Report No. 7483-CHA

China: Country Economic MemorandumMacroeconomic Stability and Industrial GrowthUnder Decentralized Socialism(In Three Volumes) Volume II: Industrial Structure, Dynamics and PoliciesJune 12, 1989

Country Operations DivisionChina DepartmentAsia Region

FOR OFFICIAL USE ONLY

Document of ̂ he World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may not otherwisebe disclosed without World Bank authorization.

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CURRENCY EOUIVALFNTS

The Chinese currency is called Renminbi (RMB).It is denominated in Yuan (Y). Each Yuan is

1 Yuan - 10 jiao - 100 fen

Calendar 1988 June 1989US$1.00 - Y 3.72 US$1.00 - Y 3.72Y 1.00 - US$0.27 Y 1.00 - US$0.27

FISCAL YA

January 1 - December 31

WEIGHTS AND MEASURES

Metric System

LIST OF ACRONYMS

AIC - Administration for Industry and CommerceCASS - China Academy of Social SciencesEEC - European Economic CorporationFAW - First Auto WorksFEAC - Foreign Exchange Adjustment CenterFTC - Foreign Trad6 CorporationsGDP - Gross Domestic ProductGNP - Gross National ProductGVIO - Gross Value of Industrial OutputIMF - International Monetary FundMOF - Ministry of FinanceNICs - Newly Industrializing CountriesPBC - People's Bank of ChinaREER - Real Effective Exchange RateSAEC - State Administration of Exchange ControlSEZ - Special Economic ZoneSNA - U.N. System of National AccountsSSB - State Statistical BureauTICs - Trade and Investment CorporationsTVE - Township, Village and EnterpriseVAT - Value-added Tax

FOR OFFICAL USi ONLY

TITLE : China: Macroeconomic Stability and Industrial Growthunder Decentralized Socialism

COUNTRY : China

REGION : Asia Region

SECTOR : Country Economic

REPORT mYE CLASSIFICATION mmtY LANGUAGE

7483-CHA ERA Official Use 6/89 English

PUBDATE : June 1989

ABSTRACT : The report is divided into two volumes. The first volumeanalyzes recent macroeconomic developments with specialattention to the reforms that have been responsible forChina's rapid growth. It also examines policiesintroduced during 1988-9 to dampen inflationary pressuresthat have resulted from high rates of expansion. Thesecond volume looks at longer term prospects forindustrial reform and development. After describing theindustrial structure and the changes that have occurredin the eighties, it concentrates on (i) the dynamics ofthe Chinese manufacturing enterprise; (ii) the factorsinfluencing the integration of the national market; and(iii) industrial strategies that are likely to promotecompetition allocative efficiency, technological progressand X-efficiency.

This document has a restricted distribution and may be used by recipik ts only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

Table of Contents

Page No.

EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . i - xi

Aims of Reform. . . . . . . . . . . . . . . . . . . . . . . . . iEmergence of Macroeconomic Instability during the Second Phase. iiFramework for Future Policy Actions . . . . . . . . . . . . . . ivControl of Inflation in the Short-run . . . . . . . . . . . . . vLong-Term Strategy. . . . . . . . . . . . . . . . . . . . . . . viii

VOLUME ONE - MACROECONOMICS

I. MACROECONOMIC OVERVIEW . . . . . . . . . . . . . . . . . . . . 1

Macroeconomic Overview. . . . . . . . . . . . . . . . . . . . . 1Political Economy ot Reform .... . . . . . . . . . . . . . . 2Growth and its Sources: 1978-88. . . . . . . . . . . . . . . . 4Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . 8Employment. . . . . . . . . . . . . . . . . . . . . . . . . . . 10Productivity. . . . . . . . . . . . . . . . . . . . . . . . . . 12Foreign Trade.. . ..... 18External Borrowing. . . . . . . . . . . . . . . . . . . . . . . 25Macroeconomic Agenda and Actions. . . . . . . . . . . . . . . . 27

II. INFLATION AND ITS CONTROL THROUGH MON.ETARY AND INCOMES POLICIES 30

Reform and Inflation Dynamics .... . . . . . . . . . . . . . 30

Section A: The Pricing System and the Pattern of Inflation . . 32Price Patterns. . . . . . . . . . . . . . . . . . . . . . . . . 33Recent Inflation and its Cost .... . . . . . . . . . . . . . 39

Section B: Monetary Trends and Management . . . . . . . . . . 41Monetary Policy: Short- and Medium-Term. . . . . . . . . . . . 51

Section C: Incomes Policy .... . . . . . . . . . . . . . . 56Labor Earnings. . . . . . . . . . . . . . . . . . . . . . . . . 56

III. FISCAL STRUCTURES AND POLICY .62

Background on Fiscal Development. . . . . . . . . . . . . . . . 62Fiscal Structures .... . . . . . ...... . . . . . . . . 64Fiscal Reforms and Budgetary Dynamics . . . . . . . . . . . . . 69Theory and International Practice of Fiscal Policy. . . . . . . 76Fiscal Policy for the Transition. . . . . . . . . . . . . . .,. 80

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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IV. INVESTMENT BEHAVIOR AND DOMESTIC RESOURCE AVAILABILITY. . . . . 85

Section A: Investment. . . . . . . . . . . . . . . . . . . . . 85Investment Pattern. . . . . . . . . . . . . . . . . . . . . . . 85Investment Planning and Management by the Central Government. . 88Investment Imperatives of Local Governments . . . . . . . . . . 95Investment Control and Financing. . . . . . . . . . . . . . . . 96

Section B: Savings ...... . .. . .. . .. . . .. . . . 101Structure and Trends. . . . . . . . . . . . . . . . . . . . . . 101Household Saving Behavior ..... . . . . . . . . . . . . . . 103The Stability of Savings ..... . . . . . . . . . . . . . . 109

V. INDUSTRY. AGRICULTURE AND LONGER-TERM REFORM. . . . . . . . . . 114

Section A: Industry. . . . . . . . . . . . . . . . . . . . . . 115

Section B: Agriculture ..... .. . . . . . . . .. . . . . 119Trends during 1978-86 . . . . . . . . . . . . . . . . . . . . 119Emerging Bottlenecks. . . . . . . . . . . . . . . . . . . . . . 121Food Production Strategy. . . . . . . . . . . . . . . . . . . . 126Future Policy Initiatives ..... . . . . . . . . . . . . . . 127

ANNEX A CHRONOLOGY OF ECONOMIC REFORMS, 1979-88 . . . . . . . . . 129-137

VOLUME II. - INDUSTRIAL STRUCTURE. DYNAMICS AND POLICIES

EXECUTIVE SUMMARY ........................... i - ix

National Market Integration. . . . . . . . . . . . . . . . . . . iDirections for Industrial Policy . . . . . . . . . . . . . . . . iiiRole of Small Firms. . . . . . . . . . . . . . . . . . . . . . . vEnterprise Microeconomics. . . . . . . . . . . . . . . . . . . . viiAdministrative Environment .................. . viii

VI. STRUCTURE OF INDUSTRY . . . . . . . . . . . . . . . . . . . . .

Pattern of Industrial Change . . . . . . . . . . . . . . . . . . 5Industrial Concentration ....... .. .. .. .. . ... 6Subsectoral Growth . . . . . . . . . . . . . . . . . . . . . . 11Small Scale Industry ....... .. .. .. .. . ..... 13Role of the Market .......... . .... ...... . 16Geographical Trends in Industry . . . . . . . . . . . . . . . . 17Industrial Finance and Enterprise Ownership . . . . . . . . . . 20Equipment and Technology.. .. 22Structure and Dynamics in Electronics,Consumer Durables and Steel . . . . . . . . . . . . . . . . . 23

Changing Industrial Contours . . . . . . . . . . . . . . . . . . 29

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VII. CHINESE STATE ENTERPRISES AND THEIR ECONOMIC ENVIRONMENT . . . . 32

Background .... . . . . . . . ... . . . . . . . . . . . . 32Enterprise Evolution . . . . . . . . . . . . . . . . . . . . 33Labor Markets, Incentives and X-efficiency . . . . . . . . . . 35Technological Change and Its Financing . . . . . . . . . . . . 41Structure of the Enterprise . . . . . . . . . . . . . . . . . . 44Resource Allocation .... . . . . ...... . . . . . . . . 48A Direction for Reforms . . . . . . . . . . . . . . . . . . . . 49

VIII. REGIONAL INDUSTRIALIZATION AND MARKET INTEGRATION. . . . . . . . 53

Pattern of Industrialization in the U.S. . . . . . . . . . . . 54China's Regional Development Policies, 1953-79 . . . . . . . . 56Measuring the Cost of the Interior Development Strategy . . . . 61Regional Development in China Compared with Other Countries . . 65Subregional Industrial Policies .... . ..... . . . . . . 73Two Regional Scenarios .... . . . .... . . . . . . . . . 74Integrating Markets .... . . . . . . . . . . . . . . .. 80Interprovincial Trade .... . . . ...... . . . . . . . . 80Marketing ..... . . . . . . . . . . . . . . . . . . . .. 85Transport ..... . . . . . ....... . . . . . . . . . . 86Investment . . . . . . . . . . . . . I . . . . . . . . . . . . 94Tariffs ..... . . . . . . ...... . . . . . . . . . . . 94Modal Choice ......................... . 95Strands of a Regional Strategy .... . . ..... . . . . . . 95

IX. ASPECTS OF INDUSTRIAL POLICY.. . . . . . . . . . . . . . . . 97

SECTION A: CHINA .... . . . . . . . . . . . . . . . . . . . 98

Legal Rules and Market Development . . . . . . . . . . . . . . 98Industrial Policy . . . . . . . . . . . . . . . . . . . . . 103Interfirm Linkages . ............... 103Industrial Regulation and Barriers to Entry . . . . . . . . . 105Price Competition . . . . . . . . . . . . . . . . . . . . . 107Bankruptcy ................ 109

SECTION B: CROSS-COUNTRY EXPERIENCE . . . . . . . . . . . . . . 110

Antitrust Policy and Administrative Guidance . . . . . . . . . 111Bankruptcy Law ................ 115Board of Directors ................ 116Takeovers ................ 117A Recapitulation of the Main Points . . . . . . . . . . . . 118Technology and Industrial Structure . . . . . . . . . . . . . 119Role of Small Firms ................ 124Industrial Policy Guidelines for China . . . . . . . . . . . 126

