China's Growth Strategies

8/13/2019 China's Growth Strategies

1/23

ChinasGrowthStrategies*

ByDerekHeadey

InternationalFoodPolicyResearchInstitutewww.ifpri.org/srstaff/headeyd.asp

RaviKanbur

CornellUniversitywww.people.cornell.edu.pages/sk145

XiaoboZhang

InternationalFoodPolicyResearchInstitutehttp://www.ifpri.org/srstaff/ZhangX.asp

August,2008

*ThisisthefirstchapterinRaviKanburandXiaoboZhang(eds.),GoverningGrowthinChina:Equityand

Institutions,Routledge,forthcoming.TheTableofContentsisgivenintheAppendix.

1
http://www.ifpri.org/srstaff/headeyd.asphttp://www.people.cornell.edu.pages/sk145http://www.ifpri.org/srstaff/ZhangX.asphttp://www.ifpri.org/srstaff/ZhangX.asphttp://www.people.cornell.edu.pages/sk145http://www.ifpri.org/srstaff/headeyd.asp


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1. IntroductionThehousehold responsibilitysystem (HRS),dualtrackpricing, townshipandvillageenterprises (TVEs),

special economic zones (SEZs), are all household names amongst development specialists. The two

commoncharacteristicsofallthesereformsarethattheytookplaceinpostreformChina,andthatthey

were innovative hybrid solutions to both the economic and political problems facing Chinese

policymakers.Sincethelate1970sthesereformshavehelpedChinaachieverapideconomicgrowthand

lifthundredsofmillionsofitspeopleoutofpoverty.Theseachievementshavebeengenerallysurprised

most observers, including economists, because many of Chinas development strategies seem to be

unorthodoxandindefianceofconventionaltheoriesofgrowthanddevelopment.

ThemiraculousgrowthrateofChinaseconomyhaspromptedagreatdealofstudy,especiallyamong

economists.One

strand

of

the

economic

literature

decomposes

Chinas

economic

growth

into

labor,

capital,andtechnologyand/orinstitutionalchangecomponents.Mostofthesequantitativestudies(Lin,

1992;Fan,Zhang,Zhang,2004)findthatinstitutionalchangeaccountsforasignificantproportionofthe

observedeconomicgrowth since the reform. Inaddition, the structuralchange from lowproductivity

agriculturetomoreproductiveindustrialandservicesectorsalsocontributedtorapideconomicgrowth.

While this body of literature undoubtedly helps increase the understanding of the major sources of

Chinasgrowth, itdoesnotaddressthequestionofhowthe institutionalchangesoccurred inthefirst

place.

There isanother largebodyof literature, includingmanychapters inthisvolume,examiningparticular

reformmeasurestojustifytheirlogicfromanexpostpointforview.Fromhindsight,manyofthereform

measuresmakegoodeconomicsenseand fitwell intothepoliticaleconomyandgovernancecontext.

Butforanygivenreforms,therearealwaysalternativepaths.Itisnotclearfromtheacademicliterature

how the seeminglyheterodox strategiesarose in the firstplace. In thisvolume, inaddition tohaving

papers from leading scholars, we also include papers from key policy advisors who were actively

involvedin

the

reform

process

and

have

played

an

instrumental

role

in

some

of

the

key

reforms.

Their

insiders view on the internal process of reforms is complementary to the writings of academic

outsiders.

In this opening chapter, we will first review the major views on Chinas development and reform

strategies. Then we discuss why the same forces behind Chinas rapid growth also create new

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challenges.Inthelastsection,wemakesomeremarksontheChineseexperienceandlessons,andtheir

transferabilitytoothercountries.

2. AReviewofChinasdevelopmentstrategiesThere are numerous studies on this topic. Jefferson (2008) provides an excellent review on Chinas

reformexperienceandonhowtheeconomics literaturehastriedtoexplainthatexperience.Onekey

differenceofourchapter isthatwetrytocombineboththe insidersandtheoutsidersviewsonthe

reform process. However, in doing so, we constrain ourselves to the major strands of the existing

literatureratherthantryingtoprovideacomprehensivereview.

RealigningtheeconomytowardsChinascomparativeadvantage

Lin,

Cai,

and

Li

(1996,

Chapter

13

in

this

volume)

and

Lin

(2007)

argue

that

Chinas

rapid

growth

since

the

reformismainlyduetotherebalancingofChinasdevelopmentsstrategyawayfromacentralfocuson

heavyindustry and in the direction of more laborintensive sectors. When the Peoples Republic of

China wasjust established, China lacked capital and faced international isolation. Influenced by the

experienceandideologyoftheSovietUnion,Chinaplacedthedevelopmentofheavyindustryasthetop

priority if itwastocatchupwiththedevelopednationsassoonaspossible.Toachievethisgoal,the

governmentsuppressedtheprocurementprice forgrains, restrictedruralmigration,andsetupsome

barriersbetweenruralandurbanresidents.Sincethisstrategywascapital intensive, itviolatedChinas

comparativeadvantage,

which

was

defined

by

limited

capital

and

abundant

labor,

and

led

to

nearly

threedecadesofstagnationinpercapitaincome.

