The Chinese Economic Growth - a Miracle or a Mission Accomplished - Case Study Example

The Chinese Economic Growth A Miracle or a Mission Accomplished Introduction China has captured the imagination of the rest of the world as a rising economic power house having one-fifth of the world’s population and a model for transition from command economy to a market driven economy. The takeover by Deng Xiaoping’s regime in 1978 was the defining moment in Chinese history. He dismantled command economy structure gradually through well orchestrated moves. The progress on the path of liberalization and departure from the beaten track has been gradual putting China on the high growth trajectory. Today China is dominant in global trade in many industries and an economic juggernaut. The economic growth in China post Deng regime has been stupendous. The objective of this paper is to analyze the factors fuelling the economic growth and to examine, whether it can be classed a miracle and not sustainable. The Economic Growth (1980 to 2007) In late 1978, Deng Xiaoping took power on the heels of the economically disastrous Cultural Revolution (1966-1976) and put China on a path toward a socialist market economy. At the time, China was predominantly an agrarian-based economy. Most workers were subsistence farmers on communal farms. Under Deng's leadership, China's economy saw a remarkable transformation. In 1978, Deng Xiaoping kicked off a series of reforms known as gaige kaifang, or “reform and opening up.” The intentions were clear and aimed at jumpstarting China’s economy and fueling rapid economic growth.1 During the pre-Deng regime, China witnessed an annual of 6% with vicissitudes along the way. The post-Deng take over, the economic growth has been consistent with fewer excruciating ups and downs. Since then, China’s growth in economy has been stupendous. It succeeded in notching 10% growth rate in the 80s, 90s and in the 21st century. It sometimes, even notched a peak of over 13% in several years. The increasing prosperity of Chinese is portrayed by the per capita income which nearly quadrupled in the last 15 years, leading to the predictions by some analysts that Chinese economy would overtake that of the US in two decades. The Chinese growth record compares well with that of the "Asian tigers"--Hong Kong, Korea, Singapore, and Taiwan Province of China—which in aggregation notched an average growth of around 7 % over the last 15 years.2 Over the last 30 years, the growth has been on the average 10%. The growth has been 9.4% between 1978 and 1995, 11.2% between 1990 to1998, and just below 10% between 1999 and 2007. The growth rate is 5 to 6 times greater than that of the United States, Japan and major European countries.3 The U.S. economy in purchasing power terms, is less than twice as large as China’s economy.4 The economic crisis that hit several Asian countries left China unscathed. China was also undeterred by the global slump at the beginning of the new millennium. The Reforms Process The Deng reforms decentralized the state economy by replacing central planning with market forces, breaking down the collective farms and getting rid of state-run enterprises. The emphasis shifted from heavy industries to consumer oriented industries.5 China’s economy was slowly globalized. The process had three distinct stages; rural reform (1978-1984), urban reform (1984-1988), Price reform (1989-1991) and Confirmation (1992-1993). The Rural reform moved the agrarian economy from community farms to property ownership, which allowed the peasants to sell the produce they grew. Urban reform gave impetus to joint ventures with foreign companies and development of Special Economic Development zones along the coast line. Further, 12 state owned companies controlled imports and exports and economic zones. The price reform brought stability to non staple prices, opened stock exchanges and attracted greater investment in multinational companies. The tariffs were cut from 56% to 43% paving way for a gradual shrinking of import barriers. Confirmation of the reform process enhanced confidence of the foreign companies in the Chinese economy. The reform process gave China a stupendous growth in the economy in terms of GDP and fivefold increase in foreign trade. Certain technology intensive industries contributing to infrastructure such as telecom received emphasis. The important features of this successful reform are the "within" and "without” production plans, which granted autonomy to the businesses to pursue their individual targets over and above the quotas set by the state. This scheme permitted the Enterprises and factories to retain profits, and deploy them to award merit pay and offer