VOLUME III - Statistical Annex

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TABLES IN TEXT - VOLUME I

1.1 Sectoral and Demand Linked Sources of Growth 1980-88 . . . . . 61.2 Savings and Investment, 1978-88. . . . . . . . . . . . . . . . 71.3 Measures of Inflation. . . . . . . . . . . . . . . . . . . . . 91.4 Sources of Growth Analysis . . . . . . . . . . . . . . . . . . 131.5 Relation between Output and Productivity Growth, 1975-1986 . . 161.6 Price Index of Non-Residential Industrial Construction, 1970-85. 161.7 Investment in Housing.. . . . . . . . . . . . . . . . . . . . 181.8 Exports of Selected Food Items . . . . . . . . . . . . . . . . 201.9 Exports of Commodities from China. . . . . . . . . . . . . . . 201.10 Imports of Commodities to China. . . . . . . . . . . . . . . . 211.11 Real Effective Exchange Rates . . . . . . . . . . . . . . . . 241.12 External Borrowing. . . . . . . . . . . . . . . . . . . . . . 272.1 Measures of Inflation . . . . . . . . . . . . . . . . . . . . 352.2 Quarterly Measures of Inflation. .. . . . . . . . . . . . 362.3 Nationwide Measures of Price and Wage Inflation . . . . . . . 362.4 Market Price Indices by Category of Commodity, 1981-87. . . . 372.5 Price Dispersion for Selected Products . . . . . . . . . . . 392.6 Growth Rates of Monetary Aggregates . . . . . . . . . . . . . 4.2.7 Contributions to Liquidity Growth . . . . . . . . . . . . . . 452.8 Contribution to Reserve Money Growth . . . . . . . . . . . . 462.9 Monetary Control Ratios . . . . . . . . . . . . . . . . . . . 472.10 Share of Loans to Enterprises and Individuals in Total Lending 482.11 Sources of Domestic Credit Growth . . . . . . . . . . . . . . 492.12 Revenue From Money Creation . . . . . . . . . . . . . . . . . 492.13 Money Demand Parameters . . . . . . . . . . . . . . . . . . . 502.14 Trend in Velocity .... . . . . . ..... . . . . . . . . 502.15 Interest Rate Structure . . . . . . . . . . . . . . . . . . . 522.16 Industrial Wage and Productivity Indicts. . . . . . . . . . . 582.17 Industrial Wage and Productivity Growth Rates . . . . . . . . 583.1 Structure of Consolidated Government Revenue, 1978-1987 . . . 653.2 Developments in Government Reveaue, 1978-88. . . . . . . . . . 663.3 Structure of Government Expenditure, 1978-88 . .. . . . . . 673.4 Developments in Government Expenditure, 1978-88. . . . . . . . 683.5 Budget Deficit and its Financing, 1979-88. . . . . . . . . . . 683.6 Changing Fiscal Importance of the Central and

Subnational Government Sectors . . . . . . 733.7 Simulation of Budget Deficits at Various Rates of Inflation,

Real Growth and Interest Rates . .. . . . . . . 834.1 Gross Domestic Investment (GDI) as Percent of GDP. .864.2 Percent Share of Total Capital Construction Investment . . . . 874.3 Proportion of Total Output Under Central Allocation. . . . . . 894.4 Financing of Domestic Fixed Investment . . . . . . . . . . . . 924.5 Central Government Priority Investment . . . . . . . . . . . . 934.6 Uncompleted Construction .................. . 1004.7 Composition of Saving, 1978-87 ... . . ..... . . . . . . 1034.8 Gross Domestic Savings, Selected Countries, 1965-88. . . . . . 1064.9 Household Savings Rates. . . . . . . . . . . . . . . . . . . . 1064.10 Growth of Financial Savings Versus GDP Growth. . . . . . . . . 1084.11 Rural-Urban Terms of Trade ...... ........ . .. . 1094.12 Household Savings Rate in China, 1978-87 . . . . . . . . . . . 1114.13 Financial Asset Holdings of Selected Countries . . . . . . . . 1135.1 Current and Projected Per Capita Food Consumption. . . . . . . 1205.2 Agricultural Indicators. . . . . . . . . . . . . . . . . . . . 1205.3 Fresh Vegetable Mixed Average Retail Prices in Major

Cities, China, May 1985 to Februarv 1988. . . . . . 12E. Land Uinder VAa'ctnhles . .- 125

TABLES IN TEXT - VOLUME II

6.1 National Inco'ae by Provinco, 1986. .. . . . . . . . . . . . 16.2 Provincial Distribution of per capita Industrial Output,

1957, 1965, 1979, 1983 and 1986 . . . . . . . . . . . . . . 46.3 Summary Measures of Interprovincial Inequality

in Gross Value of Agricultural Output (GVAO). . . . . . 56.4 Number of Industrial Enterprises . . . . . . . . . . . . . . . 76.5 Gross Value of Industrial Output . . . . . . . . . . . . . . . 86.6 Gross Value of Industrial Output per Enterprise

in 1980 constant prices. . . . . . . . . . . . . . . . . . . 96.7 Summary Measures of Industrial Concentration of China,

Korea and India . . . . . . . i . . . . . . . . . . . . . . 96.8 Gross Value of Industrial Output in

1980 constant prices, by Branch. . . . . . . . . . . . . . . 116.9 Number of Industrial Enterprises by Province . . . . . . . . . 126.10 Gross V7aiue of Industrial Output in 1980 Prices, by Province . 136.11 Industrial Shares of Township and Village Enterprises. . . . . 156.12 Ownership Structure of Industrial Output in 1987 . . . . . . . 186.13 Current Liabilities as a Percentage of Networth. . . . . . . . 216.14 Total Electronics Output Value in Top Four Regions . . . . . . 256.15 Share of Rolled Steel Production by Zone . . . . . . . . . . . 286.16 Share of Pig Iron Production by Zone . . . . . . . . . . . . . 287.1 Time Allocation by Managers. . . . . . . . . . . . . . . . . . 467.2 Structure of the Industrial Work Force, 1986 . . . . . . . 478.1 Personal Capita Income in Each Region as a Percentage of

the U.S. Average, 1840-1980. . . . . . . . . . . . . . . . . 568.2 Agricultural Growth in Interior Provinces. . . . . . . . . . . 588.3 Regional Capital-Labor and Output-Labor Rates for Large-

and Medium-Scale Industrial Enterprises in 1985. . . . . . . 628.4 Regional Differences in Large & Medium Enterprise Efficiency . 638.5 Net Material Product by Province (1985). . . . . . . . . . . . 698.6 Structure of Industry by Province in 1986. . . . . . . . . . . 708.7 Farm Incomes and Nonagricultural Employment by Province. . . . 728.8 Regional Inequality in China and the U.S. . . . . . . . . . . 738.9 The Percentage of Commodities Imported from Other Provinces

by Commercial Establishments in Various Provinces andMunicipalities in their Total Purchase of Commodities. . . . 83

8.10 Percentages of Main Industrial Products Produced by Coastal,Inland, Eastern, Central and Western Areas Respectivelyin China's Total Output. . . . . . . . . . . . . . . . . . . 83

8.11 Net Exports by Province, 1985. . . . . . . . . . . . . . . . . 848.12 Transport Investment vs Economic Output in China . . . . . . . 878.13 Railway and Road Network Density in Selected Countries . . 878.14 Distribution of Intercity Passenger Traffic by Mode

China, U.S.S.R., India, Brazil and U.S. . . . . . . . . . . 888.15 Distribution of Freight Traffic by Mode. . . . . . . . . . . . 888.16 Freight Traffic Intensities. . . . . . . . . . . . . . . . . . 898.17 Indicators of Railway Asset Utilization, A Comparison

between China, U.S.S.R., India and U.S.. . . . . . . . . . . 908.18 Transport Supply Developments. . . . . . . . . . . . . . . . . 928.19 Characteristics of Chinese Railway Freight Traffic . . . . . . 93

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GRAPHS

2.1 Different Measures of Inflation. . . . . . . . . . . . . . . 342.2 Price Dispersion for Beer, Tea and Cake. . . . . . . . . . . . 406.1 Gross Value of Industrial Output, China. . 1 . . .06.2 Number of Industrial Enterprises, China. . . . .17

BOXES

1.1 Productivity Growth in China .... . . . . . . . . . . . . . 146.1 Causality between Agriculture and Industry . . . . . . . . . . 30-31

IBRD 21483 .... . . . . . . . . . . . . . . . . . . . . . . 2IBRD 21484R. . . . . . . . . . . . . . . . . . . . . . . . . . 14IBRD 21485 ..... . . . . . . . . . . . . . . . . . . . . . 59IBRD 15512R3 . . . . . . . . . . . . . . . . . . . . . . . . . 128IBRD 15525R2 .... . . . . . . . . . . . . . . . . . . . . . 138

The Report was prepared by a mission that visited China in June 1988.Mission members were Shahid Yusuf (Mission Leader), Gerd-Peter Dittus (AS3CO),Barry Naughton, Dwight Perkins (Consultants), Gyorgy Szapary (IMF), andTejaswi Raparla (AS3CO). Background papers for the report were prepared byThawat Watanatada (AS3TE), Peter Harrold (AS3CH), Andrew Feltenstein,Dorothy J. Solinger, Renee Schwartz and Robert M. Field (Consultants).

Executive Summary

1. For the past decade, Ghinese economic reforms have promoted rapidgrowth. Now, with inflation mounting, some hard choices lie ahead.Slowing the economy and putting ceztain proposed policies on hold isdesirable in order to stabilize prices, but there is the risk that thestrong momentum acquired by the reform drive will be weakened,inefficiencies will once again begin to accumuiate increasing the system'ssusceptability to price escalation, when reflationary policies are applied.To put it differently, measures that enhance productive efficiency, improvethe trade-off between growth and inflation as rising productivity bluntscost pressures. A postponement of reforms is likely to have the reverseeffect and will raise the core rate of inflation.

2. During the decade of the nineties, the principal sources of growtnand avenues for raising factor productivity will probably be found in theindustrial sector. Both the objectives of growth as well as pricestability would be best served if industrial reform continues unabated,even as macroeconomic policy takes the edge of demand-pull pressures.Volume II, therefore, concentrates on a range of industrial concerns thaturgently require attention. These are:

e national market integration, interprovincial trade and factormobility.

* industrial organization, in particular, the roalescence ofenterprises through mergers into larger entities and therelationships between firms of different sizes.

* institutional and administrative means for stimulating marketcompetition.

* enterprise management, the internal labor market and efficiency.

The principal conclusions of the Report, that rest upon an analysis of theindustrial system in China as well as cross-national experience aresummarized below. They complement and in some instances, reinforce theproposals presented in the State Council's "Outline of Industrial Policy",issued on March 15, 1989.

