ECON 22132. Reform, Liberalization, and

Economic Growth

China’s economy 1949-1978: “Big Push” industrialization

• Before 1949, China had a traditional household-based economy.

• After the PRC was established, China’s leaders resolved to develop an industrial economy by using a high degree of socialist planning.

China’s presidents• 1949-1959 Mao Zedong• 1959-1968 Liu Shaoqi• 1968-1975 Song Qingling and Song Biwu• 1975-1976 Zhu De• 1976-1978 Song Qingling• 1978-1981 Ye Jianying• 1981 Song Qingling• 1981-1983 Ye Jianying• 1983-1988 Li Xiannian• 1988-1993 Yang Shangkun• 1993-2003 Jiang Zemin• 2003-2013 Hu Jintao• 2013-: Xi Jinping

China’s premiers• 1949-1976 Zhou Enlai• 1976-1980 Hua Guofeng• 1980-1987 Zhao Ziyang• 1987-1998 Li Peng• 1998-2003 Zhu Rongji• 2003-2013 Wen Jiabao• 2013-: Li Keqiang

• The president is the head of state; the premier is the head of government.

China’s economy 1949-1978: “Big Push” industrialization

• Priority was given to investment over consumption.– By 1954, investment was 26%

of GDP.– Even today, the world average

is 19%.• This was almost entirely

government investment in the construction of new factories, especially heavy industry.

China’s economy 1949-1978: “Big Push” industrialization

• Between 1952 and 1978:– industrial output grew by 11.5% per year on

average– the share of industry in GDP rose from 18% to 44%– the share of agriculture in GDP fell from 51% to

28%• The Big Push did jump-start the economy—

but other strategies might have worked too.

China’s economy 1949-1978: “Big Push” industrialization

• China focused on the industries at the top and middle of the value chain: natural resource extraction and materials (top), refining and machinery (middle).

• Hong Kong and Taiwan focused on the industries toward the bottom of the value chain: final products for consumers and firms, such as textiles, toys, and food products. They later moved up the value chain and had even faster growth than China.

China’s economy 1949-1978: Command economy

• Key feature: no role for prices in resource allocation.• The government owned all large factories; in rural

areas, agricultural collectives owned the land and organized the farm economy.

• Factory product prices were kept high and farm prices were kept low (with procurement quotas), so relative prices were set to push resources into industrialization.

• To keep workers in agriculture, there were restrictions on mobility through the hukou system, the household registration system providing residency permits and access to schooling and health care.

China’s economy 1949-1978: Command economy

• No need for a modern tax system: state-owned industrial enterprises were very profitable, adding to government revenues.

• Material balance planning was used to run the economy.

• Nomenklatura system (Communist party controls on employment decisions) used to manage employees.

• Compared to the Soviet Union, the economy was less controlled, with more decisions made at the local government level—but political ideology was more controlled.

China’s economy 1949-1978: Policy instability

China’s economy 1949-1978: Policy instability

• 1949-52: Recovery• 1953-57: First five-year plan• 1958-60: Great Leap Forward– Communes established in countryside; all

monetary incentives rejected– Leaders reduced the resources available for

agriculture, but increased the required procurement of grain

– The result was the largest famine of the 20th century, with 25-45 million excess deaths

China’s economy 1949-1978: Policy instability

• 1961-63: Readjustment• 1964-66: Third Front• 1966-69: Cultural Revolution– Groups of students (“Red Guards”) encouraged by

Mao to overthrow the Communist Party leadership

• 1969-71: New Leap Forward• 1971-76: Retrenchment• 1976-78: Leap Outward

China’s economy 1949-1978: Legacy

• Consequences:– Dissatisfaction with standard socialist system– Periods of experimentation showed possibilities– Mao as a scapegoat

• Neglect of consumption and services– 1952-78: investment grew 10.4% per year on average, while

per-capita consumption grew 2.3%– Services declined from 29% of GDP to 24% of GDP– No competition in consumer markets, little quality

improvement, few new products– Luxury goods like wristwatches and electric fans were

inaccessible to average households

China’s economy 1949-1978: Legacy

• Other shortcomings:– Underemployment and slow job creation due to

emphasis on capital-intensive industry– Overambitious industrialization strategy, inefficiency of

industrial products• But: high human capital– Life expectancy rose– 2/3 of the population was literate by 1982, where

literacy is defined as recognizing 1500-2000 characters

India’s economy 1947-1981: slow growth

India’s economy 1947-1981: Nehru’s objective

• Jawaharlal Nehru was prime minister from 1947 to 1964. His goal was for India to be independent.

• Nehru wrote: “The objective…was the attainment…of national self-sufficiency. International trade was certainly not excluded but we were anxious not to be drawn into the whirlpool of economic imperialism…To base our national economy on export markets might lead to conflicts with other nations and to sudden upsets when those markets were closed to us.”

