A proposal to privatize Chinese enterprises and end financial repression.

• Author: Lal, Deepak

China's remarkable economic performance during the last two decades has rightly been hailed as an economic miracle. In this article, I briefly summarize the sources of the miracle, outline the serious problems China still faces because of the continuing financial repression necessitated by its unreformed and inefficient state-owned enterprises (SOEs), and provide a possible solution based on an efficient use of China's burgeoning foreign exchange resources.

China's Economic Miracle

The sources of the Chinese economic miracle are well known. The rise in rural incomes, with the adoption of the household responsibility system (the shift away from collectivized farming) and the bonus from the demographic transition with a fall in the dependency ratio (the ratio of children and the old to workers), led to a marked rise in savings rates. A monumental unintended consequence of the decollectivization of agriculture was the initiation of a boom in small-scale, nonfarm rural enterprises, which began with Deng Xiaoping's injunction that it was virtuous to be rich. Local party officials took this to heart, becoming directors and managers of township and village enterprises (TVEs).

With the rise in farm incomes, the pent-up demand for manufactured goods and housing was met by the TVEs, which were run as profit-making capitalist enterprises, even though they were collectively owned. They provided the local authorities with "extra-budgetary revenues" and gave officials legal opportunities to become rich. Unlike SOEs, the TVEs did not carry any welfare responsibilities and were free to hire and fire the abundant local labor. With Deng's creation of the Special Economic Zones in China's southern rim in the early 1980s, the TVEs--and later individually owned private firms--became the spearhead of a Diekensian capitalism.

These nonstate enterprises have made China into the processing center for manufactured goods in the world. Success has occurred by using cheap labor in the Chinese countryside along with foreign technology, and relying on self-financing from household savings and enterprise profits, along with foreign capital from the Chinese diaspora and a myriad of multinationals, and engaging in fierce locational competition promoted by local municipal authorities. (1) This labor-intensive industrialization is now spreading inland along the Yangtze (The Economist 2004: 13).

Total employment in TVEs, rose from 28 million in 1978 to 60 million in 1996. There was dramatic growth in individually owned enterprises. Their numbers rose from none in 1978 to 4 million in 1984, and 23 million in 1996, employing 76 million people. They have been the motor of China's spectacular labor-intensive industrialization. Angus Maddison (1998) estimates that real value added in this new small-scale sector rose by about 22 percent a year during the period 1978-94.

These spin-offs from the decollectivization of agriculture were aided by the massive buildup of infrastructure by the state. Labor-intensive export industries were further helped by domestic price reforms and by one of the largest unilateral liberalizations of foreign trade in history. Today most relative prices in China (unlike India) are closely aligned with world prices. (2) Chinese exports have exploded, growing eightfold between 1978 and 1995. By 2003 China was the world's third largest trading country, when its trade increased by more than $200 billion--twice the level of India's total trade in 2002. China's share of global trade is six times that of India's (Lardy 2003).

The rapid export-led industrialization in the private sector is based on processing imported components with domestic and foreign capital and technology, and cheap domestic labor. The private sector has grown so rapidly that its share in value added in the nonfarm business sector is nearly 60 percent (see Table 1), while its share of manufacturing' output is now more than 70 percent compared with that of the moribund state sector, whose share has fallen from about 80 percent in 1978 to about 28 percent in 1998 (Lardy 2002: 15). This transition has led to spectacular growth rates of the Chinese economy during the last two decades: 9-10 percent per annum on official estimates, and 7-8 percent on independent estimates. (3) But the state sector still controls more than 70 percent of all fixed assets and 80 percent of all working capital in manufacturing.

This labor-intensive growth, based largely on private enterprise, has allowed the transfer of a vast amount of low-wage labor from both the rural sector and the declining state sector, and has enabled China to grow by "walking on two legs"--that is, keeping the SOE leg alive while expanding the nonstate sector. This strategy thus avoided the loss in output and employment and the attendant social disorder that had characterized other transition economies in moving from the plan to the market. (4) But this strategy is now running into some serious obstacles which if not tackled could lead to the erosion of the Chinese miracle. The problems are all connected with the inefficient and unreformable SOEs.

Obstacles to China's Future Development

As its nonstate sector grew, China undertook a gradual reform of its state-owned industrial enterprises. Most were set up, as in India, under the unviable heavy-industry biased industrialization strategy. In the reform period, SOEs have been kept alive to avoid losses in output and employment, until the dynamic nonstate sector is large enough to absorb the labor their closure would release.

In the pre-reform period (before 1978) China's development strategy provided only limited urban employment opportunities. Consequently, the government assigned several workers to the same job, leading to a large labor redundancy in the SOEs. As these industrial workers only received a low wage to cover current consumption, the government also had to cover their pension, health, housing, and other social expenditures from the SOE...