvantage of heavy reliance on govern- For the future, one possibility for China would be ment saving is the strain it imposes on the public finances. continuance of the past (or East European) pattern, with Tax rates must be higher than they would otherwise have government revenues as the predominant source of sav- to be, other government expenditures (on public con- ings. It is also possible, however, that increased reliance sumption or support of household consumption) lower, on market regulation and other systemic reforms might or some combination of the two. High tax rates in turn make it preferable to further increase the shares of enter- are disadvantageous because they weaken incentives to prises and households in total saving. How much to re- cut costs, innovate, and work harder and because they duce the share of government saving, though, and how to increase tax evasion and the administrative costs of tax divide the remainder between enterprises and house- collection. Reductions in other public expenditure are holds, depends on the advantages and disadvantages of disadvantageous because-despite some potential for each of these sources of saving. eliminating waste-there are pressing needs (mentioned frequently in this report) for greater government expendi- Government Saving ture in many areas of social and economic importance, Two clear advantages of government saving in the Chi- for which greater enterprise and household expenditure nese context are that it is a proven and reliable means of cannot or should not substitute. Another possible disad- achieving a high and reasonably steady aggregate saving vantage of keeping government saving as the main source rate and that it is unquestionably consistent with social of finance for investment is that this might conflict with ownership of the means of production created through expansion of enterprise autonomy in decisionmaking. saving. It could also be argued that government saving is But it might be possible to channel government saving to essential for financing infrastructural investment and that enterprises through an efficient network of financial in- it permits close control of other investment. These latter termediaries (discussed in Chapter 10). arguments are not quite so compelling. China's past Perhaps the best approach to determining the appropri- 145 ate level of government saving in China might be to think The potential future contribution of state enterprise of it as the sum of two components-first, as the main saving in China natuirolly depends hea-ily on the likely source of finance fot vital basic investlmentcs ind second, future level! of state c,.tr-..r-^ ... -ihih will also as bridging the gap between the total amount of saving affect the level and pattern of taxation needed to achieve required for rapid growth and the actual saving of enter- government revenue targets (discussed later). In China, prises and households. But even this admits a wide range unlike some other countries (where poorly run state en- of possibilities. As regards the first component, for exam- terprises are a financial burden on the rest of the econ- ple, if government saving were to finance only 60 percent omy),3 and despite the losses of many specific enterprises, of investment in energy and transport, 75 percent in the state enterprise sector has always generated substan- education and health, and 90 percent in public adminis- tial profits. A crucial question, however, is whether pric- tration and defense, its share in total saving in the year ing and other reforms will reduce the average profitability 2000 would be 20 percent (on the basis of the QUADRU- of China's state enterprises. This is hard to predict: it will PLE investment projections), but if vital basic investment be the net result of several conflicting influences. were construed to mean 100 percent in these three cate- Price reform (discussed in Chapter 10) is likely to entail gories plus 75 percent in industry and 50 percent in redistribution of profits among sectors-for example, commerce and housing, the government would account from manufacturing to mining and commerce (there has for 70 percent of total saving. Similarly, the amount of already been substantial redistribution toward agricul- gap-bridging government saving that might be needed ture). This would reduce overall state enterprise profits could-on the basis of experience in other countries- if-as seems possible, given the recent expansion of col- vary widely, depending on the amounts that enterprises lective coal mining and commerce-nonstate enterprises and households were able (or permitted) to save. were more common in the sectors whose profitability was increased than in the sectors whose profitability was E'nterpriseSaving diminished. Equally crucial, in all sectors, will be the In the four more developed countries in Table 9.1 enter- relative efficiency of state enterprise management and the prise saving accounts quite consistently for 10-12 percent relative wage level in state enterprises. If state enterprises of national income (roughly double the percentage in were less cost- or quality-conscious than nonstate enter- China). It is important, however, to distinguish among prises, or obliged to pay higher wages or employ surplus enterprises according to their ownership-and especially labor, increased competition among enterprises-some- whether they ultimately belong to the Government or to thing which would otherwise be highly desirable-could (individual or groups of) households. reduce the profits of state enterprises, and hence their capacity to generate savings. STIATE ENTERPRISES. Government saving and state en- terprise saving are obviously closely related: both result in NONSTAFE ENTERPRISES. Experience in other coun- state ownership of the means of production created tries suggests that collective and individual, as well as through saving, and one can be substituted for the private and mixed-ownership enterprises could poten- other-within limits-by varying the profit tax rate and tially contribute a large fraction of the savings required the rules governing remittance of after-tax profits (and for rapid growth in China, and at the same time could depreciation funds) to the budget. But state entcrprise contribute to increasing efficiency through competition saving has certain advantages over government saving, and microeconomic structural change (see Chapter 1). To especially in the context of a reformed economic system: do so-as China's experience especially with commune it gives enterprise managers a stronger incentive to cut and brigade enterprises confirms-nonstate enterprises costs and increase profits, and it enables enterprises to must be allowed to make substantial profits (in aggregate, function as autonomous economic units-since such units though some will lose money) and to invest and expand must control at least some investment, and at least some freely. They will then have a strong incentive to increase of their investment must be financed internally, rather their profits through cost reduction and greater attention than by borrowing. State enterprise saving may also have to customer needs and, just as important, to save and disadvantagcs, especially if otlher aspects of system reform reinvest a high proportion of their profits. It is essential, lag behind: inappropriate motivation and distorted prices however, that the owners of these enterprises should be may lead entcrprise managers to make bad investment confident that the Government will allow them to go on decisions, and profits intended for enterprise saving may operating indefinitely, without expropriation or punitive be diverted into bonuses and benefits for workers. (T[he taxation. In Hlungary, for cxample, uncertainty about the advantages and disadvantages of giving more control of future course of government policy, which now encour- investment to state enterprises are amplified in Chapter 1 0; control of worker remuneration in state enterprises is 3. World Bank, World Development Report 1983 (New York: discussed in Chapter 8.) Oxford University Press, 198 3), Chapter 8. 146 ages individual and small collective enterprises, has caused or with provision for retirement. Saving for housing is these enterprises to reinvest only a small (by international already important in China. Peasants have apparently standards) proportion of their profits in expansion and used a considerable part of their increased saving in the market development. past few years to build new houses and improve existing The main disadvantage of relying heavily on nonstate houses. in urban areas, there is also a suhstantial private enterprises as a source of saving in China would be its housing stock (mainly rather old), and some state-built potential consequences for income distribution. A consi- apartments have recently been sold to individual families. derable fraction of their after-tax profits (perhaps 50 per- In the future, the greater part of China's investment in cent, with the other 50 percent saved) must be distrib- urban housing could be financed by personal saving uted for consumption, or else the incentives for (partly through housing cooperatives), with far less provi- establishing and expanding these enterprises would be sion of workers' housing by enterprises. The Govern- reduced or even eliminated. Such distribution may be ment might provide housing directly only to the minority acceptable for collective enterprises, where consumption of people unable to pay, but could assist others by selling out of profits is used to benefit the local community, or off more existing urban housing, as well as by "sites and given to workers as bonuses, or as higher wages than they services" projects-planning and providing basic utilities could earn elsewhere. It poses greater problems in the for new individually constructed housing-coupled with case of individual enterprises, where much of the profit technical assistance and limited subsidies or tax conces- accrues to one person or family. Other countries have sions to housing cooperatives. (These could partially re- used taxation to influence the division of private enter- place the large existing housing subsidies, which would prise profits between consumption and saving (by higher need to be reduced or eliminated to provide an incentive rates of tax on profits distributed to owners than on for tenants to become owners.) Experience elsewhere reinvested profits). However, any resulting short-term re- suggests that such a system would be a powerful stimulus duction in consumption out of profits eventually tends to to household saving, as well as to better construction be offset by the higher rate of enterprise growth caused standards and maintenance. by more reinvestment of profits. A better approach to Saving for retirement (including contributions to minimizing adverse distributional effects is thus probably funded pension schemes) was discussed at the end of progressive taxation of personal incomes and wealth (dis- Chapter 8. Household saving for this purpose could cussed later and in Chapter 10). probably be substantially increased, though not as the sole or necessarily even the primary means of supporting Household Saving the elderly. It could be encouraged by organizing funded In low-income countries a large part of household saving pension schemes and other long-term saving instruments is for reinvestment in peasant agriculture and thus shares (commonly provided in other countries by life insurance most of the potential advantages and disadvantages of companies), and possibly also by payment of bonuses to nonstate enterprise saving discussed above. (It is normally workers once or twice a year-as in Japan-rather than treated as household saving simply because of the practi- monthly (this might also facilitate a closer linkage be- cal difficulty of disentangling the various sources and uses tween bonuses and profits). of income within farm households.) In China, too, the Saving for retirement by today's workers will of course introduction of the rural production responsibility sys- always be to some extent offset by the dissaving of retired tem, and repeated official confirmation of its indefinite people, although many bequeath something (often a continuation, have given farm households strong incen- house) to their children. The household sector's net con- tives to make their incomes grow faster through greater tribution to national saving is thus influenced by the saving and reinvestment. But the statistics currently avail- growth rate and age structure of the population, with a able, though suggesting a high rate of rural saving (proba- slower-growing, aging population (as China will have for bly increased somewhat by shortages of consumer the forseeable future) tending on balance to savc less. Fast goods), do not permit an accurate assessment of the rate growth of per capita income, by contrast, tends to raise of reinvestment in agriculture, as opposed to nonagricul- the household saving rate, by making the incomes of tural activities and housing (Annex 2, paras. 1. 13-1.18). today's savers higher than those from which today's dis- In particular, it is unclear whether increased household savers built up their savings. In this regard there is good investment has been sufficient to offset reduced state and potential for household saving in China-as in Japan, collective investment in agriculture. where the effect of rapid income growth appears to have Apart from agriculture, houschold saving in other more than outweighed that of an aging population. countries is partly for purchase of consumer durables and The data in Table 9.1 suggest that household saving other occasional and unanticipated expenditures (and is may be an especially important potential substitute for largely cancelled out by dissaving or borrowing for such government saving. In particular, Japan, the only large expenditures). Most, however, is connected with housing nonsocialist country to have persistently saved about 30 147 Table 9.2 Subsidies, 1981 ond, for support of household consumption through sub- sidies and transfers (income supplements and social relief). Type 'f subsidy Billions ofynan The Chuinee Government wiii have to make important nl:eSUbSldld' i^ g dCCiSic,1b Ull iulvluuai items of puDiic consumption in Industrial inputs to agriculture 2.2 the future. But for reasons discussed earlier (Chapter 1), Imported agricultural products 8.8 public consumption in aggregate may not change greatly Grain 5.9 Other 2.9 as a share of national income over the next two decades. Domestically produced staple food 15.0 At least the possible range of options (in terms of de- Grain 12.2 mands on government revenue) seems much narrower Edible oil 2.8 than for either government saving or subsidies and trans- Other commodities 6.8 Nonstaple foodstuffs 2.8 fers. Cotton 1.3 Coal 1.0 Cbina's Subsidies in Perspective Other 1.7 Large subsidies are at present the subject of widespread Housing' 5.0 concern in China. But assessment of the problem is com- Subsidies to money-losing enterprises 10.2 plicated by confusion over definitions, magnitudes, and Industrial enterprises 4.2 economic impact. The term "subsidy" is used in China Commercial enterprises 6.0 to cover various kinds of wage supplements (for every- Total 48.0 thing from nonstaple foods to baths and haircuts), as well a. Estimated depreciation, maintenance, repairs, maniagement, and interest as in its two more normal senses, namely (a) government (based on thc cost of construction), less rent paid. About Y 1.3 billion is dircct government expenditure; the rest is paid for by state enterprises. payments that reduce the prices of certain goods and Source Annex 5, ApperidixJ, Workshect D. services, and (b) government payments to keep inefficient enterprises in operation. Moreover, in China (as in some other countries) most subsidies are not explicit items of government expenditure, but instead reduce government percent of national income, has done so not mainly revenue (by lowering state enterprise profits), which through high enterprise saving, but through an extraordi- makes them hard to measure, particularly since there is narily high personal saving ratio (about 20 percent of uncertainty about what enterprise profits would or personal disposable income). In most other nonsocialist should otherwise have been. countries, where personal saving ratios are around 10 Table 9.2 shows Chinese estimates of the magnitude of percent, aggregate saving is usually only 20-2 5 percent of price subsidies and subsidies to money-losing enterprises national income. In South Korea, for example, the aggre- in 1981. They totaled Y 48 billion, equivalent to about gate saving rate is as high as 25 percent only because the 3 3 percent of budget revenues and I I percent of GDP.4 government contributes a quarter of the total. Over half the total is food subsidies, which have become Because Japan's personal saving ratio is so unusual, it much larger in the past few years as a result of substantial seems likely in China that government saving will have to increases in agricultural procurement prices with little or continue to be substantial if a high aggregate saving rate is no increase in the retail prices of staple foods. The next to be achieved. However, the Government's share of largest category (21 percent of the total) is subsidies to saving could probably be much lower than in the past, cover the operating losses of inefficient industrial and with greater reliance on both enterprise and household commercial enterprises. Another substantial item (over saving instead. What the precise balance among different 10 percent of the total) is the subsidy involved in keeping sources of saving in China could or should be in the the rent on urban enterprise and municipal housing at longer term cannot be assessed at present, since much will only a fraction of its capital and operating costs (this depend on the future course of system reform and experi- apparently is paid mostly by state enterprises rather than ence in mobilizing and using enterprise and household directly by the Government). saving (Chapter 10). But some of the possibilities are explored numerically later in this chapter, in connection _ with alternative projections of government expenditures 4. Budget revenuc is adjusted as explained in Annex 5 (Appen- and revenues. dixJ, Supplementary Worksheet 1). If government extrabudgetary funds were iicluded, the share of subsidies in total government revenue would be 27 percent. GDP is measured at "producer Subsidies and Transfers prices" (that is, less indirect taxes plus subsidies-see Figure 9.1). This specialized national accounting usage of the term "producer In addition to mobilizing saving, government revenues prices" is confined to figures and tables in this chapter. Elsewhere are needed, first, for public consumption (mainly educa- in the report, the term is used to mean ex factory or farmgate tion, health, defense, and public administration) and, sec- prices. 148 With transfer payments (at present very small) added Table 9.3 Subsidies and Transfers as Percentages of to subsidies, the total as a share of budget revenue in Government Revenue in Selected Countries China is not much higher than the average for developing Country group 1975 1979 countries, and well below the average for industrial mar- --- ket economies, where transfer payments are very large Industrial market economies' 54 56 (see Table 9.3). The difference between China and other Oil-importing developing countries' 30 31 developing countries would appear larger, however, if India 29 36 subsidies and transfers were expressed as a share of GDP, Pakistan 19 20 of ~~~Philippines 9 10 since budget revenues in China are over 30 percent of South Korea 29 34 GDP, as compared with about 20 percent in the average SriLanka 32 26 developing country. Food subsidies, moreover, are a Thailand 1 7 13 higher proportion of government budget expenditure in Chinab 33 China than in all but a few developing countries (includ- ing, in the mid- 1 970s, Egypt, South Korea, and Sri Note. Data are for central government only. Capital transfers are excluded. ng in themid1970sEgypt,South orea,ndSr a. Averages weighted by 1975 GDP, Developing country average excludes Lanka); as a proportion of GDP they are probably higher China. than in any other country except Egypt.5 b. Based on a figure of Y 44.3 billion derived from aible 9.2 (the total The incidence (or economic impact) of China's subsi- edY0minus Y 3.7 billion in housing subsidies paid for by enterprises), plus an The incience (oreconomicimpact) f China' subsi- estimated Y 2.0 billion of pensions and Y 1.0 million of social relief paid by dies can be established only on specific assumptions about the budget. Data are for 1981. the situation without subsidies and may vary dramatically Source International Monetary Fund, Government Finance Statistics Year- the siuatio withot subidies nd ma vary ramatcally book (Washington, D.C., 1982), p. 46 depending on the assumptions made. For example, Chi- na's food subsidies are often said to raise the real incomes of urban residents, but this is so only if the assumed alternative is higher retail food prices. If, by contrast, the subsidized coal discourages the purchase of fuel-efficient alternative were assumed to be lower procurement prices, stoves or when low rents cause inadequate housing main- then the beneficiaries would be not the urban population tenance. Subsidies may also be costly to administer, espe- but the rural population. An assumed alternative combi- cially if the item in question has to be rationed. nation of higher retail and lower procurement prices As instruments of income redistribution, subsidies are would imply that the benefits go partly to urban, partly at best crude, since they provide low prices to rich and to rural residents. Similarly, assessment of the incidence poor alike (as contrasted with income supplements tar- of China's urban housing subsidy is dependent on as- geted at the poor, which in principle can achieve the same sumptions about the level of wages without the subsidy. effect at lower cost). They may even have perverse ef- fects: in urban China, for example, lower-paid temporary Future Optionsfor Price Subsidies workers from the countryside and the lower-paid work- Price subsidies are not in principle a bad thing.6 If used as ers of small-town collective enterprises have less access to negative indirect taxes in the context of market regula- subsidised food and housing than higher-paid permanent tion, they can be useful economic levers for stimulating state enterprise workers, and in rural China, higher grain the production and consumption of goods and services of procurement prices may have disproportionately bene- which there would otherwise be too little from an eco- fited richer households, which have a greater marketable nomic or social viewpoint. Research, training, books, and surplus, and perhaps even have harmed some poorer the arts are common examples in other countries. Price households, which are net purchasers of grain. As instru- subsidies can also contribute to improving the distribu- ments for price stabilization, too, subsidies are of dubious tion of living standards: food subsidies tend to accrue benefit, since they encourage governments repeatedly to disproportionately to lower income groups, who spend a postpone comparatively minor price increases until the higher proportion of their incomes on food; children's required price increases become disruptively large. clothing and school lunches are sometimes also subsidized Thus although China's subsidies perhaps are not such a for similar reasons. Price subsidies can be used to a lim- serious problem as is sometimes suggested, they might ited degree to stabilize living standards in the face of advantageously be reduced, modified, or replaced with temporary fluctuations in producer prices. Especially in the way China now uses them, price sub- sidies also have some disadvantages. They can complicate 5,f fiscal planning by fluctuating unexpectedly, particularly if s. Jeffrey M. Davis, "The Fiscal Role of Food Subsidy Pro- fiscal planning by fugrams:" IMF Staff Papers, vol. 24, no.1 (March 1977); Sadiq they arise from a commitment to keep certain prices Ahmed, Public Finance in Egpt: Its Structure and Trends, Staff constant (as contrasted with, say, a fixed percentage sub- Working Paper 639 (Washington, D.C.: World Bank, 1984). sidy). They can also have adverse effects on economic 6. The advantages and disadvantages of subsidies to inefficient efficiency by distorting price signals-for instance, when enterprises are discussed further in Chapters 1, 5, 7, and 8. 