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The Chinese Experiment: Opening Markets Reduces Poverty

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Introduction

In 1980, about 60% of those living on less than the equivalent
of $1 U.S. /day lived in China and India, 600-700 million of
those in China.   According to China’s own poverty
line (equivalent to approximately $.70/day U.S.) 245 million
people were extremely impoverished.  Most of the severely
impoverished were rural peasants on communal farms.  The
system of communal agriculture had produced consistently poor
economic results characterized by periodic famines and the need
for massive food aid from the United Nations.

Between 1977 and 1999 that number dropped to 33 million.
In December of 2003, the UN announced that China would be asked
to change its status from recipient to donor, in honor of ending
its 25-year dependency on international food aid.

The secret to China’s remarkable success:

“China has introduced truly revolutionary reforms
. . . opening the economy to foreign trade and investment, and gradually
making the legal regulatory changes that have permitted the domestic
private sector to become the main engine of growth” (Dollar 16).

Opening Markets to Competition – Domestically and
Internationally

Over the past 25 years, China has taken steps toward both privatization
– opening internal markets to greater competition, and
globalization – opening its economic borders to increased
international trade.  Although we would still place China
toward the “less capitalist” end of the institutional spectrum
we constructed in the Lesson 1 activities, it is instructive
to note the reductions in poverty produced by even these beginning
steps in conferring private property rights and opening markets
to competition.

Timeline of 20th Century Chinese Economic Reform

1950’s Agrarian Reform Law (1950)

  • Abolished all private enterprise.
  • Required that all Chinese agriculture be collectivized.
    The Chinese commune system of agriculture was firmly established
    and all private farming abolished by 1958.
  • Free trade in farm products was abolished and rural markets
    were banned.
  • Output choices were made by government and commune teams
    were assigned output quotas.
  • All output was delivered to the government procurement
    agency for distribution
  • All foreign trade was conducted by the state.
    • Major trading partners were Soviet bloc countries.
    • Composition of exports and imports was determined
      by the state.
1960’s Continuation of closed, non-competitive system

  • Characterized by low levels of economic growth and widespread
    extreme poverty
1970’s 11th Chinese Party Congress (1978)

  • Deng Xiaoping called for economic reforms, including the
    creation of Special Economic Zones (SEZ) to increase foreign
    trade
1980’s Reforms increased competition

  • SEZs were established in villages in southeastern China
    • Some opening of agricultural markets was allowed
    • Foreign investors were given exemptions from all taxes
      and restrictive regulations IF they formed partnership
      enterprises with Chinese businesses (primarily export-oriented)
  • Price controls were eliminated on many products
  • “Household Responsibility System” replaced agricultural
    communes in 1982.

    • Communes were broken up.  Families were assigned
      a piece of land and were allowed to decide what to grow
      and where and how to sell what they produced.
      Individuals were no longer tied to particular pieces
      of land. People could leave farms if they wished and
      seek work in the cities.

      • (Land “assignments” were not full property rights,
        but more like leases. Landholders could not sell
        land.)
  • Government allowed the emergence of rural township and
    village enterprises from the community-level structures
    that had been associated with the old commune system.

    • Most of these were labor-intensive, export-oriented
      manufacturing firms.
    • This expansion of the non-farm sector provided alternative
      employment opportunities for rural peasants.
  • Housing was privatized.
    • (Note, however, that home “owners” were not given
      full property rights.  Even today, the insecurity
      of house “ownership” means that homes are still not
      accepted as collateral for loans.  See lesson
      2 for discussion of property rights and capital growth.)

Outcomes

  • The right to enter the market with their produce drastically changed
    the incentives facing Chinese farmers.  Faced with the opportunity
    to affect their own well-being, the farmers responded as our model
    predicts; they produced much, much more than they had produced when
    they could not sell the fruits of their labor.
  • This institutional reform led to a dramatic surge in grain production
    in China and fueled a spectacular poverty reduction between 1977
    and 1987.
  • Rural per capita income doubled.
  • Agricultural and industrial output grew by about 10% per year.

