Reform in the Chinese Economy from a Centrally Planned Economy to a Free Market Economy - Case Study Example

Name: Date: Institution: Centrally planned economy A centrally planned economy is one which is under full government control while an economy where the government has no control or a minimum control is known as the free market economy. The paper will address the reform in the Chinese economy from a centrally planned economy to a free market economy. It will also highlight a number of efforts by the Chinese government since 1978 to ensure that the country experiences economic growth and development over time. The paper also highlights major challenges that the country has faced during the transition reform. The paper outlines both the radicle and gradual reforms that the country underwent in implementing the present reforms in the economy. It will also highlight the main challenges facing the banking sector in China and how industrial firms are raising their capital through low standard banking systems (Ma, Lu, & Quan, 2008). A centrally planned economy can be defined as an economic system in which the economic decisions are made by the state instead of the interactions between the businesses and the consumers. This system of economics is different from a market economic system in that production decisions by a market economy are made by the business owners and the citizens. While a centrally planned economic system is involved in the control of the products that have been produced and distributed. It is also involved in the control of the resources used within the state. It is the mandate of state owned enterprises to produce goods and services. It is good to note that most of the developed countries embrace a mixed economy, that is, a system that will include the aspects of both the centrally planned economic system and that of a free market. A free market is one that is promoted by the neoclassical and the classical economists (Wu, 2005). The role of the government in the free market is to ensure that it protects trade and coordinate public services within the economy. In centrally planned economy, it is believed that a market cannot operate for the interest of the people and therefore some forces, that is, the government has to take control and make decisions so that the national and social objectives are generally met. The government is therefore involved is determining prices of goods and services, determine the level of production, it is also concerned with the labor and resource allocation within the market without focus much on private sectors. China is among the countries that embrace centrally planned economy. However, it has been changing from this system of economy to a mixed economic system. This country is led by Chinese communist party (Economy, 2011). This party is has a great control over the armed forces as well as the government. This party is able to control the entire Chinese economy through the following ways; five years plan, and SASAC (State-owned Asset and Supervision commission of the state council). The state council is the country’s cabinet which runs the country. SASAC is composed of companies which are owned by the state. These state companies include; banking firms, commodity and construction firms. These firms are the chief importers in the country. The state council is also mandated to give an economic report to the central government in Beijing (Morrison, 2012). The tool of five years plan is another tool used in this economy. The Chinese communist party is involved in making, ratifying and planning the five years plan. The country will then after the five years have an evaluation of the plan in order to inform their citizens on their progress. In the late 1940s and early 1970s, the country was under a centrally planned economy. The government was under full control of the economic output, it was involved in price control with the economy, allocating the scarce resources, and also set production goals. By this period of time, foreign and private enterprises in the country were very few and were also discouraged through a tough competition making them operate on losses and as a result, they had to quit the economy. However, the country later realized that its economy remained stagnant and inefficient with a GDP of 5.3% from 1960 to 1978. This was as a result of less emphasis on profitability and competition within the country. The country realized that the living standards of her people were lower in relation to other developed countries. Through this challenge, the government was to look for a way that it would raise the living standards of its people and also encourage economic growth within the country. This is what contributed to an economic transition in China in the late 1970s (Allen, Qian, & Qian, 2005). The economic reforms in China date back in 1978. This is a reform that emphasized on an agricultural production system. The reason for initiating this plan was to ensure that the rural areas within China were not left behind. The state introduced a price and ownership incentive to the farmers. This motivated the farmers to produce more agricultural products and as a result, the country experienced high productivity of agricultural products, for both domestic use and exportation. By supporting the agricultural sector, the country was able to feed its high population. The country also embraced a free market system, where the prices are determined by forces of demand and supply. The level of productivity was able to increase. Unlike in the past, the country encouraged foreign investment and private sectors within the economy. They also boosted exportation as they imported high technology products. The state developed special economic zones so that they could fuel economic development in different regions in the country as they boost economic growth and development. The country also adopted decentralized policymaking. This ensured that the provincial and local government had control over various enterprises. The main aim of decentralizing policymaking is to encourage different companies to operate and compete within the principles of a free market. In 980s the government had realized the high productivity within the country (Li, & Zhou, 2005). It identified new regions within the coastal regions and developed open cities. The state offered tax and trade incentives within these regions so that it could attract foreign investors. It also eliminated the policy of price control. The economic transition has greatly contributed to economic development within the country. With the economic reform that occurred in 1978, the average GDP had also increased in 1995, from 5.0% to 8.0%. China’s economy became the second largest economy in the world after the USA. The country, therefore, embraced a mixed economy where it encourages free market and also supports state owned companies to operate within the economy. However, the country has much support on private and foreign support via tax incentives. Eradication of price control policy has greatly motivated investors and producers since prices are determined by the forces of demand and supply in the country (Zhou, 2005). Through the reforms on trade and investment, the country encouraged foreign direct investment (FDI). By encouraging FDI the country experienced a high capital growth. With the high capital growth within the country, China has been in a position to improve the living standards of her people. The government has also been able to improve the social welfare of its citizens since the reforms were initiated. Investment and savings have also increased over time. Poverty in the country has also been eradicated, with people who lived in extreme poverty raised above the poverty line. The level of technology and literacy in the country has also increased. The country, however, has experienced a number of challenges in the process of implementation of the reforms. It has become difficult for the country to collect revenues from different provinces, individuals, and businesses. It has also been struggling to fight against corruption and other major economic crimes associated with economic reforms. It also experiences a challenge of running the state-owned enterprises in the mixed economy. The private and foreign enterprises have offered a high level of competition making it difficult for the state-owned enterprises