Since the economic reforms beginning in the late 1970s, the central government has shifted its

developmentstrategiestowardmore labor intensivesectors, initiallyagriculture,andthen increasingly

exportoriented rural industries. In the global context, China possesses an obvious comparative

advantageinthelaborintensivemanufacturingsector.Afterintroducingtheopendoorpolicy,massive

foreigndirect investmentflowed inandmarriedwithChinascheaplabor.Asaresult,bothcapitaland

labor resources were more efficiently allocated, which greatly boosted economic efficiency. Chinas

development path therefore reemphasizes the importance of adhering to comparative advantage in

creatinglaborintensive,exportorientedeconomicgrowth(Krueger1978,Krueger1983,Krueger1984,

Littleetal.1970).Avariationofthisthemeisthatrealignmenttowardscomparativeadvantagemaybe

necessary for accelerated growth, but is not by itself sufficient. Ravallion and Chen (Chapter 5, this

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volume) argue that Chinas post1978 economy also benefited from many of the social and

infrastructural investments of the pre1978 period, especially with regard to education, health and

transportinfrastructure.Thustheyinvokeafairlystandardnotionofconditionalconvergencetoexplain

Chinaspost1978catchup.

However, there are perhaps two problems with the comparative advantage explanation of Chinas

success. Firstly, comparative advantage is nearly always identified expost, or after the event (Wade

1990).Priortoimplementingreformsitmaynotbesoobviouswhatproductsacountrywillhavesome

specificcomparativeadvantage in. Discoveringspecificcomparativeadvantagesmaynotbeachieved

undera laissezfairesystembecause theprocessofdiscoveringcomparativelyadvantageousactivities

entailsrisksanduncertainties,andbecausetheentrepreneursthatcarryoutthesesearchanddiscover

activities

rarely

capture

all

of

the

rewards

to

their

success

(Hausman

and

Rodrik

2003).

Existing

research

onotherEastAsiamiracleshasalsoarguedthatthesecretoftheirsuccesswasinvestinginthegrowth

of futureareasofcomparativeadvantage (Amsden1989,Wade1990).Secondly,this theorydoesnot

explain theprocessofsuccessfultransition inChina.Since the late1970spolicymakers inmanyother

developing countries inAfricaandLatinAmericahaveattempted to shift theireconomiesaway from

capitalintensive sectors towards more laborintensive activities, but many of these countries have

experienced sluggish growth atbest, stagnation atworst.HowdidChinamanage itsownprocessof

reformsosuccessfully?WewillcometothispointwhenreviewingChinasreformprocessasrecounted

inthis

volume

by

key

Chinese

policy

advisors

(Chen,

Chapter

3;

Lou,

Chapter

3;

Du,

Chapter

4).

Incentivesmatter

Itissometimesarguedthatthefirstandmostimportantprincipleofeconomicsisthatincentivesmatter

(Easterly2002).A largebodyof literaturehasdocumented thatduring theplanningeraChinas rural

communes or collectives were dogged by weak incentives due to free rider problems, especially in

agriculturalproduction (Lin,1990).Farmersdidnotwant toworkhardbecause the fruitsof their toil

where shared among others, rather thanjust themselves. Likewise, in the stateowned enterprises

(SOEs), shirking was also reported to be a widespread problem (Xu, 2003), and many SOEs made

significant losses. A major theme of marketoriented reform studies on China is that the post1978

governmentgavestrong incentivesforindividuals includingfarmers,managersand localofficialsto

increaseinvestmentandimproveproductivity.Severalmajorreformsallhavethespiritofempowering

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ordinarypeopleor local governments tomake theirowneconomic choices and reap the rewards of

thosechoices.

Take the Household Responsibility System (HRS) one of the earliest reforms as an example. The

principleoftheHRS isthat individualhouseholdscanclaimtheresidualoftheirownproductionafter

fulfilling the grain quota to both the state and collective units. Because peasants could possess all

remnantsafterfulfillingthestatequota,their interest in increasingproductiondramatically increased.

Theimprovedincentivesystemalsohadtheeffectofimmediatelyresultinginamuchfullerutilizationof

longterminvestmentsmadebytheStateinagriculturalresearchanddevelopment,irrigation,andother

infrastructure.Inthespaceofjustseveralyears,agriculturalproductivitynearlydoubled(Fan,1991;Lin,

1992).AndasshownbyRavallionandChen (2007,chapter5 inthisvolume), itwasruralreformthat

triggered

Chinas

economic

growth

and

alleviated

a

record

number

of

people

from

poverty

in

just

severalyears.

Subsequent SOE reforms followed in the same spirit. Initially, a managerresponsibilitysystem was

introducedtogivetheSOEmanagersmorediscretionarypower inmakingdecisionsandofferingthem

performancebasedpaypackages.However,becauseSOEshadtotakecareofemployeesthatwerenot

coveredby socialwelfarebyproviding theirownhousing,healthcareandpension,SOEs still found it

hardtocompetewiththelowercosttownvillageandprivateenterprises.Bythemiddleandlate1990s,

mostsmall

and

medium

SOEs

were

privatized

or

experiencing

large

numbers

of

layoffs.

Avariantof theincentivesmatterexplanationofChinasgrowth focusesondecentralizationwithin

Chinasgovernment.Mostofthe literaturehaspaidparticularattentionto fiscaldecentralizationasa

major drive of Chinas economic growth (Jin, Qian, and Weingast, 2005, Chapter 14; Cheung, 2008).