National Market Integration

3. A large domestic market can make an immeasurable contribution toindustrial strength. China has yet to exploit fully the advantages of sizewhich it enjoys over most other developing countries. Although reforms havebrought with them the promise of closer market integration, China remains acollection of provincial subeconomies held together by the bonds of adminis-tration and political allegiance, but which are only now beginning to outgrowthe long cultivated habit of autarchy. The tight web of economic relation-ships which would be normal for a country that has attained such a respectablelevel of industrialization is missing. It poses a problem for the near term,but presents opportunities over the longer horizon. Factor immobility, themodest volume of interprovincial trade, the smallness of the average

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production unit and industrial duplication, all compromise allocativeefficiency. An industrial strategy that is successful in accelerating marketintegration; in removing some of the barriers to dr:e flow of goods and factorsacross provincial boundaries; and in drawing China more firmly into the orbitof the international trading system, could provide a substantial windfall interms of productivity gains, aside from the continuing benefits for growth andmacro stability.

4. The long run goal of a regional strategy should be to create anational market in which goods, factors and information move with the minimumof friction or hindrance. This will optimize resource allocation and slowlyeliminate income differentials. A start might be made with regional freetrade groupings which, over time could coalesce into a single free trade area.Both the experience of the United States and of the EEC indicates thatbarriers to mobility should be the first priority. To reach this goal, a hostof issues will have to be attended to.

z Industrial policies of individual provinces will require some degreeof harmonization.

* A concerted effort will be needed to dismantle administrative andother barriers that segment the national economy. For instance,restrictions on trade with other provinces; sizable differences insales and exciso taxes between contiguous provinces; procurementpolicies of local agencies; and bidding practices, in particular thevirtual absence of open tendering that is subject to review by acentral supervisory body.

* Market initiatives, that lead to consolidation of enterprises intolarger firms that sell nationwide, can provide tha organizationalmeans for straddling provincial boundaries. The growth of thenational market in the United States is inseparably associated withthe appearance of large corporations operating multiple plants.

* For smaller firms to develop markets for their products in distantparts of the country, an efficient, decentralized network ofdistributors, strongly linked to local retail outlets, will have tobe assembled. National advertising; after sales service; partsdistributors and the rest of the marketing infrastructure that hadbeen reduced to a shrunken state, will have to be built up to normalproportions.

* Inter- and intra-provincial migration has commenced. Peasants arepermitted to take up residence in cities with less than 200,000people; they can obtain temporary work permits in cities with up tohalf a million people; and thousands serve as construction workersand maids in the very large cities. Workers from the Northwest areto be found in Guangdong and temporary migrants from the interiorhave become a part of the service sector in many coastal cities. Theloosening of barriers to labor mobility is a new and importantdevelopment which is straining municipal services. Understandablythe authorities are anxious to avoid opening the floodgates but,urban conditions permitting, a national labor market is definitely avital component of a regional industrial strategy.

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* Lastly, without a dense transport network the results of otherefforts will be weakened. China has among the lowest, annual,intercity mobility rates per capita for any country in theworld -- about 500 km as against 900 km in India. The modest shareof investment in transport, averaging just 1.3% of GNP over the1976-90 period, is to blame. By emphasizing provincial self-sufficiency and by tying the development of the railway system todefense needs and the distribution of coal, the state furtherhindered the emergence of transport linkages which would aid thecause of market unification. Another feature of the transport systembased on the Soviet model, that sets China apart from otherdeveloping countries, is the heavy dependence on railways for thetransport of both freight as well as passengers. Once again, thischaracteristic is associated with the importance attached to thetranspcrt of a few bulky raw materials, and the minimal significancegiven to passenger traffic and the shipping of light manufactures.Consequently, road, water, and air transport were neglected. Thesedeficiencies must be made good and inter-provincial trade relationscemented by an adequate multi-modal transport network.

Directions for Industrial Policy

5. Efforts made to integrate the national economy must be matched byindustrial policies to strengthen market forces, stimulate competition andnudge industrial organization towards greater efficiency. Industrial policyin China cannot harness market forces to obtain desired objectives, so long asthe uncertainties besetting economic units, that have little familiarity withmarkets, cannot be reduced. The extent and definition of property rightsremains vague. Further, the binding force of contracts together with the easeand predictability of legal redress, are in need of sustained attention fromthe authorities. Efficient markets built on a system of economic law thatprovides clear rules and generates stable expectations would greatlyfacilitate the shaping of the industrial structure calculated to maximize thegrowth of productivity.

6. The emergence of markets is no guarantee that resources will be put tothe most productive use or that innovation will thrive. For that to happenboth theory and practice unanimously extol the advantages of competition. Howsuch competitiveness is to be arranged and what dose of competition isappropriate is the subject of much debate. At one extreme, the model ofperfect competition requires numerous atomistic firms, offering a homogeneousproduct, in a market where there are no barriers to either the entry or theexit of suppliers. These criteria are difficult to satisfy and they do notrecognize that competition can take many different forms and occurs at variouslevels, stretching from product markets to financial ones. A variety ofregulations to encourage competitive behavior have been tried by theindustrialized countries, depending on their historical circumstances andbusiness traditions. They have failed to achieve perfection but theexperience gained is nevertheless, instructive.

* Developed market economies have been unable to avoid industrialconcentration. They have also found that so long as "excessive"collusion is kept at bay, it need not impair allocative mechanisms.

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* The concept of perfect competition is of limited utility in derivingcriteria for measuring levels of market competitiveness or as ayardstick for the making and administering of antitrust laws.

X Averting deleterious collusion requires strong public sentimentagainst concentration and a powerful, independent judiciary. Oradministrative guidance by the state must keep competition alivebetween oligepolists.

* Barriers to entry, especially regulatory ones, are major impedimentsto market contestability in China today. Removing these can do morefor competitiveness than sophisticated antitrust laws or powerfulsupervisory agencies. Entry into or exit from the state andcollective sectors in China is strewn with red tape. Researchconducted during the early eighties suggests that exit by firms fromold lines, even in times of slack demand., is quite rare. Nor do theState and collective industries respond speedily to customer needs bymodifying products or entering new markets. In part this is theresult of managerial lethargy that time and a market environment willerode. But clearing regulatory impedimentia could lead to signalimprovements.

- Bankruptcy laws are principally concerned with debt collection andtheir significance for competition in market economies is not verylarge. The value of such laws in the Chinese milieu would be inproviding criteria for determinlng how and when to assist ailingfiras, as well as to coordinate labor, environment and tax issuesthat arise when an enterprise is closed down.

_ Company boards hold much promise in theory but have often failed tomeet expectations in practice. The institution will have to be sodesigned as to prevent the board of directors from becomingministerial surrogates, or from being coopted by enterprisemanagement as they have been in other countries.

* Takeovers have spread apprehension through the corporate ranks in theU.S. and Europe but the gains in terms of efficiency have beensurprisingly meager. It is difficult to claim that open andcompetitive capital markets have improved the efficiency ofindustrial activity by simplifying corporate raiding. Hence,administratively ordained mergers between Chinese enterprises mightbe of doubtful value.

* Perhaps the most important lesson is that the competitiveness ofmarkets seems linked to the structure of industry and its influenceon factor productivity as well as innovativeness. Until the earlyseventies it looked as though large, vertically integrated companies,exploiting scale economies and oriented towards mass markets, held acommanding lead. Such corporate firms squeezed the most product fromsociety's resource base and were best equipped to satisfy the wantsof modern consumers. This essentially American model, has beeneclipsed in the transport, machinery and consumer durable subsectorsby a Japanese-European model resting on a symbiosis between large and

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small enterprises. Prior to the early eighties most Chinese enter-prises sought vertical integration to lessen their dependence onunreliable suppliers. Since that time planners have begun experi-menting with horizontal consolidation, conglomerates and industrygroups. Meanwhile, thousands of small township, village and coopera-tive enterprises are entering the lists. What kind of market struc-tures are conducive to efficiency? This is a question for whichthere is no unequivocal answer but research from developed and devel-oping countries described below provides pointers.

7. Japanese and some German companies have moved the farthest in realiz-ing the potential of the new breed of large corporation. The principal goalof the large Japanese manufacturing company is to improve the existing productline and to introduce new products. Next comes market share. By cementingclose links with a major bank, it gains valuable financial depth and thestable supply of funds that can sustain investment in the troughs of businesscycles. The effort to economize on overheads and promote horizontalcommunication results in a relatively flat hierarchical pyramid. Concern foroverheads, plus the knowledge that efficiency stems from specialization,induces the firm to locate itself at the center of a network composed ofsubsidiaries and associated companies, all bound together to the leadingcorporation as well as the main bank by cross-shareholding, boardrepresentation and long-standing commitments. Bigger companies can buy twothirds or more of their components from subcontractors. The network serves asan internal market for information. It also pools the technical expertise ofall network members. While the large firms encourage their subcontractors toevolve independent design and research capability, they import much technicalknowle,. e through the cooperative ventures undergirding manufacturingprojects.

8. Managing a network of subsidiaries and subcontractors bound by long-term relations instead of a vast, integrated, multidivisional productionapparatus permits a freer flow of information, makes for greater flexibilityin response to the market, cultivates multiple foci for technological progressand does away with the large, remote bureaucracies that compromise thecompetitiveness of vertically integrated corporations. Emphasis on innovationand improvement motivates research.

9. Network manufacturing, anchored by leading corporations and invest-ment banks, is the regnant organizational mode in the automotive and consumerelectronic subsectors in Japan. It has also taken hold in the German automo-tive components and textile machinery industries. These arrangements, alongwith recent trends in the U.S. and the East Asian NICs are helping to define aniche for small enterprises.

Role of Small Firms

10. Policy towards small firms throughout the developing world has beenblurred by various misconceptions. On the one hand, they have been accused ofinefficiency and poor quality. On the other, they emerged in the seventies asthe torchbearers of appropriate, labor-intensive technolcgy in developingcountries and the cutting edge of the new entrepreneurial wave sweeping theadvanced sectors in the industrial economies. With the passage of time hascome a better understanding of what small companies can contribute.

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11. Within the environs of manufacturing, small companies are likely tobe the pace setters in three areas:

* Where design concerns are paramount and production is usually insmall batches aimed at differentiated clienteles. Clothing, leathergoods and jewelry fall most readily into this category.