149 altcrnative instruments over the next few years. Food not accurately compensate for increased retail prices and subsidies could in principle be reduced and regulated by rents, but would need to be combined with supplemen- adjusting agricultural nrocurement prices. This Is not an rarV incIoCm transfers to high-dependency households. attractive c n. pa!yiv hC c;,;;4 ................... i!.l V/II}-x, -... vIualAJiy aisO ;)e speciai supplementary m- cultural-nonagricultural income gap, but mainly bccause terest payments on saving deposits, which would other- it would in principle conflict with the use of agricultural wise lose part of their real value, financed perhaps by a producer prices to balance supply and demand for partic- corresponding special levy on borrowers, whose loan re- ular agricultural products (Chapter 3). In order to enable payment burden would otherwise decrease in real terms. agricultural producer prices to provide appropriate alloca- (See also Chapter 10) tive signals to farmers in changing circumstances without The specific mixture of general wage increases and sup- disrupting the budget, the Government might reduce its plementary income transfers chosen would depend on role as a buyer and seller of agricultural products, leaving the relative importance attached by the Government to the hulk of the market to collective and individual com- minimizing its outlays or revenue losses, preventing any- merce (Chapter 3). But it would also be essential to estab- one's living standard from falling, and widening the wage lish a rational relationship between the retail and pro- differences between skilled and unskilled workers (for ducer prices of food and other agricultural products. This employment and incentive reasons discussed in Chapter would involve restoration of normal distribution and 8). For example, equal proportionate wage increases processing margins, mainly through increases in retail would widen the real income differences between skilled prices. and unskilled workers (since on average the latter tend to At present producer prices, eliminating food subsidies belong to lower-income households, which spend propor- would apparently require a 50-60 percent increase in the tionately more on food and rent), but they would reduce urban retail price of grain and an 80 percent increase in living standards in low-income households unless there that of edible oil. Io maintain living standards, these were wage overcompensation (wage increases that on increases, plus those necessary to eliminate other com- average more than offset price increases) or larger income modity subsidies, would require urban incomes to he transfers to poor households, both of which would in- raised by about 25 percent on average, but perhaps by as volve greater costs to the Government. Alternatively, at much as 45 percent for the poorest urban households, lower budgetary cost, the general wage increase could be which spend a higher proportion of their incomes on proportionately larger for low wages than for high wagcs, food.7 If housing subsidies were simultaneously elimi- which would maintain the purchasing power of low nated through rent increases, the required urban income wages but would leave the wage differential between increases would be roughly 30 percent on average and 50 skilled and unskilled workers unchanged in real terms, percent for the poorest households. although it could subsequently be widened gradually by The social problems that have sometimes followed faster wage increases for skilled workers (see Chapter 8). large retail price increases in other countries seem to have There is room for disagreement as to whether such a occurred mainly because the price increases were used to major realignment of retail prices and incomes should be cut real household consumption in the face of macroeco- done in one step or more gradually. If full compensation nomic difficulties. In China, however, there is no need were provided, a carefully prepared and well-explained for a cut in urban household consumption (although it one-step adjustment could be quite acceptable and would might be desirable for urban consumption to grow more avoid the protracted uncertainty and delays to other nec- slowly than rural consumption in order gradually to nar- essary reforms associated with gradual adjustment. But it row the urban-rural gap). Urban households could and would also obviously increase the cost of errors in prepa- should thus be compensated with income increases to ration (especially calculating the required increases in offset the required retail price increases-although this prices, wages, and other forms of compensation) or im- would mean no net improvement in the budget balance. plementation. In any event, the Government has thus far A major instrument of compensation would be general chosen to take limited steps, such as the May 1985 in- wage (and pension) increases for state and large urban crease in nonstaple food prices, which was offset by a flat- collective workers. The earnings of individual and small rate per capita increase in urban incomes. urban collective workers, which are not subject to admin- istrative regulation, could not be raised so easily, but they would tend to be pushed and pulled up by the higher wages of other workers, partly because of the need for 7. These figures are rough estimates based on the urban house- small enterprises to attract labor, partly because of the ihold survey data in State Statistical Bureau, Statistical Yearbook of Cbina, 1983 (Hong Kong: Economic Information and Agency, associated increase tn money spending power. Because 1983), and on the data in lable 9.2, assuming 75 percent of the the ratio of dependents to workers (and pensioncrs) varies price subsidies in categories 1-4 are for goods sold to urban resi- among households, a general wage increase alone could dents. Urban incomes in 1981 totaled about Y 1OO billion. 150 In the long term, once normal commercial margins mentioned above. Another might be extension of the have been restored, rises and falls in the producer prices social security benefits (pensions, sickness and disability of particular goods should be reflected in corresponding payments, maternity leave) currently enjoyed by govern- changes in retail prices. This would contribute to national ment and state enterprise employees to the rest of the economic efficiency by encouraging consumers to buy nonagnicultural labor force and even to Dart of the agyri- less of things in short supply or whose production costs cultural population. Even without this wider coverage, are increasing and more of things in abundant supply or the Government might assume direct responsibility for whose production costs are falling. Experience in other providing most or all of the benefits now paid by state countries suggests, however, that it would be inadvisable enterprises. Reform of the labor allocation system to in- to provide continuing automatic compensation for retail crease mobility would necessitate some form of govern- Table 9.4 Subsidies and Transfers, Alternative Projections, 1981-2000 QDercent) 2000 Subsidies Subsidies Intermediate High eliminated, eliminated, subsidies, subsidies, low bigb low intermediate transfers tranfers transfers transfers Type 1981 (1) (2) (3) (4) Subsidies 10.8 0.9 0.9 4.7 8.6 Government subsidies 10.0 0.9 0.9 3.4 7.5 Food 6.0 0.0 0.0 1.8 4.5 Other consumer goodsa 1.4 0.0 0.0 0.7 1.4 Housing 0.3 0.5 0.5 0.2 0.4 Money-losing enterprises 2.3 0.4 0.4 0.7 1.2 Enterprise housing 0.8 0.0 0.0 1.3 1.1 Transfers 1.8 3.1 12.6 3.1 7.3 Social relief 0.2 0.2 0.2 0.2 0.2 Employee benefits5 1.6 2.9 9.3 2,9 4.3 Paid by government 0.6 0.7 9.3 0.7 4.3 Paid by enterprises 1.0 2.2 0.0 2.2 0.0 Compensation for reduction in subsidies - - 2.5 - 2.2 Unemployment compensation - - 0.6 - 0.6 Total 12.6 4.0 13.5 7.8 15.9 Paid by governmentc 10.8 1.8 1 3.5 4.3 14.8 Paid by enterprises 1.8 2.2 0.0 3.5 1.1 Note: Data are percenitages of GDP, at producer prices (see Figure 9. 1). a. Includes subsidies for agricultural inputs. b. Pensions, sickness and disability payments, maternity benefits, funeral expenses, and similar benefits. c. Possibly financed in part from mandatory contributions by employers or employees to government social isssurance funds. Source: World Bank projections. price increases in the form of general wage or income ment-sponsored unemployment compensation (Chapter indexation, since this tends to aggravate inflation. Even 8). Finally, the increase in the share of the elderly in selective indexation (of low incomes, for example, or for China's total population (see 'fable 8.4) will mean in- pension funds) should be approached cautiously. creased pension costs, paid for at least in part by the Government. Future Optionsfor Transfers Table 9.4 presents some illustrative projections of the Over time, the share of subsidies in China's national cost of subsidies and transfers in the year 2000. In 1981, income and government expenditure is likely to decline, transfer payments were very low, consisting of govern- But transfer payments could greatly increase over the ment and urban (primarily state) enterprise social security next two decades, for a number of reasons. One is possi- expenditures for employees and government social relief ble supplementary income payments to poor households, payments. They amounted to less than 2 percent of GDP, 151 with the Government and enterprises each paying about cult for the Government to capture all of these profits I percent.8 Subsidies, in comparison, were relatively high (unless perhaps state enterprises were obliged to contrib- (see Thle 9.2). Overall!, subsidics and transfers totaled ute to a Government social security fund in proportion r; zrl,- 1 * pe {!1 for b *' 2 ' I pcrccnt cvcitcd uy T;Ic 1o tneir wage biii or number ot employees). In any event, Government and 2 percent paid by enterprises. much of the cost of extending social security protection In the year 2000, at one extreme (scenario 1), subsidies to people outside the state sector would probably have to might be virtually eliminated (their share in GDP cut from be borne by the Government. 11 percent to I percent), but social security coverage would not be expanded and no major new transfer Revenue Needs and Sources schemes would be introduced. The share of transfers in GDP would nonetheless rise to over 3 percent, because of Long-term government revenue needs depend on the de- the increasing proportion of retirees in the government sired levels of government-financed public consumption, and state enterprise sectors. Subsidies and transfers to- subsidies and transfers, and government saving. Some gether would account for only 4 percent of GDP, with less illustrative projections for China in the year 2000 are than half of this amount paid by the Government. If shown in Table 9.5, which focuses mainly on alternative subsidies are eliminated, however, it is more likely that possibilities for government saving and for subsidies and transfer payments will substantially increase their share in transfers. At one extreme (the High scenario), the Gov- GDP. This is shown in scenario 2, where government- ernment might account for as much as 70 percent of financed social security coverage is extended to the entire aggregate saving (mentioned earlier), while government nonagricultural population, as well as to at least part of subsidies and transfers might be as much as 15 percent of the agricultural population; low-income urban house- GDP (scenario 4 in Table 9.4). Government revenue holds are compensated for the elimination of subsidies in would then have to exceed 50 percent of GDP, compared part through supplementary income transfers (rather than with about 40 percent at present. At the other extreme higher wages); and increased labor mobility generates a (the Low scenario), subsidies might be virtually elimi- modest amount of temporary unemployment (people nated while government transfer payments remain lim- changing jobs and employees of failing firms laid off), ited primarily to civil servants' pensions and disaster relief necessitating a government-financed unemployment (scenario 1 in Table 9.4). At the same time, the Govern- compensation system (possibly funded in part by em- ment might mobilize only 20 percent of total saving-less ployer contributions). Overall, government spending on than half the present level, but still somewhat more than subsidies and transfers would be over 13 percent of GDP, in most nonsocialist countries. Total government revenue nearly all of it transfers. could then be less than a quarter of GDP, as compared In scenario 3, the Government is only moderately suc- with 20 percent in the average developing country in cessful in containing subsidies, but transfer payments are 1977. kept low. Total spending on subsidies and transfers in this Two intermediate scenarios are used in subsequent case would be around 8 percent of GDP, with enterprises analysis in this chapter. In the High Saving scenario, the covering nearly half of the costs. In scenario 4, at the Government accounts for 70 percent of aggregate saving opposite extreme from scenario 1, subsidies fall only (as in the High scenario), and the share of government slightly as a share of GDP while at the same time large new saving in GDP rises from 1 5 percent in 1981 to 2 1 percent transfer schemes (covering the entire nonagricukural pop- in 2000. Subsidies are to a considerable extent brought ulation) are introduced subsidies and transfers total 16 under control and are not replaced by new transfer pro- percent of GDP, nearly all paid by the Government. grams (much as in scenario 3 in Table 9.4). As a result, Much additional spending on transfers would be offset government subsidies and transfers decline from I I per- by reductions in other expenditure categories. This ap- cent of GDP in 1981 to 5 percent in 2000. These changes plies to income supplements to compensate for reduc- roughly offset each other, so the Government occupies tions in subsidies as well as to unemployment compensa- about the same share of the economy in 2000 as it did in tion (which at present is in effect paid by enterprises as 1981, but it saves more and spends less on subsidies and the wages of redundant employees). Nonetheless, the larger elderly population will clearly absorb additional resources. The degree to which higher transfer payments become an additional burden on government finances 8. Enterprise "transfers" exclude the many wage-like income also depends on financing mechanisms and the tax sys- supplements, bonuses, and "subsidies" presently paid by Chinese tem. Shifting responsibility for transfer payments from state enterprises to their employees. They refer only to payments of a social insurance nature, such as pensions, sick leave, and state enterprises to the Government, for example, would maternity benefits. (Enterprise expenditures on education and cause increased government spending to be offset exactly health are considered public consumption rather than transfers, by increased state enterprise profits, but it might be diffi- though the dividing line is somewhat arbitrary-see Figure 9. 1). 152 Table 9.5 Government Expenditures, Alternative Projections, 1981-2000 percernt) 2000 High High Measure 1981 Hig Law svingtran Sbares of GDPh Total uses of government revenue' 41 52 24 42 35 Public consumptiond 1 5 16 16 16 16 Subsidies and transfersd 11 15 2 5 13 Saving 15 21 6 21 6 Ratio of government saving to total domestic saving 49 70 20 70 20 Sbares oftotal government expenditures Public consumption 37 31 67 39 45 Subsidies and transfers 27 28 7 10 38 Saving 36 41 2 5 51 17 a. Data are estimates explained in Annex 5, AppendixJ. GDP and saving for 2000 are from the QUADRUPLE projection discussed in Chapter 2. b. GDP is measured at producer prices (see Figure 9. 1). c. The size of the government deficit (equal to the amount by which government-financed investment exceeds government saving) is not projected. Therefore the figures are for total uses of revenue rather than total expenditure. d. Includes only the portion paid for by the Government; some public consumption, subsidies, and transfers are financed by enterprises (see Figure 9.1). Hence, for 198 1 the underlying public consumption figure is less than that in Annex 5 (16 percent of GDP before price adjustment), and the underlying subsidy and transfer figure is Y 3.7 billion less than in Table 9.2, this difference being the estimated portion of the housing subsidy financed by enterprises. Source. World Bank projections. transfers. In the High Transfers scenario, government sav- Revenue Sources ing would be as low as in the Low case. Subsidies would There is considerable room for choice concerning the be drastically reduced, but this would be more than offset composition of government revenue, even if total reve- by a large increase in transfer payments, reflecting the nue requirements, the structure of the economy, and introduction of government-financed social insurance relative prices are given. Some of the issues and tradeoffs schemes (scenario 2 in Table 9.4). As a result, the share of in this area are presented in Figure 9.2, which is based on subsidies and transfers in GDP would rise somewhat, and the illustrative projections in Table 9.6. overall the share of the Government in GDP would fall Pie A in Figure 9.2 presents the situation in 1981. The from 41 percent to 35 percent. Government relies overwhelmingly on levies on profits China's experience during the past few years suggests and on indirect taxes to meet revenue needs. Agricultural that it will not necessarily be easy to achieve the revenue incomes form a large chunk of the economy but are only growth required even for the two intermediate expendi- lightly taxed (through the stagnant agricultural tax), while ture scenarios. Budget revenue grew only about 40 per- wage incomes are not taxed at all. The share of indirect cent as fast as national income in 1978-82 and grew taxes in national income is somewhat higher than in most faster in 1983 only because of a new levy on enterprise- other developing countries.'" The "profits" piece of the retained profits and other extrabudgetary funds. None- pie includes two sectors that are taxed rather differently: theless, international experience does not rule out the state and large urban collective enterprises are taxed at a possibility of revenue growth fast enough to achieve the rather high rate (nearly 70 percent on average), while High expenditure scenario (tax revenues in a sample of rural collectives are lightly taxed (8 percent). Pies developing countries grew 40 percent faster than national B-E look at different possibilities for the year 2000, income from 1953-55 to 1966-68),9 although govern- based on the High Saving and High Transfers expendi- ment revenues in China are already high by comparison ture scenarios in Table 9.5, and on the macroeconomic with other developing countries. On balance, given Chi- projections introduced in Chapter 2 (QUADRUPLE for Pies na's political and administrative capabilities, the level of B-D, BALANCE for Pie E). In all cases, structural change government expenditure seems unlikely to be limited causes the share of wages in national income to be higher simply by capacity to raise revenue. Instead, the central issue will be to weigh the economic and social benefits of higher expenditure against the various distortions and disincentives associated with higher taxation, which may 9. For some countries, revenue growth was even faster. See be more significant in a reformed economic system than Background Paper 4, Table 12. they have been in the past. 10. Background Paper 4, lable I 1. 153 Figure 9.2 Income Flows and Taxation, Alternative in 2000 than in 1981 and the share of agricultural in- Projections, 1981-2000 comes to be lower. ______________________ _____________________Pic B assumteis thaT current expenditure trends and poli- Wages cies will broadly continue (the High Saving scenario in Agricultural Table 9.5) and that the Government will continue to rely incomes on the same revenue sources (indirect commodity taxes A. 1981 _ and enterprise profit tax). Indirect taxes remain constant as a share of GDP. The tax rate on enterprise profits Profits remains relatively high, which means that if nonstate Indirect taxes enterprises continue to grow more rapidly than state en- terprises, profit tax rates for the former would have to be sharply increased (by 198 3 the average profit tax rate for rural collective enterprises had risen to 14 percent). B. 'raitionlrevnue,Pie C is based on the High Transfers expenditure sce- B. Traditional revenue, .I nario (low government saving, virtual elimination of sub- high saving sidies, and high government transfer payments), but on \, .7 the revenue side there is continued reliance on traditional sources. Specifically, there are no new taxes on personal , - incomes, and indirect tax rates are increased to permit lower profit tax rates (needed because most saving must '. d ucome from enterprises' after-tax profits-see below). As a C. Traditional revenue, result, the share of indirect taxes in GDP rises from 14 high transfers percent in 1981 to 19 percent in 2000, and the average profit tax rate falls from 68 percent to 39 percent. This would permit lower tax rates on the nonstate nonagricul- ture sector and more rapid growth of the sector (with the - a X same profit tax rates as in Pie B). Given the large share of indirect taxes in national income (more than double the D. Personal income taxes, average in other developing countries) it would be crucial high transfers to levy such taxes in a way that minimized distortions (discussed later). Pie D is based on the same expenditure scenario as Pie C, but on the revenue side substantial taxes on wage incomes are introduced (part of which could be social security contributions by employers or employees), and E. BALANCE taxation of agriculture is increascd (with the burden as- sumed to fall mainly on farmers with high incomes). This results in a tax structurc in which all institutional sectors provide significant amounts of government revenue, and there is no increase in the share of indirect taxes. As in *Governnentrevc itje Pie C, there could be rapid growth and relatively light *100 After-tax incomc taxation of the nonstate nonagriculture sector. What would happen if the structure of the Chinese Noted Each circle represents the economy, with the main income flows economy in the year 2000 were similar to that in the shown as pieces of a fixed "pie"' The colored area toward the center of each BALANCE projection rather than the QUADRUPLE projec- piece represents the portion of that typeC of income tlsat becomes part of ,ACEpoetnrahrhnteQUD PLprec governiment revenue (through taxes and levies of various kinds.) Thus the tion? As can be scen from Pie E (which is otherwise based sum of all the colored portions represents total government revenuc, and on the assumptions of Pie D), the share of wages in the the ratio of the colored area to the total area of the circle is equal to the share of government revenue in the economy. The sizes of the different economy would be considerably larger and those of pieces of the pie are determined by price arid wage policies and by indirect profits and agricultural incomes somewhat smaller. tax rates, as well as by the structure of the economTiy. The share of govern- L ment revenue in each piece is determined by the average tax rate on that Lower saving requirements (resulting from greater effi- type of income (including income, profit, and asset taxes, as well as profit ciency) would mean a lower share of government reve- and depreciation fund remittances and social insurance contributionis). The nue in the economy and therefore that tax rates could be piece representing indirect taxes is somewhat diffcrent froti the others in its entirety it forms part of government revenue, and the size of the piece reduced somewhat. In Pie E, tax rates on wages and (rather than the share of the piece taxed) is determined by the average rate agricultural incomes are lower, permitting a higher stan- of indirect taxation in the economy. Source Table. 9.6. dard of living. Alternatvely, profit tax rates or indirect 154 Table 9.6 Illustrative Projections for Figure 9.2 leercent) Agricultural Indirect Government Projection incomes Wages Profits, taxes Total' subsidies, PieA (1981) Ratio to GDP 37 25 38 14 114 10 Share taxed 3 0 68 1oo - RevenueasshareofGDP I 0 26 14 41 - Pie B (traditional revenue, high saving) Ratio to GDP 28 32 40 14 1 14 3 Share taxed 3 0 68 100 - - Revenue as share of GDP I 0 27 14 42 - Pie C (traditional revenue, bigb transfers) Ratio to GDP 28 3 2 40 19 119 1 Share taxed 3 0 39 100 - Revenue as share of GI)P I 0 15 19 35 - Pie D (personal income taxes, bigh transfers) Ratio to GDP 28 32 40 14 114 1 Share taxed 6 15 3 7 100 - - Revenue as share of GDP 2 4 15 14 35 - Pie E (Pie D witb BALANCE) RatiotoGDP 26 37 37 14 114 1 Share taxed 4 13 3 7 100 - - Revenue as share of GDP 1 5 14 14 34 Note. GDP is measured at producer prices (sum of wages, profits, and agricultural incomes). a. Gross of depreciation and subsidies, but net of indirect taxes. b. Equal to GDP measured at producer prices plus indirect taxes. Subtracting government subsidies from this total yields GDP at purchaser prices (see Figure 9. 