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Growth of China's ruralenterprises: Impacts onurban‐rural relationsZhang Xiaohe a , Christopher Findlay b &Andrew Watson ca Department of Economics, School ofBusiness , Hong Kong Baptist College ,b Associate Professor in the Department ofEconomics and co‐Director of CERU ,c Professor of Asian Studies and co‐Directorof CERU , University of Adelaide ,Published online: 23 Nov 2007.

To cite this article: Zhang Xiaohe , Christopher Findlay & Andrew Watson(1995) Growth of China's rural enterprises: Impacts on urban‐ruralrelations, The Journal of Development Studies, 31:4, 567-584, DOI:10.1080/00220389508422378

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Growth of China's Rural Enterprises:Impacts on Urban-Rural Relations

ZHANG XIAOHE, CHRISTOPHER FINDLAYand ANDREW WATSON

China's rural enterprises are economic units established by localgovernment in the countryside or by the peasants and they oper-ate outside the planning system. Rural enterprises have growntwice as fast as the rest of the economy since 1984. The ruralenterprise sector has so far challenged the urban economy, inboth product markets and markets for raw materials. Whatare the prospects for their relationship - competition or co-operation? To answer the question, we develop a well-specifiedbut simple model of the rural and urban economies. The ruralenterprise boom was caused in this model by the presence ofbarriers to factor mobility within China, price distortions and thepool of available labour in the countryside. The origins of theboom imply that rural enterprise exports tend to be relativelylabour intensive. The complementarities between rural andurban enterprises are likely to dominate their future economicrelationship and lead to further growth in the rural enterprisesector.

INTRODUCTION

China's rural enterprises are economic units established by local gov-ernment in the countryside or by the peasants themselves. They operateoutside the planning system. Rural enterprise output and employmenthave grown rapidly in China. Estimates of the gross value of output of

At the time of writing Zhang Xiaohe was a Ph.D. candidate in the Chinese EconomyResearch Unit (CERU), but is now at the Department of Economics, School of Business,Hong Kong Baptist College; Christopher Findlay is Associate Professor in the Departmentof Economics and co-Director of CERU; and Andrew Watson is Professor of AsianStudies and co-Director of CERU at the University of Adelaide.

The Journal of Development Studies, Vol.31, No.4, April 1994, pp567-584PUBLISHED BY FRANK CASS, LONDON

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568 THE JOURNAL OF DEVELOPMENT STUDIES

rural enterprises indicate that since 1984, their growth has been twice asfast as the rest of the economy. Recent estimates also suggest that morepeople are now employed in rural enterprises than in the state-ownedindustry sector of the economy.

The growth in rural enterprises has been well documented byobservers outside China [Byrd and Lin, 1990; Zweig, 1991; Findlay andWatson, 1992; Zhang, 1992a; 1992b; Naughton, 1992; Findlay, Watsonand Wu, 1994] and by many Chinese researchers. Those papers focus onvarious aspects of rural enterprise growth. In this article, we concentrateon the resource allocation implications of rural enterprise growth. Weask, what were the origins of rural enterprise growth? Our answerstresses the barriers to the mobility of the factors of production withinthe Chinese economy. We apply a simple test of this model by updatingprevious work on the likely comparative advantage of the rural enter-prise sector in China and its impact on the composition of China's inter-national trade. Our main focus here, however, is the question of whatfactors will influence the longer-run relationship between rural andurban industry in China. We use the same model applied to the questionof the origins of the rural industrial sector to explain why the futurerelationship is likely to involve a greater degree of complementarity andco-operation between rural and urban industry.

RURAL ENTERPRISE GROWTH

Rural enterprises operate outside the state plan and are subject to 'hardbudget constraints' in that their owners (the peasants or the townships)do not have any guarantee of budget support from above. They buyinputs and sell outputs in free markets and do not have to fulfil planobligations to the state.1 Despite this market orientation, however, theirorigins in the collective system mean that they commonly have a stronglinkage with local governments [Findlay and Watson, 1992].

A previously published collection of papers [Byrd and Lin, 1990]documents the development of the rural enterprise sector up to 1986.However, the major growth in the sector has occurred since that yearand in this section we report a series of indicators of the more rapidrural industrialisation into the early 1990s.