* Where total innovation using skilled labor is the principal objective,entry barriers are low and there is a premium on entrepreneurialinitiative. Advantage in innovation relates to the ease of internalcommunication which a resourceful entrepreneur can use to integrateresearch, production and marketing. Information, electronics andbiotechnology have filled these requirements, except that all of theseare now entering the stage in their life cycle when large, capital-intensive firms, with a broad operational scope, are gaining anadvantage in generating innovations and, more importantly, marketingthem commercially. The contrasting experience of the electronicsindustry in Taiwan (China) and Korea pushes the point home. Taiwan(China) enjoyed a headstart and its small firms became proficientmanufacturers under license or through direct investment ofsemiconductors, keyboards, monitors and disk drives. But, by remainingsmall, these firms are being overtaken by the Korean conglomerates ableto commit large resources to research and production facilities.

_ The network milieu described above. Here the path taken by Japanesemachinery firms offers a few guideposts. Most firms are of medium andor small size. Specialization and subcontracting is the rule--fully70% of all firms subcontract, even the smallest. The sector emerged inthe fifties and has flourished since for several reasons. A reservoirof skills, low entry barriers and the financing provided by rural andsmall business credit institutions attracted small businessmen to theindustry. A highly competitive environment emerged which stimulatedthe search for new technology and market niches. Other factors were anexpanding market, both domestic and overseas; refinement and extensionof technology licensed from overseas; incentives and support from largecorporace buyers to produce sophisticated items; and the fruitfulnessof cooperative specialization. In capsule, a vibrant industrycomprised of small firms needs adequate institutional finance, sourcesof technology, growing competitive markets and specialization within aninterconnected network.

12. Reform has drawn thousands of new entrants into the least regulatedtownship, cooperative and village sectors of Chinese industry. They havebegan to fill the ranks left depleted by three decades of socialist planning.While these new enterprises may bring balance to the industrial mix and pro-vide employment, growth of the small-scale sector should be brought within thepurview of industrial policy by removing price distortions, entry barriers tolarge firms and local trade restrictions which encourage uneconomic smallscale investments.

13. Making industrial policy in a pluralistic market economy such as theU.S. presents serious difficulties, but the belief in the desirability ofcoherent long-run guidance by the government continues to spread. China is

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much better equipped in terms of tradition and instruments to pursue anindustrial strategy. At a time when reform has loosened many constraints onstructural change, strategic guidance by the central government can serve asthe framework within which firms interpret market signals and avert theentrenching of provincial industrial bases feeding local markets. It willalso be up to the government to prevent the division of the market bybureaucratic conglomerates that are neither efficient nor innovative.

14. The fine print of strategy is for Chinese policymakers to decide.What they might treat as constants for their purposes are the following:

* Price and product competition is the most important aspect of marketactivity. Competition can accelerate the growth of total factorproductivity and it may be more important than firm size indetermining innovativeness. Industrial structure, entry barriers,financial markets and other factors mentioned in this chapterinfluence competition. East Asian and American experience alsobrings out the salience of competition from trade. Not only has thisspurred Asian companies to excel, it has, more recent'y, forced U.S.firms to try and regain the technological strength sapped by anexistence in which there was no challenge.

* MITI's sedulously researched long-term vision of the industrialfuture influenced Japanese decision-makers in all walks of theeconomy. The government-instigated, informal consultative processreinforced policy, provided feedback and started a flow ofinformation that energized the myriad interlinked networks ofJapanese industry. Both the vision and the dialogue are componentsof strategy that could serve Chinese planners well into the nextcentury.

Enterprise Microeconomics

15. Labor productivity within the typical Chinese enterprise suffersbecause the compensation, tenurial and assignment arrangements do little tosharpen motivation. Earnings do not seem to be tightly linked to the short-run of the enterprise. Furthec, the distribution of bonuses does notestablish a clear link between individual worker performance, and materialreward.

16. In Japan, for instance, the lifetime compensation of a worker isbound to th; performance of his firm in the market. Profits (and thus theamount available for distribution to workers) depend upon success in themarketplace. The chances of advancement within the firm are enhanced if thefirm is able to expand. In China this link is greatly attenuated. TheChinese enterprise continues to face a "low powered" incentive environment, inwhich rewards and penalties are subject to constant renegotiation withsuperiors. There are, in addition, serious constraints on the firm's abilityto expand, and in particular to diversify into related markets which make itdifficult for the Chinese worker to reliably associate the enterprise'sperformance with his or her own future career, or lifetime compensationpackage. All these considerations suggest that the incentive mechanisms areseriously flawed and act as a brake on efficiency.

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17. A freeing of labor markets, alongside housing reforms, might be thelong-term solution. In the near future, a number of partira remedies could beconsidered, e.g., (a) Permit new workers a period of job flexibility duringwhich they are encouraged to search for the most satisfying position; (b)Spread seniority wage systems to enhance the long-term link between the workerand the enterprise. These would reduce some of the costs of the permanentemployment system; (c) Provide closer links between worker career paths andenterprise evolution. This requires both more flexible promotion paths thanappear to characterize Chinese industry currently, and measures to allow theenterprise more flexible strategies for expansion.

18. The strength of workers' commitment to the enterprise cruciallyaffects productivity and cost competitiveness through the quality of effort,diligence and absenteei3m. Employees are likely to give their best when theyare trustful of management, there is a sense of common objectives and theidentification with the enterprise is strong. Unimpeded two-way flow ofinformation between management and workers in an enterprise is one way ofwinning commitment. The ability of managers to allocate rewards in a fair anddiscriminating manner encourages effort; while active soliciting of opinionsand suggestions from the grass roots does generate feelings of involvement.

19. So far, the manager of the average state enterprise has made limitedprogress in these areas. While his formal authority may be substantial, theactual latitude he enjoys on matters pertaining to personnel, wage scales andbonuses is extremely narrow. He is not well served by the enterprisecommunications system as it was designed for the purposes of supervisoryagencies seeking information. The obtrusive behavior of supervisory bodiesis intensely preoccupying. Accommodating their occasionally capriciousrequests, absorbs so much of the manager's energy that other kinds ofcommunication with workers, suppliers and buyers are neglected. The manager'sambivalent position vis-a-vis the administrative bureaucracy and theenterprises' own lack of autonomy make it very difficult to build trust orforge commitment. Those at the firms' helm have neither the authority, northe control over incentives nor the time to define enterprise objectives andpersuade workers to pursue them with dedication. Future enterprise reformmust concentrate on redefining the manager's role.

20. Enterprise reforms have snipped away at the complex hierarchy thatbound enterprises to administrative organs. For many collectives, andtownship and village enterprises, supervisory interference has been muchdiminished. They have gained meaningful autonomy. State firms have been lesssuccessful in extricating themselves from the bureaucratic web even afterdecentralization, because provincial administrative hierarchies, binding sub-ordinate to supervisory units, remain intact. They may possibly have gainedin strength following the partial withdrawal of central controls.

21. While an attempt has been made to legislate a modicum of autonomy forthe enterprise, superior organs have a large sphere of authority within whichtheir orders to enterprises have presumptive validity. The survival of alarge area of presumptive authority remains with the extraordinarily widerange of benefits and penalties that supervisors can impose on enterprises inresponse to actions outside the authority relationship. These maintain thedependence of the enterprise on its superiors. This implies, in turn, that asignificant part of enterprise decision-making is actually slaved to thewishes and objectives of superiors, and enterprises can rarely be held fullyresponsible for their actions as would truly independent agents.

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Administrative Environment

22. The administrative system in the provinces is divided into threetiers. First come the comprehensive departments that draft broad industrialguidelines and the industrial bureaux, which direct the activities of firms intheir subsectoral domains. The bureaux claim responsibilities overadministrative, strategic, marketing and social matters. Industrial bureauxalso determine how raw materials at fixed prices are allocated; they ensurethat enterprises meet mandatory production t4rgets; and they, along withpricing agencies, set the rates at which goods subject to full control or toflexible pricing, are sold.

23. So far, the enterprise lacks the credible protection that testedenterprise law could provide from arbitrary interference by superior agencies.Further, the distribution of responsibilities across the tiers means that theenterprise exerts only partial control over decisions vital to itsprofitability and growth: R&D, product development, deployment of newmachines, automation, energy conservation pricing and personnel policies mustall be settled through negotiation with the corporation and the bureau.Decentralization, by transferring more power to the provincial authoritiesthat interact dWrectly with enterprises, has increased the amount ofbargaining and moved the relationship closer to a pure bilateral monopoly. Incertain respects this is less desirable than the conditions prevailing undercentralized control. A centralized system monitors a large number of firms byreference to a comparative standard, and the costs to the center of applyingsanctions are reduced by the alternative ways of exploiting task specificcapital.

24. The current arrangements are unsatisfactory for at least threereasons. Dividing critical responsibilities between the supervising bureau-cracy and the enterprise, rather than concentrat-ng all vital functions withinthe firm, ties the latter's hand and renders effective participation in themarket impossible. Second, the enterprise cannot evolve the organizationalsuperstructure required for autonomous management of the entire range of func-tions covered by the company in market economies. Lastly, bilateral monopolyis not a preferred state of affairs even when it strengthens the enterprises'bargaining position, because it slows decision-making and deflects it awayfrom rational economic criteria. The reaction to market signals is longdelayed and the translation of these signals itself is distorted by thebureaucratic tug-of-war. In the next phase, enterprise reform must enablefirms to gain organizational maturity and arrive at arms-length relationshipswith regulatory agencies that are subject to legally binding rules.

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VI. STRUCTURE OF INDUSTRY

6.1 China derives nearly 47Z of its GDP from industry. No other largecountry has attained a comparable degree of industrialization in the develop-ing world. Equally remarkable is the spread of industry to some of China'spoorest provinces. While the industrial heartland remains in the eastern andnortheastern parts of the country, the industrial sector accounts for a thirdor more of the national income 1/ in Guizhou, Yunnan, Anhui and Gansu.Industry's share was below one third in just three provinces--Guangxi,Xinj_.ang, and Tibet (see Table 6.1). Such uniformity has been attainedthrough deliberate effort which commenced with the First Five-Year Plan.2/

Table 6.1: NATIONAL INCOME BY PROVINCE, 1986

Share in National Income in X ofNational Income Construction,

per capita Transportation(Yuan in 1988) Agriculture Industry and Commerce

Beijing 2,130 9.1 62.8 37.7Tianjin 2,040 10.2 82.7 27.1Hebei 673 32.0 49.5 18.5Liaoning 1,299 18.6 82.9 18.6Shanghai 3,471 4.4 71.9 28.7Jiangsu 1,084 32.9 61.1 16.0Zhejiang 1,042 31.7 40.3 20.0Shandong 770 41.3 s2.2 16.6Guangdong 897 37.1 36.0 26.9Fujian 672 38.9 $8.) 23.0

Shanxi 682 21.1 S3.9 26.0Jilin 823 33.2 47.6 19.3Heilongjlang 997 27.2 66.2 17.6Anhui 699 48.7 34.7 16.6Jiangxi 643 47.2 36.2 17.8Henan 540 41.6 39.2 19.2Hubei 805 40.3 41.4 18.3Hunan 603 47.8 34.4 17.8Guangxi 460 47.6 81.3 21.1

IMAR 606 41.6 37.1 21.3Sichuan 616 43.4 36.4 20.2Guizhou 406 46.0 35.0 19.0Yunnan 453 45.4 35.9 18.7Tibet 661 69.4 7.7 22.9Shaanxi 631 34.9 43.7 21.4Cansu 670 29.8 42.8 27.4Xinjiang 740 44.9 31.8 23.3Qinghai 698 34.8 34.8 30.4Ningxia 616 38.4 36.0 25.6

National average 748 33.8 46.7 20.4

Source: State Statistical Bureau, Statistical Yearbook of China, 1988, p. 55 and 57.