1). c. Excludes enterprise housing subsidy (see Table 9.4). Source: For 1981 (Pie A), estimates based on Chinese financial statistics. For 2000, based on the projections introduced in Chapter 2 (QUADRUPLE for Pies B-D, BALANCE for Pie E), aiid on the government expenditure sceniarios in Table 9.5 For further details, see Annex S, AppendixJ. tax rates could be reduced, or government spending on tax profits compared with historical experience in China public or private consumption could be increased. Thus and in other countries, where the reinvestment rate from improvements in efficiency can help ease budgetary con- after-tax profits tends to be 50-60 percent. Enterprise straints. saving rates of 50-60 percent in this pie would have permitted personal saving rates lower than 10 percent (or Implicationsfor Saving higher aggregate saving and growth rates). Implicit in the revenue scenarios discussed above are dif- Pie Dl is based on Pie D in Figure 9.2; it brings out ferent patterns of saving. Figure 9.3 (based on the num- one possible problem of less reliance on government sav- bers in Table 9.7) illustrates some of the points on alterna- ing to achieve a high aggregate saving rate. With the tive sources of saving raised earlier in this chapter. Government accounting for only 20 percent of total sav- Specifically, it shows the implications of some of the ing, and if households save only 10 percent of their dis- revenue scenarios in Figure 9.2 for the composition of posable earnings, the burden on enterprises becomes very aggregate saving and sectoral saving rates. great. With income shares as in the QUADRUPLE projec- Pie Al corresponds to Pie A in Figure 9.2 showing tion, enterprises would have to save 75 percent of their what the situation was in 1981. Profits are highly taxed, after-tax profits in order for the economy as a whole to so their share (after tax) in the economy is rather small. save and invest enough to meet growth targets. State The Government accounts for a large proportion of total enterprises in China have typically not saved as much as saving, while enterprises save a little over half their re- 75 percent of their after-tax profits in the past (the figure tained profits. Pie BI is based on Pie B in Figure 9.2. The has been closer to 50 percent). Moreover, the nonstate share of the Government in total saving rises to 70 per- sector (where a substantial share of after-tax profits needs cent (almost as high as in 1978-Table 9.1); as a result, to be distributed as dividends or bonuses) will presumably household and enterprise saving can be relatively low. In account for a considerable proportion of total profits. particular, enterprises save a low proportion of their after- One way around this difficulty is to increase enterprise 155 Figure 9.3 Sources and Composition of Saving, profits to the point where the required saving rate out of Alternative Projections, 1981-2000 after-tax profits is reduced to a realistic level (which could be accomplished througli price or tax adjustments). Pie Sources of savin.g Composition of saving Di iiiustrates this solution. The share of after-tax profits in national income is raised from 25 percent to 37 per- Profits Households Enterprises cent, while that of personal earnings is correspondingly (3) _ epis reduced from 54 percent to 42 percent. This permits (i) achievement of a 30 percent aggregate saving rate with a Househ e nt e saving rate from enterprise profits of only a little over 50 .in, g te W percent. But the higher share of profits and the relatively Governmenit low saving rate out of after-tax profits mean that a large Al 1981 (2) proportion of total consumption would be financed out of profits. Some of this might be in the form of dividends _ (X) or wage supplements distributed to worker-owners in collective enterprises, but large amounts might also go to high-paid workers in state enterprises, or to owners of - _ J _individual enterprises (see above). This could lead to so- @ 2_ V_cial problems. An alternative, in many ways more attractive, solution B I Traditional revenue would be higher saving rates out of personal earnings. Pie D3 shows what happens if after-tax income flows are as in Pie Dl but households save 20 percent of their dispos- able earnings instead of 10 percent. The required saving rate from enterprise profits is reduced to about the same = (2) _(1) level as in Pie D2, but without the undesirable conse- quences of an increased share of profits. Pie D3 thus somewhat resembles the situation in Japan (where a high Dl Low liousehold saving aggregate saving rate is achieved through high personal savings). 5 \ ~~~~~~~~~~(3) Tax Reform (2 ) The revenue scenarios in the previous section illustrate some important choices among broad categories of taxa- D2 High profits tion: indirect taxes, taxes on enterprise profits, and taxes on personal earnings. Within each of these broad catego- ries, there are equally important choices to be made about specific tax instruments, which will play an increas- ing role in China's reformed economic system, both as indirect levers to influence the decisions of enterprises I _,. _(@X~l) and consumers (see Chapter 10), and as redistributors of _ ~~~~~~income. D3 High household saving Indirect Taxes * Saving China now relies heavily on indirect taxes, with a highly *00i Constimption differentiated rate structure (3-66 percent). These taxes h_ave several advantages. Revenues generally tend to in- Note Each large pie clart represents the economy as a wholc, but the pieccs crease automatically with production, and taxes are rela- are after-tax incomes of houscholks anid enterprises and total governmllent tively easy to collect because the number of taxpayers reveniuc (not jtust indirect taxes). Wages and agricultural incomcs irc lumped (primarily industrial producers and wholesale commercial togcther since it is assumed that the saving behavior of thcse two groups is the same. Ihe colorecl area toward thc ccnter of Cach piece of the largc ples units) is relatively small. Moreover, rate differentiation represents the part of that type of inconiie that is savcd; the sUm of all those can be used to achieve income distribution objectives colored areas is total saviog, whidh is the same share of nationial income in each of ithc pies. Beside cact large pie is a smraller one showing the ctnMpOii- (with some reservations mentioned later), as well as to tjoji of saving in the econorny, wshich can lie compared directlI with tIblc discourage the consumption of items such as cigarettes. 9.1. Source: Table 9 7. China's indirect tax system also has its disadvantages, 156 however. Taxation of intermediate products encourages moderate rate for most consumer goods; and a high rate uneconomic vertical integration and can make effective for luxury goods or goods whose consumption should be tax rates (including the taxes paid at earlier stages of discouraged. If alternative means of reducing inequality production) on particular items diverge significantly from in living standards could be adopted, there might even be nominal tax rates. Moreover, taxation of intermediate a single rate for all but the last category of consumer transactions between state enterprises may not increase goods. In either case, the retail prices of specific goods budget revenue. (including the tax) would be quite closely related to pro- Following reform of producer prices and restoration of ducer prices, thus giving appropriate signals to consumers normal retail commercial margins (discussed earlier), about relative production costs and scarcities. Intermedi- some relatively simple changes could greatly improve the ate goods should not be taxed; nor, perhaps, should in- industrial-commercial tax. One would be a drastic de- vestment goods, except to restrain investment demand or crease in the differentiation of the rate structure. For discourage uneconomic automation of production. This example, there might be only three different rates for approach would allow continued use of tax instruments consumer goods: a low rate (possibly zero) for food; a that China is familiar with, that create few economic distortions, and that generate rapid revenue growth. One problem involves taxation of commodities used both as Table 9.7 Illustrative Projections for Figure 9.3 intermediate goods and for consumption or investment, (ercent) which requires either arbitrary classification or an admin- Household E-Government istratively awkward system of tax exemptions for certain Projection earnings' profits revenues Total users. -_____ _______ ______ _______ ________ ______ ______ China is already experimenting with value added taxa- Pie Al (1981) tion (VAT) for some commodities, but mainly to discour- Share of GDP 61 12 41 114 Saving rate 141 54 3 6 - age vertical integration rather than to raise revenue. Share of saving in GDP 9 6 15 30' Wider use of VAT would have several advantages. Reve- Share of total saving 29 22 49 100 nue from VAT tends to increase at least as fast as national income. It avoids the distortions caused by taxation of Pie Bl (traditional) intermediate goods. VAT also can be rebated to exporters Share of GDP 60 12 42 114 and charged on imports, which provides incentives to Savingrate 10 24 51 - Share of saving in GDP 6 3 21 301 increase exports and economize on imports in an interna- Share of total saving 20 10 70 100 tionally accepted way (as with other indirect taxes-see Chapter 6), with a minimum of domestic distortions. Pie Dl (low housebold saving) These advantages may make VAT the most attractive indi- Share of GDP 54 25 35 114 Saving rate 10 75 17 - rect tax, perhaps supplemented by some commodity-spe- Share of saving in GDP 5 19 6 30o cific excise or sales taxes. VAT does, however, require that Share of total saving 18 62 20 loo the taxpayers (enterprises) keep fairly good accounts on input purchases as well as sales, perhaps making adminis- Pie D2 (bigb profits) tration and compliance more costly than for the indus- Share ofGDP 42 37 35 114 trial-commercial tax.' Saving rate I 0 54 17 - Share of saving in GDP 4 20 6 30c An advantage of all indirect taxes over direct taxes Share of total saving 14 66 20 loo (particularly personal income taxes) is that they are more impersonal and less visible, which may make it easier to Pie D3 (bigh household saving) mobilize large amounts of government revenue. There is Share of GDP 54 25 35 114 also less room for tax evasion, exemptions, and corrup- Savingrate 20 53 17 - Share of saving in GDP 11 13 6 30' tion. The key weakness of indirect taxes is that they are Share of total saving 36 44 20 1oo not well suited to reducing inequality in living standards Note: Income flows for nongovernmenit sectors are gross of depreciation, (since they tax all purchasers of a given commodity, not but net of all taxes and levies by the goverilment. Gl)P is measured at just those who are relatively well-off). This is true even if producer prices. tax rates are differentiated, but it is much more so if there a. Wages and agricultural incomes, after taxes. b. In 1981 personal saving appears to have been unusually high, because of Is little differentiation in the rate structure (which is desir- large stock increases in rural areas. able for efficient resource allocation). c. 'I'he aggregate saving rate in this table is 30 percent because GDP is measured at producer prices. With GDP measured at purchaser prices (as in the 1981 input-output table in Annex 5, and in the multisectoral model), the saving rate is 29 percent (see, for example, the discussion of QUADRJPIE in Chapter 2). 'I'he relationship between GDP at producer prices and at 11. However, when VAI' is calculated by the crediting method, purchaser prices is explained in Figure 9.1. firms purchasing goods have an incentive to make sure that suppli- Source: See Table 9.6. ers pay vAr so that they can receive credit. 157 Profit and Asset Taxes ate share of the surplus this sector generates is channeled Taxes and levies of various kinds on enterprise profits to society in general. Exemptions and differential profit form the othcr pillar ilv China's present tax system. ite tax rates can also bc uscd as economic levers to steer both a arcpcrt..u.a l pi;li IdA ww, ijiuoduced to repiace nonstate and independent state enterprises in appropriate direct remittance of state enterprise profits to the budget. sectoral and geographical directions. In the long run, rates But there is a different effective tax rate for each enter- of taxation for state and nonstate enterprises should prob- prise, to offset the impact of price distortions and other ably be equalized, for administrative convenience and to factors. China has also experimented with a charge on prevent distortions or problems in taxing mixed-owner- state enterprises' fixed assets, but this was apparently ship enterprises. But the great difference in effective abandoned after running into obstacles also associated profit tax rates between urban enterprises and rural col- with widely varying enterprise profitability. In other lective enterprises at present (mentioned earlier) means countries, taxes on enterprise profits have increased in that such equalization should proceed gradually in order importance during economic development and are gener- to avoid large revenue losses on the one hand or excessive ally regarded as an administratively convenient and eco- tax increases for nonstate enterprises on the other. nomically efficient source of revenue (although it is some- Careful attention must also be paid to the relationship times argued that they are in fact passed on to consumers between taxation of nonstate enterprises and taxation of through higher prices). In China, the great variation in their workers and owners. In the absence of personal effective profit tax rates among state enterprises, and the income taxation (discussed below), taxation of profits en- fact that profit tax payments are determined largely by courages tax avoidance through payment of higher wages bargaining, make the present system highly unsatisfactory to workers, managers, or owners. However, to tax both from the viewpoint of generating appropriate incentives enterprise profits and personal incomes derived from af- for enterprises and ensuring steady growth of govern- ter-tax profits is a form of double taxation which can ment revenue. Reform of the price system would make it have undesirable disincentive effects if the rates are too possible to solve the first of these problems, but the sec- high. This, for example, led the United Kingdom to mod- ond also requires improvements in enterprise financial ify its enterprise profits tax system so that distributed discipline and a change in the relationship between state profits (dividends) were subject only to personal income enterprises and the government organizations that now tax, rather than, as in the United States, to both enter- supervise them (see Chapter 10). prise and personal income taxes. Experience in other Once these problems are dealt with, the main issues countries also suggests the desirability of simplified taxes would become the appropriate rate of profit tax and on small enterprises, in order to reduce collection costs whether part of the aftertax profits of state enterprises and to avoid complex bookkeeping. For very small enter- should still be remitted to the Government (perhaps in prises, a lump sum tax or license fee, in lieu of both the form of a "dividend" on the capital provided by the profits and personal income tax, might even be sufficient. Government). There is an obvious tradeoff between In both state and nonstate enterprises, an excess profits greater incentives for enterprises from low tax rates and tax can be used to absorb differential rents earned in the need to mobilize government revenue. In this con- activities like mining. China has already introduced a text, a charge on government-financed investment in "resource" tax, which is triggered once a mining or pe- state enterprises could both raise revenue and strengthen troleum extraction enterprise's profit rate on sales cx- incentives to use capital economically. The charge could ceeds a certain threshold. These taxes can be a useful be a tax on capital assets provided by the Government source of revenue, in principle without distorting incen- through grants, or interest on (and repayment of) gov- tives (indeed they may usefully discourage overly rapid ernment loans to enterprises. A loan or asset tax system depletion of resources). But caution is needed in setting could ensure a minimum, stable return to the Govern- the tax rates because of the difficulty of distinguishing ment on the funds it provides for investment in profit- accurately between differential rent and high profits due earning sectors of the economy. But the stability of such a to greater efficiency or the need to compensate for high charge in the face of varying enterprise revenues and costs risk (most mineral exploration is unsuccessful). would tend to make after-tax profits fluctuate more, com- plicating the financial planning of relatively independent Penonal Income and Wage Taxation enterprises, especially if the tax rate were high or the loan Personal income taxes are immensely important in indus- repayment period short. trial market economies, both as a source of revenue and Profit taxes on nonstate enterprises (rural collectives, as a means of reducing income inequality, but they have small urban collectives, and individual businesses) are been largely neglected by socialist countries. China has likely to be an increasingly tmportant source of revenue recently introduced a progressive personal income tax, in China, with the relatively rapid growth of the nonstate aimed mainly at foreign residents. If this tax were ex- nonagriculture sector. They can ensure that an appropri- tended to cover, say, the highest quarter of Chinese wages 158 and salaries (see Chapter 8), as well as high earnings from ing countries. Neither income taxes nor commodity taxes individual enterprises and agriculture, it could play a use- are very effective when the tax base is scattered and ful role in regulating the increases in income inequality largely self-employed, and a large proportion of produc- that are likely to result from reform of the economic tion is consumed in kind. Indirect taxes on the procure- system. In setting tax rates, there is a difficult tradeoff merit of agricultural products by the commercial svstem, between what are perceived as inequitably low rates and or artificially low procurement prices, coupled with high high rates that discourage effort and stimulate tax eva- taxes (or prices) for industrial inputs into agriculture, are sion. In other countries, the trend in recent years has familiar means of extracting revenue from agriculture. been to reduce rates (which peaked at over 95 percent in But they can severely distort incentives, which has led some cases), while at the same time narrowing loopholes China to reduce reliance on such instruments in recent for tax avoidance and extending taxation of benefits in years. Further steps in the same direction would leave kind, capital gains, and personal wealth (especially when Chinese agriculture subject only to the very low (on aver- transferred between generations). Renewed attention has age about 2 percent) direct agricultural tax, though of also been given to personal expenditure taxes (which tax course also to general indirect taxation of manufactured consumption but not saving) as an alternative to personal consumer goods and services. income taxes. It is important to distinguish between the desirable Extending the personal income tax in China to cover level of agricultural taxation and the choice of instru- the great majority of wage earners would make it a major ments for extracting it. So long as agricultural incomes source of revenue. The extent to which this should be are on average much lower than nonagricultural incomes done depends largely on the attractiveness (including the (as seems likely for the next few decades-see Chapter 3), comparative administrative costs) and availability of alter- low direct taxation has obvious merits. But shortfalls of native revenue sources, especially indirect taxes. Experi- revenue from other sources might make heavier direct ence elsewhere suggests that income taxes on wages and taxation of agriculture unavoidable. Moreover, progres- salaries are cheap to collect, because employers can be sive taxation of unusually high agricultural incomes may obliged to deduct them from wages. Personal income be desired for reasons of equity. 'The best instrument for taxes, however, probably constitute a greater disincentive this last purpose would in principle be the personal in- to individual effort than equivalent amounts of indirect come tax, especially because it demonstrably applies the taxation. Moreover, they can be difficult to collect from same standard of equity to agricultural and nonagricul- individual enterprise proprietors and other self-employed tural incomes alike. In practice, however, it could be people, who in some countries evade most tax. difficult to collect such a tax on agricultural incomes- Taxes on wages, including employers' and employees' even if it was limited to a relatively small number of high- social insurance contributions, are also an important income farmers. source of government revenue in industrial market econ- As a means of raising large amounts of revenue from omies: in 1981, for example, social security contributions agriculture, personal income taxation (because of its high were 2 5 percent of all tax revenues in the United States, administrative costs) is probably inferior to the present 39 percent in West Germany, and 44 percent in France. agricultural tax. The latter is in essence a land tax based In China, wage taxes (discussed in Chapter 8) could be on estimated income-earning potential, levied in absolute used to finance social insurance and pension schemes. But amounts that remain fixed for several years at a time. for employment and income redistribution reasons, it I'his tax, whose fixed nature provides stronger incentives might be desirable to exempt low-paid workers and to to increase production in efficient ways than an income levy higher rates on higher wages. In most other coun- tax, could be levied at higher rates. It could also be made tries, by contrast, such taxes not only apply to all work- more flexible by expressing the tax as the product of a ers, but also have an upper limit such that no one pays standard percentage rate, common to all land, and a "tax- more than a certain absolute amount, in order to reduce able value" peculiar to each plot of land (this is the stan- inequality in contributory social insurance benefits. dard form of urban property taxes in other countries). The overall tax yield could then be varied by altering the Taxation of Agriculture standard percentage rate, with the taxable value of partic- Agricultural taxation is a difficult matter in most develop- ular plots subject to periodic reassessment. 159 Development Management A recurring theme of all the preceding chapters is the usually also seeks to limit inequality in income distribu- critical importance of system reform to China's future. tion, and in particular to assist the poorest and least This is well recognized in China today. Over the past five privileged. China's achievements in these areas have been years, far-reaching reforms introduced in rural areas have most imprcssive and compare very favorably with those had a remarkable impact on production and income. of other countries at similar levels of development. Many While reforms in urban areas have becn much less defini- of these social objectives, however, are still being met tive and comprehensive, the Central Committee Decision through policy instruments designed when the country of October 1984 indicates a firm determination to accel- was much poorer and the economy and society were less erate overall reform.' Together, the rural reforms and the stable. October Decision constitute one of the most far-reaching Perhaps more than in any other country, social welfare attempts to improve the functioning of a socialist ceo- and services for the urban population in China are pro- nomic system. Moreover, this attempt is only the begin- vided by their cnterprises or work units, with the state ning of China's overall strategy of building "socialism playing a limited role. Health and disability benefits are with Chinese characteristics," a system "integrating the provided through a labor insurance schcme, but pensions basic tenets of Marxism with actual conditions in China." are paid as part of current production cost and housing is System reform in China over the next two decades will usually provided by employers. Many social and distribu- require consistent and comparable progress in three areas: tional objectives are met by state manipulation of eco- (a) increasing economic dynamism and efficicncy through nomic instruments. For example, wages are set relatively market regulation; (b) strengthening and reforming social equal and generally at such a low level that they have to institutions and instruments to safeguard and furthcr im- be supplemented by price subsidics on essential goods and prove social welfare and equity; and (c) strengthening services. Economic security is provided to urban workers economic management through the coordinated use of through "lifetime" job guarantecs. Full cmployment is indirect and direct controls. This final chapter, drawing achicved by forcing enterprises to hire more workers partly on earlier chapters, discusses general issues in these than they need, by restricting migration from rural areas, three areas, as well as some specific issues not covered il and sometimes by scnding urban youths to rural areas. earlier chapters. The first section discusses the role and For the rural population, a subsistence level of grain is responsibility of the state toward the individual, focusing provided to the poorest households. on issues of income inequality, economic security, and Although egalitarianism was a guiding principle in the basic social services. The second section reviews the rcla- past, the level of welfare or security provided has been tionship between the state and state-owned enterprises, as uneven. 'I'he quality of social services and housing pro- well as collective and individual enterprises, and procceds vided to workers in different enterprises varies substan- to a discussion of investment and prices. I'he following tially and in ways unrelated to the performance of the section discusses the role of the state in planning and workers or the enterprises. State-owned enterprises gcn- managing the economy. erally provide better services and greater benefits than The State and the Individual I. Communique of the Tlhird Plenary Session of the Twelfth In a modern society, the state generally provides a degree Central Committee of the Chinese Communist Party, October 20, of economic and social security for all of its citizens. It 1984. All quotations in this chapter are from this document. 