Duringcentralplanning, localgovernmentshad to turn inmostof their local revenues to the central

government, and there was no clear rule as to how central finances were to be devolved to lower

governments.Sincethe1980sChinahasadoptedaseriesoffiscalreformsaimedatimprovingthefiscal

contractarrangementsbetweendifferent levelsofgovernments.After fiscal reforms, localandupper

level governments shared fiscal revenues according to a predetermined formula. Since local

governments can keep a significant portion of the increased local revenues, they face stronger

incentivestoincreaselocalrevenue(notetheanalogytotheHRS).

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Of course, fiscal decentralization need not result in faster growth unless local governments have

incentives to use increased finances productively, yet governance reforms in China did indeed

complementfiscaldecentralizationwithimprovedincentives.ModernChinahasalwayshadcentralized

meritbasedgovernance structure. In theplanningeconomyera, theevaluationofcadreswas largely

based on political performance. However, since the Chinas reforms initiated in 1978, political

conformity gaveway toeconomic performance and other competencerelated indicators as the new

criteriaforpromotion.ThepromotionofChinacadresisnowlargelybasedonyardstickcompetitionin

severalkeyeconomicindicators,includingeconomicandfiscalrevenuegrowthrates,andsomecentral

mandates,suchasfamilyplanning(LiandZhou,2005,Chapter12,thisvolume).These indicatorshave

been written into local leaders contracts. This creates tremendous pressure for local government

personnel tocompetewitheachother through superior regionalperformance.Consider the fact that

China

has

over

2,000

counties

and

that

because

capital

is

largely

mobile

these

counties

have

to

compete

for capital in a probusiness environment wherein investors are trying to maximize returns (Cheung,

2008). Strong incentives for local governments to achieve rapid economic growth helps explain why

Chinahasgrownsoquicklydespitealackofwelldefinedpropertyrightsprotectioninthedefactorlegal

system (Zhang,2007): competition serves as thedisciplinarymechanismbywhich localgovernments

provide dejure protection of investors property rights. Of course, the existence of strong growth

oriented incentives also explains why the protection of the property rights of other groups, such as

farmers,hasbeenweak(Zhang2006a).

Tosummarize,theChinesecentralgovernmenthasusedbothfiscalincentivesandpersonnelpoliciesto

ensure that local governments use their financial empowerment to increased economic growth.

Althoughthereisnotmuchsystematicinternationalevidenceontheimportanceofdecentralizationfor

economicgrowth,aresearchprogramonDecentralization,FiscalSystemsandRuralDevelopmentinthe

mid1990sacross19countries(orprovincesthereof)foundthatJianxiprovince inChinaeasilyhadthe

highestdegreeofdecentralization(Mcleanetal.1998).Otherstudieshavealsopointedoutthatmaking

decentralizationand localempowerment schemeswork requires the fulfillmentofa largenumberof

conditions inadditiontofiscaldecentralization (MansuriandRao2004,Prud'homme1995).Chinahas

benefited fromanumberof favorable conditionsethnichomogeneity, landequality, strongcentral

governance but Chinas experience also reiterates the importance of good incentives for local

governments, even if the mechanism by which governors are disciplined is not the electorate. So

although theprincipleof incentives is ratheruniversal, theexact formsused to improve incentives in

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Chinamaynotbeeasily transferable.Moreover, fiscaldecentralizationcancomeatacost,especially

insofar as it increases spatial inequality (Kanbur and Zhang 2005, Chapter 6 in this volume; Zhang

2006b).

Experimentationandmarginalreformasasolutiontorisk,uncertaintyandopposition

As argued above, good reforms can be very difficult to identify ex ante. But even if a good reform

measure has been identified, reformers still need a reform strategy capable of overcoming or

circumventingpoliticalresistancetoreform.Indeed,thepoliticalchallengeofreformcanbeatleastas

difficult as the intellectual challenge of identifying the economic direction of reform. Traditional

economic models of development generally do not address the political viability of reform (Ahrens

2002).Thepublicchoiceschoolwhichattemptedtoapplyeconomicchoicetheoreticalmodelstothe

political

arena

seeks

to

explain

policy

decisions

in

terms

of

individual

incentives

and

the

outcomes

of

deliberations between political groups e.g. factions, lobbies, political parties (Rodrik 1996). But such

modelsaregenerallydissatisfactory inthiscontextbecausetheyassumethatgoodpoliciesareknown

exanteanassumptionwehavealreadyquestioned andthatthepreferences(ideologies,beliefs,

normative objectives) of individuals and groups are exogenous. This second assumption is also

insufficient because as the chapters in this volumeby the reform insiders demonstrate, successful

politicalreformoftenrequirespersuasion,or,moreexplicitly,changingpeoplespreferences,ideologies,

beliefsandnormativeobjectives.

In that vein, institutional and behavioral economics generally offers a more flexible framework for

thinkingabouttheprocessofreform.AccordingtoDenzauandNorths(1994)notionsofsharedmental

models,insituationsofuncertaintysuchasChinain1978 peopleactinpartuponthebasisofmyths,

dogmas, ideologies and "halfbaked" theories. Moreover, the psychological notion of cognitive

dissonance suggests that people do not easily disassociate themselves from their existing mental

models,especiallywithoutoverwhelmingevidencetoviolatethe incumbentmodel.1Chinas insulated,

1Inpsychology,cognitivedissonanceisdefinedasanuncomfortablefeelingorstresscausedbyholdingtwo

contradictoryideassimultaneously(e.g.suchassocialismworksandmarketswork).Thetheoryofcognitive

dissonanceproposesthatpeoplehaveafundamentalcognitivedrivetoreducethisdissonancebymodifyingan

existingbelief,orbyrejectingoneofthecontradictoryideas.FromthisviewpointmanyofDengsstatementscan

beseenasmeansofdiffusingcognitivedissonance.Forexample,DengXiaopingemphasizedthat:

"Planningandmarketforcesarenottheessentialdifferencebetweensocialismandcapitalism.Aplanned

economyisnotthedefinitionofsocialism,becausethereisplanningundercapitalism;themarket

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ideologydriven,singlepartypre1978societymeantthattheorthodoxsharedmentalmodelofChinas

leadersanditspeoplefoundedonMaoistandSocialistprinciples wasasignificantbarriertomarket

oriented reform. Changing this model was therefore both an important precondition of successful

reform,anda resultof reform.Akey insight, then, from theinsiderchaptersof thisvolume is that

Chinaseliteschosereformstrategiesthatinvolvedminimizedpoliticaloppositiontoreform.

Inthepoliticalarena,Dengandothermarketorientedreformersmadeuseoftwostrategiesaimedat

changingthesharedmentalmodelofthenation.InfluencingthemindsetofChinasrulingelitewasthe

firstobstacle.DengXiaopingwasrelativelyuniqueinthathehadlivedasubstantialperiodoftimeina

Westerncountry (France)andhad seen thebenefitsaswellas thecostsofcapitalism,anexperience

whichevidentlymadehisownattitudesrelativelypragmatic. Inorder tochange themindsetofother

leaders

he

encouraged

them

to

take

education

tours

overseas,

and

persuade

Singapores

leader,

Lee

KuanYew,tovisitChinaandspeakontheissueofreform.Downtheline,however,itwasalsoimportant

to address the mindset of the greater population, which had long been taught to venerate Maoist

Socialism.ChinascontroloftheStatemedia,ofeducation,anditstraditionofhierarchicalgovernance,

meant that the Chinese leadership could very effectively publicize the direction of reform in China.

Famous public announcements such as the Four Modernizations, "socialism with Chinese

characteristics",and"seekingtruthfromfacts"allhelpedtheshiftpeoplesmindsets,andsignaltothe

broader economy that China was heading in a new direction. Whilst economists largely ignore such

hyperbole,the

political

economy

literature

regularly

emphasizes

the

importance

of

credible

reform,

and

more recent researchhasalsoemphasized the importanceofsoft institutionalchange (in thecaseof

India,forexample,seeRodrikandSubramanian(2004)).

In the economic arena, Chinese reformers used two related strategies to simultaneously promote

economiclearningandovercomepoliticalresistancetoreform:(1)reformsatthemargin(e.g.dualtrack

pricing inagricultureandhousing);and(2)moreexplicitexperimentation.2Theeconomicroleofthese

policiesisselfdiscoveryinthefaceofuncertainty.ToquotetheoftcitedphrasefromDingXiaoping,the

economyhappensundersocialism,too.Planningandmarketforcesarebothwaysofcontrolling

economicactivity."

2Wenotethatalthoughmarginalreformshavesomefeaturesofexperimentation(likeexperiments,theymaybe

morereversiblethanwholesalereform,andtheyalsopromotelearning),buttheyalsohavesomedistinguishing

featuresrelativetootherexperimentalreforms.

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supreme leader in theearly reformperiod,Chinas reformhasbeencrossingthe riverby feeling the

stones.Thepolitical role ismorepragmatic,asnoted in theinsiderchapters in thisvolume,which

emphasize the important role that experimentation in overcoming political resistance to reform.

However,someeconomistoutsidershavealsoemphasizedthisrole.

(1) ReformsatthemarginStudies on the dualtrack price reform (Lau, Qian, and Roland, 2000) are a noted example. Prior to

reform, inthehierarchicalpropertyrightandentitlementsystem,urbansectorsandparticularlystate

ownedenterprises(SOEs)cameunderthecontrolofthecentral,provincial,andmunicipalgovernments

andtherebyenjoyedprivilegedaccesstoavarietyofscarcematerialsandcapitalgoodsthroughquotas.

There were few quotas, however, for other lowerlevel stateowned enterprises and even fewer for

collectively

owned

enterprises.

The

dual

pricing

system

allowed

state

owned

enterprises

to

sell

unused

inputquotaatmarketpricestotownshipandvillageenterprises(TVEs)thatwereoutsidethecommand

economy.Suchexchangesnotonlyprotectedtheoriginalprivilegesofhigherrankingentitlements,but

alsopresentedTVEswithopportunitiestoaccessindustrialinputsviamarketchannelsandtoparticipate

in the market economy. In other words, the dual pricing system provided a functional pricing

mechanism for rentsharing through both hierarchical and market systems. Because the dualprice

reforminitiallydidnothaveanegativeimpactontheSOEsentitledplannedquota,theirresistancewas

muted.Overtime,astheprivatesectorgrewrapidlyandthemarketpriceandplannedpriceconverged,

thedual

track

was

eventually

unified

into

asingle

track,

or

market

price.

