Enterprise Reform and Private Sector Development Some Possible Lessons from China Qimiao Fan, the World Bank

Presentation Outline Is China Relevant for Madagascar? China’s Enterprise Reform and PSD Experience Some Possible Lessons

China and Madagascar Value Added by Sectors, % of GDP Is China Relevant for Madagascar?

China and Madagascar Employment by Sectors, % of Total

China and Madagascar GDP per capita in US$

Both China and Madagascar are low-income developing countries Similar initial conditions in late 1970s and early 1980s with economy dominated by agriculture and state-owned enterprises in the urban sector Despite similarities in initial conditions, performance differed significantly in the past two decades in the two countries Policies do matter

China’s Enterprise Reform and PSD Experience Liberalization of the Agricultural Sector Encouraging the Growth of the Non-state Sector Through Liberalization from the Start of Reforms  Township and village enterprises (TVEs)  Special Economic Zones (SEZs) and Foreign-invested enterprises  Encouraging the Growth of Small and Medium Enterprises Gradual but Progressive Reform of the Stated- owned Enterprises (SOEs)  Management autonomy and responsibility  Dismantling central planning  Ownership reforms

Liberalization of the Agricultural Sector  Started with one village by the villagers in Eastern China in 1978  Rapidly extended to the rest of the country in 1979  Led to the decollectivization of the rural society  Individual household agriculture became the norm  Free market transactions for agricultural commodities  Eighty percent of population affected  Between 1979 and 1984, agriculture grew about 10% per annum  Agricultural production increased 126%  Per capita consumption doubled in real terms

Encouraging the Growth of the Non-state Sector Through Liberalization from the Start of Reforms  Township and Village Enterprises (TVEs)  Developed to initially support the agricultural production needs of the rural population  Owned by members of the township or village and/or governments at the township/village level  Operated completely outside state planning  Strongly encouraged by the central government  But lacked clear ownership and access to financing  Contributed 25% to GDP growth between 1979 and 1994  Share of total employment increased to 20% by 1999  Share of exports increased to 45% by 1997  TVEs provided significant competition to SOEs and also made reform of SOEs much easier by demonstrating the benefits and creating employment

 Special Economic Zones (SEZs) and Foreign-invested Enterprises  Important part of the open-door policy  Set up in the coastal provinces to experiment with various reforms, to attract FDI and to promote exports  The key policies are liberalization allowing both foreign and domestic private investors to invest in most sectors and fewer regulatory barriers  Local governments in the SEZs have significant autonomy over policies, regulations and investment approval  The SEZs set the standards and provide competition to the rest of the enterprise sector including the SOEs  Successful policies, experiences, best practices and managerial and technical know-how quickly extended to the rest of the economy  The coastal regions linked to the SEZs attracted over 90% of total cumulative FDI as well as large amount of domestic investment

 Encouraging the Growth of Private Small and Medium Enterprises  Initially, individuals and private enterprises were allowed into the service sector in the late 70s and early 1980s  Private enterprises were then quickly allowed into many industries in manufacturing and transport  Individual enterprises were first mostly in the informal sector with little regulation but as they grew, they quickly moved into the formal sector  Domestic private enterprises have been gradually allowed into many other sectors including infrastructure and recently financial services  Some private enterprises have grown into large conglomerates

Gradual but Progressive Reform of SOEs  SOEs dominated the urban economy and most sectors outside agriculture  SOEs burdened with social responsibilities and politically more sensitive to reform because of ownership issues  As a result, SOE reforms have been much more gradual but progressive  Started with contract responsibility system to increase managerial autonomy and incentives in mid 1980s, followed by price liberalization, gradual abolition of central planning and public investment in competitive sectors in early 1990s  Small and medium SOEs were privatized through sales and partial ownership reform of large SOEs undertaken through stock listing in both domestic and overseas markets in late 1990s  Growth of the new non-state sector has been crucial for SOE reforms as they demonstrated the benefits of reforms, created employment to absorb layoffs from SOEs and provided competition and pressure for SOEs to improve performance

As a Result of the Reforms, New Private Enterprises Contribute Increasingly More to GDP Growth  In the early part of the reforms, agriculture contributed most of the growth  But starting in the mid 80s, most of the growth came from the non-state industrial sector including the TVEs, foreign funded enterprises and private domestic enterprises  Contribution from the SOE sector has declined steadily

Possible Lessons from China Strong and Continued Political Commitment at the Highest Level is Critical  Clear and formal statement of commitment (e.g., the open-door policy and protection of private property rights have been enshrined in the Communist Party Charter and the country’s Constitution in China)  Commitments need to be reaffirmed whenever there is doubt and uncertainty (e.g., when a new leadership comes in or after major political events)  Clear and strong endorsement of new reform initiatives that are consistent with the overall direction of reforms (e.g., agricultural reform initiated by farmers in a village)

The Reform Strategy Has to be Credible, Consistent but Pragmatic  Reform strategy should set clear directions for overall reforms  But should leave sufficient room for experimentation and local initiatives  While slowdowns and pauses are sometimes inevitable, reversals are costly, damage credibility and should be avoided at all costs

Political Economy Aspects of Reform Are Crucial - Minimizing Resistance and Maximizing Support for Reforms Through Careful Sequencing and Articulating and Demonstrating Benefits  Starting with the most affected sectors or areas where the benefits are likely to be large and visible and support is strong (e.g., agriculture in China)  Training and educating the key stakeholders (e.g., government officials and SOE managers) will help reduce resistance to and increase support for reforms  Articulating and demonstrating the benefits of reforms through experimentation and pilots (e.g., China’s SEZs)  Quickly and decisively extend reforms and best practices to the rest of the economy once proven successful through formal legislation, regulation and training

Encouraging the Growth of New Enterprises and FDI is the Key to the Success of Reforms  Allowing the entry of new private firms into previously closed sectors is usually easier than reforming the existing SOEs  Growth of new private firms create employment and increased tax revenue that will make reform of SOEs much easier  Success of new private firms will provide demonstrations on the benefits of reforms, help maximize support and increase pressure for SOE reforms  Entry of new firms will also provide competition to SOEs and help improve SOE performance