After 1978, rural enterprises experienced an unprecedented phaseof rapid development. Some of the data available2 are reported in Table1. The total number of rural enterprises increased to over 20 millionin 1992, more than a threefold increase over 1984 (see Table 1). Their totallabour force by the end of 1992 was nearly 106 million, surpassing the totalemployment in state-owned enterprises {People's Daily, 13 Jan. 1993, p.2).

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GROWTH OF CHINA'S RURAL ENTERPRISES 569

TABLE 1

RURAL ENTERPRISES: NUMBERS AND WORKERS, 1978-92 (MILLION)

Year

19781979198019811982

. 1983198419851986198719881989199019911992

All Rural Enterprises

Number ofEnterprises

n.a.n.a.n.a.n.a.n.a.n.a.6.07

12.2215.1517.4518.8818.6918.5019.0820.78

Number ofWorkers

n.a.n.a.n.a.n.a.n.a.n.a.

52.0869.7979.3787.7696.4593.6792.6596.09

105.81

Township and VillageEnterprises

Number ofEnterprises

1.521.481.421.341.361.351.861.851.731.581.591.541.451.441.52

Number ofWorkers

28.2729.0929.9929.7031.1332.3538.4841.5243.9247.0248.9447.2045.9247.6751.49

Note: *'n.a.': not availableSource: ZTN 1988, pp.287 and 292; ZTN 1990, pp.250, 309 and 395-401; ZTN 1991,

p.65; ZTN 1992, p.392; ZXQN 1990, pp 72-7; ZXQGBQ 1988, p.656; ZXQTX1992, pp.1, 8 and 10; and SSB, A Statistical Survey of China 1993, p.67.

While the number of township and village enterprises (those ownedcollectively) has remained about the same, employment in those typeshas' risen from 28 million in 1978 to 52 million by 1992. The townshipand village category accounted for 49 per cent of employment in thesector but only seven per cent of the number of enterprises.

In 1984 the share of rural enterprises in the gross value of output wasalready 13 per cent of national output value and about one third of ruraloutput value. But these shares rose to 32 per cent and nearly 66 per centrespectively by 1992. Even by 1987 rural enterprises were more impor-tant in the rural economy than was agriculture [Rural EnterprisesBureau, 1992; Chen, Findlay, Watson and Zhang, 1994].

Rural enterprises are spread across all the sectors of the economybut, in 1990,74 per cent of total output value of all rural enterprises (84per cent of township and village enterprise output value) came fromindustrial activities [Rural Enterprise Bureau, 1991]. Other activities arein the service sector and a small proportion (around two per cent) is

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classified as agriculture, but this is usually intensive agricultural activi-ties like meat production.

Rural enterprises now also account for significant shares of nationalexports. In 1990, it was reported, their export earnings made up some 25per cent of the national total.3 Estimates from other sources show alower figure (see Table 2). The data in Table 2 illustrate the rapid growthin rural enterprise exports, at least up to 1991. They rise from about$US1.3 billion in 1985 to over $US10 billion in 1991 according to thesource reported in the table. Other sources reported a much highervalues: US$13 billion in 1990, US$18 billion in 1991 and US$20 billionin 1992 (People's Daily, 12 Nov. 1992, p.l; 23 Jan. 1993, p.2).4 Also ofinterest in the debate about the impact of the 1989-90 austerity pro-gramme on rural enterprises is that in 1990 rural enterprise exports fellwhile national exports rose.

The national figures, however, disguise significant regional variations[Findlay and Watson, 1992]. The growth in the share of rural industriesin output was particularly marked in the coastal provinces with low percapita land ratios, dense populations, better infrastructure and thepotential for rural enterprises to build profitable links with existingindustries. The eastern provinces of China5 account for 65 to 70 per centof national gross income of rural enterprises [Ministry of Agriculture,1990]. This is subtantially higher than the shares of those provinces in

TABLE 2RURAL ENTERPRISE SHARE OF CHINA'S NATIONAL EXPORTS 1985-91

(BILLION YUAN)

Year

1985198619871988198919901991

NationalExports

(a)2735030 94039 4404752052 54062 06071910

RuralEnterpriseExports

(b)13252 6354 2907 9129 8399 640

11173

Rural Shareof National

(b)l(a)(%)