The urban housing reform makes use of the same compensation principle. In the socialist period,

Danwei (SOEsorgovernmentunits)were responsible forprovidinghousing tourban residents.Along

witheconomicreform,SOEswerecompelledtobemoreprofitdriven.Thereforetheprovisionofpublic

housingwassloweddownandcouldnotkeepupwithincreasingdemand.Thisforcedthegovernment

toundertakeurbanhousingreforminthe1990s.Thehousingreformpackagestreatedtheinsidersand

outsiders differently. Those already living in public housing were allowed to buy their occupied

apartments at a discount price. However, employees buying new houses were made to pay market

priceswithemployerscontributingsomematchingfundstoaspecialhousingaccountsoastoeasethe

burdenofpurchase.Underthispolicy,thehousingmarketwasprivatizedquicklywithoutcausingmuch

resentment. More importantly, the emergence of a semiprivate real estate market sent powerful

signals to consumersandproducers.Since theurbanhousing reform,Chinasconstruction sectorhas

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boomed.Injustfifteenyears,percapitalivingspaceincitieshasjumpedfrom8.8squaremetersin1986

to15.5squaremetersin2001(ChinaStatisticalYearbooks).

(2) ExperimentationandlearningbydoingPragmatism,trialanderror,evidencebasedpolicymaking,andexperimentationwithsmallscalepolicy

reformsthatare laterscaledup,areallkeyfeaturesofChinasreforms.Mostsuccessfulreformshave

experienced pilot experiments and impact evaluations before being scaled up. Learning by

experimentation isakeystrategywhenreformersfacehugeeconomicandpoliticaluncertainty.When

facingchoicesneverseenbefore,itisextremelyriskyforagentstomakeradicalchoices.Foranyreform

goal, there are potentially many different paths to take (Lou, Chapter 3, this volume). Due to

uncertainty, it ishard tojudgewhichoption ismore feasible from theexantepointofview. In such

circumstances,

experimentation

can

be

a

useful

tool

to

search

for

more

information

and

for

testing

and

updating prior hypotheses. Experiments yield information to help understand what works and what

doesnot.Thus,even failurescanbehelpfulbecause theycanhelpeliminateunfavorableoptions,as

shownbyLuo(2008).Thefailureofhis laissezfairepricereformexperiment inHebeiProvincehelped

himcomeupwiththeideaofdualtrackpricereform,whichisanimportantexampleofanexperiment

whereWashingtonConsensuswisdomwascontradicted.Moreover,experimentationcanhelpcontrol

the possible disastrous consequence of wrong choices. A wrong choice, at large scale, may be

irreversible,and thereforemayundermine the credibilityand stabilityof thepolitical leadership,and

weakenoverall

learning

capacity.

An important point to note here, in the context of emergence of randomized microeconomic

experimentswithindevelopmenteconomics(Duflo,2005),isthatmostofChinasexperimentswerenot

random.Specifically,experimentswereofteninitiatedinisolatedpoorareas.Asshowninthechapterby

Du(Chapter4,thisvolume),the leaderspurposively initiatedthehouseholdresponsibilitysystemasa

pilot reform inseveral remoteprovinces inorder toavoidminimize thepotentialcostsof failureand

reduce the political resistances. Similarly, the Wenzhou area, which used to be a remote region in

ZhejiangProvincebut isnowoneofthemostdynamicregions inChina,receivedspecialpermissionto

be a pilot region for rural industrializationprecisely because of its isolation at the time (Zhu,2008).

Underthespecialpolicy,Wenzhoumadeboldexperimentsinreformingtownvillageenterprises(TVEs)

and legalizingprivate firms.Afterobserving its success,mostTVEsand smallandmediumSOEswere

privatizednationwidebythe late1990s.Althoughsuchexperimentswerenotsorigorouslyconducted

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astoincludecontrolgroups,thepilotsenabledresearchersandpolicymakerstoobservewhatworked

andwhatdidnotontheground.AnotheradvantageofChinasapproachisthatitinvolvedanelement

of experimentation in macroeconomic reform, whereas contemporary randomized experiments are

confinedtomicroeconomicexperiments(Rodrik2008).Dualtrackpricesandspecialeconomiczonesare

twosuchexamples.

Such experimentation has been particularly important in overcoming several major obstacles to

effectivereforminChina,relatedtothecountryssize,itsdiversity,andthehistoryandstructureofits

hierarchicalpoliticalsystem.Fora largeanddiverseeconomy likeChina, it isverydifficulttoderivea

singleonesizefitsallblueprintforreformsimplybyapplyingtextbookeconomictheories.Instead,trial

and error processes can help discover local best practice. Second, the basis for formulating sound

market

oriented

policies

in

1978

was

limited.

Few

bureaucrats

had

any

formal

training

in

orthodox

economics,norevensubstantialexperienceof living inmarketeconomies.Chinese reforms therefore

felt compelled to use experimentation as a collective learning mechanism. Moreover, successful

Chinese reformers moved quickly to overcome Chinas limited research base by employing young

recruitstoworkinthinktanks,suchastheChinaRuralDevelopmentandResearchCenterledbyMr.Du

Runsheng,theauthorofChapter4 inthisvolume.Such institutions inturnhelpedovercomearguably

the most binding constraint to effective decisionmaking in China, information asymmetry. Because

Chinasbureaucratsare rewardedbasedonperceivedmerit,bureaucratsalwayshavean incentive to

falsifyfacts,

as

was

the

case

in

the

Great

Famine

in

which

statistics

on

experimental

yields

were

grossly

falsified. Institutions such as theChinaRuralDevelopment andResearchCenterplayed a key role in

reducing these information biases by screening best practices and feeding them back to top policy

makers(Keyser,2003).

Pressureasacatalystforreform

People evaluate the risks and payoffs with regard to the consequence of proposed policy change.

However,they

often

have

different

(subjective)

perceptions

of

the

uncertainty

related

to

change.