    For example:

    “. . . [L]and-short Hong Kong industries were
    allowed to expand their operations into special zones.
    As a part of this arrangement Chinese farmers were able to sell
    foodstuffs directly to them at whatever prices the peasants’
    produce could command.  At the same time the state reduced
    the village rice quotas by 40% and eliminated other quotas all
    together.  Indeed within months the government’s procurement
    office for agricultural produce was closed down in the commune
    market town, and in its stead wholesalers from Hong Kong were
    allowed to set up buying stations.  They purchased fresh
    produce at prices several times higher than those previously
    available from the state.  This allowed Chen families to
    put most of their cultivation efforts into lucrative vegetable
    plots and they were also able to convert some rice paddies into
    commercial fish ponds for Hong Kong’s dinner tables.”
    (Chan)

The reforms also made an impact on non-agricultural sectors of the
Chinese economy.

  • Foreign direct investment grew from $916 million in 1983 to more
    than $3.5 billion in 1990.
1990’s The success of 80s reforms served to highlight remaining
problems:

  • The coexistence of planned and market sectors of the economy
    gave rise to inflation and increased corruption.
  • Competition was still highly constrained in most markets,
    which led to climbing prices for many products, especially
    urban prices for agricultural products.  (The Tiananmen
    Square Uprising was evidence of discontent with rising prices.)

Deng Xiaoping was, however, convinced that China was headed
in the right direction and he determined to continue reforms.
In 1992, he toured the SEZs in southern China to highlight the
success of his liberalization policies and to launch a second
wave of measures that further increased market competition:

  • Foreign investors were allowed to create wholly-owned
    subsidiaries, and were no longer required to set up joint
    ventures with Chinese companies.

    • (In 1991, the first McDonald’s opened in Beijing.)
  • In order to encourage imports of advanced technology and
    exports of manufactured products, 15 free trade zones, 32
    state-level economic and technological development zones,
    and 53 new industrial development zones were established
    in large and medium-sized cities.
  • Private enterprise was allowed to enter sectors of the
    economy that had previously been closed.

    • In rural areas, local township-village enterprises
      were allowed to privatize.
    • In 1997, the 15th National Party Congress
      committed to reform and/or privatized SOEs (State-Owned
      Enterprises) in steel, coal, shipbuilding and other
      heavy industries.
  • Eased price controls further.

Outcomes

The Chinese economy has become noticeably more market-oriented:

Composition of National Industrial Output (%)
1978 1999
State-owned 77.6 28.5
Collective-owned 22.2 38.5
Private 0.2 33.0
Composition of National Retail Sales (%)
1978 1999
State-owned 54.6 24.3
Collective-owned 43.3 18.2
Private 2.1 51.5

Source:  Statistical Yearbook of China; China
Economic Information Network (www.cei.gov.cn),
January 31, 2000.  from “China’s Economic Reform:
Past, Present and Future,”  by the Overseas Young Chinese Forum.  http://www.oycf.org/Perspectives/5_043000/china.htm
(accessed March 4, 2004)

  • In December of 2001, China formalized an agreement on conditions
    allowing it to enter the World Trade Organization (WTO):

    • China agreed to reduce its average tariff rates from 21.2%
      to 17% by 2004.
    • China agreed to eliminate non-tariff trade restrictions on
      wheat, rice, corn, cotton, soybean oil, sugar, and wool.
    • China agreed to open its financial service industry to foreign
      banks and investors by 2007.
  • 1998 exports of agricultural products totaled $26.2 billion,
    a 150% increase over 1980.
  • In 2002, China became the world’s top destination for foreign
    direct investment, with $53 billion in investment flows.
  • 2003 GDP was 8 times as big as it was 25 years earlier, in 1978.
  • 2003 share of global trade was 6 times as big as it was in 1978.

Conclusion

While China has certainly not abandoned communism, the government has
taken steps to incorporate some forms of the property rights and
market institutions characteristic of capitalism.  Most noticeable
have been the opening of domestic markets through increased privatization,
and the globalization of the Chinese economy through entry into
international markets.  The fact that China has experienced
such great poverty reduction as a result of having taken only small
steps toward incorporating markets offers impressive evidence of
the ability of capitalist institutions to generate wealth and raise
standards of living. Economic growth is the key to increasing standards
of living, and clearly, China’s willingness to begin opening markets
to competition has reaped the predicted benefits of lower prices,
higher incomes, and rising standards of living.  Since 1980,
fledgling market institutions in China have resulted in a soaring
rate of economic growth that has outpaced not only developing countries
but also the United States and other western nations.  The
beneficiaries of that growth are the millions of nameless Chinese
no longer included in the world’s “extremely impoverished.”