160 collectives, while the self-employed receive few benefits. pable managers, hard-working farm households, and tal- In rural areas, welfare and social services are provided ented innovators in all fields. The resulting degree of mainly through the collective efforts of the local popula- income disparity might well be larger than socially desir- tion, with limited assistance from the state, so that the able. But rather than distorting or suppressing economic quality of service varies greatly among localities and is forces, it would be preferable, to the extent possible, to generally much below that in urban areas. deal with inequality through social policy instruments Two important questions must be addressed: Do Chi- designed for this purpose. Specifically, high incomes gen- na's social policy instruments still meet the social and erated by a more market-oriented economic system could equity objectives of a modernizing society rapidly ap- be reduced to socially acceptable levels by directly taxing proaching middle-income levels? And are they compatible the incomes of the rich more than the poor (progressive with the other changes that are taking place in the eco- income taxation), by making high-income earners con- nomic and social system? Unwillingness to confront the tribute more to social security, or by imposing high taxes possible social consequences of economic reform has been on goods and services consumed by the rich. Some op- a critical flaw in many East European attempts. The tions in these areas were discussed in Chapters 8 and 9. result is often an incorrect impression that reform must It is essential, however, that income taxation-or other entail the abandonment of social concerns. This risk ex- measures to reduce income disparity-should not be seen ists in China also, perhaps to an even greater degree than as a punitive measure against high-income earners. In- in other socialist countries, because income distribution deed, continuous education of the population about the and economic security objectives are being met in un- policy of the Government-and the Party-on the legiti- usual ways, and particularly because social instruments macy of high incomes will be necessary. It would be are so entangled with economic instruments. better for the central government to set a clear policy on this issue, and to take the lead in introducing the policy Issues of Income Dispanly instruments necessary to reduce income disparity, than to It is recognized in China today that "prosperity comes allow local communities to set their own standards-as unevenly in the course of economic development," and currently seems to be happening in some places. that reform will require a new way of thinking about International experience suggests that it is better to different types of income and income inequality. An espe- confront the problem of high incomes directly. Faced cially difficult issue in this regard may be the legitimacy with the dilemma of having to reward very productive or and possible size of incomes from entrepreneurship. important members of their societies in the face of politi- Some people in China, unfortunately, still associate entre- cal pressure for equality, some countries have tried to preneurship with all the worst aspects of pre-Liberation obscure high incomes and consumption. In some coun- capitalism. Entrepreneurship, however, will be critical in tries, for instance, the wages of public officials have been achieving China's economic objectives, partly by causing kept low, but extensively supplemented through bribery markets to function more smoothly and efficiently. Entre- and corruption. In other countries, formal incomes are preneurs, for instance, buy goods at low prices in places low and fairly equal, but senior officials and important where they are in surplus and sell them at higher prices in members of society receive special privileges such as bet- places where they are often urgently needed; or they ter housing, second homes, access to special stores provid- produce and sell necessary goods and services initially at a ing goods not available elsewhere, and sometimes even high profit, thus luring others into the same activities, unrecorded but regular supplements to their official sala- which increases supply and drives profits down.2 Al- ries. The benefits of such obfuscation are strictly tempo- though their motivation is obviously to make money for rary, since these practices quickly become well known, themselves, they are nonetheless useful. Entrepreneurship and the costs are large and long term, as they may set in is also essential for technical or economic innovation- motion an irreversible evolution toward a corrupt and the search for ways to produce something at lower cost hierarchical society. or of higher quality and to respond to changing market conditions when there are no assurances that the search will be successful (see Chapter 7). Because entrepreneur- ship involves taking risks and is successful only occasion- 2. Especially in the early stages of economic reform, reflecting ally, it will flourish only when successes are well re- the huge imbalances created by the previous rigidly administered warded. system, entrepreneurial incomes tend to be large even in some In a socialist economy, income disparity resulting from activities that would not normally result in such high incomes. 'o prope wilabe re.ltiv limie. Some entrepreneurs in China are already earning annual incomes private ownership of property will be relatively limited. of Y 10,000, even Y 100,000, by raising chickens and selling eggs But considerations of economic efficiency and dynamism to the urban population, by opening small restaurants, or by per- will require that high incomes be permitted-and indeed forming badly needed household services, all of which were previ- encouraged-for successful entrepreneurs, unusually ca- ously prohibited. 161 Social Security and Welfare to build on. In urban areas, a houschold registration sys- At the other end of the income spectrum, a social secu- tem, which includes detailed information about cach rity .. cr th the -cuus or a reformed household's situation, forms the basis for crain and other cca. o, s yb... .. ;, ^ c_--- .En.c-pis ImU.t alUp ttioning. I his system could be used initially in increasingly as economic entities, which will inevitably administering social security programs. Even in remote conflict with their current role as providers of many so- rural areas, the former system of communes, brigades, cial services. Prices and wages need increasingly to reflect and teams proved highly effective in reaching every economic considerations and cannot be manipulated to household and in pursuing economic and social objectives the same extent as in the past to meet social objectives, with limited resources. Although the economic functions Rapid economic change will mean accelerated growth of of these institutions were eroded by agricultural reform, some enterprises but contraction and closure of others. they or their successors could continue to administer col- Some skills will become obsolete, and some workers- lective social services as well as state-run social security sometimes through no fault of their own-may become programs. at least temporarily unemployed. Thus, the absence of The major function of most social security programs is any organized means of supporting the unemployed and to supplement the income of households whose incomes others suffering from economic change will become in- are low either temporarily (for example, unemployed or creasingly unacceptable. Rising expectations among the ill workers) or permanently (for example, retired workers people as a consequence of economic growth will also without other pensions). In this connection, the challenge increase pressure for the state to assume a growing and is to provide for those in need while minimizing disincen- increasingly direct responsibility for social security and tives to work. Providing all households with a fixed in- welfare. come supplement (or "social dividend"), regardless of Especially in the last few decades, social security pro- their work and other sources of income, would minimize grams have been introduced in all industrial countries, any disincentive to work (since they would keep all other with the objectives of ensuring an adequate level of in- income), but would be far too costly an option for China come for all citizens and minimizing the risk of poverty to consider. A guarantee by the state to bring the incomes due to old age, illness, disability, unemployment, and of all households up to a given level would be less costly, other personal misfortune. These programs have grown but would remove incentives to earn income below the rapidly, and in most Wcstern industrial countries they guaranteed level. Concentrating income supplemcnts on now account for 15-20 percent of national income. families with special characteristics (such as retired people Many, howevcr, have cvolved from a scries of smaller, with no other income, single-parent households, and fam- fragmented programs, each responding to particular so- ilies with many children) reduces budgetary costs and cial, economic, and political exigencies. Although individ- disincentives, but can increase administrative costs and is ual programs may be quite sensible, the social security inequitable for other impoverished households. Thus all programs as a whole are not necessarily so. In somc programs involve some tradeoffs among budgetary and countries, for instance, complex income tax and welfare administrative costs, disincentives, and inequities. Careful regulations have combined to produce unintended ab- design is needed to suit a country's particular social and surdities. In some West European countries, generous economic conditions and priorities.3 unemployment benefits for young people have contrib- In most Western industrial countries, social security is uted to increased unemployment by deterring them from based largely on the insurance principle-citizens contrib- taking arduous, dull, or low-paid jobs. Despite these and ute to a fund that then compensates them for loss of other problems, however, there is little doubt that large income due to old age, unemployment, illness, and so and steadily increasing government spending on social forth. The level of individual benefits sometimes depends security, medical care, education, and other social services on the size of individual contributions. The main role of has contributed greatly to the reduction of inequality in industrial market economies. A major potential advantage of social security pro- 3. All options involve some compromise. Many economists grams is that benefits go only to those in need. By con- propose that the state should establish a basic (maximum) supple- trast, price subsidies-the most important way in which ment, whose amount would vary according to the size and other the state attempts to assist the poor in China today- consumption needs of the household. The amount actually paid to benefit the rich, as well as the poor, and are therefore an individual household would depend in some specified way on much more costly. Compared with price subsidies, com- the income earned hy the household, so that a household with no prehensive social security programns are of course adminis- other source of income would receive the full basic supplement, while a household with income over a cutoff level (which would tratively much more complex. Yet in this regard, China have to be higher than the amount of the basic supplement) would has considerable advantages over most other countries, receive no supplement at all. This sort of scheme is sometimes particularly since it already has an institutional structure referred to as a negative income tax. 162 the state is to administer the program, sometimes aug- may be desirable to give the local administrators in rural menting its resources with other government revenues areas substantial freedom in organizing the entire range of when necessary, and to provide a "safety net" of noncon- social services-including social security, pensions, health, tributory income supplements for those who are not cov- education, and family planning-subject to some national ered by insurance or whose income would otherwise fail policy guidelines. There is also a need for what may be below an established minimum level. An alternative to termed "preventive welfare" (similar to preventive medi- this insurance approach, however, would be for the state cine), which involves social assistance of various kinds to to assume direct responsibility-as China has in the improve the earning capacity of individual families. For past-for ensuring a minimum level of economic security instance, the unemployed-in addition to income sup- and to finance this from general budgetary revenues. The port-may require retraining, help in obtaining new em- state-run and budget-financed scheme could then under- ployment, and possibly aid in organizing for community pin additional schemes, which would use the contribu- work programs. tory, insurance principle to provide extra benefits. Thus there will be a growing need for state agencies to A possible scheme following this second approach, and assist individuals in coping with the changing economic which would also address the problem of high incomes, environment.4 Institutions for this purpose will need to would be to establish a nationwide social security fund. be developed and strengthened. One important step High-income earners would be required to contribute to might be to consolidate and extend the present enter- the fund a portion of their wages or incomes above an prise-based labor insurance and welfare programs into a established level, while households with incomes below a modern state-run social security program. Because of the specified minimum level would receive an income supple- many complex issues involved-including administrative ment. Eligibility for the supplement would extend to arrangements, financing and use of funds, determination households afflicted by old age, unemployment, disabil- of beneficiaries and benefit levels, and relations with the ity, and other adverse natural or economic circumstances, state budget and other insurance schemes-it might be but not to those who simply refused to work. The costs desirable to create a high-level social security commission of these income supplements-which are likely at least to formulate a long-term plan to be implemented in initially to be considerably greater than the contributions stages. of high-income earners-would be financed largely from budget revenues. Such a scheme would minimize admin- Social Security and Services in Rural Areas istrative costs, because the majority of households, which A difficult issue in planning for a social security program, have middling incomes, would not be involved. Since which affects both equity and cost, is thie proportion of high-income earners would be making a direct contribu- the population to be covered.' With regard to the urban tion to the relief of poverty, it might also alleviate the population, any state-run social security program should apparently growing resentment against them in some surely cover everyone, whether employed in the state, communities. Moreover, this kind of scheme would help collective, or individual sectors. To do otherwise would to ensure that reform and policy measures introduced be inconsistent with the current objective of promoting a later (for example, allowing enterprises to dismiss work- multiple-ownership system in the economy. Workers in ers, widening wage scales, and eliminating subsidies for township and village enterprises, as well as in collectives food, rent, and other goods) would cause no families to in small towns, should probablv also be included. Over fall below a socially acceptable income level. the past few years, workers in collective enterprises in Such a national scheme for providing a low but uni- some rural townships have begun to organize their own form level of income support throughout the country pension and social security programs. Although these ini- could be augmented by provincial and local schemes fi- tiatives should be encouraged, local governments might nanced by local funds or contributions from participants. attempt to consolidate these fragmented efforts into Groups of workers (in particular occupations or localities) could also be encouraged to save for retirement and share risks in areas such as health and disability. Especially for 4. Recently, for instance, after introducing an economic respon- retirement, a minimal social security program should be sibility system, the Capital Iron and Steel Corporation found that seen only as an underpinning for self-financing pension several thousand workers were redundant. The corporation orga- schemes sponsored by local governments, employers, or nized these workers to form a service company and to work on other groups. (Options for organizing pension schemes environmental improvement projects, while some were retrained. have been discussed in Chapter 8). Such efforts are highly commendable, and more of them will be needed. Ultimately, however, responsibility for retraining redun- Other countries experience manageent dant workers and helping them find new jobs will have to rest of social security programs can often be more effective if mainly with the Government. closely linked to the provision of other social services, 5. The possible future fiscal implications of social security such as health and education. In China, for instance, it schemes of varying comprehensiveness were outlined in Chapter 9. 163 larger programs, which would be more effective because money and effort should likewise be put into boosting of their larger numbers of participants. school attendance (Chapter 8). China has long experience F.xrersion of a sociai security program to agricultural and proveni capability in such mqtterc, hut action is ur- VVUAikCeI alid Iirlalllliiies wouia be a more ditticult and gently necded. complex task. In all low-income countries, as in China, The problems of poor areas can be exacerbated by the clash between the desire for equality of social welfare misguided concern about equality-for example, paying for all people and the limitations of administrative and workers the same as in more developed areas, thereby financial resources has led to different treatment of the impeding the development of poor areas (Chapter 5). But rural and urban populations. The question is whether this it is also necessary to guard against mistakes of the oppo- compromise remains necessary or desirable in China- site kind. For instance, some localities in China are appar- especially because economic trends by themselves may ently making even the basic education and health systems not sufficiently narrow rural-urban income disparities financially independent, which is causing their scope and (Chapters 3 and 5) and because poorer areas are likely to quality in poor areas to deteriorate further. In some of fall further behind other parts of the country (Chapter 5). these localities, moreover, the generally sound concept of The state may therefore need to intervene more force- "cost recovery"-making beneficiaries pay the full cost of fully in the social sphere to alleviate emerging inequality services-is being incorrectly extended to basic social ser- and potential poverty. vices. These developmcnts seem contrary to the objec- A rural social security program subsidized by budget- tives of system reform in China and need to be corrected ary revenues, for instance, would be an efficient means of through policy directives from the central government. transferring nonagricultural productivity gains to the agri- cultural population (Chapter 3). While the long-term tar- get should be to have a uniform basic social security The State and Enterprses program for the whole population, an interim measure The recent Central Committee decision has identified the might be to combine and augment the existing subsis- task of "invigorating enterprises as the key to reforming tence grain support and Five Guarantees into a rural the national economy," and acknowledges that "socialism social security program providing needy households and with Chinese characteristics should, first and foremost, be communities not only with basic food, but also with a able to instill vitality into the enterprise." Attention has small cash income. The amount of cash income and other been focused on state-owned enterprises (or more accu- benefits could then bc increased over timc as incomes rately, enterprises owned by the wholc people); however, rise, with the objective of eventually merging the rural policy toward nonstate enterprises-collective and indi- social security program with the urban program. vidual-will also be critical in China's reform of the ur- A disturbing aspect of recent rural reform has been the ban economy and could indirectly contribute to reform weakening of the cooperative health system in poor ar- of state enterprises. eas; school attendance has also been adversely affected, and in some poorer localities is now rather low (Chapters Control and Management of State-Owned Enterprises I and 5). These trends should be of major concern to Over the past five years, various reforms in the manage- China's planners. There is overwhelming international ment of state-owned enterprises have been introduced, evidence that investment in human resources-in basic mostly on an experimental and piecemeal basis. These health and education-has not only been a most effective have included: enterprises retaining a proportion of way of helping the poor, but has also contributed directly profits for workers' bonuses, collective welfare expendi- to economic growth.6 Thus, neglect of basic education tures and small-scale investment; some freedom for enter- and health runs counter to the pursuit of both social prises in selling part of their output and in securing in- equity and economic efficicncy. puts; some flexibility in setting prices; and increases in The state should probably finance an increased propor- managerial authority ovcr production decisions and per- tion of the costs of social services in poor arcas, although sonncl matters. These changcs, similar to reforms tried in self-reliance may remain satisfactory for well-off rural ar- nearly all socialist countries, havc had some good results. eas. Because cooperative schemes have proved effcctive in They represent only marginal changes, howevcr, and the the past, assistance could take the form of marching fundamcntal problem remains of the proper relationship grants to townships or villages below a certain average between the state and the enterprise. income level (that is, the state would provide an amount In the past, "ownership by the whole people was taken equal to, or some multiple of, the amount of funds col- to mean direct operation by state organs." As a result, lected through the cooperativc system). Assistance by the state could also include assigned government health workers, subsidized training of local health workers, and 6. See, for instance, World Bank, World Development Report priority to poor areas in state health investment. More 1980 (New York: Oxford University Press, 1980), Chapters 4 and 5. 