1/ National Income, or net material product as the Chinese define it, isthe sum of the primary incomes of the population and enterprise.

21 Semi-autarkic development by individual provinces is also a part of theexplanation for what may be an overexpansion of intermediate productindustries and consequent provincial underspecialization. See TheDistorted World of Soviet-Type Economies, by J. Winiecki, University ofPittsburgh Press, 1988, Ch. 3.

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6.2 During the fifties, the egalitarian bent of government strategysupported transfers from the richer provinces to promote development in placessuch as Henan, Guangxi and Sichuan. From the mid-sixties, industrialdeepening in the south and southwest began in earnest as defense concernsinduced the authorities to carve industrial bases in remote parts of Sichuan,Yunnan, Guizhou and in Gansu (see Chapter VIII). By the time investment inThird Front facilities was suspended in the early seventies, some of China'smost backward areas had acquired industrial complexes, complete with thenecessary infrastructure, capable of producing metal products, petrochemicals,machinery and transport equipment. Between 1963 and 1965, 38? of totalinvestment was absorbed by the Third Front. It rose to 53Z in the second halfof the sixties; and accounted for 41X of gross investment over the period1971-75.3/

6.3 Government grants, directed capital spending, and the transfer ofplant from the Eastern seaboard abetted industrial equality. Industrialgrowth was faster in the interior and southern regions between 1957 and 1979and per capita industrial output rose, whereas the east and northeast regionsexperienced a decline. In the eighties, the industrial sector has registeredsteady and sustained growth in all provinces, but the older industrial areasin the north and northeast, along with some of the emerging coastal provincessuch as Shandong, Jiangsu and Zhejiang, were in the lead and able to take fulladvantage of new opportunities arising from the reforms (see Table 6.2).After descending from 15.1 to 11.5 the range in per capita GVIO (as a ratio ofthe national average) has fallen more gradually to 6.1 in 1986. Meanwhile,provincial disparities in per capita agricultural production, which wererelatively low at the outset, narrowed somewhat between 1957 and 1979 (thecoefficient of variation went from 22 to 19) but the variance increasedslightly through the mid-eighties. Although the direction of causality isdifficult to determine, research in other countries suggest that agriculturalproductivity is related to the availability of industrial products-fertilizers, pesticides, machinery--and the spread of urban markets.4/(Table 6.3). Provinces turning in a strong industrial performance also didrelatively better in the sphere of agriculture, Zhejiang and Jiangsu beingamong the front runners. Statistical tests using cross provincial data forthe period 1981-86 (six of the less developed Western provinces were notincluded in the sample) show that there are strong causal relations runningfrom the growth of industrial output to agricultural expansion. The reversecausality is appreciably weaker. (See Box 6.1, p. 30-31).

3/ "The Third Front: Defense Industrialization in the Chinese Interior,"by Barry Naughton, China Quarterly, No. 115, September, 1988.

4/ 'The Transformation of Agriculture in a Semi-Industrialized Country:The Case of Brazil' by W.M. Nicholls, in The Role of Agriculture inEconomic Development, ed. E. Thorbecke, Columbia University Press, 1969,esp. p. 341-63.

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Tablo 6.2: PROVINCIAL DISTRIBUTION OF PER CAPITA INUSTRIALOUTPUT, 1967, 1965, 1979, 1988 AND 198

(ratio of national average)

Province 1967 1966 1979 1983 1988

NortheastHeilongjlang 2.2 2.0 1.4 1.1 1.0Jilin 1.8 1.6 1.2 0.9 0.9Liaoning 3.9 8.3 2.6 1.7 1.7

NorthBeijing 4.8 3.9 6.1 8.3 8.0Tianjin 11.2 6.7 6.0 8.6 3.8Hebei 0.6 0.9 3.8 0.8 0.6Shanxi 0.9 n.a. 0.9 0.7 0.7Nei Uonggol 0.6 2.8 0.6 0.6 0.6

EastShanghai 15.2 11.7 11.1 8.9 8.4Shandong 0.6 0.8 0.9 0.7 0.7Jliangsu 0.8 0.9 1.4 1.1 1.4Zhejiang 0.8 0.7 0.9 0.8 1.1Anhui 0.4 0.4 0.6 0.4 0.4Jiangxi 0.6 n.a. 0.5 0.4 0.4Fujlan 0.7 0.6 0.8 0.4 0.6

Central-SouthHenan 0.3 0.4 0.5 0.4 0.4Hubei 0.7 0.6 0.9 0.8 0.8Hunan 0.4 0.4 0.6 0.6 0.6Guangxi 0.3 0.3 0.6 0.3 0.3Ouategdong 0.8 0.9 0.8 0.8 0.7

NorthwestGansu 0.6 0.9 0.9 0.5 0.6Shaanxi 0.6 0.7 0.8 0.6 0.5Ningxia 0.1 0.2 0.8 0.6 0.6Qlnghii 0.6 0.7 0.8 0.4 0.6Xinjiang 0.8 0.9 0.6 0.6 0.6

SouthwestSichuan 0.8 0.6 0.6 0.4 0.4Yunnan 0.5 0.4 0.4 0.3 0.3Guizhou 0.3 0.6 0.4 0.3 0.3Tibet /b 0.1 0.1 0.1 0.1 0.1

Range 16.1 11.6 10.7 8.8 6.1

/ Underlying data for gross value of Industrial output are in 1967 pricesfor the years 1967, 1986 and in 1970 prices for the year 1979, and in 1980prices for the years 1983 and 1988.

b Tibet is not included in computing range and coefficient of variation.

Source: Riskin, C., China's Political Economy, Oxford University Press, 1987,Table 10.1, p. 228. and Statistical Yearbook of China, variousissues.

Table 6.3: SUMMARY MEASUES Oc INTERPROVINCIAL INEqJALTIN GROSS VALUE OF AGRICULTURAL OUTPUT ((VAO)

1987 - 1986

RangeBetween Highest and Lowest National Coof, ofRatio Absolute difference Average Variatio#

GVAO per capita L1957 2.2 87 9a 221979 2.2 128 1A3 191986 2.1 204 276 22

Note: 1979 figures are based on 1970 prices, except distributed income, whichis in current prices. Figures for other years are in 1957 prices,Table 10.3, p. 232. except 1967 GVAO per capita, which is in 1962prices.

Source: Riskin, C., China's Political Economy, Oxford University Press, 1987,P. 232, and Statistical Yearbook of China, various issues.

6.4 In the five years preceding the start of reforms (1973-77), indus-trial growth was exceedingly choppy and averaged 6.6Z p.a. The rate of expan-sion accelerated to 12X p.a. over the 1978-86 period and the oscillations weredampened. A further trend acceleration occurred during 1987-88 with annualgrowth averaging nearly 182 (Table 6.5). As can be expected, a decade-longspell of progress has left its mark on the industrial structure, but,surprisingly, certain features of the system have remained largely unalteredand may reflect the interaction of provincial interests and the remainingvestiges of planning in the decentralized environment.

Pattern of Industrial Change

6.5 The total number of enterprises rose from 348,000 in 1978 to nearlyhalf million in 1987, with much of the increase taking place after 1983.Predictably, the ranks of the collectives swelled much more rapidly than thoseof state-owned enterprises during 1978-84, but since then, the shares havestabilized at 4.2:1 as against 3.2:1 in the prereform period.5/ Because ofthe emphasis on expanding the consumption of light manufactures, both thenumber of producers and the share of light industry grew until 1981, butthereafter, it declined slightly and has remained stable since 1984 at around462 in 1987 of total output. Heavy industry accounted for 572 of productionin 1978. Its share then fell to one half, but, because of the surge incapital spending and the investment in power facilities, the sector hasregained the lead once more, albeit by the slimmest of margins.

5, In 1980 the ratio rose from 3.2:1 to 3.5:1 and in 1984 it jumped to4.2:1. Some of this may be related to changed statistical reportingpractices or to administrative reclassification.

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6.6 The explosive growth of collective, township and private enterprisesis apparent from the shares of output. More than four-fifths of industrialoutput originated in the state sector in the late seventies. It has declinedeach year since and was down to 70% in 1987. Township and village enterprisesincreased their share to 132 from just 52 nine years earlier.

6.7 A trend with important implications for the future (see Chapter IX),is the gradual increase in the proportion of large firms in the totalpopulation and their rising percentage of industrial output. Their numbershave advanced from 1,200 (0.3X) to 2,900 (0.52) from 1978 to 1987 and they areresponsible for 25.7Z and 28.6Z of production in 1978 and 1987, respectively(see Tables 6.4 and 6.5). Among the medium and large enterprises, in 1985,sixty-six firms had assets exceeding one billion yuan, and their total fixedassets accounted for a quarter of the industry sector. At the apex of thepyramid were 21 firms in subsectors such as iron and steel, petroleum, coal,autos, 4achinery and textiles with assets of two billion yuan each.6/

6.8 The size of firms has increased across all categories. Most signifi-cant has been the change in average production for light industry (80.2Z), andsmall firms (432) (see Table 6.6). Enterprises in the heavy industrial sectorhave also grown larger (25Z).

6.9 Industrial Concentration. By the standards of the industrialnations, China is a land of relatively small enterprises. Weak transportlinkages and the provincial thirst for a measure of self-sufficiency have leftan imprint on industrial distribution and enterprise size that reforms haveyet to efface. Except for a few subsectors, decentralize?d industrializationhas prevented concentration ratios from rising to levels commonly encounteredin other countries (see Table 6.7). Steel and basic chemicals are the topthree with their respective three firm ratios being 23% and 11Z. In thefertilizer industry the share of the three leading firms is 4Z, in cement 3%and so on down to textiles where it is less than 1Z.

