The Chinese Experiment: Opening Markets Reduces Poverty

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 20^th 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 21^st Century.  Texas: Federal Reserve Bank of Dallas, 23-24 Oct.
2003.

Dollar, David. “Capitalism, Globalization and
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for Teaching Economics. Mar. 2003.

Gilbert, John, and Thomas Wahl.  “Agricultural
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Unpublished Paper written at Washington State University.

“Growth of Output.”  2003 World Development
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Krueger, Anne. “Trading Phobias – Governments,
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Stern, Nicholas et. al.  Globalization,
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Waldrom, Scott, and Colin Brown.  “State Sector
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Wu, Jinglian.  “China’s Economic Reform:
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