164 "the state exercised excessive and rigid control over enter- Giving direct control of state-owned enterprises to prises" and "enterprises became subordinate bodies of their workers would promote a strong sense of economic administrative organs." The relationship between the democracy and worker participation. Japanese experience state organs and the enterprises was strictly hierarchical, also shows the economic advantages of strong worker and the former frequently interfered in enterprise opera- coml1mitm11.tent to the well-being of the enterDrise, based tions. An important step has been taken, therefore, with not just on profit-related bonuses but also on constant the recognition in China that "ownership right can be education and frequent consultation. But the concept of duly separated from operating right." The direction of worker management suffers from the fundamental prob- reform will be toward a more complex system of manage- lem that state enterprises should operate for the benefit of ment, in which a multitude of state agencies, as well as the whole society and not only of those who work in the enterprise itself (both workers and managers), assume them-a particular problem in China where state enter- various responsibilities. Since the state retains the author- prise workers are already a relatively well-off group. Ex- ity to determine the division of responsibilities among the perience in Yugoslavia and elsewhere, including that of various state organs, including enterprises, it will, of nationalized industries with powerful labor unions in cap- course, retain ultimate control. italist countries, suggests that worker control could result 'fhough the principle that state enterprises should have in excessively high wages and worker benefits, inadequate much greater autonomy than in the past is accepted, labor discipline and effort, restrictions on employment important and difficult questions remain. One is the (partly though excessively capital-intensive investment de- proper degree of autonomy: should it be confined to day- cisions), and indifference to profitability-net of pay- to-day operating and marketing decisions, or should it ments to workers-beyond the minimum necessary for extend to appointment of managers, major investment enterprise survival. and diversification decisions, and the right to close down Experience in industrial market economies suggests part or all of the enterprise? Some possible answers to that giving control of state enterprises instead simply to this question are considered in the next section of this their managers would have important advantages, includ- chapter. ing a strong urge to expand, improve, and innovate. It Another question is how the state could or should also suggests, however, that completely independent en- regulate the activities of autonomous enterprises. With terprise managers sometimes choose a quiet life, or, more the exception of strategic and key enterprises (discussed commonly, seek personal power through expansion, with below), it is impossible in a complex and rapidly changing insufficient attention to profitability. In socialist coun- market-regulated economy for the state to know or, spec- tries, moreover, managerial control tends to differ only ify what individual enterprises should do, which may slightly from worker control, since managers often find it make it pointless or counterproductive for the state to hard to resist worker demands for greater benefits or to attempt to direct the activities of enterprises from within. insist on the often unwelcome changes in work practices Instead, the state should primarily seek to create an exter- needed for innovation and increased efficiency. This has nal environment such that the self-interest of enterprises been the Hungarian experience. It is also already a prob- guides them in directions consistent with the national lem in China: studies of experimentally reformed enter- interest, thus making it unnecessary for managers or oth- prises controlled mainly by their managers reveal large ers within enterprises to be charged specifically with rep- increases in worker benefits, but small increases in eco- resenting the interests of the state. Such an environ- nomic efficiency. ment-whose creation is the subject of much of the rest An alternative approach, common in nonsocialist of this chapter-involves appropriate prices, wages, and countries (and now being tried in Hungary), is to givc interest rates, a high degree of competition, and a well- strategic decisionmaking authority in each enterprise to a specified legal framework, as well as the use of regulatory board of directors. The board could contain some reprc- levers such as taxes, subsidies, and credits. sentatives of society at large, as well as of the workcrs. How enterprises are controlled and managed internally But to provide the necessary motivation, the board will largely determine what constitutes their self-interest. would mainly have to consist of(or represent) institutions Even with an ideal external environment, inappropriately with a strong interest in the entcrprise's profits. This motivated enterprises-especially those that do not ac- would be the case, for example, if the institutions were tively and continuously seek increased profits (discussed owners entitled to dispose of the enterprise's after-tax later)-may act contrary to national interests. Moreover, profits, eithcr by reinvesting them in the cnterprise itself experience in China and other countries confirms the or by withdrawing themll for consumption or investmllent difficulty of devising appropriate internal management elsewhere. Thc board could then insist that the enter- arrangements for state enterprises. The various alterna- prise's managers behaved appropriately, partly by its au- tives to the past system of direct administrative control all thority to appoint and dismiss them, partly by linking have weaknesses as well as strengths. their remuneration to profitability. The managers might 165 in practice make most decisions, even major ones, but activities that are no longer wanted by the market or would be greatly influenced by their ultimate account- where they cannot compete with more efficient enter- ability to thc ud.ec;is. priscs. Spc.iiCallV. effitVriI e-nrrprice, should be allowed Exper" --clsc;vh .... c~. lltC11dk~ it ~Ic t'hat mereiy estab- to grow rapidly, through the use of their retained profits lishing boards of directors for state enterprises is not and other sources of finance (financial flows are discussed enough. What is necessary, in addition, is that these in a later section), in new activities as well as existing boards should be not just profit-oriented, but also free activities. T'hey should be permitted to compete for mar- from direct intervention by state administrative organs. kets, for investment funds, for land, and for foreign ex- However, precisely because these are state enterprises, change. TIhe objective should be to make the widest use this may he difficult to achieve. Even if an enterprise's of the superior management and entreprenieurial skills of board of directors were to consist of representatives of these enterprises. the Ministry of Finance or a new Ministry of State Prop- Poor performers, however, should bear the full force of erty, rather than representatives of the relevant sectoral market competition. They should be forced to adjust and ministry or the government of the locality where the improve, and if this is not possible, to reorganize, seek enterprise is situated, informal connections and pressures new kinds of activities, or close down if necessary. In this could effectively pcrpetuate direct government control of connection, Cihina needs to begin formulation of laws the enterprise. and regulations on the treatment of enterprises, both A possible solution might be to spread the ownership state-owned and others, in financial difficulties. When of each state enterprise among several different institu- assistance through state intervention is clearly desirable tions, each in some way representing the whole people, for social reasons, this is best provided throughl financial but with an interest mainly in the enterprise's profits subsidies (including, for example, wage subsidies), so that rather than directly in its output, purchases, or employ- the costs of such assistance are explicit. Assistance ment. Examples of such institutions, in additioni to cen- through restriction of entry for othet enterprises' prod- tral and local governments, are banks, pension funds, ucts or other means of lhamperinig competition is much insurance companies, and other enterprises. This possible less desirable. Financial subsidies should he given for a system of socialist joint stock ownership has no parallel fixed time only, so that frequent reviews can determine elsewhiere, but contains clements found in other coun- whether the subsidies continue to be justified. tries, including extensive enterprise ownership by pension For enterprises in financial difficulties, hut for which funds in most industrial market economies and by vari- state subsidies are not justified, explicit procedures for ous levels of government and socially owned banks in reorganization or closure are necessary. Most countries West Germany (see Box 10O.1). In China, such a system have bankruptcy laws, for instance, stipulating a time of socialist joint stock ownership could perhaps be cre- period during which an enterprise would be allowed to ated initially by suitable dispersion of the ownership capi- stop paying its debts while it reorganizes its finances. tal of existing state enterprises. Over time, it could be re- 'I'hese laws usually include the possibility of having a inforced by a more diversified pattern of investmenit court- or government-appointed administrator take over finiance (discussed later), with a variety of state institti- the management of the enterprise and define the rights tions acquiring financial interests in existing and new and responsibilities of the existing board of directors, enterprises. managers, and workers. 'I'hey also usually specify legal procedures for closure of plants, disposition of assets, and Competition treatment of workers and managers, which would some- 'f'he critical importance of competition in promoting effi- times be handled by specialized bankruptcy courts. ciency and innovation is increasingly recogllized in Any reorganization of enterprises that impedes compe- C.hina. Competition means that "enterprises will be di- tition should be avoided. In China recently, and fre- reetly subjected in the markets to the judgment and eval- quently in the Soviet Union and Easterni Europe, enter- uation of the masses of consumers, so that the superior prises have been reorganized-partly in an attempt to will survive and the inferior be eliminated." 'The Party's separate enterprise management from state administra- unambiguous position1 on this issue is crucial, because tioIl-into large holding companies, trusts, or centrale. promoting competition amonig state enterprises will re- Often the holding companies are economic entities in quire not only chaniges in policv, but also fundamental name only, and the result is to substitute one form of changes in the attitudes of' many people. bureaucratic intervention for another. Moreover, even if An essential policy to promiote competition is allowing these companies truly function as enterprises, there is a free entrv into all kinds of economic activities. Enter- high risk that they will quickly become monopolistic, prises (both state and nonstate) should be given the right which may vbe even less desirable than having enterprises and, indeed, encouraged to enter new kinds of activities if controlled by administrative organs. China is fortunate they have the capability to do so, and to withdraw from that its vast size offers the possibility of domestic compe- 166 tition in most sectors, but steps will have to be taken to Effective competition, and indeed most other aspects of discourage local governments from imposing restricttons reform, will also depend on expansion and improvement on internal trade and competition (Chapter 5) Im- of China's legal system A decentralized economy, based provements in transport, commerce, and communica- primarily on horizontal linkages among enterprises, with tions, especially the transmission of market information, a tot of internal ttade and complicated financial arrange- will also be needed to create a unified national market ments, cannot function properly without a comprehen- (Chapter 5) In many sectors, much greater competition sive system of commercial and contract law, and the from imports will be desirable, as will competition of institutions and personnel (accountants and auditors, as more Chinese enterprises in world markets (Chapter 6) well as lawyers) needed to implement it Laws are also Box 10.1 Dispersed Social Ownership in the Federal Republic of Germany West Germany has a market economy dominated by pri- have apex institutions (Landesbanken), which are some- vate ownership of the means of production Public enter- times owned by groups of local savings banks, sometimes prises (those with at least 50 percent public ownership of partially or wholly by state governments A long-term equity or voting rights) account for only about 10 percent development bank (the Kreditanstalt fur Wiederaufbau), of (.DP But the true cxtent of social ownership is much owned 80 percent by the federal government and 20 per- greater Minority government ownership in enterprises is cent by states, plays a major role in financing government- widespread, for example, the nominally private energy and approved projects in developing countries, in export fi- industry giant VMBA is 44 percent owned by the federal nance, and in promoting regional development and aiding government VEBA in turn has holdings in many other small businesses firms some of which own still other businesses In some An example of the ownership ties that link West Germa- corporations like the Rhine-Westphalia Electrical Works ny's socially owned banking system with key setors of the (RWE), local governments exercise voting rights that are a economy is the Westdeutsche Landesbank (VVestl,B), the large multiple of their nominal stock ownership largest of the regional apex institutions for savings banks In addition to being widespread, social ownership in and the third largest bank in the country overall WestLB's West Germany is highly dispersed, among federal, state largest shareholder is the State of North-Rhine/Westphalia (provincial), municipal, county, and community govern- (43 2 percent), the other owners are associations of savings ments and various kinds of cooperative or publicly owned banks in Rhineland and Westphahla-Lippe (16 7 percent banks Multiple ownership is common, and in gencral each) and associations of local governments in the same public ownership does not mean close operational ties two regions (11 7 percent each) WestLB is a significant between enterprises and individual government agencies shareholder in thirty-three major corporations and scores Social ownership is pervasive in West German banking of other enterprises in such diverse fields as housing and In 1980 five of the ten largest banks were socially owned, real estate, finance, leasing, energy, engineering, mechanics as were all of the next tier (eleventh to twentieth in size) and optics, construction, machinery, textiles, and com- Socially owned banks account for around 60 percent of puters Some of these companies in turn own other busi- the total volume of bank business Banks have a considera- nesses For instance, WestLB is a 32 percent owner of ble ownership stake in many firms They also tend to have Kommunale Energie Beteilgungsgesellschaft, a large en- close credit ties with particular enterprises and are heavily ergy conglomerate whose other shareholders are a number represented on boards of directors Most banks engage in a of local governments at various levels This company in variety of activities, even local savings banks may lend to turn is a 32 6 percent owner ot Vereinigte Elektrizi- or own industrial enterprises, directly or through their tatswerke Westfalen, which itself has holdings in eleven apex institutions other enterprises, including a mining company which Is a The socially owned banking sector is characterized by a small shareholder in Ruhrkohle, West Germany's biggest diversity of forms Urban and rural cooperative banks are coal-mining concern (whose largest shareholder IS VEBA) permitted by law to lend 50 percent more than other Widespread social ownership in West Germany appar- banks with the same equity capital, which has enabled ently does not lead to inefficiencies rhis is probably due them to grow rapidly in recent years Trade union-owned in part to the fact that government and other social entities banks, originally established to manage the funds of trade owning enterprises generally act like ordinary stockhold- unions, have been amalgamated into the Bank fur Ge- ers, particularly in their detachment from the daily opera- meinwirtschaft, West Germany's ninth largest bank in tions of firms Moreover, the dispersed and often indircct 1980 The local savings banks (Sparkassen) are not character of social ownership and the coexistencc of a large "owned" by anyone in the traditional sense, but are private sector mean that competLtive pressures to maintain "guaranteed" by the lowest level of government They efficiency are preserved 167 needed to provide for the founding and closing of enter- profit is a more difficult issue. Some large enterprises in prises as well as to regulate the economic activities of capitalist countries have profit-sharing schemes for work- independent enterpriscs and individuals. in addition to cis, because thev believe th!s to be good for inccntivc idir gfcr"r~d~ d "; t,p klWt-1 w safety, environmental and morale. But most do not, mainly on the grounds that protection, and so on, legislation should prohibit-as in variations in profitability over time are not much influ- other countries-specified types of monopolistic, anti- enced by worker behavior, as opposed to management competitive, or exploitative behavior. At present in decisions and external conditions. This would be true also China, the situation is unsatisfactorily vague, with enter- of most state enterprises in China, with the added com- prises and local officials free to place their own interpreta- plication that profit-sharing schemes, whether introduced tions on general guidelines from the center, which in by individual enterprises or uniformly prescribed by gov- some cases causes unacceptable abuse, in others (probably ernment regulation, could undermine macroeconomic more numerous) economically valuable activities to be wage control (Chapter 8). In the longer term, if state regarded as illegitimate. enterprises were controlled by boards of directors inter- ested in increasing profitability, administrative control of Motivation of Workers and Managers wage bills might cease to be necessary, and enterprises Appropriate enterprise motivation should include a could be allowed to introduce profit-sharing schemes strong desire to increase profits. Avoidance of losses is an where they felt this to be conducive to efficiency. But for important aspect of this, but by itself is insufficient, since the time being, the disadvantages of linking the remuner- China needs enterprises that not merely pursue a passive ation of workers directly to profits may well outweigh strategy of staying out of trouble, but rather actively seek the advantages. to increase production and sales of existing, improved, Managers-the staff responsible for major decisions on and new products and to cut costs of all kinds. With production, engineering, sales, and other activities- rational prices and competition, the best single measure should be held accountable, much more than the work- of enterprise performance in this regard is usually me- ers, for the enterprise's performance, both in the long and dium-term profits (especially after deduction of the cost- short run. Entrepreneurship is also part of the enterprise depreciation and interest-of the capital employed). The management function, and the criteria against which desire of peasant households to-in effect-increase managers should be judged and rewarded should include profits because their standard of living depends on it lies the enterprise's ability to respond to market demands, to at the heart of China's recent agricultural successes. Out- seek ways of producing goods at lower cost and of higher side agriculture, the same motivation is a natural feature quality, and more generally to innovate and introduce of individual and family enterprises and of small enter- technological changes. A large proportion of managers' prises owned and operated collectively, or as partnerships, incomes, and decisions concerning their promotion or by their workers. In medium-size and large enterprises, dismissal, should thus depend on enterprise profitability. however, establishing the necessary link between profits In China, this will require a broader view of the responsi- and individual rewards is more complicated. bilities of enterprise managemcnt and a willingness to A distinction needs to be made between managers and reward superior managers appropriately. workers, especially in large enterprises. Incentives for Obviously price reforms, including appropriate charges workers are mainly a question of wage policy (discussed for use of valuable assets (such as capital, skilled labor, in Chapter 8). There have been many recent attempts to natural resources, and urban land), arc needed in order to introduce a production responsibility system, similar to make profitability an economically rational or socially that in agriculture, for individuals and units within enter- defensible basis for managerial remuneration. Moreover, prises. Progress has apparently been limited, partly be- no schemes for linking individual or group pay to enter- cause managers are not yet sufficiently motivated to pay prise performance will work properly without substantial workers by results and partly because many workers-as improvements in financial accounting and auditing. At in other countries-resist this, but also because it takes present in China, there is apparently little discipline in time and experimentation to devise incentive payment accounting, and enterprises are able to ignore state regula- schemes that fit the varying circumstances of individuai tions by, for instance, recording bonuses as collective wel- enterprises. It will probably be necessary to allow each fare expenditures. Accurate accounts, subject to thor- enterprise to establish its own payment-by-results system ough, compulsory, and independent audits, with severe for workers, based on qualitative and quantitative evalua- penalties for noncompliance, will be essential if China is tion of performance, in accordance with its particular to establish a workable, efficient, and honest system of conditions but in line with general principles established independent enterprises. by the Government. The extent to which an enterprise's total wage bill Management of Strategic and Key Enterprises (including all bonuses and benefits) should be linked to State enterprises in China cover a vast range of activities, 168 from power stations and railways to neighborhood res- The proportion of state enterprises designated as strate- taurants, and come in many sizes, from huge industrial gic or key, and hence subject to direct government regula- complexes such as Anshan Steel employing several hun- tion, should perhaps be larger in the early stages of re- dred thousand workers, to small retail stores employing a form, when distorted incentives, bottlenecks, and few persons. It would be impractical to try to manage all uncertainties are more serious, and when mandatory pro- these enterprises in the same way. A more realistic ap- duction planning and materials allocation still play an proach might be to identify various categories of enter- important role. But as other aspects of urban economic prises for which particular principles of state control and reform proceed, such directly regulated enterprises could management would apply. become a small (albeit very significant) minority, with Some enterprises will surely remain under the direct independent enterprises constituting the overwhelming supervision or control of state administrative organs, for bulk of the state sector. instance defense-related industries, as well as basic public services such as electric power and rail transport. Diversification of the Ownersbip System And in sectors where the economically optimal scale of Reform of state enterprise management is the central operation is so large that enterprises naturally became element of urban reform, but by itself is likely to be regional or national monopolies, direct state regulation insufficient. Many types of economic activities cannot be may also be necessary. But even in these strategic enter- efficiently undertaken by state enterprises, however man- prises, managers should be given increased authority, and aged. Even in socialist economies dominated by public incentive systems established to reward and penalize ac- ownership, collective and individual enterprises can play cording to agreed performance criteria and evaluation an important and irreplaceable role as discriminating pur- procedures. In this regard, the experience of some East chasers, as efficient suppliers of inputs, and as competitors European countries (most notably East Germany), as well to the state sector. Dynamic nonstate enterprises can thus as some nonsocialist countries, in evaluating managers of both assist and put pressure on state enterprises to im- noncompetitive enterprises may be useful. In France, for prove efficiency and upgrade technology. Perhaps as im- instance, many state-owned enterprises are managed on portant as the recognition of the need to reform and the basis of formal three- to five-year contracts between invigorate state enterprises, therefore, is the position the government and the enterprise, which set out a num- taken in the recent Party decision that "the initiative of ber of performance targets for the enterprise and the the state, the collective and the individual should all be obligations of the government regarding financial support encouraged. We must work to develop diversified eco- and policies affecting enterprise performance. These con- nomic forms and various methods of management." tracts also distinguish between normal operational objec- Evidence from many countries, socialist as well as non- tives and any specific social objectives that the enterprise socialist, illustrates the kinds of nonagricultural activities is expected to meet.7 that are difficult to organize in state enterprises (or even The state may also wish to exercise direct control over large corporations in capitalist economies). They include selected key enterprises, including those exploiting energy personal services (restaurants, repairs), much retailing and and other mineral resources on a large scale, very large wholesaling, small-scale construction and transport, high- enterprises in other sectors, and some enterprises in prior- quality consumer goods, specialized services to industry ity subsectors. Particular machine tool enterprises, for (technical consulting, research and development), and instance, might be selected for state-directed technical small-order parts and components not suitable for assem- transformation in order to compete in international mar- bly line production. In the course of economic develop- kets, or pilot plants in electronics could pioneer the use of ment, moreover, demand for activities provided by small- advanced technology. scale enterprises normally increases just as fast as demand Such selective intervention has been successfully pur- for the products of large-scale industry, partly because of sued even in countries where governments do not nor- increasing specialization in material production, but also mally play a direct role in industrial development. France because services (such as preparing meals, making clothes, and Japan, for instance, have been particularly successful repairs) hitherto organized within the household become in selective interventions in specific industries and enter- parts of the exchange economy, and because there is a prises, especially because they have insisted on increased growing need for business services to lubricate the in- efficiency and technological progress (by contrast, many creasingly complex economy (for example, communica- countries have nationalized declining or inefficient indus- tions, information services, consulting, financial services). tries, but have seldom succeeded in making them eco- nomically viable). Competition, from both domestic and foreign firms, is thus vital for key enterprises. Subsidies may be justified when these enterprises are still in an 7. For other examples, see World Bank, World Devoelopment Re- infant stage, but only for a fixed period. port 1983, Chapter 8. 