6/ "Basic Situation of the Whole Industry," The Office of Leading Group ofNational Industrial Census under the State Council, PRC, January 30,1988.

Table 6.4: NUMBER OF INDUSTRIAL ENTERPRISESUnit: Thousands

1978 1983 1984 1987

Total 348.4 392.6 437.0 493.6

State 83.7 87.1 84.1 97.6Collective 264.7 304.6 352.1 392.1

Township 164.1 186.1 217.2 237.9Other .0 .8 1.0 3.9

Light 204.4 242.2 287.4 275.0Heavy 144.0 160.3 169.8 218.6

Large 1.2 1.6 1.8 2.9Medium 3.1 4.2 4.6 7.0Small 344.1 388.7 430.8 483.7

Percentage shares

Total 100.0 100.0 100.0 100.0

State 24.0 22.2 19.2 19.8Collective 76.0 77.8 80.5 79.4

Township 47.1 47.4 49.7 48.2Other .2 .2 0.1

Light 68.7 61.7 61.2 66.7Heavy 41.3 38.3 38.8 48.6

Large .8 .4 .4 0.6malum .9 1.1 1.1 1.2Smail 98.8 93.9 98.6 98.2

Indexes /a 112.7 126.4 141.7

/a Total number of industrial enterprise In 1978 Is 100.

Sources: Statistical Data on China's Industrial Economy, 1949-84;and Statistical Yearbook of China, various Issues.

Note: The coverage of most published series for the value of industrial output Is notconsistent for the years since 1978. There have been three major changes duringthe period. First constant prices were changed from those of 1970 to those of 1980In the year 1981. Because the officia! method of converting the data to comparableprices is defective, this means that official data in 1980 constant prices andoutput indexes are not completely reliable.

Second, the coverage of industry was changed in 1984, when village and below-village industry was reclassified from agriculture to industry. This was asensible change as village and below-village industry had risen from 11.7 percentof the gross value of agricultural output in 1978 to 17.0 percent in 1984. By1984, it was too large to bury in the value of agriculture. The change, however,is the source of two major difficulties. One is that branch of industry data forvillage and below-village Industry do not appear to be available, at leastaccording to definition of the State Statistical Bureau. The second is that thereis no clear and consistent distinction between the value of output for village andbelow-village industry in current and constant prices. Because of this, includingvillage and below village industry introduces a small upward bias in the data forindustry as a whole.

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Tho third major change occurred In 1985, when a now system of branches of Industrywas Introduced. The number of branches was raised from the previous 15 to thocurrent 40. This change also presents a difficulty because the continuity of timeseries has been broken. Not even the value of light and heavy industry remairs thesame. And the published overlap in the data is sketchy at best.

The mapping between the old and new systems requires a very detailed disaggregationof the data--much more detailed than available In the published data. For somebranches of industry, the data cannot be reconciled.

In fact, continuity appeare to be a problem not just for foreign scholars but forthe SSB as well. For example, virtually all time-series data have disappeared fromthe 1987 SSB volume on industrial statistict In the 1987 statistical yearbook,the coverage of light and heavy Industry Is changed without warning and the Indexesnumber are calculated by linking indexes for the earlier years in the old coveragewith indexes for the recent years in the new coverage. Furthermore, no branch ofIndustry Indexes are given.

Table 6.5: CROSS VALUE OF INDUSTRIAL OUTPUT(billion yuan, 1980 prices)

Anrgual GrowthGrowth Rate Rate

Yoar 1978 1983 1984 1988 1987 1978-1988 1988-1987

Total 421.2 818.4 703.0 902.8 1036.6 11.9 14.8

State 343.0 474.8 617.1 620.1 690.2 7.7 11.8Collective 78.2 135.4 176.8 283.7 318.2 186. 19.9

Township 22.0 41.3 68.9 96.1 n.a. 20.t -Other .0 8.2 10.0 19.0 30.1 - 58.4

Light 180.4 308.0 348.4 449.0 618.8 12.1 15.1Heavy 240.8 310.6 864.8 463.9 619.7 8.2 14.6

Large 108.4 161.7 184.2 268.9 298.4 11.5 14.6Medium 77.0 116.8 131.1 188.2 193.4 10.3 16.0Small 236.8 338.9 387.7 480.9 646.3 9.3 138.

Percentage shares

Total 100.0 100.0 100.0 100.0 100.0

State 81.4 77.0 73.6 68.7 88.8Collective 18.8 22.0 26.0 29.2 30.6

Towaiship 6.2 6.7 7.7 10.6Other .0 1.0 1.4 2.1 2.9

Light 42.8 49.6 4986 49.8 49.9Heavy 67.2 60.4 50.4 60.3 50.1

Large 26.7 28.2 28.2 28.1 28.8Medium 18.3 18.8 18.8 18.6 18.7Small 68.0 66.0 66.1 63.3 62.7

Note: Robert Michael Field, 'China: The Changing Structureof Industry',' in Joint Economic Committee of the USCongress, China's Economy Looks Toward the Year 2000,Washington, 1988, p. 509-513.

Sources: Statistical Data on China's Industrial Economy,1949-84; and Statistical Yearbook of China, variousissues.

- 9 -

Table 686: GROSS VALUE OF INDUSTRIAL OUTPUT PERENTERPRISE IN 1980 CONSTANT PRICES

(Unit: thousands)

X increase1978 1983 1984 1988 1978 to 1986

Total 1,209 1,671 1,808 1,808 49.6

State 4,098 6,461 6,149 6,404 56.3Collective 296 446 499 669 123.4Township 134 222 2418 387 188.8

Other 7,800 10,090 7,969

Light 883 1,263 1,303 1,691 80.2Heavy 1,672 2,086 2.088 2,091 26.1

Large 90,348 91,233 101,080 97,164 7.6Medium 24,841 26,438 27,577 27,224 9.6Small 885 919 900 980 4P.1

Sources: Statistical Data on China's Industrial Economy, 1949-84; and Statis-tical Yearbook of China, various issues.

Table 6.7: SUMMARY MEASURES OF INDUSTRIAL CrNCENTRATIONIN CHINA, KOREA AND INDIA

CHINA (1985) KOREA (1982) INDIA (1983-84)

CR8 Herfindahl Gin) CR3 Herfindahl Ginl CR3 Herfindahl C;in

IndustrySteel (refined) 0.236 0.202 0.171 0.668 0.188 0.706 0.077 0.002 0.094Basic Chemicals 0.116 0.006 0.146 0.616 0.129 0.816 0.240 0.019 0.034Fertilizer 0.044 0.001 0.108 0.994 0.492 0.771 0.422 0.071 0.228Cement 0.030 0.000 0.004 0.860 0.369 0.867 0.369 0.069 0.298Textiles 0.009 0.000 0.071 0.541 0.144 0.947 0.124 0.009 0.422Paper 0.038 0.000 0.131 0.963 0.608 0.684 0.236 0.020 0.150Machine Toole 0.089 0.003 0.066 0.717 0.202 0.669 0.677 0.160 0.819

Source: Statistical Yearbook of China, 1987; Market and Market Shares, March 186, by Centerfor Monitoring Indian Economy; and Korea Development Institute and Economic PlanningBoard December 1988. p.22-29.

Note: The three-firm concentration ratio, CR3, refers to the share of the three largestfirms In total subsectoral output. Lorenz curve shows, as a continuous function, thepercentage of total sales accounted for by an given fraction of the total companypopulation, with the firms ranked In order of market share or size. The Ginicoefficient gives the difference between the Lorenz curve actually obsrved and a curvethat would assign equal market shares to all firms. Thus a Gini coefficient of zerowould Indicate perfect equality and a coefficient of one would reflect perfectinequality. The formula for

Nthe Herfindahl index Is H = S1

2 where Si Is the market share of the ith firm.;=1

Under pure monopoly the coefficient is equal to 1.0. As the number of firmsIncreases, the value doclines. It increases when there Is great inequality betweenfirms. By squaring the shares, the Herfindahl index weights larger firms more heavilythan smaller ones. See Industrial Market Structure and Economic Performance, by F.M.Scherer, Rand McNally, 1980, p. 67-8.

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Graph 6.1

Gross Value of Industrial Output, Chinaa/b Shares of output by Province

14-

1 2 -. .. ... .. .. . .. .. .. . .. ... .. .. .. ... .. .. ... ..... .. .. ... .. ... .. .. .. . .. I... . .. .. . .. .. .. . .. .. .. . .. .. .

10 f f ..........................................................................................................I...........................................

r 8 . .......... .....................I,........ ...................I................................................I.................

4 . ........ .................................... ......

12.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~1

I a 3 4 6f 6f r 6 0 10 11 19 14 gIfV14 " 9 tott Iso t 2ss4s o n662 96 90Proviln"

S Sham of 10.7 % tb of les

.a/ Graph is based on Table 6.10. It ?lots the provincial

shares of industrial output in 1978 and 1986.

CODE PROVINCE

i Shanghai2 Liaoning8 Jiangsu4 Shandong6 Sichuan6 H.ilongjlang7 Hebei8 auongdong9 8.1itng10 Henan11 Hubei12 Tianjinla Hunan14 Zhejiangis Jilinle Shanxi17 Anhui18 Shaanxi19 Gansu20 Jiangxi21 ousngxl22 Fujian28 Yunnan24 Guizhou25 Nei Monggo12C Xinjiang27 Qinghai28 Ningxia29 Tibet

- 11 -

6.10 Subsectoral Growth. Based on subsectoral statistics, the largestgains in shares of industrial production were recorded by textiles andmachinery. The former went from 12.3% in 1978 to 15.4Z in 1985, while thelatter also rose by three percentage points to 272 over the same period (seeTable 6.8). There was a proliferation of food processing firms but a smalldrop in their share of total product.

