Economic Growth in China SUMMARY BY: JOHN POWERS

2. How Reform Worked in China Author: Xiadong Zhu (2012) Zhu, Xiaodong "Understanding China's Growth: Past, Present, and Future." Journal of Economic Perspectives, 26(4): Understanding China’s Growth: Past, Present, and Future Author: Qian, Yingyi (2002) Qian, Yingyi, "How Reform Worked in China," CEPR Discussion Papers 3447, C.E.P.R. Discussion Papers.

Part 1: China’s Unprecedented Growth  The pace and scale of China’s economic transformation have no historical precedent.  1978: One of the poorest countries in the world. Real GDP per capita = 1/14 of the United States.  Since 1978 GDP has grown at an average rate exceeding 8 percent per year. GDP per capita now 1/5 of the United States.  Largest economy in the world by some measures.

The Past ( )  China was a world economic and technological leader in the “premodern” era. (Song Dynasty 1200)  Leaders in iron output, urbanization rate, advanced technologies.  By end of 15 th century China began to fall behind Western Europe well before Industrial Revolution.  Why? Political-Institutional System, Elite Groups, Resistance to adoptions of new technologies

The Past Cont’d  Imperial System significantly weakened after Opium Wars and Sino-Japanese War of  Continued unrest and WWII prevented industrialization process from gaining momentum until 1950’s. Per capita GDP Declined between  average growth rate of real per capita GDP modest 3%. Government-led Industrialization period.

Government-led Industrialization ( )  Popular thinking – To speed up industrialization process increase investment in heavy industries -> Steel, Concrete, Heavy Machinery  China’s Approach – Limit household consumption and set low prices for agricultural goods -> Force savings and surplus -> Extract from Agricultural Sector and use for investment in Industry.  Not Sustainable, Welfare Consequences, Decreased Agriculture production + Weather Shocks  Great Leap Forward = Great Leap Famine (15 million deaths)

Present  Industrialization policies pursued from created adverse incentives and gross misallocation of resources. Resulted in declining aggregate productivity, recurring food crises and little improvement in living standards.  Enter Deng Xiaoping -> Sought to improve aggregate economic performance and living standards.  Policy: Gaige Kaifang “ reform and opening up”

1978 – Present Cont’d  No grand design of systematic reform policies  Reforms gradual, experimental and decentralized  Total Factor Productivity Grew Rapidly except in State Sector  Government Increased Prices for Ag. Goods  Collective Farming System -> Household-Responsibility System ( fixed quota at set price – excess sold for market rate)

Other Areas of Growth  Productivity growth in nonagricultural sector mainly due to rise of the nonstate sector (5.87 percent)  share of total employment in nonstate sectors increased to 39% ( +15%)  “Fiscal Contracting System” City-county level governments controlled state owned enterprises. Township and Village level governments controlled rural collective enterprises. “Township and Village Enterprises”  Nonstate Employment now 60% of total Employment.

Future  So far when the effect of one set of reforms on productivity seem exhausted, the government finds a way to initiate new reforms that reignite growth. Sustainable?  Evidence from other East Asian economics Japan, Korea, Taiwan suggest the growth must eventually slow.  What will be the key source of growth?

Opportunities  From total factor productivity has risen from 3 percent to 13 percent of U.S. level.  2 more decades of growth and productivity still below Japan in the 1950’s or South Korea and Taiwan in 1960’s.  Opportunity to raise productivity by reducing still-existing distortions and inefficiencies in production.  Despite reforms Banking Sector still dominated by state-controlled banks lending to government projects and state sector business.

2. How Reform Worked in China  Underling China’s reform is a serial of institutional changes concerning the market, firms and the government in the form of “transitional institutions.”  The institutions achieve two objectives -> Improve economic efficiency through incentives and competition. Make reforms a win- win game and interest compatible for those in power.  Evolution of Imperfect Institutions

Effective Reform  Overtook United State in total GDP in term of PPP (purchasing power parity) this year.  Largest economy in the world by this measure.  No question that reform has worked  China has adopted many policies advocated by economists (open trade, foreign investment etc. ) but without liberalization, privatization and democratization. Impressive!

The Challenge of Reform  Not about knowing where to end up but about searching a feasible path toward the goal.  Not enough to study the best practice institutions as desirable goal. One needs to fit imperfect institutions and political reality who function as stepping stones in transition process toward the goal.  Efficiency improvement and total factor productivity badly needed reforms and improvement. China has shown imperfect but sensible institutions can perform.

Conclusions  China is a great example of an argument against simplistic and naïve views on institutional reform. Every economy has tremendous amount of moving parts.  Institutional development needs to fit into initial conditions and be compatible with ruling groups. Does it need to be this way forever? Probably not.  This study does not predict eventual success but argues that reform is certainly not doomed to fail because they do not follow traditional reform.