169 'Thus, in industrial countries such as Japan and the United from financial extortion by misguided or corrupt officials States, small-scale enterprises account for a large share of at lower levels-a problem common in other countries, .ational output. piartly as subcontractors to iarge corpora- of which exanmples are now pmmrrnn2 in China. Regula- arc axsu wil tmanr sources of innovation tions that remain in force for many years are also essential (Chapter 7). to persuade nonagricultural entrepreneurs, like farmers, Even when collective and individual enterprises have to take a long-term view and invest in their businesses, been restricted, as in many socialist countries, such activi- rather than aiming at quick profits for immediate con- ties have nonetheless flourished, but have become part of sumption (Chapter 9). a "second economy." An estimate for Yugoslavia for Some state enterprises in small-scale industries and re- 1973-77 was that about 30 percent of services and re- pair and service activities might be contracted to groups pairs were performed illegally. In the Soviet Union during of workers who would then manage them as collectives the 1 970s, in addition to large earnings by private hous- (as is currently being considered in China) or simply sold ing repairmen, using supplies and materials of question- to collectives or individuals. The latter option may be able legality, new urban housing construction earned especially relevant for state enterprises suffering persistent black market builders an estimated I billion rubles per losses (which would otherwise be closed down), but also year. Because the output and services of the second econ- for highly successful parts of some enterprises, which omy are in great demand, official restrictions have not might be spun off as specialized small-scale enterprises. only been rather ineffectual, but have also had unfortu- Chapter 7 gives the example of a machinery-producing nate side effects. The Soviet Union, Yugoslavia, and workshop within a bicycle enterprise, which in most Hungary have all found that making individual activity other countries would be spun off as a specialized com- illegal results in a tremendous amount of illegality, brib- pany to further develop its capability. Similarly, the re- ery, and corruption, waste of working hours, and theft of search or engineering departments of some enterprises state property. Potential tax revenue is lost, control over might be spun off as consulting companies, which could relative earnings is weakened, and respect for the system then serve more enterprises. of economic management and regulation is undermined. Small collectives share with individual enterprises the Promotion of collective and individual enterprises in major advantage of an extremely close link between the socialist countries requires above all the removal of re- enterprise's financial performance, both short and long strictions on their activities and of discrimination against term, and the personal rewards of its workers-who in their owncrs and workers. There is usually a vast store of most cases will also be the owners. This advantage is lost initiative that can be tapped once restrictions are re- in large collectives (such as those in urban China, which moved. Despite the recent Party decision, however, it are managed much as state enterprises) and more gener- will take time for the population generally to view em- ally in all collectives whose workers do not share heavily ployment in nonstate enterprises as comparable to state in their ownership. An interesting exception to this gen- employment, because of the long history of discrimina- eralization has been China's commune and brigade enter- tion against small collectives and individual activities, and prises. Although these enterprises are owned by the en- people will need to be convinced that the new policy will tire township or village and not by their managers or remain in force. workers, the latter all come from the township, whose An important step would be to provide equal access to population is highly immobile. There is therefore a much social services and welfare benefits for workers and entre- greater feeling of solidarity and a stronger incentive to preneurs in the nonstate sector. They should also be develop and expand these enterprises and, most impor- given access to credit from banks and other financial tant, to create employment opportunities for relatives still institutions. Large collectives may continue to be taxed working in agriculture. Experience in other countries, on the same basis as state enterprises, but taxation of including France, Spain, and the United States, confirms smaller collectives and individual enterprises should be that enterprises owned by communities work particularly simple to minimize bookkeeping requirements (Chapter well when the community is stable and well integrated, 9). Access to materials and premises is also crucial: collec- especially in remote areas. tive and individual enterprises are seriously handicapped But there are few examples in the world of success with by the present allocation system and would benefit from genuine large and medium-scale collectives (where the its relaxation or replacement by market regulation, espe- workers are the owners), especially in manufacturing. cially for key materials. Most successful collectives are small or in nonindustrial Most important will be a set of simple, unambiguous, lines of activity, especially commerce and distribution and stable regulations on the establishment and operation (where they are often consumer or producer, rather than of these types of enterprises. Such regulations, backed up worker, cooperatives). The problem seems to be in re- by legal arrangements for enforcement and appeal, taining a strong sense of ownership beyond a certain size; would, among other things, protect small enterprises the few successful examples of larger-scale industrial col- 170 lectives (for example, Mondragon in Spain) have devel- Investment Decisions and Financing oped elaborate procedures regarding contributions and In infrastructure, education, health, and defense, the withdrawals of capital. The advantages and disadvantages Government will want to retain direct control over the of the different forms of collective enterprises will thus bulk of investment decisions. Similarly, in agriculture, it require continuous review in the course of reform. will want to control investment in infrastructure such as Incentives to increase efficiency and innovate are obvi- irrigation and land development, though most other in- ously strong in enterprises owned and managed by indi- vestment will probably be undertaken by households and viduals or families. The issues in China are the maximum collectives. In industry, however, an issue that needs to be acceptable scale of these enterprises (and related questions considered is the extent to which investment decisions such as the number of workers they can employ) and the should be made at the enterprise level. acceptable share of these enterprises in overall economic An argument for investment decisions by enterprises is activity. To prohibit the growth of individual enterprises that a degree of responsibility over thefuture of the enter- beyond a certain size, or to restrict their numbers, would prise, in addition to responsibility for current production stifle a potentially dynamic force within the economy. An decisions, would give enterprise managers more meaning- alternative might be to require individually owned enter- ful responsibility for the enterprise. Enterprise perfor- prises to sell majority ownership to the state, or other mance depends, after all, not only on current manage- socialist institutions (such as state enterprises or banks) ment decisions, but also on investment decisions made in once they exceed a certain size. The minority owners the past. Enterprises, and their managers, cannot be held could continue managing the enterprises, perhaps super- accountable for current performance if investment deci- vised by a board of directors representing all owners. For sions were made by state administrative organs. this approach to work well, without discouraging promis- Enterprise responsibility for investment decisions is also ing small enterprises from expanding, the sale of owner- often necessary to improve the efficiency of investment. ship rights to the state would of course have to be at a fair All investment decisions involve risk, and a certain pro- price-diminishing the control of the individual, but not portion of failures-and unexpected successes-is inevita- confiscating his wealth. In other countries, many success- ble with any decisionmaking system. But, as with produc- ful small businesses are voluntarily sold after a few years tion, managers of enterprises should have a much better to larger firms. understanding than state administrative organs of the Socialism with Chinese characteristics is envisaged by benefits and costs of available investment opportunities. the Party to include "a cooperative relationship between This advantage of decentralized investment decisionmak- state, collective and individual enterprises." T he next two ing is enhanced during intensive growth (Chapters I and decades-and beyond-will be a period of continuous 7), which requires continuous reassessment of the existing and experimental search for the mix of ownership and structure of production, as well as a continuous search for management systems that would best serve China's eco- ways of lowering costs and improving quality. nomic, social, and political objectives. What seems cer- Moreover, higher-level administrative officials, how- tain is that there will be a variety of types of enterprises, ever intelligent and conscientious, have no financial stake each suited to certain sorts of activities. Diversified own- in the success or failure of the projects they are deciding ership arrangements are already emerging even within the on. By contrast, decisionmakers at the enterprise level- state sector, with enterprises being established by other the owners in small businesses, managers appointed and enterprises, with provincial and local governments coop- supervised by boards representing the owners in larger erating to found new enterprises, and with joint ventures concerns-have or can be given a substantial direct per- between state and collective enterprises and between Chi- sonal financial interest in the enterprise. Experience- nese state enterprises and foreign private enterprises. positive and negative-both in China and elsewhere sug- gests that personal financial involvement in the outcome Investment and Price Reform of an investment decision can be a very effective way of encouraging bold and innovative thinking combined with A central element of system reform is to expand the role thorough analysis, hard-headed calculation, and the of market regulation. An important component of this avoidance of waste. This is true not only of the expansion effort is, of course, the reform of enterprise management or renovation of existing enterprises, but also of the estab- discussed in the preceding section. Other components, lishment of new enterprises. including changes in the labor allocation, wage, and tax Finally, delegating more responsibility for investment systems, stronger incentives for technological change and decisions to independent enterprises could help in striking dissemination, and reform of internal and external trade, a better overall balance between infrastructural and other have been discussed in earlier chapters. This section dis- investment. Economic efficiency in China, as in other cusses two additional issues-investment decisions and socialist countries, has suffered from a "medium-sighted" financing, and price reform. bias in favor of directly productive industrial investment, 171 which in practice still remains strong, especially among resources flow to the uses offering the highest economic local governments. This bias might be reduced if govern- returns. In Yugoslavia and Hungary. not only is the flow m^.eni aL ail ieveis niad less of a roic in organizing and of investmenr findmf-on enterDrlses limited, hiit -nter- ..na.ci..g suJi u IjvtIIuiient ana could tnus concentrate prises are constrained in their ability to enter new lines of more on infrastructural investment. In particular, making activity. As a consequence, enterprises have often made enterprises independent and giving them more invest- investment decisions that might be sensible from their ment responsibility could oblige local governments-as in own perspective, but inefficient from the national per- other countries-to improve infrastructure in order to spective. Since each enterprise's own resources are lim- attract industrial investment. ited, there has also been a bias toward projects below the Many socialist countries, including China in recent economically optimal scale. Delegation of investment de- years, have permitted state enterprises to retain a part of cisions to enterprises thus has to proceed in parallel with their profits for specified categories of investment. This reforms of the price system and other aspects of enter- has had some good results, but has also encountered prise management, and with increased mobility of invest- serious problems. In China, irrationality of prices, short- ment funds. comings of the material supply system, and protection of local industries have led enterprises and local govern- AL[ERNAMI'VE CIANNELS OF INVES'MEN TFLOWS. In ments to make some investment decisions that are highly the traditional socialist system, mobility of savings is undesirable from the national perspective. There has largely vertical. Savings are mobilized by the state budget been overinvestment in sectors with high administered through profit remittance, taxation, and other fiscal in- prices, underinvestment in vital but unprofitable sectors struments and then allocated according to the plan either such as energy and transport, and continued proliferation through the budget as grants or through state-run banks of uneconomically small and low-quality projects aimed as credits. In addition, there is some compartmentalized at increasing local self-sufficiency in materials or equip- reinvestment of savings generated within particular sec- ment (Chapter 5). tors and localities. In a reformed socialist economic sys- Another problcm has been inappropriate motivation of tem, the relative importance of different institutional enterprises and their managers (discussed in the previous sources of saving could be quite different (Chapter 9), as section). State enterprises have much to gain from expan- could be the ways in which saving is channeled into sion of fixed assets and production-increased bonuses investment. Vertical flows and compartmentalized rein- for staff and workers, more resources for collective wel- vestment, although they would remain important, should fare, and the enhanced prestige and power that come be increasingly supplemented and replaced with horizon- with larger size. The negative consequences of misguided tal flows. investments are also much attenuated by subsidies and First, enterprises could be allowed and encouraged, as other forms of assistance from state organs. This leads to mentioned earlier, to enter new kinds of activities, financ- "investment hunger,' as in other socialist countries, with ing such new activities with credits or other external funds enterprises competing for investment resources even as well as internal resources (more profitable enterprises when the potential economic returns are low or negative. tend to have better access to both internal and external TIhe resultant tension between central planners seeking to finance). This would not only create flows of investment control the level of investment and the hungry enterprises funds (as well as other resources such as management skills, frequently results in sharp investment cycles. Even in labor, and capital equipment) to new activities or sectors China, where the authority of enterprises over invest- where they could be more usefully employed (even though ment has been very restricted, this tension nonetheless they remained within the enterprise), but would also exists between central and local authorities (including the greatly increase competition in the economy. rural collective sector), with similar investment cycles. Second, horizontal flows of investment resources could In Hungary and Yugoslavia, which have experimented be achieved through direct investment between economic more than any other socialist countries with decentral- units. Enterprises could be permitted to invest in other ized investment decisionmaking, this has not improved enterprises, establish new enterprises, or participate in investment efficiency also bccause of the limited mobility joint ventures with other enterprises, local governments, of investment funds. Highly profitable enterprises tend to collectives, or even foreign companies. Such horizontal he efficient and dynamic and should therefore be allowed flows and cooperation are already emerging in China, in more investment resources-but not necessarily for in- many different forms, mostly from lower-level initiatives, vestment in their existing activities. They should also but with the Government's encouragement and support. consider investment opportunities elsewhere in the econ- (Ensuring the supply of key materials has apparently been omy, evaluating these against opportunities for either a major motive-for instance, investment in Shanxi coal new activities or expansion of existing activities within mines by industrial enterprises in energy-deficient their present fields. Only in this way could investment Jiangsu.) 172 These forms of direct investment between economic administrative. In addition to financial support, the finan- units should be encouraged and, with further reforms in cial intermediaries could also-as in other countries- other aspects of the economic system, will be increasingly provide technical assistance in financial management and guided by economic criteria. But these horizontal flows information in areas such as technology and marketing. can offer only a limited channel for investment resource Indeed, the activities of such institutions as highly moti- mobility. They are comparable to bilateral trade (barter- vated gatherers and disseminators of economically rele- ing) for commodities, since they involve the direct ex- vant information would be just as important as the finan- change of resources between suppliers and potential us- cial flows themselves. ers. For more efficient and possibly larger flows of Diverse organizational forms and a multiplicity of over- investment resources, horizontal flows through financial lapping and competing institutions would be highly desir- institutions functioning as intermediaries between the able (see Box 10. I on variegated social ownership in West suppliers and users of resources will also be necessary. German banking). If only a single financial institution One function of financial institutions would be to mo- existed, or several that had mutually exclusive areas of bilize investment funds from individuals, collectives, state responsibility, they would tend to become monopolistic, enterprises, and local governments, by accepting deposits bureaucratic instruments of particular levels (or agencies) and by issuing financial instruments such as bonds (either of government. In China, which has begun to diversify its by themselves or on behalf of the users of capital). They financial system since 1979, there could be many differ- would have to offer an interest rate (or other return) that ent forms of financial institutions-banks, credit coopera- reflected the scarcity of investment funds in the economy. tives, investment trusts, insurance and pension funds, and In this way, enterprises with internal funds available so on. In rural areas, for instance, some of the economic would be made aware of the potential returns to invest- institutions of the former communes and brigades, which ment opportunities elsewhere in the economy and would still exist following the reorganization of local govern- be able to choose rationally between direct investment ment administration, could be transformed into financial (internal or in another enterprise) and indirect investment institutions. Such township banks or investment compa- (by depositing the funds with financial institutions). nies could mobilize investment resources from collective The funds raised by these institutions would be made enterprises to establish new enterprises, help existing en- available to potential investors, particularly enterprises of terprises expand and modernize, and support agricultural all kinds. The funds could be provided as loans, with development. However, the operations of financial insti- fixed rates of interest and repayment periods. At least tutions should not be geographically restricted. The expe- some financial institutions, however, should be able to rience of Yugoslavia confirms that regional banks tend to provide ownership capital, partly because many worth- impede rather than facilitate flows of investment re- while projects are too risky to be financed largely by sources between regions and thus contribute to regional loans, partly because directly sharing in the risks and autarky. benefits would motivate financial institutions to give State intervention in the management of financial insti- more assistance in project design and implementation. In tutions, and specifically in their allocation of funds, is a this case, the financial institution would be an investor more complex issue. There is obviously a need for state itself, much as local governments, bureaus, state enter- regulation. A major function of financial institutions is to prises, and collectives now participate in joint investment reduce risk for both savers and borrowers and thus in- projects. crease incentives to save and invest efficiently. Govern- These institutions would thus be similar to commercial ment regulations and intervention are required largely to banks, investment trusts, development finance compa- reduce the risk to savers, through deposit insurance nies, and other intermediaries in capitalist countries, but schemes, restrictions on the scope of various institutions' with the difference that they would be dealing with flows operations and the types of assets held, requirements on of funds that were to a large extent socially owned-by full disclosure of information, and monitoring the perfor- government organs, state enterprises and other state insti- mance and viability of these institutions. Since the activi- tutions, or collectives. They would, however, also be ties of the financial sector may have a substantial impact fundamentally different from existing banks in socialist on the overall level of economic activity and prices, the countries, which primarily implement planned vertical Government clearly also has to intervene in financial flows. These institutions would in effect create a socialist markets in order to regulate the overall supply of money market for investment funds. and credit (see Box 10. 