III. Market Transition Flashcards
The Reform Process : Market
Transition Strategy, Success and
Problems
Lecture 3.1
Historical Background: Political
Relaxation and Rural Breakthrough
- Cultural Revolution ended
- Social experimental reforms - possible
- Success of experimental rural reforms – political dividend
- Anhui province ( Lecture 4.1)
- Farmers shouldered the brunt of the planned
economy - More, deeper and coherent reforms possible
- Transition can move faster
- By 1984 a more coherent framework was crafted
Factors Behind the 1978 Reforms
- Failure of the GLP
- Rapid development of newly-industrialized
economies ( Taiwan, Korea, HK, Singapore) - Reforms to strengthen legitimacy of the CCP
- Failure of the GLP – became obvious
- “Acceptance”
– for replacement* Failure of the GLP - Rapid development of newly-industrialized
economies ( Taiwan, Korea, HK, Singapore) - Reforms to strengthen legitimacy of the CCP
- Failure of the GLP – became obvious
- “Acceptance” – for replacement
What is market-
oriented reform?
- Increases scope for fair competition
* (i) Enables more participants
* (ii) Making rules more transparent and
fair - Gradualist approach
▪ Party remains in control
▪ Reforms started without blueprint/plan
▪ China Low-income developing country
▪ Overemphasis on heavy industries
▪ Neglect simple consumer goods
▪ Debate: reform vs transition
▪ Reform – contribution to growth
▪ Transition – moving towards market
economy
First Phase
1978-1984: Reforming
Micro- Management Institutions
▫ Agriculture/rural sector
▫ Stimulate/improve incentive system to improve
efficiency
▫ Low efficiency, lack of incentives
▫ Macro policy and planned resource allocation
institutions - not intuitively clear
▫ Rural areas - collective farms - back to the
household responsibility system
▫ The relevant historical institution ?
1st Phase: SOE Reform
State-owned enterprise
Replaced profit remittances with corporate taxes
From profit remittances to taxes
Corporate taxes 55% of income
Profit was divided between State and
enterprises
From budget to indirect bank loans
Difference?
Second Phase 1984 - 1993 Reforms on the Resource allocation Mechanism
▫ Allow SOEs to operate outside the
Plan
▫ Source materials in open markets
▫ Expansion of rights to sell their products ( legal/ institutional reforms)
▫ Restrictions on sales of materials under the plan are lifted
▫ Allow flexible supply methods
▫ Setting up markets for production factors
▫ Develop networks to reduce transactions cost
2nd phase - 1985 onwards
1985 onwards : planned allocations in 1984 constant levels for in-quota demand
Number of materials in the plan - reduced at all
levels
Number of goods in the open markets - increased
▫ Prices of energy, metals were raised
▫ Plan prices were increased
▫ Prices outside the plan were liberalized
▫ Naughton’s framework – dual track
▫ Market development was fostered
▫ Naughton’s market reunification
How did the SOE reform work
Govt says: now you can seek resources outside of the planed economy
○ 2nd leg: everything must be replaced by the price system
○ If the 2nd leg will be replaced by the price syste, the number of goods allcoated by the 2nd leg
○ To eventually replace the 2nd leg with th eprice, the levels have to be constant proportion of that constant level over the years become smaller
■ Economy is growing
2nd phase reform: MACRO POLICY environment
The last contradiction — Macro policy reform
Improved market conditions, reforms in the two
trinity ( micro institutions and planned resource
allocation mechanism)
Environment for rent-seeking improved but caused many problems ??
Reform of the Macro Policy Environment
Price reform - consumer goods, intermediate goods and production factors
1978-1984 relative prices were adjusted
Prices of goods in shortage was raised; prices of
goods with surplus was reduced
Dual Track – goods under the plan – set by Gov’t
– goods outside the plan – market-
determined
▫ Second period of price reform
▪ Introduction of market mechanism into price
formation
▪ 1985- onwards dual track was introduced
▪ 1996 - 93% of all retail goods, 79% of all
agricultural products and 81% of total sales of
production factors were priced by the market
▪ Proportion of goods determined by mandatory
prices decreased from 70% in 1979 to 5% in 2000
▫ Exchange rate reform – deferred until section VI -> Internationalization of China’s economy
▫ Interest rate reform - fall’s under financial reform
▫ Price of labor ?