59

1117191616

Note: Sources: Editorial Committee of Zhongguo Duiwai Jingji Maoyi Nianjian,Zhongguo Duiwai Jingji Maoyi Nianjian [China Foreign Economic Relations andTrade Yearbook], 1988/90, p.299; ZTN 1991, pp.65, 97 and 101; ZNN 1990, p.5;ZXQN 1990, p.174; Jingji Xiaoxi Bao [Economic News], 1 Sept. 1990, p.3; andRenmin Ribao [People's Daily], 10 Jan. 1992, p.l and 22 Jan. 1992, p.2.

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national population of 41 per cent and of rural gross output value of 59per cent in 1989 [SSB, 1990]. The four top provinces are Jiangsu,Shandong, Guangdong and Fujian.

On average rural enterprises account for about 25 per cent of nationaloutput value and about the same proportion of national exports. Thusrural enterprises are at least as export orientated as the national aver-age. However, there is substantial regional variation in export orienta-tion. The Eastern region accounted for an even higher share of ruralenterprise exports than of output value over the second half of the1980s.

In summary, rural enterprises have emerged over the second half ofthe 1980s as a major economic force within the Chinese economy. Theynow account for large shares of output, employment and exports. Thereare, however, significant regional differences in the importance of ruralenterprises.

In the next section, we summarise some analyses of the origins ofrural enterprise growth. We stress the origins of rural enterprises in thesegmentation of the labour and capital markets in China. In followingsections, we apply that model to make predictions about (a) the charac-teristics of rural enterprises, (b) the composition of their exports and (c),in our concluding section, their likely future development, includingtheir relationship with enterprises in urban China. In another paper,Findlay and Watson [1992] stressed the challenge of the rural sector forthe urban economy and raised the prospect of how the cities might be'surrounded from the countryside' as the wave of reform overwhelmedthe urban enterprises. In this article, we suggest a manner in which thatconflict might be resolved.

A THEORETICAL FRAMEWORK

Method and Review of Previous WorkThe model which we use to discuss the origins of rural enterprise devel-opment highlights barriers to movements of labour and capital betweenthe rural and urban economies in China. We present the model in moredetail below. Since it is a model of the process of development of thissector, it inevitably abstracts from a number of complexities of thesituation in rural China. We comment on some of these below.

Other attempts have been made to 'model' the rural industry sector.For example, Du [1990] identifies a number of factors that have con-tributed to rural enterprise development including a number of policyand economic variables. Svejnar and Woo [1990] also develop a series of'models' which stress in turn geography and history, human resources

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and technology, access to capital and government policy. In contrast tothese approaches, we attempt to build a model which is one of thesimplest possible and which is consistent with the growth observed inthe rural enterprise sector. Before using the model to tackle the mainquestion of interest here, we also apply a simple test of its relevanceusing export data.

Another group of models of rural enterprise behaviour is applied atthe firm level. For example, Byrd and Zhu [1990] offer some characteri-sations of patterns of competition and adjustment by the firm. Ouranalysis is applied at an aggregate or sectoral level.

Furthermore, none of the 'models' in papers to which reference hasbeen made so far are presented in the diagrammatic style which weuse here. Our style of presentation is also more readily applicable to theanalysis of the effects of various new shocks on the rural enterprisesector. One paper which does use a similar structure is that byWilliamson and Mclver [7993] but in that case the model is applied to adifferent question, in particular, the costs of the household registrationsystem in the pastoral areas of China. See also Anderson [7993] for amodel of the interaction between agriculture and industry in a reform-ing economy. In an earlier work, Zhang [1992a] developed a more com-plex model than that used here to discuss the implications of the ruralenterprise boom for China's trade. We use here a 'cut-down' version ofthat earlier model and illustrate its relevance by updating Zhang's dataon the product mix of rural enterprise exports.