Exogenous social, economic and political pressures though adverse in some sense can help

policymakersinducepolicyreformsthat,incalmertimes,wouldgenerallyberesisted.

Thepressurewhichstimulatedtheearliestreformsofthepost1978erawasthethreatofeconomic

crisis. A crisis can have a silver lining in the context of reform in that it may help update peoples

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perceivedrisksandpayoffsregardingalternativepolicyoptions,andtherebyrealignpolicyprioritiesso

thatnewapproachesemergeoutofpreviousfailures. Sodespitethenegativeeffectsofanycrisis,crises

necessitate change and reexaminations of current policies, in a manner analogous to Joseph

Schumpetersnotionofcreativedestruction.

After the Cultural Revolution (19661976) China was on the verge of collapse under the planned

economy system. More than two thirdsof thepeople livedunderone dollarper day (Ravallion and

Chen,2007,chapter5 in thisvolume).With stagnantagriculturalgrowthand fastpopulationgrowth,

food was in short supply. At the onset of reform, it seemed China faced extremely high barriers to

escapingthelowlevelequilibriumtrapwherepovertypersisted.However,asshowninchapter4byDu,

one of the architects of Chinas rural reform, crisis may trigger reforms. After the end of Cultural

Revolution,mostofthetop leadersandthemassesrealizedthattheplannedsystemwasnotaviable

optionanymore,

even

ifthere

was

still

uncertainty

and

debate

as

how

next

to

proceed.

Under

these

circumstances, top leaders were more willing to listen to different opinions and allow open policy

debate. Inotherwords,thecrisisprovidedwouldbereformerswithawindowofopportunitytopush

new agendas. Significant reforms do not come automatically and require policymakers to seize the

dayinatimelyfashion.

Onenotedexample istheruralreformdocumentedbyDu.Chinesefarmers,whohadsufferedterribly

undertheGreatFamineinthelate1950sandearly1960s,stillhadavividmemoryofthedisaster,and

knewthat

collective

farming

did

not

work,

especially

in

times

of

crisis.

So

with

another

imminent

weather shock looming in 1977, the local government in Fengyang County, Anhui Province the

provincehardesthitbythefamineinthelate1950s3 decidedtocontractthecollectivelandtofarmers

becausetheyknewthecollective farmingsystemcould leadtoanother famine intheeventofsevere

shocks.Yao(2007)providesanextensivereviewoflandtenurechangesinruralChinaandhowtheHRS

was successfully scaled up (again, largely because farmers elsewhere had similarly critical views of

collectivefarming).

Chinasjoining

the

World

Trade

Organization

(WTO)

is

another

example

of

the

use

of

an

external

pressureto invokeand lockinreform.Inthe1990s,bankingreformmetenormousresistancebecause

Statebanksdidnotwanttogiveuptheirmonopolypositions.Manylocalgovernmentsalsoopposedthe

3AccordingtoYang(1996),themortalityrateinAnhuijumpedfrom11.9intheperiodof195658to68.6per

thousandin1960,thehighestamongalltheprovinces.

12


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reformbecausetheywereafraidof losingtheirabilitytodirectcredit,whichmade itverydifficult for

Statebankstoreallyoperateascommercialbanks.Largelyasameansofforcingfurtherreformsinthe

bankingandotherkeysectors,thetopleadersmadeaboldmovetoenterChinaintotheWTO.Although

theWTOgavedomesticbanksa fewyearswindowofprotection, in theend,mostof thebarriers to

entryinthebankingsectorhadtoberemovedsuchthatStatebankswereeventuallyforcedtocompete

onalevelplayingfield.ByusingexternalpressurefromtheWTOaccessionthegovernmentwasableto

induceaseriesofreformswithinStatebanks.Althoughnotcomplete,mostChinesebankshaveshedoff

badloans,severalmajorstatebankshavelistedtheirstocksinoverseasmarketsandaresubjecttothe

scrutinizingofinternationalfinancialmarkets,andlocalbankbranchesnowfinditmucheasiertorefuse

loanstolocalofficials.Thustheuseofexternalpressurelargelyachieveditsimplicitgoals.

AnoteonthecompatibilityofeconomicandpoliticalexplanationsoftheChinesemiracle

We have discussed four basic types of explanations of Chinas remarkable economic success: (1)

comparativeadvantage(andconditionalconvergence);(2)incentivesmatter(fiscaldecentralization

and realignment of incentives towards growthmaximizing activities); (3) experimentation (as an

economic and political discovery mechanism); and (4) pressure and crisis as inducers of reform. We

conclude this sectionbynoting that all theseexplanations arehighly compatible and complimentary

with each other, and that together they comprise a compelling and holistic explanation of Chinas

economicmiracle.

This holistic explanation of Chinas success, which incorporates both the outsiders and insiders

viewpoints,runsasfollows.TheconventionaleconomicexplanationofChinasgrowthmoreefficient

utilizationofChinasexistingendowmentsconvincinglyaccountsfortheproximatecausesofChinas

growth,butdoesnotexplainthecauseofreformorwhytheprocessofreformitselfwassosuccessful

bothpoliticallyandeconomically.Thesuccessfulprocessofreformisinturncompellinglyexplainedby

boththeincentivesmatterandexperimentationarguments.Indeed,bothargumentsinvokeseveral

ofthesameingredientsofsuccessfulreform,suchasovercominginformationasymmetriesbyderiving

local solutions to local problems, and discovering comparative advantage through trial, error and

observation. Experimentation and marginal reforms, however, also served to overcome political

constraintstoreformbycompensatingwouldbe losersofreform,andconvincingpotentialopponents

of thebenefitsof reformby reducing theuncertaintyofoutcomesof reform.Finally, thecatalyst for

13


14/23

reformwasaneconomicandpoliticalcrisisthatjoltedChineseleaders,andtosomeextentitsordinary

people, into revaluating theirmentalmodelsofwhere theChineseeconomy shouldbeheading.This

storyneednotprecludeotherfactors,suchastheimportanceofgoodleadership(Jones2005)orgood

luck,buttogetherthesefourargumentscertainlyprovideacompellingexplanationofthreedecadesof

rapideconomicgrowth.