incentives, which in turn fueled productivity.6 The Effect of Reforms In the pre 1978 reforms era, nearly four out of five in China served the agriculture sector, which by 1994 shrank to one out of two. The augmentation of property rights gave impetus to the formation of nonagricultural businesses in villages. Measures such as De-collectivization and higher price realization for agro products gave a fillip to productive farms owned by families raising the efficiency of labor. Despite the use of hoes instead of tractors, there was a dramatic increase in crop yields. The production of wheat doubled from 41 million tons in 1978 to 87 million tons in 1985. By 1987 Chinese increased the output of grains and tubers to the level of three times that of India and almost equaled that of the U.S. and Soviet Union. The increase in the number of village enterprises attracted substantial number of people from agriculture to manufacturing, which had higher value addition.7 The greater autonomy to enterprise managers enabled them to set their own goals, sell the products at the best price, motivate their staff with incentives and bonuses, retrench non-productive staff and retain a part of earnings for capital investment. The benefits that accrued were many such as creation of jobs, development of needed consumer products, foreign exchange earnings through trade and payment to the exchequer which imparted resilience to the economy.8 Impetus to the flow of foreign investment as a sequel to China’s open-door policy imparted vigor to the economic transformation. The cumulative foreign direct investment rose from negligible amount prior reforms to nearly US$100 billion in 1994. The contribution of foreign inflows increased from less than 1% of total fixed investment prior to reforms to 18% in 1994. This money has been effectively deployed for building factories, creating jobs, linking the country to the international markets and enabling technology transfers in key areas. The economic reforms hiked the exports which rose by a robust 19% per annum during 1981-94. The special economic zones were vehicles of this progress.9 In the area of price reforms, the government has exercised utmost caution. It granted considerable autonomy to the consumer goods and agricultural goods manufacturers and much less to others. The intermittent bouts of inflation have prevented the government from implementing full scale price liberalization. Though it is contained, inflation continues to be a threat to a growing economy.10 Productivity: The Driver of Growth The IMF research team studied the factors that fuelled the spectacular economic growth of China and observed that a sharp sustained growth in productivity fuelled the growth. During 1979-94, the productivity gains contributed to over 42% of Chinese growth, while capital formation and labor together constituted the rest 58%. The capital formation and labor together slid by 25 percentage points post 1978 boom. Though China invested heavily in production of goods and services, the capital-output ratio was unfavorable indicating a lack of capital deepening. By early 1990s, productivity gains had supplanted capital as the most important source of growth. The economic growth fueled by productivity is more sustainable. This productivity growth stemmed from the reforms process.11 The study of Chinese economy is fraught with theoretical and empirical issues due to central planning regime which tend to give rise to distortion in prices and resource allocation. Further, the Chinese accounting system differs markedly from those prevalent in the west leading to difficulty in arriving at internationally comparable data, which would in turn result in different interpretation. IMF did however made some appropriate adjustments to national income statistics and indirect business taxes in their study.12 The Chinese economic juggernaut was powered by productivity which grew at an annual rate of 3.9% during 1979-94, in sharp contrast to 1.1 percent registered during 1953-78. In early 1990s, China witnessed the share of productivity in growth in output exceeding 50 percent, while the corresponding share of capital formation sliding below 33 percent. The extent of productivity growth in China can be seen as spectacular when compared with that of US, which averaged 0.4 percent during 1960-89.13 The OECD reports that the growth in Total Factor Productivity in US, Japan, Germany, UK and France since 1990 has been strikingly similar at about 1%. Andrew Cates, an economist at UBS, has tried estimate the growth in Total Factor Productivity in emerging economies over the past twenty years (see Figure-1). He concluded that China’s growth in Total Factor Productivity has been highest at