1.02 China's Transformation from an Agrarian Economy to a Manufacturing Giant (1978 - 2005)
4 August 2018
Deng Xiaoping Reforms & Liberalization and the Rise of Rural Entrepreneurism in the 1980s
China’s economic miracles over the past decades began in December 1978 when Deng Xiaoping set the country on its path of economic reforms and liberalization (改革开放) at the Third Plenum of the Eleventh Central Party Committee (中共十一届三中全会).
Even though the objective was to modernize China through industrialization, reforms began first in the rural agricultural sector where there was relatively less vested interest. The crux of the agricultural reform was to release the latent productivity of the peasants from the straitjacket of the egalitarian people’s commune system through a contract responsibility system.
The agricultural reforms had an immediate impact on output of grains and cash crops. Tremendous growth was also seen in animal husbandry and fishery. The overall strength of the rural economy improved substantially. As agricultural yield and household income rose, farmers began to diversify their activities. Some started their own small private business while others formed collective enterprises known as Township and Village Enterprises (TVEs) with the support of local government. These non-state enterprises in the rural areas began by producing light consumer goods to meet rising demand in the rural areas. Many other farmers also left home to work with the rapidly growing TVEs in the towns or seek employment in the cities.
In short, the success of agricultural reforms stimulated the extraordinary development of the rural non-state industrial sector spearheaded particularly by the collective-owned TVEs. Therefore 1980s was irrefutably a decade of rural entrepreneurism. It was rural entrepreneurism that started China off on its road of economic reforms.
As for the urban state industrial sector, pilot industrial reform programs were developed and carried out in selected factories and limited localities during the initial years of the reform. At the same time, the economic activities of the foreign sector supported by the inflow of FDI were restricted to the experimental special economic zones (SEZs) set up in 1979. By 1984, these experiments in attracting FDI were determined to be largely successful and fourteen additional areas known as “open coastal cities” were established to speed up the inflow of FDI.
The dynamism of the non-state sector in the 1980s was a sharp contrast to the slow dawdling pace of economic reforms in the urban state industrial sector. The slower pace could be attributed to high organizational complexity of the state sector as well as to deeply-entrenched vested bureaucratic interest, not to mention also the millions of state employees who were depending on the state-owned enterprises (SOEs) for all their needs thus far. Moreover, the central planning authority had absolutely no experience of implementing and running a market-based system. There were also incentive issues at the enterprise level where the entire organizational structure had been oriented towards the fulfillment of quotas set by the state. Finally, there were also ideological debates on the fundamental direction of the reform for the socialist state. While the reformists advocated deepening market-oriented reforms, the conservatives fought to maintain the dominance of the planned economy.
Hence, even though industrial reform was initiated in 1978, programs introduced before 1984 were mainly pilot measures to lay the groundwork in preparation for the eventual increased marketization and modernization of the urban industrial sector. Examples of such measures include “substitution of loans for fiscal appropriations” (拨改贷) in 1980 to reduce the state role in fiscal allocations to the SOEs; “tax for profit scheme” (利改税) in 1983 to provide incentives for SOEs to raise productivity; "factory director responsibility system" (厂长责任制) in 1985 to give more autonomy to the managers and to tie rewards of the employees and managers to the performance of their enterprises; and the creation of the “dual-track price system”, in 1985, comprising of a state-set price for the amount of capital goods produced according to the state-plan and a market-determined price for the extra-plan output; and changes pertaining to labour law in 1986 giving enterprises the rights to recruit new employees based on contract and to dismiss non-performing or redundant employees.
By the late 1980s, the negative effects of the sluggish reform of the state sector and the coexistence of the two tracks began to surface in the late 1980s. Despite reform measures to give SOEs more autonomy in their operations, efficiency improvement was limited and output growth was supported mainly by vast input of resources. Competition between the invigorated non-state sector and the sluggish state sector also became more intense. Financial conditions of SOEs started to deteriorate. The implementation of power-delegating and profit-sharing was not accompanied by establishment of effective control measures, leading to rent-seeking activities by the managers and the softening of budget constraints over the SOEs. The poor financial performance of the SOEs in turn contributed to a persistently huge fiscal deficit which created inflationary pressure. In 1989, the economic disorder, exemplified by the astonishing high inflation rate, led to the June 4 Tiananmen Incident. In the aftermath, there was a resurgence of conservative thinking which put the blame of the national crisis squarely on market-reforms.
