4.1 Responses and Evolution of State-Run Enterprises (SREs)

As previously mentioned, before the start of the reform, depending on their contribution to the industrial development of China, state-run enterprises were prioritized within the state allocation, production and distribution systems. However, regardless of their level of importance to the state, each faced risks of a different sort. Take input supplies as an example. The more advantaged enterprises had to worry about the state raising output without increasing input supplies while the less advantaged enterprises faced constant threat from lack of stability in input supplies.

Furthermore, with an increasingly crowded and competitive industrial landscape, the highly stratified organizational and institutional environment that the SREs operated in became a great handicap that impeded competition with the new and nimbler collective and private enterprises. Despite the adoption of market-based reforms, the organizational rigidity and inflexibility persisted even after the start of reform until mid-1985 (Lin 2001, Pg. 54). Changes within the state-sector were conspicuously lagging behind market developments because of the long-term deeply entrenched vested interests and the organizational complexity involved. There was little room they could maneuver since they were powerless in inducing policy changes by the supervising agencies. Hence, in response to the new competitive landscape, the only thing SREs at different levels could do was to pursue different strategies to circumvent their organizational and environmental handicap.

The favoured SREs strategized to sustain or enhance their advantages while those at the lower rungs of the hierarchy sought to contain or reduce their disadvantages. For example, the more advantaged enterprises sought to maintain a certain degree of organizational slack and limit the extent to which state plans were over-fulfilled to prevent output quotas from being raised in the following year.[i] The less advantaged enterprises, on the other hand, bargained for a lower output target and more discretion in self-arranged sourcing activities. Through such actions, the SREs succeeded in expanding the breathing space but failed to result in fundamental changes in policies (Lin 2001) that could radically change the ways enterprises were managed internally and market relations were fostered externally. While such a passive strategy was an appropriate approach in a non-competitive and rigid centrally-command environment, it was hardly an effective response to the freely competitive market environment. With increased competition from the new enterprise, the slack strategy was grossly inadequate in turning the tide that was rising against the state enterprises.

At the start of the reform, the SREs were therefore still shackled by the centrally-directed system and enjoyed no autonomy in almost every aspect of their operation. The rigid governance structure greatly limited their strategic response to the encroachment of collective and private enterprises. Their inflexibility, coupled with inefficiency and the high cost structure, put them at a grave disadvantage compared to these new enterprises which were not bound by any state-plans and were therefore nimbler. Besides competing for supply of tightly-controlled resources through avenues outside the state allocation system, the non-state firms also intensified the competition in product sales through self-arranged transactions. Since these new comers had a lower cost structure and were not restricted by centrally-drawn state plans, they could be more aggressive in pricing than the state enterprises. They also had the flexibility to customize their products according to the needs of their customers.

The emergence of these private enterprises and their ensuing expansion of activities therefore had an important impact on the SREs. The gains by the new enterprises demonstrated the opportunity costs of the centrally-directed rigid structure and decision-making process and became a frame of reference for quantifying loss of revenue. At the same time, they also became a basis for SREs to lobby and negotiate with their supervising agencies for institutional changes.

For the SREs, fortunately, the wait for changes did not last too long. The autonomy that the leaders of the SREs craved for eventually materialized, at least partially and progressively, by the mid-1980s. The introduction of measures such as “substitution of loans for fiscal appropriations” in 1981 and “tax for profit” in 1983 laid the necessary groundwork for the impending fundamental changes. In 1984, with the adoption of “CCP Central Party Committee Resolution on Economic System Reform” at the Third Plenum of the Twelfth Central Party Committee, full rollout of reforms was effected in the urban industrial sector. In 1985, the introduction of “factory director responsibility system” returned the autonomy of running the SREs to the enterprise leaders. The removal of price control over consumer goods and the creation of the dual-track price system for capital goods between 1983 and 1985 further deepened the reforms toward marketization of the state sector. Also, as a result of increasing marketization, ideological indoctrination and political activities within the enterprise declined in significance. More importantly, the adoption of contract responsibility system became a strong motivating factor as enterprises were allowed to keep the surplus beyond the target amount. At the same time, the contract system increased the autonomy of the factory leaders in matters relating to production, sourcing, sales and personnel. Rewards for its employees could now be tied to the enterprise’s performance. Redundant and non-performing workers could be axed through various measures such as early retirement and voluntary resignation with compensation. In the process of adjusting to all these changes, many SREs found room for changes that they had clamoured for in the past.