• Nehru referred to economic independence as the key objective of his advocacy of heavy industry.

India’s prime ministers• 1947-1964 Jawaharlal Nehru• 1964 Gulzari Lal Nanda• 1964-1966 Lal Bahadur Shastri• 1966 Gulzari Lal Nanda• 1966-1977 Indira Gandhi• 1977-1979 Morarji Desai• 1979-1980 Choudhary Charan Singh• 1980-1984 Indira Gandhi• 1984-1989 Rajiv Gandhi• 1989-1990 Vishwanath Pratap Singh• 1990-1991 Chandra Shekhar• 1991-1996 P.V. Narasimha Rao• 1996 Atal Bihari Vajpayee• 1996-1997 H. D. Deve Gowda• 1997-1998 Inder Kumar Gujral• 1998-2004 Atal Bihari Vajpayee • 2004-present Manmohan Singh

India’s economy 1947-1981:Industrial policy

• India’s industrial policy had three key elements: a dominant role of the public sector, regulation of the private sector through licensing, and price controls.

• A large role for the public sector was necessary because India wanted to keep out foreign investors, and the private sector had too few resources to take a larger role.

• Because of the need for licences and permits, India’s economic policies were known as the “Licence Raj.”

India’s economy 1947-1981:Industrial policy

• At first, only industries with larger factories (more than 50 workers) were subject to licensing, but all industries came to be included. Licensing meant that firms could not expand capacity, change the goods produced, move location, or increase production without permission.

• As the economy grew more complex into the 1960s, the licensing system grew more chaotic and corrupt.

• Price controls were instituted to control inflation and grew in importance in the 1960s. Price controls were imposed on goods from iron and steel, nonferrous metals, coal, and fertilizers, to cotton textiles, paper, sugar, cars, bicycles, tires and tubes, soap, and matches.

India’s economy 1947-1981:Agricultural policy

• Agriculture had a low priority at first, with little role for price incentives. Nehru stated that he did not want to “encourage acquisitiveness beyond a certain measure.”

• The zamindars (revenue-collecting landlords) were eliminated in the first round of reforms, but there was slow progress on land redistribution, and slow growth in agricultural output.

India’s economy 1947-1981: Growth 1951-1965

• Growth in GDP was 4.1% on average between 1951 and 1965, due to rising investment rates (from 9.7% of GDP in 1954-55 to 14.1% in 1964-65) and to expansionary fiscal policy (that would prove unsustainable).

• From 1965 to 1981, growth was much slower. Between 1965 and 1975, GDP grew by only 2.6% on average; since population grew by 2.3%, this meant a virtual standstill in the standard of living.

• A per-capita growth rate of 0-1% has been called the “Hindu” rate of growth.

India’s economy 1947-1981: Growth 1951-1965

India’s economy 1947-1981: Political context

• Nehru was prime minister from independence until his death in 1964. In 1966, his daughter Indira Gandhi became prime minister and (except for 1977-80) ruled until her assassination in 1984.

• With stagnation caused by the droughts of 1971-73 and inflation caused by the 1973 oil price shock, the heavily-controlled economy could not adjust. Mrs Gandhi was found guilty of fraud in the 1971 election but declared a state of emergency rather than step down.

• She called an election in 1977 and lost power, but three years of a failed coalition led to her re-election in 1980.

• After her assassination in 1984, her son Rajiv became prime minister until 1989.

India’s economy 1947-1981: 1960s• Trade deficits, droughts, and war with Pakistan led to a

crisis in 1965, and India was forced to devalue its currency and liberalize its trading regime. Both were politically unpopular and the liberalization was short-lived.

• The government then imposed further controls on industry, tighter restrictions on foreign investment, and tighter licensing restrictions, and introduced a policy reserving certain products for small-scale industry (including clothing, shoes, leather products, and other goods that a labour-abundant country would have a comparative advantage in producing and exporting).

India’s economy 1947-1981: 1960s• Labour-market regulations were introduced that made it almost

impossible for larger firms (more than 100 employees) to fire workers.– Detrimental to productivity– Drove entrepreneurs towards capital-intensive industries and capital-

intensive technology• In 1969, larger banks were nationalized. This caused more branches

to be opened in rural areas, but could this have been done at a lower cost?

• The Green Revolution (the use of high-yielding dwarf varieties of seed from Mexico) was the most positive development of the 1960s. This was controversial, but India was self-sufficient in food by the late 1970s.

• http://www.youtube.com/watch?v=HucSCNQ01X4

India’s economy 1947-1981:Growth 1965-1981

• Whether due to poor economic policy or adverse external shocks, India did experience slower growth in the 1965-81 period compared to the 1951-65 period.

• But growth should have been much faster.– During 1965-75, the world economy grew rapidly,

including the GDPs of developing countries in Latin America, Africa, and Asia.