2). All this would require broaden- Whether capital is provided as loans or equity, the ing and strengthening the functions of the People's Bank, relationship between the financial institution and the en- which is to become a specialized central bank. terprise that receives the capital (or that was founded by The appropriate degree of government intervention in the financial institution, either alone or in cooperation credit allocation and interest rates is more controversial. with other institutions) should be economic, rather than Excessive intervention obviously risks turning financial 173 Box 10.2 Monetary Control Reform of China's system of economic management will ments of monetary control. greatly increase the importance of monetary control. In other countries, one pillar of monetary control is the When most goods are administratively allocated, the avail- imposition of minimum reserve ratios on individual banks, ability of money and credit to pay for them is of secondary which require them to keep at least a certain proportion of importance, and monetary policy plays a passive, accom- their assets in the form of cash and deposits with the modating role. Moreover, when most enterprises are ad- central bank. This puts an upper limit on the "money ministrative organs, whose economic survival is guaran- multiplier"-the relationship between the stock of "high- teed, it is futile to attempt to restrain their spending powered money" (cash plus deposits at the central bank) through monetary and credit restrictions. In Eastern Eu- and the total stock of money, including all bank deposits, rope, for example, state enterprises respond to a tight which is several times larger. The second pillar of mone- credit policy by refusing to pay their bills on time, generat- tary control is central bank regulation of the stock of high- ing involuntary trade credit that cascades throughout the powered money, most commonly through purchases and economy as firms settle accounts outside the banking sys- sales of government bonds ("open-market operations") tem and formal or informal separate clearing mechanisms and varying the terms of central bank lending to commer- emerge. This creates great difficulties for the banking sys- cial banks (the "discount window"). tem, and sooner or later the authorities feel compelled to Monetary control of a market-regulated economy is by return to a relatively easy credit policy. no means easy. Opinions differ as to whether the main By contrast, in a market-regulated economy, with finan- object of control should be money (variously defined), cially independent enterprises, the supply of money and credit, or interest rates. The size of the money multiplier credit crucially affects the overall level of (monetary or may fluctuate unpredictably, for example, if banks keep nominal) demand for goods and services, and hence, espe- more than the required amount of reserves. Changes in the cially in the medium term, the general price level. For this money supply likewise do not cause precisely predictable reason, and particularly since the inflationary surge of the changes in the overall level of demand for goods and ser- 1 970s, the governments of market-regulated economies vices, which in turn do not have precisely predictable ef- have attached increasing importance to monetary control. fects on the price level (or the real volume of economic In China, both the need to control money and credit and activity). None of this vitiates either the need for, or the the existence of a connection between fiscal policy and feasibility of, strict medium-term monetary control. But monetary policy are well understood. But a separate cen- the short-term causes and consequences of changes in tral bank was established only in 1 984, and recent experi- monetary magnitudes may be too complex and uncertain ence of unexpectedly rapid credit expansion suggests that to permit exclusive reliance on any simple or automatic there may be scope for improved techniques and instru- formula for monetary control. institutions into state organs, impeding improvements in trol was exerted indirectly, by offering low interest rates the efficiency of investment, without necessarily increas- and favorable repayment terms to particular activities of ing effective central control. In Yugoslavia, after thc 1965 private enterprises. Unlike those in Yugoslavia, these en- reform, for example, the government kept the interest terprises were highly motivated to increase profits over rate (after allowing for inflation) at a level much below the medium term and were made conscious of the true that necessary to balance the supply of and demand for economic value of their subsidized credits by informal investment funds, and hence the investment hunger of parallel financial markets, which among other things "re- enterprises and local governments persisted, requiring fre- cycled" some of the subsidized funds at much higher quent administrative intervention by state organs in the interest rates. Moreover, as their economies have devel- financial system and causing continued cyclical invest- oped further, both Japan and South Korea have given ment fluctuations. greater independence to their financial systems. During periods of rapid growth in Japan and South Korea, in contrast, their governments played a major role EVOLUIIONARY CHOICE. For China, continued ex- in the allocation of credit to specific sectors and enter- perimentation and exploration in the area of investment prises. Since in both countries' credit accounts for an decisionmaking and financing will be nccessary, especially unusually large proportion of enterprise investment because the experience of other countries provides no funds, this gave their governments a lot of control over precedent for a socialist financial market. T'he exact the allocation of investment, although much of this con- shares and relative importance of alternative forms of 174 investment allocation and financing should be allowed to selves constitute obstacles to price reform-including lack evolve with the lessons of experience and the develop- of competition, inadequate motivation to hold down ment of institutions. costs, and investment hunger, all of which contribute to Savings mobilized through the state budget would at a chronic shortages of many commodities. minimum continue to finance large amounts of invest- One ingredient of reforrm should thus be to minimize ment in infrastructure, energy, and the social sectors. In the nonallocative role of prices, through grcater reliance addition, part of budgetary savings could be channeled on taxes, transfer payments, and other instruments dis- through financial institutions to enterprises to finance cussed earlier to achieve social and fiscal objectives. Prices other investment. The government would also indirectly could then be used mainly to signal relative costs, needs, regulate the level and content of the growing share of and scarcities to enterprises and households, guiding their total investment undertaken directly by enterprises and production, expenditure, and investment decisions in households. economically appropriate directions. 'To accomplish this, Financial intermediaries would mobilize an increasing as the Government recognizes, the price-setting system share of savings, tapping the potential for household sav- must itself be changed to give market supply and demand ing, as well as funds from enterprises with limited internal forces a greater role. Administered changes in prices set investment opportunities. These institutions would also by the state are also needed, especially in the near term. play an increasing role in investment decisionmaking, Several aspects of price reform were discussed in earlier through their evaluation of investment proposals by bor- chapters, including more flexible pricing of agricultural rowing enterprises and through their own direct invest- products (Chapter 3), altering the prices of various ment. sources of energy (Chapter 4), restoring the link betwecn Enterprises would not only make an increasing propor- producer and retail prices of essential consumer goods tion of investment decisions, but would also generate an (Chapter 9), adjustment of prices that influence the spa- increasing share of savings from their retained profits, tial location of economic activities, especially transport supplemented (largely at their discretion) by loans or eq- tariffs and land use charges (Chapter 5), and stronger uity capital from other institutions. The speed with connections between domestic and world prices (Chapter which enterprise-level investment should increase in im- 6). This section concentrates on some general issues relat- portance depends on the speed with which it is possible ing to adjustment of energy and raw material prices and to establish, first, linkages between the personal interests to the reduction of administrative price control. of managers and the outcome of investment decisions, and, second, economically rational prices, interest rates, ADJUS'I-MEN'I'S C)F' ENERGY ANI) IRAW MA'INERIAI. and other signals that reflect relative costs in the econ- PRICES. The most obviously distorted of all China's pro- omy. ducer prices are the state-set prices of energy and some While many of the vertical and horizontal flows of raw materials-far below opportunity costs' in domestic investment funds would be in the form of credits, some and world markets. But the sheer magnitude of these would be in the form of equity capital. The latter would distortions makes them hard to correct: to introduce the include flows between enterprises (both state and non- required price adjustments at one stroke would involve state), between financial intermediaries and enterprises, dramatic changes in the financial circumstances of many and from households to enterprises, either directly or enterprises and institutions; yet to make thcm in small through financial intermediaries such as pension funds. steps would undesirably prolong the period of adjtust- Divcrsified flows of funds would therefore be both conse- ment, particularly because these key prices directly and quence and cause of a diversified pattern of enterprise indirectly influence almost all othcr prices, which are ownership. themselves in need of other sorts of adjustments. Whether in one administrative step, or in a number of Price Reform announced steps, or through rapid transformation of the It is recognized in China that "rational prices constitute present two-ticr pricing system into a unified market pric- an important condition for ensuring a dynamic and stable ing system, major adjustments of energy and raw material economy, and reform of the price system is the critical prices seem urgently needed. Postponement of these ad- element of the entire program of system reform." This is justments over the past few years has led to the extension because the decentralized decisions of independent, of ad hoc state interventions in other arcas, including profit-oricnted enterprises would otherwise often be inef- ficient for the whole economy. Yet price reform is com- plcx and difficult, partly because prices have up to now . Opportunity cost is the value of other economic possibilities been used largely for other purposes, including income created or forgone by producing or consuming a specific commod- redistribution and government revenue raising. More- ity. For goods that can he traded, consideration of opportunity over, deficiencies in other aspccts of the systcm them- costs should include markets abroad as well as in China. 175 enterprise-specific subsidies and "adjustment" taxes and differing energy intensities and to eliminate other current retroactive and frequent changes in tax rates. Hungarian irrationalities in the relation of prices to production cost experi-nce confirms that minazvcvrions of this kind tend and ploduct qualitv). F rnterpnse's operating in more com- , '7,an JW uI I iutlier progress) 0o petitive areas could be given greater tlexibility in varying socialist system reform. their output prices, since competition and market pres- Possible adverse effects on state revenues are one of the sure would work against excessive price increases. concerns that have inhibited the government from in- creasing energy and raw material prices. In principle, of MARKET PRICING. Despite their potential usefulness course, since state enterprises constitute the great bulk of in correcting accumulated distortions, there is increasing both producers and users of these commoditics, price recognition in China that administrative price adjust- adjustments should mainly simply redistribute an un- ments-which tend to lack the flexibility, complexity, and changed aggregate amount of profit and tax among state precision needed in a modern economy-are only part of enterprises. Even so, this could alter budget revenues price reform. More critical is to give market demand and unless there were simultaneous adjustment of the varying supply a greater role in price determination. There has rates of profit tax on individual enterprises. Moreover, been progress in this direction over the past few years: given China's weak accounting and auditing, enterprises the prices of many minor items, and of some transactions whose profits increased as a result of these price adjust- in more major items, are already determined by market inents might report less of a rise than they should, while forces. Major progress has, however, been impeded by others might exaggerate their additional costs. (Following the fear that, because there are chronic shortages of many recent increases in coal prices, some coal mines even goods, price decontrol might lead to a sudden accelera- claimed that their profits went down becausc of unau- tion of inflation. thorized increases in input prices!) Such leakages would In a properly functioning economy, excess demand in make enterprises better off at the expense of the statc: if one sector would imply excess supply in others, and such there were tight control of worker remuneration and imbalances would be corrected through relative price benefits, this would mainly increasc the proportion of changes induced by market forces. Generalizcd exccss investment funds in the hands of enterprises-a conse- demand and price inflation would in principle arise only quence that would be less worrisome once prices more if there were macroeconomic mismanagement-for ex- accurately reflected relative costs. ample, budget dcficits financed by money creation or The possible ripple effects of largc energy and raw excessive expansion of bank credit. The solution to such material price increases on the prices of other goods are problems would thus lie not in price control, but in more another source of concern in China. But many of these restrictive macroeconomic policies. ripplc effects should be welcome: higher energy prices, Experience in Cihina and elsewhere strongly suggests, for example, cannot and should not be fully absorbed in however, that thcre are more deep-rooted causes of gen- energy-using enterprises, but should bc partly passed on eralized excess demand in most socialist economies. in the form of higher priccs for energy-intensive products, These include the inefficiency and rigidity of centralized whose use needs to be discouraged in order to improve material allocation and production planning, the lack of the overall energy efficicncy of the economy. Moreover, concern among enterprise managers about cost and prof- increases in the prices of energy and energy-intensive itability, the absence of competition, and the "investment products would not necessarily raise the general price hunger" of enterprises and local governments (discussed level, since they would soak up purchasing power and later). The "seller's markets" that prevail for most com- hence tend to reduce the demand for, and prices of, other modities in such economies thus cannot be eliminated products. simply through tight fiscal and monetary policies. The state might nonetheless wish to manage the ripple Ilhe fact that chronic shortage appears to be a universal effects caused by major adjustments of energy and raw and permanent feature of the traditional system of social- material prices. For "strategic" and "key" enterprises ist economic management suggests, however, that reforn (discussed earlier), a unified program for the adjustment itself would create the necessary preconditions for price of product prices, costs, and taxes could be worked out in decontrol. This view is supported by China's experience some detail by controlling administrative organs, includ- in the past few years, especially in agriculture, where ing the Price Bureau and the Ministry of Filance. In relaxation of direct controls has turned long-standing other areas, where competition is still minimal, enter- shortages into abundance. The same could happen in prises might be required to pass on only a specified pro- other sectors with the implementation of reforms in en- portion (larger in sectors with lower profitability, and vice terprise management, commerce, competition, and so versa) of their increased costs in higher average product on. Increases in specific prices could eliminate shortages prices. They could be allowed greater latitude in varying by stimulating supply and reducing demand. These price the relative prices of individual products (both to reflect increases, moreover, would tend to reduce purchasing 176 power over (and hence the prices) of other goods, pro- cause of the costs it might inflict on certain-especially vided that the Government did not give compensating poorer-groups. There is also fear that initial moderate tax reductions or subsidies and more generally kept strict price increases might be greatly magnified by panic buy- control of the budget balance and the availability of ing, especially because household bank deposits are now money and credit. very large (at the end of 1984 they equaled 36 percent of Implementation of the other reforms necessary to elim- the year's retail sales). inate chronic shortages will take time, however, as will The experience of other countries suggests that these some of the required demand and supply responses in apprehensions are not without foundation, but can easily nonagricultural sectors. Smooth adjustment could also be be exaggerated. Most increases in the prices of particular impeded by downward inflexibility of some prices and of consumer goods will be offset by decreases in the prices wages. In addition, China lacks experience of indirect of other consumer goods, provided that fiscal and mone- macroeconomic management through fiscal and mone- tary policies are prudent. Even if it is not possible to keep tary policy, which would become much more important the consumer price level absolutely stable, most people in a reformed economic system (see Box 10.2). Even are apparently adaptable enough to live easily with mod- countries with much greater experience in this regard still erate inflation, especially if their incomes are increasing suffer from rising prices (although rapid inflation has al- steadily in real terms. And although general indexation of most invariably been the result of political irresponsibil- incomes is not to be recommended (Chapter 9), the living ity, especially unwillingness to restrain consumption or standards of some vulnerable groups can be protected by investment to the limits set by production and external indexation, as well as by allowing and encouraging greater borrowing capacity). For these reasons, price decontrol household ownership of real assets such as housing. probably has to be gradual though steady. Indeed, an early major incrcase in the extent of home ownership in urban areas could serve several related ob- PRICE DECON'I'ROL OF PRODUCER (OOI)S. The Gov- jectives. It could be accomplished by offering most state- ernment's strategy is to reduce administrative control of or enterprise-owned residences for sale to their occu- the prices of materials, machinery, and equipment in par- pants, while at the same time announcing a schedule for allcl with the gradual dismantling of annual production substantial increases in their presently hugely subsidized planning and allocation. 'I'his has already happened to a rents. Though these rent increases should be compen- significant degree the number of goods subject to pro- sated by wage and other income increases (Chapter 9), duction planning and allocation has declined. And for they would nonetheless give people an incentive to make many goods, only a part of total output remains allo- use of their savings to purchase their homes, probably at cated, at a fixed price, to meet requirements for high- a somewhat concessional price. T'his would lead to better priority production. Enterpriscs acquire their remaining maintenance of housing. It would provide many people requirements at the prevailing market price. This two-tier with an asset that in other countries has proved an excel- pricing arrangement has substantial advantages over the lent hedge against inflation. And it would enable the state former system, but also gives rise to certain problems, to absorb a large fraction of urban household bank de- including inequities anmong using enterpriscs and the coIll- posits. (Toward this last objective, especially in rural areas plexities involved in determining and regularly adjusting where most housing is already privately owned, the Gov- the state allocations. It should thus probably be only a ernmcnt might also encourage lump-sum contributions to transitional means of reforming the price and material pension funds-as mentioned earlier and in Chapter 8). allocation systems. One option would be to move the administered price of each commodity, say, halfway to- ward the market price in each time period (thc length of Economic Planning the period being determined by progress in other aspects An implication of the preceding discussion is that the of reform mentioned above), so that the two prices even- state should reduce its direct involvement in many eco- tually converge. Another option-which could be com- nomic areas, including production, commerce, prices, bined with the first-would be to gradually reduce the and employment. This would release resources, financial share of output subject to allocation and administered and human, for much needed increases in state activity in prices until all transactions were at market prices, other areas of economic and social importance. More- over, it will continue to be the primary responsibility of I)ECONTROL OF CONSUMER PRICES. Though the the state to guide the country's overall development. This prices of many minor items now float freely, the Govern- will, however, require a broader and fundamentally dif- ment is especially hesitant about decontrolling the prices ferent concept of planning than in the past. of other-essential or major-consumer goods. The im- mense inflation before Liberation has not been forgotten, New Approach to Planning and even slow inflation is regarded as unacceptable be- Direct control over economic activities has been the sin- 177 gle most important feature of China's past management controls will lead to more uncertainty. The number of system. Three main instruments may be distinguished: economic decisionmakers is, after all, greatly increased, physical nlanning of production. ccntralized allocation of and their objcctBvcs arc not mutually con.sistent, nor nec- mater:.!.> *-n3 hIilO y;} tr: n f-r fixcd s ili.- essariiy in harmony with the Government's objectives. gether, these instruments constituted a system for manag- Much will thus depend on the clarity and stability of ing the economy mainly by controlling supply. What was medium-term policies, which constitute the core of the not controlled was not planned in any meaningful way. development plan; the better these are enunciated, the The central plan for coal production and allocation, for less the uncertainty surrounding decisionmakers or other instance, did not include output from coal mines con- economic agents, and the less the chances of their deci- trolled by provincial authorities; provincial plans for coal sions having a destabilizing effect. Even so, indirect con- did not include output from mines belonging to rural trol involves a relationship between instruments and ob- communes and brigades. Similarly, provincial investment jectives that can never be precise, since it depends on the plans did not take account of investment projects fi- responses of a multitude of individual decisionmakers, nanced either by the central government or by collective including farmers, enterprises, collectives, and consumers. enterprises. In fact, often the absence of control implied It is impossible to predict their behavior with complete the absence not only of planning, but also of knowledge: accuracy, and therefore the instruments used will never provincial authorities had little knowledge of where out- be exactly what is needed to achieve particular objectives; put from centrally controlled enterprises was allocated or the residual is a source of uncertainty that defies policy of the overall level and content of investment activities in intervention. This shortcoming of indirect control may the province. It is this notion that direct control equals be no greater than some of the shortcomings of the tradi- planning that causes some in China to fear that a reduc- tional system of direct control. But especially in the early tion of direct control must mean the erosion of planning. stages of reform, when the coordinated use of indirect Planning in a meaningful sense must extend beyond instruments of control is still a new concept, planning and activities under direct state control, and indeed in a re- policy will need a high degree of flexibility and respon- formed system a large part of the planning effort will siveness. involve measures of an indirect nature. Reforms that have Of major importance to the new concept of planning is already been introduced, as well as possible further the newly established view in China that planning and changes discussed in earlier scctions, will mean that markets can coexist and develop harmoniously. Although farmers and enterprises have greater latitude to make the potential for clashes between direct and indirect con- their own supply decisions and to use various market trols should not be forgotten, and although the govern- channels for their sales. Central control over invcstment ments of other countries differ widely in their attitudes allocation could also be reduced. There will thus be a far toward markets and planning, international experience greater number of decisionmakers, each with some con- tends to support the prcsent Chinese view. Planning has trol over a part of national resources. Planning will ac- been used to a differing extent bctween countries and cordingly and increasingly have to involve detcrmination over time, and it is not easy to generalize about its cffi- of the economic environment within which relatively cacy, especially since actual developments cannot be di- independent economic agents-farmers, enterprises, fi- rectly attributed to the extent or quality of planning. But nancial institutions-operate. where market mechanisms were neglected or not taken '[his raises the qucstion of whether greater reliance on sufficiently into account, planning