Despite so, as the reform progressed, SREs continued to face many challenges. The declined in mandatory production quota and relaxation of price control[ii] was accompanied by a corresponding reduction in input supplied at state-set prices. SREs needed to source for any shortfall in the materials from the market at the higher market prices. Next, the SREs were charged higher interest for loans from the state banks, starting from 1983. Thirdly, for most SRes, the sales of their output were no more guaranteed or arranged by the state. They were left to seek out users and arranged for the transactions. This put them head on in competition with not only other SREs, but also collective and private enterprises. In short, SREs operated increasingly based on market considerations as the economic space delineated by the central authority shrank.

In response to the increased autonomy over their operations, SREs began to shift their strategy from one of passive adjustment to active pursuit of revenue and profit. As mentioned previously, the SREs did not constitute a homogenous group. Depending on their strategic importance to national and industrial development, some SREs enjoyed more privileges than others. These favoured SREs, besides having greater access to supply of inputs, also were the first to be aware of emerging opportunities which include new projects that would make them the showcase within the state sector and their industries. For the officials in the supervising state agencies, the success of these showcase enterprises became important milestones that would help to advance their careers.

The shifting of authority from the central authority to the local government however did not result in diminished government’s influence in the running of the SREs. Instead, the interference now came from the local officials and the supervising agencies that had been empowered by the decentralization move. This resulted in the formation of a political market parallel to the exchange market where goods and services were transacted. In the political market, state agents (i.e. the local government and the supervising agencies of the enterprises) peddled their power to influence outcome of transactions in the exchange market. The increased marketization in the market for products and factors, therefore, did not preclude the working of the political market. For example, the contract responsibility system offered an avenue for enterprises to exercise their strong lobbying strength within the authority relations to negotiate for more favourable terms such as the level of profit retention and retention and use of foreign exchange. Some enterprises, for example, bargained successfully for reduced income tax rate or gained the right to import and export directly without having to go through state foreign trade agencies (Lin 2001). In short, even with the use of marketization tools such as contract responsibility system, the indelible influence of the central control through the state agents was still visibly present. The particularistic actions of the state agents, motivated by individual or collusive group gains, had a direct impact on the wellbeing of the state enterprises. The more progressive SREs began to lobby for changes that would help to consolidate their leading positions within the state sector.

Gradually, some SRE shifted from slack to market strategy by seeking growth opportunities to make profit outside the plan. One example was for some to bargain to be the first to adopt new reform measures or policies on areas such as capital use, output contract and labour practice. Doing so gave these enterprises the exclusive rights to moving ahead of the other state enterprises, thereby granting them a competitive advantage over their peer enterprises. Naturally, large and strategically important state enterprises tend to have an initial edge in receiving such ad hoc favourable treatment from their supervising agencies. The latter had a greater vested interest in seeing their star enterprises, rather than other lower profile subordinate enterprises, perform better.

However, for the strategy to work for the star enterprises, a lot of work had to go into maintaining high visibility to the leaders of the state agents who could then use them as showcase to higher level authorities and thereby securing and advancing their own careers. Therefore, besides making sure that the new policies actually produce positive results, it was important that the good results were publicized. Special attention had to be paid to public relations and good relationship must be maintained with official media and the party propaganda agencies. Most importantly, the top city leaders must be frequently invited to inspect the factory so that they could take credit for the good work (Lin 2001; Pg. 177).

However, as the successfully tested policies were introduced to other state enterprises, the edge that the favoured and pioneering state enterprise enjoyed would eventually by narrowed. So the situation was never static and the advantage gained would likely to be short-lived. The favoured state enterprises had to be constantly on the look out for new areas of reform in order to keep ahead.[iii] In this way, institutional changes took place constantly and good practices became more diffused over time within the state sector.

Thus, 1980s marked the beginning of the widespread endemic practices of systemic rent-seeking though collusion between state agents and state enterprises. The pursuit by state agents of private gains through favour exchange in market-oriented economic activities not only happened within the scope of the state economy but also stretched to outside the plan. Such exchange could involve the channeling of state’s physical, financial, and human resources, the ad hoc modifications or interpretation of existing regulations, and the creation of an inequitable and opaque economic opportunity structure, all of which bestowed unfair competitive advantages to enterprises within the web of collusive interests. In return for their particularistic actions, state agents secured various forms of benefits, ranging from outright monetary bribes or gifts in kinds.