– By keeping itself closed off from the world economy, India missed out on this growth.

India’s economy 1947-1981:Growth 1965-1981

Reform in China after 1978

• By now, China has spent a longer period building a market economy than it spent under a command economy. However, the transition is not yet complete.

• The first phase of reform (“reform without losers”) was gradual and began to develop a market economy alongside the command economy.

• The second phase was more thorough.

Reform in China after 1978• The reform process in China was very different from

transition in Eastern Europe and the former Soviet Union.• There was no “big bang” in China, whereas in Eastern

Europe, the goal was to move as quickly as possible to a market system, despite the short-run costs.

• In China, the focus was always on economic development. Areas of unregulated activity (special economic zones [SEZs] or township and village enterprises [TVEs]) were allowed to operate since they would help lead to growth.

• Gradually the balance between the planned economy and the market economy began to shift.

Reform in China after 1978• The reforms started in the countryside in 1978, with

farmers in Anhui province taking over land to use privately. The government called this the “household responsibility system,” in which farmers were responsible for sending a certain amount of grain to the government but could retain their extra output.

• The result was increasing production. Lin (1992) shows that agricultural output grew at an annual average rate of 7.1% during 1979-1984, compared to 2.7% during 1970-1978.

• The reforms in the industrial sector followed a similar path, with enterprises given residual control over production.

Reform in China after 1978

• Characteristics of the early phase of reform:– Dual-track system: coexistence of a traditional plan and

a market channel.– A commitment to growing out of the plan over time,

i.e., keeping the traditional plan constant and allowing the market channel to grow. This meant that both farms and enterprises faced market prices at the margin.

– Government monopoly over industry was relaxed and new entrants were allowed.

– Gradual loosening of price controls.

Reform in China after 1978

• Continued characteristics of the early phase of reform:– Managerial reforms, not privatization; new emphasis on

profitability and autonomy even in state-owned enterprises (SOEs).

– Rise of SEZs, TVEs, and other areas of detachment from planned economy.• Experiments to attract FDI started in Guangdong province in

1979.• TVEs produced 26% of GDP by 1996.

– Saving done by households rather than government.

Reform in China after 1978• Industrial output grew at an annual rate of 9.3% between 1978 and

1993.• Most groups benefited from reform; workers in SOEs were protected.• In 1989, anger over rising inflation (over 25%), corruption, and

possibly unfulfilled expectations of more rapid political and economic change led to weeks of demonstrations in Tiananmen Square in Beijing. After a political struggle behind the scenes, conservative leaders ordered the military to clear the square. Hundreds were killed and reform slowed for a couple of years.

• Deng Xiaoping’s 1992 “Southern Tour” got reform back on track. “Development is the only hard truth. It doesn’t matter if policies are labeled socialist or capitalist, so long as they foster development.”

Reform in China after 1978

• The second phase of reform started in 1993 and is ongoing.

• Characteristics include:– Market reunification: no longer a dual track.– Fiscal reforms and the introduction of a tax system

to boost government revenue.– Macroeconomic austerity to reduce inflation.– Restructuring of the banking system.– Foreign trade reforms, including WTO membership.

Reform in China after 1978• Outcomes of the second phase:

– Downsizing of SOEs: the number of workers who are employed in state-owned firms has dropped by 40% since the mid-1990s.

– Privatization (“restructuring”).– Reform with losers, e.g. SOE workers.

• Continuing reforms:– Financial system: dominated by state-owned banks with weak

budget constraints.– Corporate governance.– Regulatory agencies.– An increase in inequality and poverty, with pensions and health

insurance lagging behind.

Kotwal, Ashok, Bharat Ramaswami, and Wilima Wadhwa, “Economic Liberalization and Indian Economic Growth: What’s

the Evidence?,” Journal of Economic Literature 49:4 (2011), 1152-1199.

Problems with data

• Measuring output– Production measured at current prices vs. constant

prices.– Comparing countries using exchange rates vs.

purchasing power parity.• Data quality– It is unusual for economists to even acknowledge that

data are not always trustworthy.– The Penn World Table used to give grades for data

quality.

Maddison, Angus and Harry X. Wu, “Measuring China’s Economic Performance,” World

Economics 9:2 (2008), 13-44.

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China GDP per capita, PPP (constant 2005 international $)India GDP per capita, PPP (constant 2005 international $)United States GDP per capita, PPP (constant 2005 in-ternational $)

Bosworth, Barry and Susan M. Collins, “Accounting for Growth: Comparing China and India,” Journal of

Economic Perspectives 22:1 (2008), 45-66.

Eichengreen, Barry, Donghyun Park, and Kwanho Shin, “When Fast-Growing Economies Slow Down:

International Evidence and Implications for China,” Asian Economic Papers 11:1 (2012), 42-87.