China’s Spontaneously Driven Economic Reforms

Paul Gregory, research fellow at the Hoover Institution, says that China’s economic miracle has been a product of spontaneous order.

At the Econolog Mr. Gregory writes,

China's private enterprise reforms began first in agriculture in 1978 and spread from there. Agriculture accounted for most of Chinese output and most of the labor force when Mao died in 1976 and the reform period could begin. The freeing of agriculture from collective farms is the most important untold part of the Chinese growth story.

Agricultural reforms began spontaneously from below, even before the "Reform" Party Congress of 1978 that installed reformer Deng Xiaping in power. A Chinese reform official later admitted: "In fact, reform wasn't discussed. Reform wasn't listed on the agenda, nor was it mentioned in the work reports." What became known as the "contract responsibility system" was sparked spontaneously by eighteen peasants from Xiaogang village in Anhui province. They secretly divided communal land in November 1978 and agreed to farm their plots individually, each contributing their share of the state quota. The state got its due and the peasants kept what was left over. The peasants' separation of their land from the collective farm was illegal, highly dangerous, and done without the approval of regional officials. Why did they take the chance?

Kate Zhou explains that the peasants had seen their parents and children die from starvation during the 1958-1961 famine of the Great Leap Forward. They understood they had to take care of themselves. The contract responsibility system spread like wildfire from village to village and from province to province, notably without endorsement by or encouragement from regional or national authorities.

As agricultural production soared, Deng Xiaping and his CPC realized that they should not resist something that was working. By 1982, more than 90 percent of rural dwellers worked under the contract responsibility system, but they were allowed only one- to three-year contracts on their land. It was only in 2003 that the state gave out longer-term leases.

The spontaneous reforms in agriculture meant that new supplies of food products needed markets and that markets needed infrastructure. Rural dwellers created a private trade network, and, within one year, most state food stores were out of business. Rural entrepreneurs then created new businesses, such as hotels, services, private restaurants, and small-scale manufacturing, through the three Fs (friends, family and fools). They bribed local officials to register their companies as "township and village enterprises." They created fake "red hat" enterprises, that is, private companies masquerading as state companies, and sham collective enterprises, or they used state enterprises to issue receipts and open bank accounts. Large private manufacturing firms developed first in predominantly agricultural provinces. China's largest agribusiness was founded by brothers who left the city to found their company in rural Sichuan. Rural entrepreneurs built the largest refrigeration and air-conditioning companies in China.

Read the rest here

That was then. Today’s conditions have been different.

Further in the article, Mr. Gregory points out some very important factors

-Today Chinese economy has been roughly split 50-50 between state owned and privately owned enterprises

-State companies use political means of “higher taxes, stricter regulation, and bureaucratic meddling” to “drive out private competitors”

-State banks discriminate in terms of lending where “only four percent of their loans to private businesses”. Thus, the recourse of private businesses has been through the informal or shadow banking systems. Ironically, transacting with unofficial credit markets “can be a criminal offense punished by long jail terms or worse”

The implication of the above is that much of China’s present day economy remains influenced by political forces. This means we cannot trust statistical figures to show real economic growth as they may likely be manipulated for immediate political goals.

This also means that a substantial segment of the nation’s resources have been utilized inefficiently which entails of massive wastages and of capital consumption.

Ghost cities, empty malls and stadiums are evidences of these.

While it may true that the private sector may have been outperforming the state owned companies, the latter’s substantial share extrapolates to the crowding out of the private sector.

Also, political authorities through state owned enterprises have used politics to undermine their private sector counterparts.

And in order for the private sector enterprises to survive and compete they have gone beyond the ken of authorities through the underground/informal economy (e.g. shadow banking). But doing so means having to take upon greater legal and regulatory risks.

All these goes to show how China has been discriminating against the private sector while favoring state owned enterprises.

Ever wonder why China has been a hotbed for 'fake' and or inferior goods?

Apparently globalization has been a key dynamic in forcing the reluctant hands of China's political authorities to liberalize.

And so far the good news has been that political trends appear to signal the emergence of the entrepreneurs as a political force.

This seems evident in the realm of China’s financial markets.

Over the past few months China authorities has undertaken a flurry of liberal oriented reforms; particularly China has recently eased on restrictions on Exchange Traded Funds (ETFs), has lowered transaction fees on share trading, has proposed to ease delisting rules, and seeks to increase the participation of foreign investors into China’s equity markets by expanding the Qualified Foreign Institutional Investors (QFII).

Nonetheless political trends will determine if China’s economic miracle will continue, put to a halt or reverse. All these will rest on China's appetite for economic freedom.