3. Afterthreedecadesofgrowth:thechallengesofthepresentandthefutureAfterthreedecadesofspectaculareconomicgrowthinChina,theproblemisnolongerhowtoachieve

growth but how to manage growths consequences and how to sustain growth. Chinas spectacular

growthandpovertyreductionhasbeenaccompaniedbyrising inequality,environmentaldegradation,

and

increasing

social

tensions.

The

institutions

that

have

brought

rapid

growth

so

far

are

now

under

stress,andthereisaneedtoreformandinnovateonthisfrontinordertosustainrapidgrowth,andto

obtaingrowthwithequity(Lindbeck,2008,Chapter10inthisvolume;Ji,Chapter11inthisvolume).

Rising inequality is one of Chinas most serious problems (Demurger et. al., 2007, Chapter 7 in this

volume; Benjamin, Brandt and Giles, 2005, Chapter 8 in this volume). In particular, the regional

dimensionofinequality rural/urbanandinland/coastal dominatesinacountryaslargeasChina,and

especiallywithitsparticularhistory.RegionalinequalityhasbecomeakeyissueforChinaandanumber

ofinterventionshavebeenintroducedtoaddresstheproblem.ThesearediscussedinFan,Kanburand

Zhang(2009).

As shown by Kanbur and Zhang (2005, Chapter 6 in this volume), the pattern of Chinas regional

inequalityclosely followsthehistoryof itsdevelopmentstrategies inthepasthalfcentury.Theheavy

industry oriented development strategyjustified the creation of the household registration system

(hukou) which was a major contributor to the large ruralurban divide. The opendoor policy, which

grantedpreferentialtreatmenttocoastalareas,hashelpedthecoasttobetterexploit itscomparative

advantageintheinternationalmarkets,butleftmanyinteriorprovinceslaggingbehind. Similarly,fiscal

decentralization policy promoted local government officials to develop their own economies, but

differencesininitialendowmentstendstoleavetheeffectivetaxrateregressiveacrossChineseregions

(Zhang,2006b).Regionswithbetterendowments therebyhavemore revenues left to invest inpublic

goodsand improvebusinessenvironmentafter turningoveraportionof their fiscal revenues to the

upper levelgovernmentandmaintainingthedailyoperationoflocalgovernment.Incontrast,the local

14


15/23

governmentsinpoorregionshavedifficultyincompetingwiththegovernmentsonthecoasttoattract

investment and develop the local nonfarm economy. Their local revenues are sometimes barely

sufficienttocoverthesalariesofcivilservantsonthepublicpayroll.Consequently,theyaremorelikely

to levy heavy taxes on existing enterprises, worsening the business investment environment. In

summary, the successful development strategies mentioned in the above section also have some

deleterioussideeffects.

In responding to rising ruralurbandisparityand stagnatingagriculturalgrowth,Chinahas launcheda

newruralmovementcampaign inthepastseveralyears(Chen,Chapter3 inthisvolume).Agricultural

taxation has been abolished, the government has provided direct subsidies for grain production.

However, significant challenges still remain. Facing rising food and fuel prices, the government has

placedaceilingonthegrainprocurementprice,whichmaydampenfamersincentivestoincreasegrain

productionin

the

long

run.

The interjuridical competition is a key contributing factor to the increasingly serious environmental

problems. In order to attract investment, many local governments loosen their environmental

regulations to allow polluters to operate as long as they generate lucrative revenues for the local

government.Intherapidlyindustrializingcoastalareas,suchasJiangsuProvinceandZhejiangProvince,

the degree of water pollution and industrial waste hazard is alarming. The cost of cleaning up the

environmentproblemmayeatupalargeportionofthegainsfromindustrialization.

Theinvestmentdrivengrowthmodelalsoinduceslocalofficialstocolludewithinvestorsattheexpense

oftherightsofindividuals(Zhang,2007;Chow,Chapter9inthisvolume).Inordertoattractinvestment,

manylocalgovernmentsprovidepreferentialtreatmentto investors,suchasfreeland.Intheprocessof

procuringfarming landfor industrialorothercommercialuse,thecompensationtofarmerswasoften

farbelow themarket level.Resenting thisunfair treatment,manyrelocated farmers filedpetitions to

theupperlevelgovernmentforhelp,andlanddisputeshavebecomeabreedinggroundforsocialunrest

all over China (Yu, 2003). How to make local government officials accountable has become an

increasinglyimportant

issue.