two-phase framework — when is 1st phase and when is 2nd phase
1st phase - 1984 to 1989
2nd phase - 1993 to 1999
First phase
First Phase (1984-1989)
Dual Track
1. Entry
2. Dual track inside State firms
3. Market prices
4. Growing out of the Plan
5. Particularistic contracts
6. Incremental managerial
reforms
7. Disarticulation
Macro stabilization
Macro stabilization
1.Planned instrument for
stabilization
2. High S & I
3. Macro cycles
Integration: Lin’s Trinity and Naughton’s Framework of the FIRST PHASE
First Phase (1984-1989)
Dual Track
1. Entry - Third Leg Micro
2. Dual track inside State firms – Third Leg Micro
3. Market prices – Micro and Planned Resource Allocation ( 3rd and 2nd)
4. Growing out of the Plan - Planned Resource Allocation 2nd Leg
5. Particularistic contracts
6. Incremental managerial reforms
7. Disarticulation
Macro stabilization (Distorted Macro Policy – first Leg)
1.Planned instrument for stabilization
2. High S & I
3. Macro cycles
Second Phase
Second Phase (1993-1999)
Regulatory and Institutional
Restructuring
Market Unification
Recentralization- fiscal reform
Macro austerity
Banking and Finance system
Corporate Governance
WTO membership
Explain the dual track system of the first phase
1978 to 1992
Retained features of the planned economy to provide stability
Introduced market forces
All goods had two prices, a planned and a market price
SOEs operated under the Plan: additional output under market prices
SOEs – introduced to market forces; allowed to learn and adapt
Base quota: sold to government under planned prices
Over the quota: sold are market prices
- Interests are built into contracts government need access to grains and basic raw
materials; farmers, workers are provided with incentives - Two prices can exist as long as markets are
separated /fragmented - Requires strong institutions to administer policy and monitor compliance
(1) Entry in 1st phase
- Barriers were lowered in lucrative SOEs
- Entry to protected industrial sector was
allowed
New firms joined; were never part of the
planned economy
Promoted competition
Ownership was mixed: collective, private
and foreign ( think HK)
(2) Dual Track in SOEs
Planned output – remained
Allowed to use additional capacity to
produce above plan/market goods
Allowed SOEs to learn the market
economy
Can do business with non-state firms
(3) Market Prices - dual track system
Prices outside the plan – flexible determined by supply and demand/market force
- Prices – legal sanction in 1095
- gradual decontrol of prices for
consumer goods
(4) How did they grow out of the plan during the 1st phase
- Materials allocation plan remained fixed in
absolute terms - Size of the Plan relative to economy became
smaller as the economy grew - Faced market prices at the margin – Why?
- Incentives for the enterprises were altered
(5) Particularistic Contracts
- Individual contracts with each SOE
were signed
Delivery of target quota output
No corporate tax – taxes were calibrated
for each firm
Contributions to the materials-balance
plan
(6) Incremental Managerial Reform
- SOEs experienced competitive pressures
from private and foreign firms - Managerial reforms were implemented,
incentives improved - Government continued to retain control
(7) Disarticulation
- Export enclaves were created
- No link/relationship with the rest of the
economy - Sections of economy were separated
from the planned economy - Protect the core/plan economy from
disruption - E.g. SEZs- no links to the rest of the economy
Macro Stabilization
Transition caused many macro
imbalances….
Challenge – transition versus reform
(1) Pillars of Trinity for stabilization
The institutions of the planned
economy – restrain the economy
(2) Continued high S and I
-Erosion of government’s monopoly
position
- household and private sector took
over the savings
Y= C + S + G
Government investment decreased
Household S compensated for decrease
in G savings.
(3) Macro Cycles
Transition and reform caused a self-
propelling cycle
- Decentralization to vigor; to disorder ; to
retrenchment; to stagnation; to
decentralization - Decentralization to vigor: economy is
“pumped” with relaxed entry , easy access to
credit; investment demand shifts;
Vigor to disorder: overheated: constrained by
supply side bottlenecks ?
- Bottlenecks – shortage of inputs/raw
materials; AG> AS - Inflation?
- Disorder to retrenchment
- Government cuts back investment
- How ? back to Pillar 2
- Retrenchment follows
Retrenchment to stagnation: lower
investment leads to less output – lower
GDP growth
- Stagnation leads to decentralization !
Conclusion for 1st phase reform
▫ Reduce entry barriers through reduction of state monopoly power
▫ New firms entered together with adoption of a market economy leading to competition
▫ Induced SOEs to be more efficient or exit ( hard budget constraint
▫ Success not obvious
▫ Reforms were criticized relative to growth rather than to transition
Tiananmen
Massacre when
April to May
1989
Why Tiananmen Massacre
▫ Urban discontent
▫ High inflation eroded real incomes
▫ Implicit social contract not honored
▫ Deng intervened
▫ Reform resumed after 2 years
▫ Market socialist economy endorsed in 1992 by the National People’s Congress
▫ Deng’s Southern Tour – for digression
2nd phase when
1993 onwards
2nd phase
▫ Achievements in the first phase - used to
implement further reforms?
▫ The second phase reform can be viewed in
terms of pre-requisites; regulatory approach
and administrative restructuring
2nd phase focuses on what needed to happen before making changes, such as setting rules, and reorganizing how things are managed.
2nd phase parts (1993-1999)
Second Phase (1993-1999)
Regulatory and Institutional
Restructuring
Market Unification
Recentralization- fiscal reform
Macro austerity
Banking and Finance system
Corporate Governance
WTO membership