6.11 When the focus shifts from subsectors to the interprovincialstructure of industry, signs of structural changes are accumulating, but it isremarkable how little industrial shares have altered over 10 years (seeChart I). For instance, while the ranking of the four most industrializedcoastal provinces differs between 1978 and 1986--Shanghai, Jiangsu, Liaoningand Shandong--they accounted for 362 of industrial production in 1978 and for35Z in 1986. Within this group there was a shift in shares as provinces withmore dynamic light industries gained at the expense of those where heavyindustry is more firmly entrenched. Among the other industrial provinces theshare of Beijing and Hebei fell by 14Z and 18% respectively. Sichuan's shareremained constant at 5.4% and Guangdong, one of the chief beneficiaries of thereform era, went from 4.72 to 5.8% over a span of eight years (Table 6.8).What this reveals is the limited mobility of capital in part because of the

Table 6.8: CROSS VALUE OF INDUSTRIAL OUTPUT IN 1980 CONSTANT PRICES,BY BRANCH

1978 1986Billion Billion Average1980 Percentage 1980 Pe-contage Annualyuan shares yuan shares Growth Rate

Total 421.2 100.0 829.6 100.0 10.2Metallurgy 40.8 9.6 88.4 8.0 7.3Ferrous 28.6 6.8 44.4 6.4 6.5Nonferrous 12.0 2.8 22.0 2.8 4.2

Electricity 16.2 3.8 27.3 3.3 7.7Coal & coko 16.3 3.9 20.8 2.6 8.8Coal 15.2 3.6 19.4 2.8 3.6Coke 1.2 0.3 1.6 .2 3.4

Petroleum 28.8 6.4 37.3 4.6 4.8Chemicals 47.7 11.3 92.7 11.2 10.0Machinery 101.5 24.1 223.6 27.0 11.9Building materials 16.6 3.9 36.1 4.2 11.3Timber 9.6 2.3 13.3 1.8 4.9Food 60.8 12.1 96.2 11.6 9.4Textiles 62.2 12.4 127.3 16.4 13.8Tailoring 8.7 2.1 19. 9 2.4 12.6Leather 3.4 .8 7.7 .9 12.1

Sources: Statistical Date on China's, Industrial Economy, 1949-84; andStatistical Yearbook of ChWna, 1986.

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decentralized nature of industrial planning, partly also because financiallinkages between the various regions of the country are weak. The tendency ofenterprises to reinvest retained earnings in expanding their own facilities isanother contributing factor. As both industrial and bureaucratic reforms hadnot bitten deep by 1986, it is likely that the balance of provincial power andindustrial vested interests ensured proportional rates of increase. Thepattern may have begun changing since, although several more years may have toelapse before the intersectoral ratios established in the seventies will beginto drift farther apart under the influence of relati';e prices, demands,transport development, and regional comparative advantages. Between 1978 and1986, 19 provinces registered a decline in shares, 2 maintained their sharesand 8 provinces enlarged their stake in the industrial sector. Under thepressure of market forces, such a trend in concentration can be expected tocontinue.

Table 6.9: NUMBER OF INDUSTRIAL ENTERPRISES BY PROVINCE

Difference In1978 1987 Porcentage

Thousand Percentage Thousand Percentaoge Shareso,itorprlaes shares enterprisos sharos 1978-1988

Total 848.40 100.00 493.67 100.00 100.00BoiJIng 4.20 1.21 6.76 1.17 -0.04Tianjin 4.00 1.16 6.86 1.19 +0.04Hebel 14.10 4.06 21.62 4.88 +0.33Shanxi 9.40 2.70 11.67 2.84 -0.36NeJ Monggo 4.60 1.29 8.12 1.56 +0.36Liaoning 14.60 4.19 24.61 4.97 +0.78Jilin 10.80 8.10 13.69 2.76 -6.86He7longjiang 14.60 4.16 17.62 3.67 -0.69Shanghai 8.00 2.80 11.88 2.81 +0.01Jiangsu 27.20 7.81 47.26 9.67 +1.76Zhejiang 21.80 8.11 46.43 9.20 +3.09Anhui 13.70 3.93 23.48 4.78 +0.83Fujian 8.60 2.47 12.81 2.80 +0.13J iangxi 11.80 3.24 17.09 8.46 +0.22Sha dong 18.60 6.34 24.98 6.06 -0.20Henan 14.70 4.22 19.34 3.92 -0.30Hubel 16.90 4.56 26.29 6.3a +0.77Hunan 19.70 6.65 28.17 4.69 -0.96Guangdong 21.20 8.08 27.94 6.66 -0.42Guangxi 10.10 2.90 10.29 2.09 -0.81Sichuan 44.00 12.63 47.82 9.69 -8.04Guizhou 8.90 2.56 7.94 1.61 -0.94Yunnan 7.30 2.10 11.83 2.40 +0.30Tibet 0.26 0.05 +0.06Shaanxi 9.80 2.81 12.84 2.60 -0.21Gansu 6.80 1.66 6.88 1.19 -0.47Qinghai 1.80 .87 1.41 0.29 -0.08Ningxia 1.10 .32 1.78 0.36 +0.04XinJiang 3.70 1.06 3.30 0.07 -0.99

Sources: Statistical Data on China's Industrial Economy, 1949-84; andStatistical Yearbook of China, 1988.

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Table 6.10t GROSS VALUE OF INDUSTRIAL OUTPUT IN 1980 PRICES, BY PROVINCE

Difference in1978 1988 Average Percentage

1980 Percentage 1980 Percentage Annual Sharesyuan shares yuan shares Growth Rate 1978-1986

Beijing 17.6 4.2 32.2 3.6 7.9 -0.6Tianjin 16.4 3.7 30.0 8.3 8.7 -0.4Hebei 20.6 4.9 35.9 4.0 7.2 -0.9Shanxi 11.1 2.6 20.6 2.3 8.0 -0.3Nei Monggo 3.9 0.9 10.3 1.1 13.1 +0.2Liaoning 39.2 ;.3 71.0 7.9 7.7 -1.4JiTlin 12.0 2.8 22.8 2.5 8.4 -0.3Heilongjiang 22.6 5.4 37.8 4.2 6.6 -1.2Shanghai 61.1 12.1 87.4 9.7 6.9 -2.4Jiangsu 32.0 7.6 98.3 10.9 16.1 +3.8Zhejiang 12.5 3.0 61.6 6.7 19.4 *2.7Anhui 10.5 2.6 25.1 2.8 11.6 .0.3Fujian 6.1 1.5 16.6 1.7 12.4 +0.2Jiangxi 7.3 1.7 18.9 1.9 11.1 +0.2Shandong 29.1 6.9 59.1 8.6 9.3 -0.4Henan 16.3 3.9 33.6 3.7 9.5 -0.2Hubei 16.2 3.8 46.4 6.1 14.1 +1.3Hunan 13.9 i.3 29.3 3.2 9.8 -0.1Guangdong 20.0 4.7 62.7 5.8 12.9 +1.1Guangxi 7.0 1.7 13.8 1.6 8.9 -0.2Sichuan 22.8 6.4 48.6 6.4 9.9 0.0Guizhou 4.2 1.0 8.6 0.9 9.3 -0.1Yunnan 6.9 1.4 12. 1.3 9.3 -0.1Tibet 0.2 0.0 0.1 0.0 -3.6 0.0Shaanxi 9.7 2.3 18.3 2.0 8.2 -0.3Gansu 8.0 1.9 12.3 1.4 6.6 -0.6Qinghai 1.6 0.4 2.1 0.2 4.6 -0.2Ningxia 1.6 0.4 2.4 0.3 6.1 -0.1Xinjiang 3.3 0.8 8.0 0.9 11.6 -0.1

Total 421.2 100.1 902.8 100.0 289.4 0.3

Average 14.5 3.6 31.1 3.6 9.3 0.01

Sources: Statistical Data on China's Industrial Economy, 1949-84; andStatistical Yearbook of China.

6.12 Small Scale Industry. Aggregated series tend to obscure anothermajor development, which is the afflorescence of smaller state, collective,township and village enterprises. They were the first to benefit from thedismantling of bureaucratic controls and have been unusually successful in

g( _ ~~~~~~~~~~~~ ~~~~U. s. s. R. ) \

U. S. S. R. 2 f) _t A2 t

, ~~~~~~~~~~~MONGOLIA

- 15 -

colonizing certain subsectors. Among these, township and village enterprises(TVEs) have proven to be the most dynamic. In four branches of industry--building materials, metal products, arts and crafts anid furniture--theyaccount for at least a third of total output, with b:!ilding materials beingthe most important. Township enterprises are also beginning to make theirpresence felt in textiles, machine building and food processing.

Tabl 6.11: DOUSTRIAL SHARES OF TOISIP AND VILLACE ENTERPRISES,1988

Total Township Village

Mining of buildingmaterials 72 32 40

Building materials 47 26 22Metal products a8 19 7Arts and crafts 34 18 18Furniture 33 18 15Textiles 10 15Machine building 10 11Food 9 8

Source: Statistical Yearbook of China, 1987.

6.13 By all accounts the number of small enterprises has mushroomed but,unfortunately, the statistics do not allow a decomposition of the small scalesector into other categories. One fact of interest is the increase in thenumber of individual enterprises, each with an average output of 8,960 yuan.A few years ago there were hardly any. In 1987 some 5.6 million were countedand their share in GVIO was nearly 3Z.

6.14 The very small enterprises in China seem to fall into fourcategories. Those in the first category depend largely on subcontractingrelations with large state-run enterprises. In both the Shanghai and Tianjinsuburban areas, more than 50Z of small-scale output consists ofsubcontracting. A second, related category consists of firms who produceprimarily on contract for foreign producers. They are concentrated inGuangdong, and engage in cooperative production with Hong Kong firms. Incontrast to linkages with state firms in the previous category, which tend tobe long-term and may involve substantial technical cooperation, theserelationships are usually short-term, contractual and processing agreements.Producers of building materials, food processors, etc fall into the thirdcategory, manufacturing items, that are costly to transport over longdistances, for the local market. Finally a fourth category consists of firmsproducing light consumer goods. Marketing for such enterprises is oftencarried out by specialized enterprises who may send marketing representativesthroughout the country. A clear example would be the private producers ofbuttons, ribbons and small plastic items around Wenzhou in Zhejiang. In thiscase, the easy portability of the items produced makes a distribution networkfounded on personal travel by sales representatives feasible.

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6.15 Role of the Market. Since the early eighties, the market has beenexercising a stronger influence on enterprise decisions. Concrete statisticsthat would make possible an estimate of autonomous, market-guided actions arerelatively scarce.71 One sample survey embracing 420 industrial enterprises,conducted in 1985, revealed that 572 of sales were distributed directly by thestate and 33% were marketed independently.8/ State enterprises sold over 71Zthrough official channels, and for large medium sized enterprises 842 wasdistributed by way of the State apparatus. By comparison, urban collectiveschannelled just 4.42 through the State, as was the case with small firms.Clearly large, state-owned enterprises have the least discretion when it comesto selling through the market. As of 1984, they also received 84Z of theirsupplies from the State, whereas urban collectives obtained just 6.5Z. Itshould be noted that the operative ratios vary depending on the sector. Onaverage, certain heavy industries are most subject to state transactions.