4. ConcludingRemarksChinasexperiencesince1978hastaughteconomistsmany lessonsabouttheprocessofdevelopment,

but also about the study of economic development. Our reading of Chinas history, and of the

15


16/23

explanationsthateconomistshaveproposedtoexplainthathistory,reiteratetheincreasinglyaccepted

conclusion that while economic principles may be universal ingredients of successful development

strategies, thespecific recipesthatembody theseprinciples tend tobehighlycontextspecific (Rodrik

2007, Headey 2008,). For example, Chinas strategy contains all the usual elements of successful

developmentgettingincentivesright,adheringtocomparativeadvantage,providingsecure(butoften

notprivate)propertyrights,investinginhumancapital,andachievingrapidagriculturalgrowthbutthe

pathwhichChinatookfromplantomarketwasalmostentirelydistinct.

ThisconfirmationofChinasadherence to theseprinciplesshouldnotbeunderestimated,butChinas

uniquehistory,itsenormoussize,anditsdistinctiveeconomicsystemshouldalsoremindusthatChinas

specificreformstrategiesareunlikelytoapplytootherdevelopingcountries,especiallysmallcountries

and thosewithverydifferent institutionalhistories.Forexample, smallcountries that relyheavilyon

externaldonors

for

both

finance

and

technical

assistance

will

typically

have

alimited

policy

space

in

whichtoformulateheterodoxpolicysolutions.Similarly,democracies,evendemocraciesofsimilarsize

suchas India,have limitedabilitytoexperimentthewayChinadid.Nordotheytypicallyprovidesuch

strongincentivesforbureaucratsorelectedofficialstomaximizegrowth.

Given the uniqueness of Chinese history, perhaps the key lessons of Chinas reform experiences are

mostvaluableforChina itself.Withrapideconomicgrowthandballooningrevenues,policymakerscan

easilybecomecomplacentandoverconfident, ignoringthepragmaticandexperimentalapproachesof

yesteryear.Data

collected

by

Heilman

(2008)

shows

that

the

proportion

of

policy

reforms

with

experimentation componentshasdeclined from around50% in the1980s, to40% in the1990s, and

downfurthertojust20%since2001.Thesestatisticsareconsistentwithwhatisbeingobservedonthe

ground.Thenew laborcontract law (Cheung,2008),whichwaspassedwithout littleexperimentation

andlimitedconsultationin2007,isanotedexample.ThelawgeneratesmuchcontroversyinChina.Forexample, the law stipulates that an employer must sign an open term contract an employee after

finishingtwofixedtermcontracts.Thisgreatlydiscouragesfirmsfromhiringworkers.Thereformstoriespresentedinthisvolumehighlightthevirtueofpragmatismandexperimentationinthereformprocess.

Toovercometheemergingchallenges,itisimportantforChinesepolicymakerstomaintainapragmatic

attitudetoreform,andtokeepfocusingoninnovationsfromtheground.Whenpolicymakersbecome

morecomplacent,theyaremorelikelytomakecentralizedautocraticdecisions,neglectingthewisdom

of localknowledgeandthevirtuesofexperimentation. Inessence,Chinarunstheriskofkickingaway

theladderbywhichithasreacheditscurrentheights.ThisisakeylessonforChina,fromitself.

16


17/23

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20/23

AppendixGoverningGrowthinChina:EquityandInstitutions

Editedby

RaviKanburandXiaoboZhang

Overview

1.ChinasGrowthStrategies

DerekHeadey,RaviKanburandXiaoboZhang

PARTIPolicyChallengesandOptions

2.ChinaisAlreadyCapableofSolvingtheThreeDimensionalRuralProblem

XiwenChen

[KeynoteAddressatthe2006ChineseEconomistsSocietyConference]

3.TwentyYearsReviewandDeliberation:TheChoiceofPrioritiesinReform.

JiweiLou


20


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4.TheCourseofChinasRuralReform.

RunshengDu

PARTIIPovertyandInequality

5.China's(Uneven)ProgressagainstPoverty,

MartinRavallionandShaohuaChen

[JournalofDevelopmentEconomics,82(1):142,2007.]

6.FiftyYearsofRegionalInequalityinChina:AJourneyThroughCentralPlanning, Reformand

Openness,

RaviKanburandXiaoboZhang

[ReviewofDevelopmentEconomics,9(1):87106,January2005.]

7.EconomicLiberalizationandRisingSegmentationinChinasUrbanLaborMarket,

SylvieDemurger,MartinFournier,LiShiandWeiZhong

[AsianEconomicPapers,5(3):5699,2007.]

21


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8.TheEvolutionofIncomeInequalityinRuralChina

DwayneBenjamin,LorenBrandt,andJohnGiles

[EconomicDevelopmentandCulturalChange,volume53(4),(2005),pages769824.]

9.RuralPovertyinChina:ProblemandSolution

GregoryChow


PARTIIIGovernanceandInstitutions

10.EconomicSocialInteractionDuringChinasTransition

AssarLindbeck


[EconomicsofTransition,16(1):113139,January,2008]

11.RedefiningRelationsBetweentheRuleofLawandtheMarket

WeidongJi


22


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12.PoliticalTurnoverandEconomicPerformance:TheIncentiveRoleofPersonnel ControlinChina

HongbinLiandLiAnZhou,2005

[JournalofPublicEconomics,89:17431762,2005.]

13.TheLessonsofChinasTransitiontoaMarketEconomy

JustinYifuLin,FangCaiandZhouLi

[CatoJournal,Volume16(2),1996]

14.RegionalDecentralizationandFiscalIncentives:Federalism,ChineseStyle,

HehuiJin,YingyiQian,andBarryR.Weingast

[JournalofPublicEconomics,89(910):17191742,2005.

23

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