A key analytical difference between this model and previous work isthe degree of attention given to the institutional arrangements associ-ated with rural enterprise ownership. Watson and Findlay [1991] havestressed a different 'model' of rural enterprise development which high-lights the institutional features of the fiscal relationships betweenregional and higher level governments. That model stresses the role oflocal government in providing finance for rural enterprises and stresseslocal government interests in using available policy instruments to pro-tect local manufacturing activities. In that model, the focus is on theincentives of the owners of these enterprises and on distortions in finalproduct and raw materials markets. Here we abstract from somefeatures stressed in that paper by adopting the simplifying assumptionthat the owners of rural enterprises act in a profit-maximising fashion.Also, instead of focusing on distortions in product and raw materialmarkets, we stress the barriers to factor mobility within China.

In summary, the model applied here compared to the previous litera-ture is parsimonious, is applied at an aggregate or sectoral level and ispresented using diagrams.

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Segmented Labour Market

In this model we make a distinction between sectors of the economy andactivities which take place within those sectors. There are always twosectors - rural and urban. We assume that in the urban sector the onlypossible economic activity is manufacturing. But in the rural sector bothagricultural and manufacturing activity is possible. This is the result ofassuming that there are three factors (land, labour and capital) in theeconomy. Agricultural activity employs labour and land, and all land islocated in the rural sector, while the manufacturing activity employslabour and capital. Capital and land are immobile between rural andurban sectors.

An important assumption here is that the prices of manufactured andagricultural goods are determined exogenously and independently ofthe local supply and demand, that is, the firms are price-takers in thiseconomy. This assumption is reasonable if one considers the dominantrole of government pricing in Chinese economy in the 1980s.6 Howeverthe size of the rural industry sector suggests that there will be a tendencyfor prices to fall as output increases, thereby cutting profits in boththe rural enterprise and competing state sectors. This process is stressedin Naughton's [1992] analysis of the effects of the 'lowering of entrybarriers' into markets previously dominated by urban and state-ownedfirms. However, the possibility of changes in prices is a complicationwhich does not affect the main points here.

A key difference between rural and urban manufacturing activity inpractice is the tighter budget constraint operating on rural enterprisesbut for simplicity we abstract from that difference by assuming cost-minimising behaviour prevails in both sectors. In a situation wherestate enterprise managers face a declining allocation of state resourcesand strong motives to maximise profits, such an assumption is notunreasonable.

Factor rewards will be determined by the demands from both manu-facturing and agricultural activities, given the factor stock in the twosectors and commodity prices. This situation is represented by thebeaker-shaped diagram of the labour market in Figure 1. The totalquantity of labour in the economy is indicated by the length of thehorizontal axis, the quantity in the rural sector being read from the ori-gin on the right, and the quantity in the urban sector from the origin onthe left. The vertical axes show the marginal products and the wage rate[defined in terms of the price of manufactured goods] in each sector. Weshow the manufactured goods' demand for labour curve relative to theurban origin and that for the agricultural goods relative to the ruralorigin.

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Policy changes in 1984 [CCP, 1984] endorsed the growth of ruralenterprises, essentially removing any remaining barriers to their entryinto markets for industrial products. In terms of the model this changeimplies free trade in goods within the economy.

The question is whether there was also a national market for labour.Suppose that there was, so that labour is perfectly mobile between thetwo sectors (and activities), then the labour market would clear at E.The equilibrium wage rate is We, at which the two labour demand curvesintersect (MPm for manufacturing and MPa for agriculture). Manufactur-ing employment is the distance of LuLe, and agricultural employment isLeLr at the wage rate We. Agricultural labour will work in the rural sec-tor but so far there is nothing in the model to say whether manufactur-ing labour works in the rural or urban sectors.

FIGURE 1

SEGMENTED LABOUR MARKET

Real wage

W,,

MPm

L*

This version of the model assumes that labour is mobile betweenmanufacturing and agricultural activities. In fact there are some restric-tions on factor mobility which need to be incorporated into the model.Restrictions apply to the movement of labour between the rural andurban sectors in China [Guo and Liu, 1990; Anderson, 1990, Zhang1992d\. There are also restrictions on capital mobility due to the institu-tional barriers to the flows of funds between urban and rural China[Zhang, 1992a]. Naughton [1992] alternatively, describes these barriersas between industry and non-industry. Evidently when factor movement

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between rural and urban areas is prohibited and each sector specialisesin different activities (rural sector in agriculture and urban sector inmanufactures), sectoral barriers are also industrial barriers. Neverthe-less, we prefer to call them sectoral barriers rather than industry barriersbecause the latter will not necessarily lead to a rural industrial boom butthe former will inevitably lead to one, as we will discuss below. Thesesectoral barriers are the source of the difference between China's pathto industrialisation and those of other developing countries.