6.16 Anecdotal information suggests that these proportions have shiftedsubstantially in favor of greater discretion for the medium and large enter-prises in the sale of products as well as the purchase of raw material throughthe market. Only a tiny percentage of transactions conducted by collectivesare directly affected by the State's allocative activities. The large stateenterprises, of course, remain subject to State controls but even they havebegun venturing more into the market during 1987-88. Among the firms visitedin June 1988, a major producer of automobile transmissions sold between aquarter and a third of production by means of market contracts, and casualempiricism suggests that this may be the representative level for producers ofmachine tools, transport equipment, some chemicals and steel.9/

7/ An earlier enterprise survey conducted by the World Bank during 1981-82found that enterprises operating in a seller's market sold no more than102 of their output through the free market. However, some of theenterprises functioning in a buyer's market were forced to sell much oftheir production in this fashion. See "The Role and Impact of Markets,"by W. Byrd in China's Industrial Reform, eds. G. Tidrick and ChenJiyuan, Oxford University Press, 1987, p. 247-250.

8/ "The present management environment in China's Industrial Enterprises,"by Zhang Shaojie and Zhang Amei, in Reform in China, ed. B.L. Reynolds,Sharpe, 1987, p. 52-56.

9/ Because of shortages, market prices of cold rolled sheet, galvanizedsheet, electromagnetic sheet and steel pipe are double the prices set bythe state.

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Geographical Trends in Industry

6.17 Shanghai was the center of light industry in the fifties, Liaoning ofheavy manufacturing. Most of China's industrial capital was concentrated .nthe east and the north-east. Then, for more than two decades, industrialadvance in these parts was surpassed by provinces towards the south and south-west. By 1983, the Northeast had dropped from second to fourth place and theshare of the South in GVIO had risen from 13.7Z in 1952 to 18.5Z. Now theeast is starting to regain its earlier supremacy. Shanghai slipped from firstplace to the second slot in 1985, but the provinces that are emerging as thenew industrial leaders are all clustered nearby. From Tables 6.9 and 6.10, itcan be seen that Jiangsu and Zhejiang are the leaders in terms of change inshare of GVIO between 1978 and 1986 and increase in the number of enterprises.Guangdong has also done well. Beijing, Tianjin and Liaoning have all lostground, albeit modestly. The slowest increase has been recorded by therelatively backward interior provinces such as Gansu, Ningxia, Qinghai andShanxi (see Graph 6.1).

6.18 One of the reasons for the differences in growth is apparent fromTable 6.12, which gives the distribution of enterprises by ownership.Collective and private enterprises, least subject to planning and mandatorycontrols, are prominent in all the faster growing provinces. There is a clearlink between the share of collective and private enterprises and industrialgrowth;10/ for every percentage point increase in the share of collective andprivate enterprises, provinces register an additional 0.16 industrial growthon average. Collective and private enterprises have a conspicuously smallshare in Qinghai, Gansu and Heilongjiang. As discussed in Chapter VIII, theEast Coast had a headstart as regards human capital and infrastructure. Thishas been reinforced in the eighties by a more rapid spread of markets and anoutward orientation.

1O/ See China's Rural Industry: Structure Development and Reform, eds.W. A. Byrd and Lin Qingsong, World Bank, forthcoming.

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Table 6.12: ONERSIIP STRUCTURE OF INDUSTRIAL OUTPUT IN 1067(Unit: Percent)

State-owned Joint ventures Collective Annual Growth ofProvince Industry and foreign and private OVIO 78-86

Zhejiang 83.2 1.0 66.8 19.4Jiangsu 386.7 2.2 61.1 16.1Guangdong 49.7 8.0 42.3 12.9Shandong 60.6 0.2 49.8 9.8Fujian 62.9 8.7 38.4 12.4Hebel 63.1 0.3 4686 7.2Henan 68.8 0.2 41.0 9.6

Anhui 61.4 0.3 388. 11.6Liaoning 64.0 8.1 32.9 7.7Shanxi 64.9 0.1 86.0 8.2Hunan 86.2 0.2 34.6 9.8Hubei 66.0 0.3 383.7 14.1Sichuan 67.6 0.6 32.0 9.9Tianjin 69.0 8.1 27.9 8.7Beijing 70.6 2.8 26.6 7.9Jiangxi 71.2 0.4 28.4 11.1Xizang 71.4 0.0 28.6 -3.6Shaanxi 71.7 0.2 28.1 8.2Jilin 71.8 0.1 28.1 8.4Shanghai 74.0 6.0 20.0 8.9Guangxl 74.6 0.3 25.2 8.9Yunnan 77.2 0.4 22.4 9.3Ningxia 77.8 0.3 21.9 6.1Gulzhou 78.9 1.3 20.8 9.3Nel Monggo 79.3 0.1 20.6 18.1Heilongjlang 80.6 0.1 19.4 686Xlnjiang 82.8 1.2 16.0 11.8Qlnghai 83.7 0.0 18.8 4.5Gansu 84.7 0.0 16.3 t.5

Region 1: ShanghaI- 13.1Jiangsu-Zhojiang 6.6 8.1 12.0

Region 2: Beijing-Tianjin-Hebel-Shandong 47.2 67.7 1.1 8.4

National Average 59.8 2.0 38.8 10.0

Note: Joint ventures include domestic joint ventures between differentownership forms. 1988 Statistical Abstract, p. 37.

6.19 Once the changes in ranking have been duly observed, it is stillnotable that after ten years of intensive capital spending, industrial shar)scontinue to display a marked constancy. Industrial geography is being mod4 .-fied quite slowly. The pull of comparative advantage on resources is weak andeach province is straining to the utmost to augment its own industrial base.Many of the less developed provinces continue to be aided by the state,although to a diminishing extent; they are falling behind, but there is muchclustering of growth rates. The majority be in the 7-10? band; a group of theeast coast provinces grew at somewhat higher rates and three provinces,averaged rates of less than 6Z (see Table 6.10).

- 19 -

Graph 6.2

Number of Industrial Enterprises, China* Share of # of Enterprises by Province

14-

...................................................................................................................................................................10-.

b

2 S466 E E1 r1 1118nw1416161711Su01uuu341o6g6l7363

-F-s 8bx Pd lar -s.8u f

Note: Graph is based on Table 6.9.

CODE PROVINCE

1 Sichuan2 Jiangsu3 Zh.j lung4 Ouangdong5 Hunan6 Shandong7 Hubei8 Henan9 iJuoning10 Hellongjlang11 Hebel12 Anhul13 Jiangxi14 Jilin15 Ouangxl16 Shaanxi17 Shnnxt18 Oulzhoie19 Fe3 ian20 Shanghal21 Yunnann22 Oanau23 Nei Vonggol24 BeIjing25 T'inJln26 XinjIang27 Qlnghal28 Ningxi29 Tibet

- 20 -

Industrial Finance and Enterprise Ownershi,p

6.20 Since the early eighties, the financial structure of Chineseenterprises is being transformed in fundamental ways because of changes inrelative prices that erode profitability. Total industrial revenues (profitsplus tax) did not increase between 1985 and 1986, in spite of a 12.52 growthin output for several reasons. First, by redefining the financial system,reform has tended to reduce profitability. Some accounting profits have beenreclassified as taxes in recent years, and increased interest rates anddepreciation cut into profit. Second, higher relative prices of agriculturaland other raw materials raise costs, although there is substantial evidencethat enterprises can pass through this category of cost increases. And third,increased wages may be squeezing profits (see Chapter II).

6.21 As a result of stagnant .rofits, rising investment and the absence ofinstitutions supporting equity-fliance, industrial firms are becomingincreasingly leveraged. Debt is overwhelmingly to banks, although someenterprises have begun issuing fixed income securities. Current liabilitiesas a percentage of net worth in state-owned industry were around llZ in 1978;they climbed to 33% in 1984; to 69Z in 1986; and a preliminary estimate foryear-end 1987 would yield a figure of around 76Z. These debt ratios are stillrelatively low by international standards, but the trend is striking. From1978 through 1986, firms financed three fourths of their investment throughborrowing. If this pattern continues, Chinese state-owned industrial firmswill gradually approach a debt ratio of about 260Z. This would be in theleague of Japan or Korea (which maintained ratios around 350% during the late1970s), and far above that of Taiwan (c. 160%), or the United States (justbelow 1002). Leveraging, by increasing the level of enterprise financialrisk, could complicate the transition to different forms of cG.'nership based ona more diffuse system of shareholding.ll/ It also makes price reformhazardous for many firms.

11/ Some issues concerning enterprise capital structures are discussed in"State Enterprise Management and Organization: Reform Issues andOptions," World Bank, September 11, 1987.

- 21 -

Table 6.18: CURRENT LIUAILITIES AS A PERCENTAGE OF NEIWORTH

Korea /a 360XChina ( arg nal 1978-88) 262%Taiwan (China) La 160XUnited States 96%China 1988 69%China 1978 11%

Is These might be biased upwards because of the absence ofinflation accounting, and because a full account may not havebeen taken of reserves and of compensating balances.

6.22 Reforms in the accounting system have restructured ownership ofassets in such a way that enterprise net worth is now divided between a"state" and an "enterprise" portion. Nominal ownership of fixed and workingcapital is assigned to the party which was the source of the initial invest-ment. As investment from enterprise--retained funds has grown in importance,enterprise "owned" capital now accounts for a significant proportion of thenet value of enterprises (aggregate statistics are not available). So far,however, this "ownership" has no clear operative significance.12/

6.23 Indeed, the ownership of Chinese "state-owned" enterprises is becom-ing increasingly ill-defined. Ten years ago, all industrial assets in thestate-run economy were clearly controlled, and effectively "owned" by variouslevels of government, which exercised both ultimate management power and finalclaim on residual income. Today, managerial authority and claims on incomeare split between government and the enterprise itself, as well as, to alesser extent, the banking system. The uncertainty attending on the ownershipsystem is putting serious obstacles in the way of improved performance. Givenlong-term employment relations, effective work incentives require a means tolink the lifetime incomes of workers with the firm's profitability. Thisrequires some kind of definition of the terms of ownership. A highly lever-aged ownership structure may be compatible with close links between employeeinterests and firm performance (as in Japan), but this requires legal defini-tion of employee rights and interests. (See para. 7.21).

6.24 The banking structure emerging in China is similar in some importantrespects to that which now exists in Japan and Korea. In both thesecountries, industrial corporations maintain close ties, cemented by equityholdings, with the principal banks. Such a system has the great advantagethat diversified industrial groups can move rapidly into new product lines,mobilizing substantial financial and technical resources to rapidly expandproduction of new items. The Chinese system as it currently exists does notpermit firms to take advantage of this potential, because of the system of

12/ See Foo