According to Lin (2001), in addition to indirect rent-seeking acitivties, a large numbers of state agencies, including communist party organizations and the military also directly participated in economic activities by forming their own profit-making front organizations. In other words, these state agencies operated as both referees and player, profiting unfairly from the advantages that came with their privilege status. Many, for example, divert plan-allocated resources for arbitrage. Such diversions were detrimental to the state agencies as they deprived the state agencies and enterprises under their command precious resources that could otherwise be used for normal production as stipulated by the plans. Some of these backyard profit centers also brokered regulatory favours, resulting in distortions in market activities. Finally, there were also other state agencies that set up businesses to compete directly and unfairly with ordinary enterprises.

Clearly, from the above description, state enterprises acquired unfair advantages either because of their own privilege status or because of accessibility to an avenue through which special privileges could be brokered with other state agencies. Howwever, besides working to fortify their relationship within the state sector through the state agents, many SREs also began to seek symbiotic relationships with non-state enterprises. The emergence of non-state enterprises was not all bad news to the state enterprises. Firstly, SREs and collectives, with the license to important raw materials, could bring in more than what they needed and sell the excess to factories that could not obtain enough supply from state allocation or from private enterprises that received no state allocation. This form of arbitrage (倒卖) became a sideline for privileged enterprises to make quick profit outside their normal operations. Secondly, the lower cost structure and higher efficiency of the non-state firms provided opportunities for state enterprises to find ways to work with the former for mutual benefits. For example, by subcontracting part of the operations to the private enterprises, SREs could lower their costs and thus enjoyed a higher profit margin. For the newly setup private enterprises, subcontracting provided them not only guaranteed sales but also technical support and a steady supply of raw materials needed for the productions. Such arrangements help to deepen the marketization of the economy and were healthy development of the industry as a whole.

But for SREs that were too slow in adapting to the new environment or lacked the long term strategic vision of a new horizon, the consequence was catastrophic. Through various forms of working with the SREs, many private enterprises acquired the necessary technical skills and managerial expertise and began to produce products that competed with SREs. A case in point is the aforementioned SRE manufacturing Shuanxi pressure cookers which was eventually overtaken in the market by its once contract manufacturer Suboer (Wu, 2007).[iv] By the end of 1980s, many SREs have regained their competitive edge while many others became victims of the increasingly crowded and competitive landscape and fell by the wayside.

The following pertinent points can be noted from the above discussion about SREs’ development in the 1980s. Firstly, SREs did not constitute a homogenous group. Some SREs were strategically more important and were under the direct control of the central governments. Other SREs, on the other hand, fell under the charge of local governments or state agencies.

Secondly, with the advent of fiscal and administrative decentralization power became more diffused among the various hierarchical levels of the state apparatus. This led to the emergence of distributed power centres. In other words, the post-Mao era has seen a shift of the locus of state actions from centralized institutional authority to decentralized bases of power. The function of these power bases could be explained by what some called local developmental state thesis (Lin 2001). Except for SREs in selected key industries that still remained firmly within the control of the state, the responsibility of the remaining SREs were delegated to local government which now had been given the autonomy to promote economic growth based on local conditions as well as endowment of resources. On one hand, fiscal decentralization by the central government led to shortfalls in public finance at the local levels. On the other, administrative decentralization accorded local governments with increased decision-making power to regulate local economic activities and allocate public resources. To redress their dire financial position caused by falling state handouts, local governments sought to increase their revenue by promoting economic growth to expand their local tax revenue base. Many began to introduce pro-market policies regulating economic activities that fell within their jurisdiction.

The absence of a strong and well-established central regulatory body led to the emergence of diverse sets of local rules and regulations in place of a common set once stipulated by the central authority and strictly adhered to by all state agents in the past. The differences in rules now provided room for ad hoc interpretations of regulations and for particularistic actions by different local governments in ways favouring firms that they supported. At the same time, as local official’s financial and career rewards became more tied to the growth of local government revenue, competitions between regional governments for market and resources grew. There were increasing incentives for local governments to support growth of selected local enterprises under their purview.