Suppose in the first instance that all the existing capital stock is inurban China. Consequently, all manufacturing is located in urban Chinaand agriculture is the only economic activity in rural China. Then we cancharacterise the restrictions on labour mobility as follows.

Urban employment as a result of these restrictions is fixed at LuL*.This would break the manufacturing labour demand curve MPm at Eu.The MP curve is also broken at E . As a result of the restrictions, and

d a

given the assumption of a fixed stock of capital in the urban manu-facturing sector, the capital intensity of manufacturing sector produc-tion would be higher than otherwise. The marginal productivity ofurban workers will also be greater which in turn will lead to a higherurban wage rate equal to Wu.

The rural wage rate will be determined by the intercept of MPa andthe division line at L* in the figure. The rural wage is Wa and the corre-sponding employment levels are LuL* and L*Lr in manufacturing andagriculture respectively. As Anderson [1990] and others explain, therestrictions on labour mobility are so tight that Harris-Todaro types ofqueues are not present.

We can now use this model to discuss the origins of the rural enter-prise sector. The first round effect of the rural reforms was to raise theproductivity of land and labour use in agriculture.7 The MPa curve shiftsbecause of a combination of effects of a rise in the price of agriculturalproducts relative to manufactures and increased input productivity[including lower management costs]. This shift leads to higher incomes,some of which is saved. Given the institutional barriers to capitalmobility, that capital remains for investment in rural China.8 Further-more, the distortions to product prices in favour of manufacturing andthe relatively low rural wages mean that investment in manufacturingactivity in rural China is more profitable than investment in agriculture.

These forces help to create a new demand curve for rural manu-facturing labour, MPr

m in Figure 2, together with the new agriculturalmarginal product curve, MPa'. As that curve emerges, labour is drawnout of rural agriculture into rural manufacturing (L*U). The rural wagerises to W '. In this model, both rural manufacturing employment and

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FIGURE 2RURAL INDUSTRIALISATION

Real wage

wu

wv v a

the wage rate increase. In this case the urban employment of manufac-turing activities is LuL* as before, but manufacturing employment inthe rural sector is L*L', leaving the remainder, L'Lr as agriculturalemployment.

An important question is by how much will the wage rate rise? Herewe draw on actual data which indicates there are still significantrural-urban wage differentials on average, so in Figure 2, Wa' lies belowWu. Rural enterprise 'booms' but that boom is not yet sufficient toremove the gap between wage rates in urban and rural China. As aresult, urban manufacturing is more capital intensive than that in therural sector, no matter what products they make.

A Test of the Model: Production and TradeThe picture from the previous section of relatively labour intensivemanufacturing activity in rural China at the early stages of its industri-alisation is consistent with the evidence on the financial indicators ofrural compared to urban enterprise in China. Zhang [1993] reports aseries of financial indicators of township and village enterprises com-pared to state run enterprises in industry sector. Two indicators of par-ticular interest are the value added per worker and the share of wagesin value added. More labour (time)-intensive processes will tend to havea lower value added per worker. They may also have a higher share ofwages in value added.9 Zhang reports that the ratios of fixed capital per

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worker and value added per worker in state enterprises to rural enter-prises in the industrial sector are many times greater than unity, that is,state-owned enterprises are relatively more capital-intensive. Theseresults are consistent with our earlier prediction about the relative factorintensities of production in the two sectors.

The labour intensity of the production process in rural enterprise isalso consistent with the composition of their exports. Table 3 reports thecomposition of rural enterprise exports compared to the national total.The factor intensity classification of exports is based on a schemereported in Zhang [7993]. About 80 per cent of rural enterprise exportscan be classified as labour intensive compared to 60 to 65 per cent in thenational total. Conditions under which they operate lead rural enter-prises to use more labour-intensive activities.