to expand and grab a high market share within the economy. The Chinese economy has done away with pure public ownership structures and installed multi-ownership structure which is characterized by different economic structures. First, the country eradicated the pure public ownership structure with the aim of expanding their economic share. In such a structure, individuals are less motivated to work hard and therefore the level of output in the economy remains low. This led to low standards of living among the Chinese compared to other developed countries. By introducing a multi-ownership structure, the government encouraged free market (Castells, 2010). The government also introduced tax and trade incentives that encouraged foreign and local investors to invest in the Chinese economy. The market mechanism in China has played a key role in different areas and has positively contributed to the expansion of the competitive market. The country at first has adopted state-owned enterprises, this discouraged competition in the market. The market was under control of the government. The government was involved in decision making and price determination. The interference of the government with the market hindered economic growth and development. However, the country adopted a free market mechanism and embraced an open economy. This served as an incentive to local investors and foreign investors. The country also encouraged FDI which served as a major source of capital growth within the country. Major changes have been witnessed in the economy due to reforms in the following systems; banking, public finance, taxation, and investment. These reforms have also led to a transformation in the labor market due to the change in the level of income over time. The economic reforms in China occurred gradually. The gradualism of the Chinese economic reform has ensured that there is a great reduction in the cost and risks that are associated with the economic transition. The country was in danger of experiencing major risks if it adopted radical changes. The remarkable gradual transition in China is price and price and ownership structure reforms. In price reform, there was an introduction of a two tier price system (Mol, & Carter, 2006). In this system, the prices of the goods and services under the planned control economic system is allowed to adjust gradually till it matches the prices of the market price. However, this transitional reform has been associated with frictional cost. This is less risky in the economy compared to when market prices were radically applied to the prices of all goods and services in the economy. In ownership structure gradual transition reform, the country allowed the establishment of non-state-owned enterprises (non-SOEs). The establishment of these non-SOEs led to the expansion of this sector. This had a positive impact on the entire economy. By encouraging an increase in this sector, there was greatly reducing the extent of the centrally planned economic system within the country and encouraging a free market system. China is different today from the centrally planned economy. This country in the world has been ranked as the most influential country over the economy. The country did not completely eradicate state firms and banks. Instead, these institutions still remain prominent. The country also retains the five years plan and the communist party is still in power. With the introduction of the free market policy, the country’s economy, therefore, operates in a mixed economy. However, SOEs in China are different from those of the 1990s. This is because the number of SOEs has greatly reduced. They have also increased in size including those operated by the central government. These SOEs operates in very important sectors of the economy such as; telecommunication, energy, banking, mining, transportation, and in public utilities. The SOEs leap less profit in the country than the private companies (Zhou, 2005). However, due to their ability to generate profit to the country with the government investing less capital in them, it is good to retain them. It should be noted that these SOEs enjoy the privilege of monopoly and hinder the entry of private firms in these sectors. China operates on an open economy. The openness of the economy has encouraged healthy competition for both foreign and domestic goods. This has made the different sector to grow rapidly and to attract foreign investment. The quality of products, knowledge, and standards has also increased greatly particularly in the heavy industries. The country encourages foreign investment through the reduction of trade barriers such as tariffs ensuring that more investors are able to get into the country and this will increase GDP level within the country. The country also supports foreign trade. This helps the country to have a wider market for their products. Through foreign trade, the country is also able to get skilled personnel and a high level of technology (Wright et al. 2005). The country, however, faces a major challenge in the service market. In the banking sector, for example, the country is dominated by four state-owned banks. Since these banks operate under no competition, they drag the economy within this country since the level of management is inefficient and discourages entry of any other bank into the economy due to the unnecessary competition. These banks are also under the political influence. The firms within this country will raise their capital via nonstandard financial institutions due to the great weakness in the banking sector (Li, & Zhou, 2005). In conclusion, Chinese economy operates on a mixed economic system. In the early 1940s, the country was operating under a centrally planned economic system. This system required that the government control all the market factors such as price, and decision making. This system, however, was not effective since; it discouraged foreign and private investment, and as result, the level of productivity in the country remained low. Discouraging FDI within this country discouraged capital growth within China. However, opening the economy, the government encouraged, importation of high technology tools, improved human personnel into the country, expanded their markets for their local goods, supported foreign investors into the country, and also private sectors were encouraged. The Chinese government has embraced transitional reforms. The transition reforms have occurred gradually except the agricultural reform which was a radical reform. The reason for gradual reform is to ensure that the government is able to control and reduce the risks associated with reforms and also ensure that the transition is cost friendly. However, the Chinese government has monopolies in a number of important sectors. Such sectors include; mining and banking. The banking system has however been so weak. This has made most of the industries to raise their finances through less developed banks and as a result, dragging the economy to a slow growth and development. The country experiences high productivity compared to the early 1940 and 1970s. This has been brought about by removal of trade barriers, and an increased level of competition. This made the number of industrial firms to increase. The numbers of SOEs were reduced in number as the remaining few increase in size. The government also identified a number of special economic zones (SEZs) in order to boost economic development in the country. In agricultural production, the country adopted cash crop production. Vegetable and production also had a notable increase and this made a great improvement in the agricultural production. The transformation in the agricultural sector was also important in that the country was able to feed its high population. References Allen, F., Qian, J., & Qian, M. (2005). Law, finance, and economic growth in China. Journal of financial economics, 77(1), 57-116. Castells, M. (2010). End of Millennium: The Information Age: Economy, Society, and Culture| (Vol. 3). John Wiley & Sons. Economy, E. C. (2011). The river runs black: the environmental challenge to China's future. Cornell University Press. Li, H., & Zhou, L. A. (2005). Political turnover and economic performance: the incentive role of personnel control in China. Journal of public economics, 89(9), 1743-1762. 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