Average Annual Percentage Growth in GDP

GDP Agriculture Industry Manufacturing Services
1980-1990 1990-2001 1980-1990 1990-2001 1980-1990 1990-2001 1980-1990 1990-2001 1980-1990 1990-2001
China 10.3 10.0 5.9 4.0 11.1 13.1 10.8 12.1 13.5 8.9
U.S. 3.5 3.4 3.2 3.5 3.0 3.7 3.1 4.1 3.4 3.7
High income countries 3.3 2.5 1.9 1.1 3.0 1.8 1.7 2.4 3.5 3.0
Middle income countries 2.9 3.4 3.4 2.1 3.2 2.7 3.7 5.7 3.2 3.7
Low income countries 4.5 3.4 3.0 2.6 5.5 2.9 7.7 3.0 5.5 5.1

Source:  http://www.worldbank.org/data/wdi2003/pdfs/table%204-1.pdf

Case Study Sources:

Berg, Andrew and Anne Krueger.  “Lifting All
Boats: Why Openness Helps Curb Poverty.”  Finance and Development 39.3 <http://www.imf.org/external/pubs/ft/fandd/2002/09/berg.htm>

Chan, Anita. Chen Village Under Mao and Deng. Berkeley, CA:  U of California P, 1992.

Chang, Chun.  “Progress and Peril in China’s
Modern Economy.”  The Region (Dec. 2003).  Reserve
Bank of Minneapolis. 3 March 2004 <http://minneapolisfed.org/pubs/region/03-12/chang.cfm>.

“China Takes Steps to Protect Private Ownership
of Land.” Guardian Newspapers 22 Dec. 2003.  Buzzle.com.
4 Mar. 2004 <http://www.buzzle.com/editorials/12-22-2003-48869.asp>.

Chow, Gregory. “Free to Choose in China.”
Conference Paper:  The Legacy of Milton and Rose Friedman’s Free to Choose: Economic Liberalism at the Turn of the 21st Century.  Texas: Federal Reserve Bank of Dallas, 23-24 Oct.
2003.

Dollar, David. “Capitalism, Globalization and
Poverty.”  Consignment research paper written for The Foundation
for Teaching Economics. Mar. 2003.

Gilbert, John, and Thomas Wahl.  “Agricultural
Reform in China:  Impacts on Welfare and Rural-Urban Incomes.”
Unpublished Paper written at Washington State University.

“Growth of Output.”  2003 World Development
Indicators.
New York:  World Bank Group, 2003.
The World Bank Group.  4 Mar. 2004  <http://www.worldbank.org/data/wdi2003/pdfs/table%204-1.pdf >.

Krueger, Anne. “Trading Phobias – Governments,
NGOs and the Multilateral System.”  The Seventeenth Annual
John  Bonythom Lecture.  Melbourne, Australia.  10
October 2000.

Stern, Nicholas et. al.  Globalization,
Growth, and Poverty – Building an Inclusive World Economy.

New York:  World Bank and Oxford UP, 2002. 111.

Waldrom, Scott, and Colin Brown.  “State Sector
Reform in China:  Structural Considerations in Agriculture.”
Lecture delivered at the Proceedings of the 15th Annual
Conference of the Association for Chinese Economics Studies in Australia
(ASCEA).

Wu, Jinglian.  “China’s Economic Reform:
Past, Present and Future.”  Perspectives 1.5. 15 Mar.
04 <http://www.oycf.org/Perspectives/5_043000/china.htm>.

Ying, Du.  “China’s Agricultural Restructuring
and System Reform Under Its Accession to the WTO.”  ACIAR China
Grain Market Policy Project Paper No. 12  (Department of Policy
and Law, Ministry of Agriculture, China). Presented at Adelaide
University School of Economics: Canberra, Australia, November 2000.