IMPLICATIONS FOR RURAL-URBAL RELATIONS

Competition or Co-operation?Investment in rural enterprises continues to be profitable because ofthe relatively lower cost of labour and a high marginal productivityof capital in rural China, although the gap will narrow when thestate's previous degree of market power in markets for industrial prod-ucts is attacked by the rural enterprises [Naughton, 1992]. This analysistends to stress the urban-rural conflicts in markets for finished products,and for raw materials [Watson, Findlay and Du, 1989].

While our analysis stresses the opportunity for rural industry to entermarkets previously dominated by urban sector firms, it also highlightsthe differences in factor intensities employed in enterprises in ruraland urban China. Theories of the basis of trade then suggest there willalso be scope for exploitation of the complementarities between thesetwo sectors. In addition, the corollary of differential factor rewardsbetween two sectors within one national economy suggests there will bepressures to relax the barriers to factor mobility between those sectors.In this section, we explore some of the possible outcomes of greaterdegrees of factor mobility, using the model specified above.

In principle, there are three cases to consider:

(a) capital barriers decline and labour barriers remain;(b) labour mobility restrictions are removed and capital mobility

restrictions remain;(c) all restrictions on factor mobility are removed.

In fact, as we explain below, case (c) is unlikely.

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TABLE 3THE STRUCTURE OF RURAL ENTERPRISE EXPORTS 1986-91

Classification

Natural Resource IntensiveNative ProductsAnimal ProductsMineralsLabour IntensiveTextilesSilk TextilesClothingFood ProcessingLight ManufacturesHandicraftsOthersCapital IntensiveChemicalsMachinerySub-TotalNatural Resource

(national level)Labour Intensive

(national level)Capital Intensive

(national level)

Total Rural Exports

1986(Ym)

255351557

2060

970957

15332532

428305

1163

8052

733

9949

(%)

346

21

1010

1525

43

12158164

721

100

1987(Ym)

395864778

3195

17751485

25303564

817792

2037

12549

1609

16196

(%)

255

20

119

1622

55

131177651023

100

1988(Ym)

48311511358

4288130430172713287237923266

15051123

2992

21252

2628

29871

(%)

245

144

109

101311

54

109

71639

28

100

1989(Ym)

68514721915

6164.195548943492384648264087

20761782

4072

29264

3858

37141

(%)

245

175

139

101311

65

117

79651028

100

1990(Ym)

70217732450

8093290863824186635261384471

24702639

4925

38530

5109

48500

(%)

14

' 5

176

139

13139

55

10

79

II

100

1991(Ym)

93021482813

10714338698045307

1017081726524

32393786

5891

54077

7025

66993

(%)

134

165

158

151210

56

9

81

10

100

Sources: Editorial Board of Rural Enterprise Yearbook [190:174]; Ministry of Agriculture [1990:13];International Economic Data Bank,ANU, and updated from Zhang [1992a]; Rural Enterprise Bureau, Ministry of Agriculture[1992: 31];

Note: The national level of export pattern and classification are derived from Zhang [1992a].

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'Fence with Holes'

The first of the barriers likely to fall is that to the movement of capitalbetween the two sectors. Already Chinese commentators (in interviewsin Beijing in February 1992) describe the barrier between the rural andurban sectors as a 'fence with holes'. There are strong incentives for theurban sector to relocate its capital into rural China. That redirectioncould take the form of new funds for investment being located in ruralprojects.10 Already there is some evidence that as much as 40 per centof rural enterprise exports may be produced on sub-contract to theurban sector.11

It could also take the form of foreign investors taking up joint ven-tures with rural instead of urban industry. The extent of foreign jointventures involving rural industry is also estimated to be significant.There were about 2,400 joint ventures between foreigners and ruralenterprises in 1986, which increased to 8,500 by the end of 1991 [RuralEnterprises Bureau, 1992: 29]. Converting at the official exchange rate,the value of fixed assets in these joint ventures rose from $US0.14 billionin 1986 to $US1.42 billion in 1991. This tenfold increase is much greaterthan the 2.3 fold increase in total realised foreign investment in Chinaover the same period [SSB, 1992: 642].

Other factors also promote urban/rural linkages. For example in thetextile sector, exports are restricted by quotas, a result of the MFA-typeof protection in high income countries. The export quota system is man-aged by the planning system and urban enterprises tend to get priorityin the allocation of export quotas. They may sub-contract rural enter-prises which do not already have export quotas to produce exportableitems.