Hence, the development of the product market does not preclude the emergence of the political market that worked in parallel to the former. Even though concrete markets for products and factors have emerged, they often failed to behave in an equitable manner because of undue influences arising from particularistic state actions. The existence of the political market provided SREs with an avenue to win favours from state actors whose particularistic actions could provide them with a competitive edge over the other SREs. These particularistic actions came in the form of ad hoc redistribution of rights or opportunities and increased allocation of precious resources.  For the SREs, therefore, their fortunes depended immensely on their ability to gain such favours. In response, many large and strategically important SREs began to adopt a strategy of actively pursuing market growth especially through seeking particularistic actions from their supervising agencies or the local government. This strategy gave them first-mover competitive advantages over their peers and helped them to maintain their leadership positions within the state sector.

Next, as competition from the emerging non-state enterprises became more intensified and as reforms deepened and SREs gained more autonomy, many SREs began to adapt to the new competitive landscape by seeking to work with the non-state enterprises. This collaboration could simply involve re-selling (i.e. arbitraging) the state-allocated resources for a quick profit to the private enterprises which had no access to such resources. Alternatively, SREs also used the non-state enterprises as subcontractor to help to lower their cost of production and raise the profit margin.

Finally, the increase in autonomy also provided opportunity for leaders of enterprises to work for personal gains, especially in collusion with corrupt state actors who could provide legal justifications to their otherwise illicit acts.

Finally, despite the increase in autonomy, the financial rewards of enterprise leaders were not tied to the level of efficiency of their enterprises. This weakened the incentive for intensive efforts aimed at improving enterprise performance. At the same time, the increase in autonomy also provided opportunity for leaders of enterprises to work for personal gains, especially in collusion with corrupt state actors who could provide legal justifications to their otherwise illicit acts. Many enterprise leaders also resorted to turning state assets to personal assets (Lin 2001, Pg 172) through various means. Corruption was no more restricted to public officials. Systemic collusion between state agents and economic actors became widespread leading to endemic corruption involving misappropriation of increasingly larger sum of money or diversion of state assets. The extensive corruption aroused widespread discontent among the public. As macroeconomic environment worsened in the late 1980s, the discontent surfaced and evolved into events of mass civil disorder in 1989.

4.2       Responses and Evolution of Non-State Enterprises

As mentioned earlier, the TVEs were collective enterprises transformed from the commune- and brigade-run enterprises when the people’s commune system was replaced by the township and village government in 1984. Since the start of the reform in 1978, however, many new collectives were also started by private entrepreneurs with the support of local governments or by the local governments themselves.

For the rural entrepreneurs, registering a new business as a collective enterprise offered several advantages. Even though China had officially embarked on its economic reform, ideologically it was still a socialist state. Operating as a collective was therefore an ideologically safer bet during the initial period of reform, especially when China was just emerging from the shadow of the tumultuous Cultural Revolution. Next, the entrepreneurs during those days had very limited means to start with. With the support of the local government which had control of critical resources and state assets, the new collective enterprises could gain access to state assets and resources such as free land, raw materials, and capital. In the assistance provided by the local government, entrepreneurs could embark on a business venture very quickly and build it up to a reasonable size even though they had very little personal resources to start with.

Of course, starting as a collective also had its price. Many rural collectives were placed under the supervision of a unified economic authority at the township or village level. Theoretically, as the representative body of the “collective”, they retained control over matters relating to investments and human resource. They managed the assets, appointed enterprise leaders, authorized major decisions, coordinated the activities of different enterprises, and collected a management fee from the enterprises. The party secretary within the enterprises could still exercise overriding authority over the founding leader. In reality, however, many collectives were very flexible in terms of organizational structure and genuinely independent in nature. In fact, throughout the 1980s, most of the supposedly collective TVEs operated as private enterprises in practice.

One high price which many entrepreneurs found they had to pay sometime further down the road, especially when the enterprise was extremely successful, was about ownership rights (产权不明确的长期隐患). Within the collective enterprise, the founding entrepreneurs, as managers, had “use rights”. The “ownership rights”, on the other hand, stayed with the collective. This fuzzy arrangement of property rights became a deeply troubling issue especially when many of the collective enterprises grew and became very successful. Even though the achievement of the enterprise could be undoubtedly attributed in no small part to the hard work and sacrifices of the founder, the ownership of the enterprise belonged legally to the township or village.