was usually lcss effec- indirect controls would reduce the Government's ability tive and national priorities became distorted, often with to manage the economy. In this regard, it seems impor- inefficient use of scarce resources. Conversely, there is tant to recognize that-as discussed above-direct con- considerable evidence that planning can be strengthened trols are inevitably limited in scope, while indirect con- if it is exercised in a way that allows market forces to trols generally influence the whole economy. An reinforce rather than oppose it. additional drawback of direct, as compared with indirect, Mutually consistent roles for plan and market imply control is that it must be shared among vertically distin- that planning must be based on managing demand as well guished sectors, or horizontally divided localities, or some as supply. This is essentially because it is the growing level compromise between the two, which leads-as is well and evolving structure of demand, reflecting the rising known in China-to autarkic tendencies and segmenta- prosperity of the society, that should mainly drive the tion of the economic management effort. On balance, changing composition of supply. In a large part of the then, indirect controls appear potentially at least as effec- economy, planning is thus mainly a matter of the state's tive as direct controls in economic management and al- managing and guiding changing demanid, with supply re- most certainly more efficient. sponding through the decentralized decisions of peasant A second and closely related question concerns the households and cnterprises. Mandatory planning of sup- extent to which a different mix of direct and indirect ply, involving directives from planners or other state ad- 178 ministrative organs, will still be esscntial in developing limited reliance on direct controls. It attempts to use infrastructure and in regulating part or all of the produc- available instruments in ways that influence the decisions tion and use of certain commodities. For a large and of market participants, bringing these into line with the growing proportion of economic activities, however, plan objectives of medium- and long-term development. Eco- objectives should be realized through guidance, including nomic policies nced to form a coherent and internallv manipulation of taxes and credits to influence the relative consistent package rather than to be formulated individu- profitability of different sorts of production and invest- ally. The translation of development objectives into a set ment. of policies that directly and indirectly guide the develop- ment process thus requires considerable coordination ANNUAL PLANNING. The nature of annual planning within the government-more than now exists in China. in the future depends on what happens to the material Governments are not monolithic, and the interpretation allocation system. Without centralized material alloca- of general development objectives in terms of responsibil- tion, annual physical planning of production loses much ities and actions may differ among ministries and be- of its meaning. China has already reduced, and is contin- tween central and lower-level government organizations. uing to reduce, the scope of mandatory production tar- While it is essential for each agency to look at its own gets and material allocation. The question is now responsibilities in the wider context of national develop- whether they could be abandoned altogether in the near ment, it is equally essential for one government agency to future, weighing the possible benefits of retaining the have the analytical capability to develop comprehensive present system against its costs, including the incentives it policy scenarios and to present these as the basis for creates for local governments at all levels, as well as enter- policy decisions by all the agencies concerned. prises, to invest for self-sufficiency and assured supply. Policies cannot be expected to achieve the desired im- 'fhe experience of Hungary, which abandoned directive pact immediately, and policy planning must have a me- production planning in a single step in 1968, strongly dium-term (three- to five-year) horizon. Moreover, any suggests that such a change would not disrupt or destabi- set of policies agreed for the medium term will require lize the economy-though, of course, Hungary is a far phased implementation and may need to be adjusted in smaller country than China. But it would cause annual light of changing economic circumstances and assess- plans to become mainly the step-wise implementation of ments of effectiveness. Examples abound in China and the medium-term plan. This should be closely linked to abroad of economic policies that were appropriate and the budget cycle. effective for several years, but lost their usefulness as the Annual planning and budgeting in a mainly indirectly economic structure gradually shifted. These same policies controlled economy also involves regulating the overall have frequently ended up as stumbling blocks for policy pace and stability of growth through fiscal, monetary, reform. Particularly in countries expecting rapid struc- and exchange rate policies (rather than-as in the past- tural and technological change, as in China over the next through direct intervention in production, investment, few decades, an argument can be made for the promulga- prices, and foreign trade). Among other things, mainte- tion of policies for strictly limited periods, at the end of nance of short-term macroeconomic stability involves the which they expire unless explicitly renewed. manipulation of taxes, government expenditures, money In preceding chapters, the nced for policy planning has and credit (see Box 10.2), and the exchange rate to offset been discussed in several contexts: guiding price trends temporary fluctuations in economic activity of domestic and ensuring price stability for agricultural products; lead- or external origin. ing the technological transformation of industry; correct- The experience of other countries shows that such indi- ing distorted energy prices; decreasing the rural-urban rect macroeconomic management is not easy, although income gap; changing and extcnding the social security China is fortunate in being a large and diverse economy, system; assisting poor and backward localities; and using with a relatively small foreign trade sector. But experi- foreign trade to promote economic efficicncy. Thlese are ence elsewhere has also provided much useful informa- issues that cannot be dealt with through short-term tion concerning the coordinated use of fiscal, monetary, actions or with a single policy instrumenit. Also, the ef- and related policies, which have been perhaps the main fects of the necessary policies are pervasive and their subject of theoretical and empirical research among West- macroeconomic consequences difficult to assess. Ihere ern economists during the past half century. China could are moreover alternative ways of addressing these issues, benefit from this body of information and experience, each with its own costs and benefits. Comprehensive possibly in part through contact with organizations such analysis of alternative scenarios is nccded, on whichi deci- as the International Monetary Fund. sions can be based, but the institutional capability for doing this does not yet seem to exist in China. POLICY PLANNING. Theplanningofeconomicpolicies The medium-term plan is thus the core of the entire is the central element in a planning system that places planning system, serving as the vehicle for policy adjust- 179 ment and change, and as the instrument to forge the planning efforts. Particularly in sectors where long lead consensus needed about those policies between all the times are required for new investments, or where a long- agenCjpQ encrn--.A .-^. iti mulill-rm - p tcrm Itchllocal stra i eRventeal, there is a need for lli~ t 1 uuilt-el'llpolicy plan- ter nuotca n'.r,g ilil >oC..aiij icPtntiisibiiity of tne a longer perspective, say, fifteen to twenty-five years. State Planning Commission, or of some other high-level Planning for these sectors will require the framework of a organ without specific responsibility for implementing longer-term view-not necessarily very precise or de- any particular set of policies. This in turn will require tailed-of the whole economy. I'he sector plans are un- development and strengthening of the statistical and ana- likely to be fully consistent with the overall long-term lytical capability to evaluate and study the current situa- framework; some may be subject to a significant margin tion, to offer comprehensive programs of policies to ad- of error or present alternative scenarios. 'I'he essence of dress specific issues, including time phasing for long-term planning is, rather, to anticipate possible basic implementing the programs, and to monitor program problems, so that timely policy adjustments can avoid implementation. otherwise insuperable bottlenecks or imbalances. France and Japan, for example, were selcctive in choos- PROVINCIAL PLANNING. The division of responsibility ing the sectors for planning; their objective was to make between central and local governments is a difficult issue these sectors more efficient and enable them to face inter- that cannot be resolved quickly. It appears consistent national competition. Both countries emphasized consul- with the direction of reform that the central government tation with the enterprises in the industries concerned would increasingly concentrate on policy planning while and the need for a consensus. France's planning agency planning of much infrastructure development and most was not sufficiently highly placed in the government to social services would take place at lower levels. have powers of direct enforcement, but merely tried per- Indeed, the consideration being given in China to dele- suasion, backed by investment subsidies. In Japan, the gating major responsibility for planning to provincial gov- leading role was assumed by the Ministry of International ernments, or perhaps even to municipal authorities, Trade and Industry, which could back up its strong views which would also have responsibility for surrounding ru- about the course and character of industrialization with ral areas, seems to fit quite well with the new approach to resources and policy instruments, but still relied mainly planning suggested above. Provincial governments should on consensus and allowed dissenting views. (Japanesc be able to monitor and project the growth of production, experience in strategic planning of technological develop- the creation of new employment opportunities, and the ment was discussed in Chapter 7. Comparable South generation of incomes within provincial boundarics. Korean experience in electronics is described in Box 7.3.) Their proximity to lower-level authorities and markets Sector plans should not be limited to targets for output, should allow them to identify problem areas and reme- efficiency, and profitability, but should also address such dies quickly. Moreover, provinces are large enough to be issues as changing the organization of production; the able to remove bottlenccks by reallocating resources, to number, size, and location of enterprises in the sector; promote promising investments, and to ensure a fair and therefore the closure, merger, or expansion of exist- distribution of the benefits from growth within their ing production facilities and the establishment of new boundaries. ones. They should also address the creation or strength- Over the next two decades, interprovincial trade will ening of research capability and the training of skilled rapidly gain in importance, overcoming past autarkic ten- staff. Ministries responsible for formulating plans and dencies. Thus the national economy will be more inte- consulting with enterprises about their implementation grated, but the central government will correspondingly must be well informed on the state of technology in their need to promote more consistency among the various sector, both in China and abroad, and capable of dissemi- provincial production and investment plans. The Gov- nating this knowledge. Thus the role of sectoral minis- ernment will also need to monitor and regulate the levels tries in China could change greatly, yet remain of critical of saving and investment in different provinces and flows importance to the task of development management. of investment funds among provinces-especially be- tween those with widely differing income levels. Thesc To olfi-r,lan nizng flows will partly involve transfers through the central The quality of planning depends not only on the way it is budget, but the Governmlent may also wish to participate organized, but also on the quality and relevance of infor- in investments across provincial boundaries and to influ- mation received. Adequate analytical capability is needed ence flows through the banking system. to handle inflows and outflows of information. LONC-TERM PLANNING. Although the medium-term INFORMAFION SYSTEMS. rhe quality and timeliness plan can function as the core of all other planning activi- of decisionmaking depends on the information available tics, it may not provide a sufficient framework for all to decisionmakers. At present in China, both vertical and 180 horizontal information flows are inadequate for sound (consumption, investment, and external trade) on pro- policy planning. The process of aggregating data before duction, investment, and employment. It is not suited passing them to the next highest level of government either to analyzing most problems of specific sectors (it precludes analysis of more detailed data at higher levels, was supplemented with more detailed agriculture and even for the main economic indicators, as well as differ- energy projections), or to investigating some other mac- ent aggregations of data. Another problem is that data are roeconomic issues, such as urban-rural income distribu- passed up through vertical channels, but not adequately tion or government revenue-raising (which Chapters 5 distributed horizontally. Thus, a provincial planning com- and 9 addressed with simpler projections). mission may not be aware of the production, employ- Constructing models for these and other purposes, and ment, or investment data that state enterprises under maintaining approximate consistency among them, could central control are reporting to their ministry. be made easier if the various kinds of data collected in For proper planning and delegation to lower levels, China were based on an overall accounting framework further work is needed to manage existing and new data such as a social accounting matrix. Many statistics are flows in ways that provide meaningful information. collected for administrative purposes, and their coverage Comprehensive tabulations need to be designed to meet is limited by administrative needs and spheres of control. the particular requirements of each level of government Economic analysis, in contrast, requires data by sectors, for data on production and consumption, financial flows, commodities, or economic activities, irrespective of the interprovincial and external trade, and investment ex- agencies involved in their production, trade, or use. So- penditures. Most important, users-economic research- cial accounting could provide the necessary integrating ers, policy analysts, planners-should have a major voice framework and thus assist policy analysis and planning. in deciding what types of data are collected and should The potential contribution of economic modeling, or have access to the primary data base. other sophisticated analytical tools, should not be exag- In a decentralized economy, the behavior of the numer- gerated. The effectiveness of all tools depends not so ous economic agents controlling resources needs to be much on their technical complexity, but on how they are understood when designing economic policies. This re- used. The quality of economic planning in China will quires collection and analysis of data on the behavior of thus depend largely on the common sense and good judg- economic agents-a field of statistical activity barely ment of planners, on improved economic training (not touched in China. The most obvious gap concerns con- only for planners, but also for decisionmakers throughout sumer behavior, in different parts of the country and at the economy), and on wider dissemination and discussion different income levels, in response to changes in incomes of economic and social information. and prices. Although household budget data are col- lected, they are not processed in ways that allow much economic analysis. Similarly, on the production side, little Overview is known about the supply response to prices and other Coordinated changes are required in many aspects of market forces, whether in the agricultural or the nonagri- China's economic and social system. One set of changes cultural sectors. involves increasing the dynamism and efficiency of the economy through greater autonomy for peasant house- ANALY'1'ICAL 'I'OOLS. The range of analytical devices holds and enterprises, more lively competition, and pro- for planning includes both the very simple and the very motion of collectives and individual enterprises to com- sophisticated, as well as both specific and comprehensive plement the state sector. International experience, as well tools. In many countries, planners use quantitative as experience in China over the past few years, makes models for policy analysis. Only a few countries have, clear the need for coordination among the various ele- however, constructed models for medium-term planning; ments of this economic reform. To be efficient, for in- even fewer have succeeded in putting these models to stance, enterprises must be motivated to increase their timely and effective use. The task is far from easy, requir- profits and to respond to demand; they must be given ing the allocation of scarce talent, well in advance of the independence and freedom of maneuver; they must be planning process, to a demanding and even risky under- faced with economically rational prices; and they must be taking. subjected to competition. None of these elements is indi- Models also have to be designed with specific objec- vidually easy to establish, and the absence of any one of tives in mind. A set of specifically focused, but not ex- them reduces or nullifies the benefits of the others: for actly mutually consistent, models is usually more helpful example, appropriate motivation produces bad invest- for policy purposes than a large multipurpose model. For ment decisions if prices are irrational and exploitation of example, the multisectoral model described in Chapter 2 customers in the absence of competition. is useful mainly to analyze the long-term effects of An enlarged role for markets and competition, though changes in the level and composition of final demand it will undoubtedly improve efficiency and accelerate 181 technological progress, could potentially also have unde- overcoming its weaknesses. This will surely not deter sirable economic and social consequences, including un- China-in the past, a successful pioneer in many areas- emplovment unacceptabh, low (and high) wages, Ibank- from moving ahead. But it arg-ucs foCI a gradual advance, ruptcv y,f J.,t .......-,-.;1= C"2 'i:!- i-Ssa! cc, aiLLIC with experimentation and evaluation at each step, even poor and the backward being left further behind in the though a one-stroke change would in principle involve development process. Increasingly, there will thus be ten- fewer internal inconsistencies. Experience in Eastern Eu- sions between concern for greater efficiency and dyna- rope also suggests the importance of moving steadily and mism, and concern about fairness and about the very of trying to avoid ill-judged steps in the direction of poor. These tensions could become especially great in market regulation that subsequently have to be reversed China, not only because its socialist ideology emphasizes or administratively tampered with, thus creating needless fairness and poverty alleviation, but also because many of uncertainty. Indeed, quite apart from the immense size of China's current social institutions and instruments are ill- China and the need to avoid major mistakes, the type of suited to deal with the emerging problems of a reformed reform envisaged by China's leaders requires a new way economy. Reform in China must therefore include of thinking, and a new pattern of bchavior, from eco- strengthening policies and institutions to address social nomic decisionmakers at all levels that can come only and equity concerns, and especially to help the poor. gradually. Reform in China must also involve strengthening the Not all the steps need be small, though. In some cases, state's ability to direct the future course of economic and despite the greater risk of error, it may be best to intro- social development, combining more limited use of dircct duce substantial packages of simultaneous reforms. Nor controls with much expanded use of indirect controls. need progress be slow. What has been accomplished in Thle range of instruments available to the Government China's rural areas in the past few years has provided not will need to be selectively used in a consistent, purpose- only an example, but also an excellent opportunity and ful, and effective manner. Many of these instruments will indeed a vital need for complementary and similarly rapid need to be designed to influencc decisionmakers through- progress in the urban economy. Though in many ways out the economy, rather than to confine or prescribe the more complicated and troublesome than rural reform, behavior of specific economic units. urban economic reform probably has the advantage of On each of these fronts, there are promising ways for- not needing to be so uniform. Other countries-notably ward, but also problems and hard choices to be faced. In France and Japan in recent decades-have successfully addition, it is hard to overstate the importance and diffi- applied different management methods in different sec- culty of striking a correct balance among the three. Very tors and enterprises, and China should be able to do the few countries have combined state and market regulation sarne, while constantly seeking to refine and improve the in such a way as to produce rapid and efficient growth, mixture. and fewer still have also managed to avoid intolerable In system reform, and in the many other areas covered poverty among substantial segments of their populations. by this report, both the potential for progress and the On the contrary, there are far more countries in which problems involved are so large, and there is so much that unhappy combinations of plan, market, and social institu- is without historical precedent, that an even-handed and tions have produced neither rapid growth, nor efficiency, credible conclusion may be impossible. At a minimum, nor poverty reduction. though, China's long-term development objectives seem There is thus a vital need to guard against losing the attainable in principle, and if recent experience is any strengths of the existing system-its capacity to mobilize guide, there is a good chance that they will be attained in resources, as well as to help the poor-in the course of practice. *lM 1d0- 14O MONGOLIA~~~~~~~~~~~~~~EUEI 4A~ONG 0 300 ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~3NaeTen ' 500-3000 P--Intrnaovnce boundaries Rivers SEPTEMBER 1985 The most recent World Bank publications are described in the annual spring and fall lists. The latest edition is available free of charge from Publications Sales Unit, Department B, The World Bank, Washington, D.C. 20433, U.S.A. U China's ultimate economic objective is to catch up with the industrial countries, while maintaining a socialist system in which the benefits of prosperity are widely shared. During the next two decades, China could add substantially to the major. though uneven, progress that has already been made toward this goal and could lay the foundations for rapid and equitable growth in the twenty-first century, But to do so China will have to steer a difficult course, in both development strategy and system reform. This book examines critical issues over the next twenty years in virtually every aspect of China's economy; agriculture, energy. technology, transport, industrial location, internal and exter- nal trade, population. education, employment, and finance. It finds that success in effectively using available resources, especially people, will depend largely on success in reforming the sys- tem of economic management on three fronts. First, greater use of market regulation is needed to stimulate innovation and efficiency Second. stronger and more effective planning, combining indi- rect with direct economic control, is required. Third, social institutions and policies need to be modified and extended to maintain the fairness in distribution that is fundamental to the Chinese ideals of socialism. It is, nonetheless, vital to guard against losing the strengths of the existing system-its capacity to mobilize resources and to help the poor-in the course of overcoming its weaknesses. This reser- vation will surely not deter China from moving ahead. but it argues for a gradual advance, with experimentation and evaluation at each step. The book's analysis suggests. however, that not all the steps need to be small. In particular, it recommends reforms that could be introduced simultaneously in various sectors, and it argues that the accomplishments in China's rural areas in the past few years provide an excellent exam- ple for complementary progress in the urban economy ISBN 0-8018-3314-0