around 4% and could be the highest ever notched by any country in the history of mankind. According to Goldman Sachs, China’s average return on physical capital has exceeded by far the global average. It was even less than half the global average, ten years ago.14 Figure 1: Total Factor Productivity, Average Annual Growth, 1990-2008 (%) Sources: qtd in The Economist, Secret Sauce, 12 Nov 2009, The rate of absorption of technologies, tempo of scientific innovation in the country and the management of production are major drivers of productivity growth. These are in turn dependent on country’s readiness and acceptance of foreign direct investment, international trade, impetus to education and labor market flexibility.15 Mr.Cates observes that there is a strong linkage in the country’s progress in technology and growth in productivity. Though China trails substantially behind the US in technology, its pace of improvement has been highest in the past ten years. Its openness to foreign investment, which is more than many of the emerging economies, explains its pre eminent position.16 The rise in productivity can only hinge on reforms which introduced profit motive to many players in the economy both rural and urban. The result is strident. Between 1978 to 1992, the share of State Owned Enterprises (SOE) in the country’s output shrank from 56% to 40%, while that of the collective enterprises increased from 42% to 50% and the private businesses and joint ventures increased their share from 2 to 10%.17 Conclusion In the post Deng era, China’s economic climate was radically changed with well orchestrated and gradual reform process. The three distinct stages; rural reform (1978-1984), urban reform (1984-1988), Price reform (1989-1991) and Confirmation (1992-1993) ensured the gradual progression. The Rural reform empowered peasants and urban reform enabled joint ventures and flow of foreign direct investment. The price reform reined in the inflation tendency. The confirmation stage bolstered the confidence of foreign investors. The economic growth was not due to just pumping in investment. The reforms gave boost to total factor productivity which factors in labor and capital productivity. The productivity improvements would not have accrued but for the inflow of foreign investment and technology transfer from abroad. The pace of innovation and technology absorption was heightened through directed governmental strategies. The job market was augmented with enlargement of the opportunities with liberalization. Though some may call Chinese growth a miracle, it is less of a miracle than a deliberate and well thought out determined departure from the command economy structure. Since the Chinese economic growth rests on the strong foundation of consistent productivity gain, it is more sustainable in the ensuing years. The very fact that the economic turmoil of late 1990s which devastated many eastern emerging economies and the recession in the new millennium did not scathe China shows the sustainability of the economic growth. Chinese economic growth has lessons to many other countries. The capital investment is crucial and is a necessary but not sufficient for growth. The market oriented reforms are crucial to harness these investments. Together they can unleash productivity spurt, which would be sustainable. Therefore Chinese economic achievement is decidedly not a miracle but a targeted achievement through potent strategies and is here to stay. According to Carsten.A.Holz, Since China’s economic growth pattern fits into identified growth patterns by economic theories of development and trade, which are structural change, catching up and factor price equalization, the past economic growth may continue.18 NOTES 1. Christopher Evan Hearne, Causes of China’s Economic Growth, 9 May 2009, http://modernchinesedynasties.suite101.com/article.cfm/causes_of_chinas_economic_growth, 2. Zuliu Hu and Mohsin S. Khan, Why is China Growing So Fast? , June 1997, http://www.imf.org/external/pubs/ft/issues8/index.htm, 11 Jan 2010 3. Jeffrey Hays, Deng Xiaoping’s Reforms (2008) http://factsanddetails.com/china.php?itemid=372&catid=9&subcatid=59 , 11 Jan 2010 4. Carsten A.Holz, China’s Economic Growth, 1978-2025: What We know Today about China’s Economic Growth Tomorrow , 2 Nov 2005, 3 http://129.3.20.41/eps/dev/papers/0512/0512002.pdf, 11 Jan 2010 5. Hays 6. Hays 7. Hu and Khan 8. Hu and Khan 9. Hu and Khan 10. Hu and Khan 11. Hu and Khan 12. Hu and Khan 13. Hu and Khan 14. The Economist, Secret Sauce, 12 Nov 2009, The Economist Print Edition, http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=478048&story_id=14844987 15. The Economist 16. The Economist 17. Hu and Khan 18. Holz, 2 Read More