Overview of the Chinese Economy

Background on the Chinese Econmy


The growth of the Chinese economy in the past few decades since economic reform in 1979 has been one of the wonders of modern economic development. China has experienced unprecedented growth in the past thirty years, with GDP rising on average by 9.5% per year over that period. Indeed, China currently has the fourth largest GDP, measured in nominal US dollars, with the 2006 figure standing at US$2.68 trillion.

Background on the Chinese Economy

Under the rule of Deng Xiaoping in 1979, China began the long process of transformation from a Soviet-style planned economy, where production decisions were made by the state, to one where market mechanisms would be the main driving force behind economic decisions. The National Party Congress cited a lack of economic growth and an increasing economic divide with the West and other Asian countries as the reason for the change. The changes were not to be a total abandonment of communist principles but to combine capitalist ideologies with Chinese characteristics.

Reform of the Chinese Economy

An initial process of reform was proposed to ease the economy gently into its new guise, whereby any significant disparities between an open economy and the Chinese one would be ironed out. Key to this was expansion and liberalisation of the export program, development of major infrastructure, generation of power, and utilisation of raw materials.

The significant problem of food shortages for the sizeable and ever increasing population was one of the first to be addressed. Farmers were given incentives to increase production levels whilst at the same time lowering the costs of production, a scheme which had the effect of greatly increasing food supplies. The authorities believed that the success of this initial trial period in isolated areas warranted a nationwide implementation and so it became; almost the entirety of the country’s farm system was governed by this method come the mid-1980s. The free market mechanism was deepened and led to further increases in production and demand, fuelling farm incomes.

One particularly important development was the new freedom given to company leaders. Although inherent production and decision making differences between agriculture and industry prevented a similar success story to that in agriculture taking place, there were significant gains to be made. Rather than being put in a proverbial managerial straightjacket, business managers were given more freedom to set production targets as well as experimenting with incentive techniques to boost productivity amongst workers. They were allowed to hire and fire workers. Further, measures were brought in to create profit incentives for the firm as a whole. Prior to this, firms were obliged to submit all profits to the state with none being reinvested into the firm itself, a situation which hinders incentives to maximise productive efficiency. The new rules required that firms pay only a proportion of their profit to the state, essentially a corporate tax, leaving the remainder to be used for the good of the firm, as managers saw fit. The source of funds for investment was also shifted from zero interest government loans, which did not have to be repaid thus giving no incentives to generate profit. Firms were now required to borrow repayable bank loans which carried a positive rate of interest. Though critics argued that the chosen rate was perhaps too low to generate the necessary incentives, though it marked a crucial shift in the country’s banking market.

In addition, to make use of the country’s considerable workforce the government proposed the idea of creating firms which would be collectively owned by workers so that their income would be based on how well the firm performed, again providing an incentive to raise productivity. This also had the knock-on effect of boosting certain sectors the government wished to promote, by allocating these workers to the appropriate areas.

The creation of more independent and market oriented firms meant the appearance of a burgeoning domestic consumer market, with citizens being given a consumption choice that they had never had before. The central government actively encouraged the delegation of production decisions to the market, in spite of underhand measures by local authorities to disproportionately tax private sellers, and the private system expanded to levels where they rivalled their state owned counterparts by the mid-1980s.

Foreign Investment

But perhaps the most important influence behind China’s growth was opening up to the outside world. The authorities decided that the goal of Chinese self-sufficiency was largely unattainable and trade was a necessary part of a modernising economy. It was made significantly easier for international trade to take place with the Ministry of Foreign Trade permitting firms and other departments to discuss investment opportunities with their foreign counterparts. Moreover, increased trade was facilitated by the legalisation and liberalisation of trading and credit agreements.

The situation further improved after 1982 with foreign trade comprising an ever larger percentage of national income, a figure which reached 35 percent in 1986. A major driving force behind this increase was the creation of so-called Special Economic Zones where incentives were given to foreign invested enterprises to engage in joint ventures with Chinese firms or set up solely foreign invested firms. These were located in strategic areas such as coastal regions close to the economically advanced Hong Kong and Taiwan. In addition to this economic development zones were set up in important commercial and industrial coastal cities. As a result, restrictions on trade were loosened further in the mid-1980s, and foreign investment was legalized. The most common foreign investments were joint ventures between foreign firms and Chinese units. Sole ownership by foreign investors also became legal, but the feasibility of such undertakings remained questionable.

Chinese Economy - Problems 

However, as with all economic ‘miracles’ there has also been a negative side to this development, and such huge growth has had an impact upon many areas of society and the environment. There became a huge gap between the urban rich and the rural poor, due to the massive incentive and investment programmes targeted in the cities, and to this day the divide remains the one of the largest in the world. Choking levels of pollution affect a great number of Chinese cities to the extent that China can boast the unenviable accolade of being home 7 of the world’s 10 most polluted cities. Other environmental concerns include the loss of substantial amounts of arable land, soil erosion and a drop in the level of the water table. Unemployment has been difficult to contain with huge lay-offs from the previously inefficient state-owned enterprises. These and other problems show only minor sign of receding in the near future so China faces a struggle to balance its unrelenting modernisation with countering domestic imbalances and global environmental concerns. Whether there is a desire and drive within the government to implement the appropriate policies is a subject of considerable debate.

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