The greater degree of integration in financial markets will alsofacilitate the capital flows between the two sectors but via the interme-diation of the banks rather than via direct investment. For example, theresidual bank loans of township and village-run enterprises were 73billion RMB in 1988, a 32-fold increase over that in 1978 [China RuralEnterprise Yearbook, Editorial Board, 1990: 71].

Human capital can also flow between the two sectors. Already thephenomenon of the 'Sunday engineer', that is, an engineer from anurban enterprise working in a rural enterprise at the weekend, is com-mon. There are also examples of people who have retired from urbanindustry taking up positions in rural enterprises, in some cases, return-ing from coastal China to work in their old home towns.

In those circumstances, capital flows into the rural sector. In terms ofFigure 2, the MPm

r line rises and industrial employment in rural Chinaincreases. The short run scenario involves even faster growth of rural

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enterprises. The MPm line in the urban economy is lower (compared towhat might otherwise have been the case in a growing economy). Theimplication is that there will be a tendency towards convergence in wagerates between rural and urban China. This is the case even though thebarriers to labour mobility (indicated by the fixed position of the verticalline at L*) remain.

Labour MobilityThe barriers to capital mobility are likely to be more permeable thanthose to labour mobility. There are reports of a substantial 'floatingpopulation' in Chinese cities of at most 80 million.12 However, it isimportant to distinguish between permanent and temporary movementsof labour. Reforms to housing and food markets in Chinese cities willfacilitate permanent movements in the longer run. But in the mediumterm, capital is still likely to be the relatively more mobile factor of pro-duction, since permanent rural-urban migration of labour may increasethe demand for housing, transport and the other facilities of the largecities. There are already a lot of constraints on meeting the demand forthese facilities in urban areas. China will, according to this analysis, con-tinue to follow a different path to industrialisation than that of manyother developing economies.13

Implications for AgricultureA further implication of an urban to rural capital flow (and also of alabour flow into urban China) will be a more rapid decline in the rela-tive importance of the agricultural sector in the economy. The demandfor labour in the rural manufacturing sector increases as capital flowsinto rural China and pulls labour out of agriculture. This is also illus-trated using Figure 2 by raising the MPm

r curve. The agriculture sectoris 'protected' by the present barriers to mobility of factors of production.An increased degree of factor mobility would therefore also decreaseChina's self sufficiency in agricultural products.

SUMMARY

The boom in rural enterprises in China was associated with the combi-nation of the barriers to labour and capital mobility, in the presence ofincome growth induced by the agricultural reforms. Capital accumulatedas a result of the growth in income in the countryside and was investedto work with the pool of labour available there. The outcome was therapid growth of enterprises created by local communities which oper-ated outside the plan.

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The origin of the boom has implications for patterns of specialisationand trade. They imply that rural manufacturing production and exportsare relatively labour-intensive. Consequently rural enterprise exportsare more highly concentrated in the labour intensive category than is thecase for national exports. A corollary is that the growth of the ruralenterprise sector has contributed to the rapid growth of China's exportsof labour intensive products.

While we can understand the recent experience of rural enterprisegrowth in terms of barriers to factor mobility, the prospects for indus-trial growth in rural China are more likely to be influenced by the eco-nomic forces which will break down those barriers to mobility. Theeffects will be a relatively faster rate of growth in rural China. Someof the economic impacts include a convergence in rural-urban incomelevels, a change in the structure of output and employment, including ashift away from agriculture, and a continuing contribution of rural enter-prises to China's export growth.

Rural enterprise growth also has a number of political implications.For example, we expect a strengthening of political support for thereform process, given the operation of these enterprises outside theplan. On the other hand, there will also be some important politicalissues to resolve, such as those created by uncertainties about the owner-ship of these enterprises. These issues, which are outside the scope ofthis paper, are discussed in more detail by Findlay and Watson [1992].

final version received July 1994

NOTES

1. Rural enterprises are not the only type of firm operating outside the state plan. In theurban economy, for example, there are some collectively or privately owned enter-prises that are outside the plan. While large in absolute terms, employing about 35 mil-lion people (China Daily, 15 Feb. 1992) their significance is small in urban economiesrelative to state enterprises. In recent years, there have been some reports of particu-lar rural enterprises receiving planned allocations of inputs but this is the exceptionrather than rule. According to the Rural Enterprises Bureau [1992: 7, 11, 29] ruralenterprises are also involved in joint ventures, with state-owned enterprises (0.08 percent of the total number of rural enterprises in 1991 but 5.4 per cent of the value offixed assets in rural enterprises), with foreigners (0.04 per cent and 2.9 per cent respec-tively) and with urban collectives (0.02 per cent and 0.64 per cent respectively). Allthese categories are included in the total number of rural enterprises in Table 1.