Full-Scale Reforms of the State Sector in the 1990s under Jiang-Zhu Administration
This bout of conservatism held sway until 1992 until Deng’s 1992 Southern Tour (邓小平南巡) to revitalize the reforms. Meanwhile, regulatory changes continued unabated as policymakers strived to improve the regulatory framework for the working of a market economy. Shanghai Stock Exchange began trading in 19 December 1990. Regulations pertaining to issuance of shares were introduced in April 1992 for enterprises to issue tradable and non-tradable shares. During the 14th National Congress of the CCP in October 1992, the target of establishing a socialist market economy was set. It was decided that hitherto reforms in the non-state sector should be firmly extended to the state sector so that an overall advance of the economy could be achieved. Specifically, changes would be carried out to five subsystems, namely the fiscal and taxation system, the banking system, the foreign exchange control system, the enterprise system, and the social security system. For example, changes in the enterprise system led to the passing of the Company Law in 1993 that laid the foundation for the establishment of a modern enterprise system characterized by clearly established property rights, well defined power and responsibility, separation of enterprise from government, and scientific management.
In 1994, under the leadership of Premier Zhu Rongji, the Chinese government announced a new strategy of “grasping the big ones and letting go of the small ones” (抓大放小) so that resources could be concentrated on the large and medium-sized SOEs that were essential to the national economy while small and medium SOEs would be closed or released to non-state sector by means of merger, leasing, contracting, takeover, or bankruptcy.
In 1998, fundamental changes were incorporated into the Amendments to the Constitution to protect the lawful rights and interests of the individual business sector and private sector, for the first time. At the same time, in line with the strategy of “advancing in some areas while retreating from others”, the central government would reduce the scope of the state sector by retreating from non-critical industries while advancing to control key industries vital to the national economy and security. The strategy provided room to promote the healthy development of non-state sectors.
As for the foreign sector, FDI growth slowed briefly after the 1989 Tiananmen Incident but resumed and quickly grew after Deng Xiaoping’s 1992 tour of Southern China when policies of openness and market-oriented reforms introduced earlier were reaffirmed. During this phase, foreign investments also began to overflow into the centres of China’s (state-owned) heavy industry manufacturing and finance. Of these, Shanghai and the neighboring provinces were the clear beneficiaries and they become the next-largest recipient area by 1995.
By the turn of the twentieth century, China looked increasingly unstoppable, having successfully surmounted various obstacles including challenges from remaining remnants of the old-guards to slow down or turn back reforms and from the adverse impacts of the 1989 Asian financial crisis.
Accession to WTO and Explosive Growth as Factory of the World in the 2000s
The real turning point that propelled China into a manufacturing giant is China accession to WTO in 2002 which provided Chinese-made goods with ready access to global markets. The abundant supply of redundant migrant workers created a huge pool of low-cost labour which attracted a massive influx of FDI into the coastal region. The inflow of capital was accompanied by imports of foreign technologies and managerial knowhow.
As recently as 1980, China was still trailing Italy as the seventh largest manufacturing economy. By 2011, however, China has overtaken the US as the world’s largest producer of manufactured goods. As of 2017, China accounts for about 25% of the world’s manufacturing activity, more than any other country on earth. Today, it is the second largest economy in the world after the US.
China achieved the amazing feat of transforming itself from an agrarian economy to become the factory of the world within one generation. Even more impressive is the boost in Chinese people living standards brought about by the huge manufacturing engine. The country’s GDP per capita, for example, doubled within a decade after its accession to WTO. In comparison, the industrializing United Kingdom took 150 years.
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 See Forest Hou, Arthur Wang, and Ting Wu. (2071). “A digital upgrade for Chinese manufacturing.” McKinsey Quarterly. May 2017.
 See McKinsey. (2013). “A new era for manufacturing in China.” McKinsey Quarterly. June 2013.