2. Abbreviations used here include:

ZNN: Zhongguo Nongye Nianjian (China Agricultural Yearbook)ZTN: Zhongguo Tongji Nianjian (China Statistical Yearbook)ZXQGBQ: Zhongguo Xiangzhen Qiye Guanli Baike Quanshu (Chinese

Encyclopedia of Rural Enterprise Management)

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ZXQN: Zhongguo Xiangzhen Qiye Nianjian (China Rural Enterprise Yearbook)ZXQTZ: Zhongguo Xiangzhen Qiye Tongji Zhaiyao (A Summary of China Rural

Enterprise Statistics)

3. Summary of World Broadcasts, Part 3, The Far East, FE/W0159/A/1,19 Dec. 1990. Seealso Zhongguo Xiangzhen Qiye Bao, 12 Dec. 1990, p.3.

4. These data are from the Ministry of Agriculture. The Ministry of Agriculture [MOA]source reports higher values than the SSB data used in Table 2. This could be becausethe MOA counts as rural exports products made by rural enterprises on sub-contractswith urban enterprises, whereas the SSB may attribute these same products to theprime contractor [Zweig, 1991: 717].

5. Eastern China includes the provinces of Liaoning, Hebei, Shandong, Jiangsu,Zhejiang, Fujian, Guandong and Guangxi, and the cities of Beijing, Tianjin andShanghai. Central China includes Heilongjiang, Inner Mongolia, Shanxi, Henan,Hubei, Anhui, Hunan and Jiangxi. Western China includes Xinjiang, Gansu, Ningxia,Shaanxi, Sichuan, Guizhou, Yunnan, Qinghai and Tibet.

6. In fact, the pricing regime was greatly liberalised during the reforms in the 1980s.However, price distortions remained for some time, especially with respect to therelative prices between agricultural and industrial products, and have not improvedsignificantly during the decade in China [Nolan, 1991: 38: Zhang, 1993].

7. See Findlay, Watson and Martin [1993] for a recent review of the reforms.8. This analysis is consistent with the source of funds for rural enterprises [Yuan Peng,

1992]. Initially the expansion of rural enterprises depended mainly on the accumula-tion of capital through internal profits. After the government's call to accelerate ruralenterprise development in 1984, this changed. More credit became available and ruralenterprises developed a high dependence on loans as a source of capital. Their debtto equity ratios increased. In contrast, state enterprises continued to rely on alloca-tions from the state budget as a major source of capital. There were important regionaldifferences in the sources of finance. Those in the less developed regions tended tohave a greater reliance on debt compared to those in developed regions. They also hadlower levels of internal accumulation. Capital formation in the different regions wasstrongly affected by local economic, social and geographical factors. The process ofcapital accumulation in privately owned enterprises was also very different to that inthe township and village owned enterprises. It was largely dependent on funds gener-ated within the enterprise and the proportion of local government allocations andbank loans was very low.

9. Human skill intensive activities which employ high wage labour will also tend to havehigh shares of total wages in value added but they will also report high value addedper worker.

10. In 1991, output from joint ventures with state-owned enterprises accounted for 5.5 percent total rural enterprise output compared to 3.4 per cent in 1986.

11. See note 3.12. Some of the floating population will be urban workers: see Summary of World

Broadcasts, Part 3, Far East, FE/0689/B2/5, 15 Feb. 1990.13. According to a Xinhua report of 31 Jan. 1994, China's central ministries have begun

to work on dismantling the household registration system in order to correct the dis-tortions in rural enterprise development: see Summary of World Broadcasts, Part 3,Far East, FE/1911/G9-11, 2 Feb. 1994.

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