Furthermore, despite the strong support from the local government, collective enterprises were still handicapped by several factors which include shortage of input materials, lack of technological knowhow and modern machinery, shortage of skilled manpower, weak distribution network, and the absence of a recognizable brand that customers could readily identify with. Even so, the rural enterprises were unstoppable in their growth.

How were the rural entrepreneurs able to respond to the market changes so quickly and on such a massive scale, given all the aforementioned deficiencies? Many found ingenious ways of overcoming their weaknesses. For example, going without a R&D department had its advantage. Besides saving itself time and huge amount in R&D investments, it left the enterprises free to seek out available technologies that had been developed in universities and research institutes but yet to be marketized. This allowed many entrepreneurs who had absolutely no history in the production of a certain product to enter the market very quickly. Many TVEs and private enterprises sought to work with these domestic intellectual property holders based on a win-win relationship, with technical assistance and support provided by the latter.

As for the machinery, many acquired them from SREs that were poorly managed and were therefore under-utilizing their equipments. At the same time, many SREs were importing the latest and sophisticated equipments, rendering their old ones obsolete. To help the rural enterprises use the equipments, “Sunday engineers”[v] from the SREs and research institutes in the cities were engaged to provide training and consultancy during weekends. An even more direct and popular approach for the rural enterprises was to work with SREs in the form of joint ventures (lianying 联营). Under this arrangement, the latter would not only provide equipment and technical assistance at low cost. Rural enterprises would also have obtained the rights to use the established brands owned by the SREs. Some SREs went a step further by subcontracting part of the operations to the rural enterprises to lower their costs. It was a win-win situation. More importantly for the SREs, the joint ventures provided an avenue for the rural enterprises to bypass any restrictions or to gain entry into areas of businesses which were reserved only for the SREs.

In the long run, the benefits for the SREs proved to be short-lived. The rural enterprises, on the other hand, gained tremendously from their associations with the SREs. Many rural enterprises started by producing parts for the SREs and migrated eventually to being OEM manufacturers for the SREs. Over time, they learned the technology and managerial expertise good enough to eventually usurp the SREs’ dominant positions in the market. One such example is Suboer (苏泊尔) which started by producing parts in 1986 for Shuangxi (双喜), the biggest manufacturer of pressure cooker in China. A few years later, Suboer itself started producing pressure cooker which it sold under Shuangxi brand name, paying the latter a substantial amount for the use of the name. Before long, Suboer decided that it was time to wean itself from Shuangxi and started producing pressure cooker under its own name. By 1999, Suboer managed to grab most of Shuangxi’s market share, accounting for 48% of all pressure cookers sold in China. Suboer is by no means an isolated example. The mode of growth became an emulative model for many private enterprises (Wu 2007, Pp. 168).

Such was the fluidity of the environment during the early stage of economic reform and opportunities were abound for the most enterprising. Basically, the entrepreneurs ‘borrowed’ (拿来主义) all resources they needed and started with a very small amount of capital but lots of peserverance and talking. For the clueless, nothing could happen because of the rigid environment. But for those with guts, conviction, imagination, perseverance and the right connections, anything was possible.

Not all stories ended in success though. Usually, a shortage in supply of a product attracted other firms and new entrants to increase production. By then, new policies were implemented, resulting in an oversupply situation.[vi] As the market became more crowded, profitability declined and a shakeup in the industry ensued. Businesses that had over-expanded, especially those non-state enterprises which did not have the soft budgetary support of the local and central governments, fell by the wayside.

During the initial stage of reform till mid-1980s, for example, demand for polyester fiber[vii]increased substantially because of the emergence of new textile enterprises. Supply was however constricted because large polyester fiber producers were SREs still under tight planning in production, input supplies and output sales. The artificial short supply created opportunities for many other SREs that had just become more autonomous, as well as other emerging private enterprises to expand production quickly. One such firm was No. 2 Polyester Fiber Factory established as a collective in 1973 when the economy was recovering from the chaos of the initial years of the Cultural Revolution. To meet the insatiable demand, the enterprise underwent rapid expansion and increased it workforce from 800 to over 1300. The enterprise also upgraded its technology in 1989 and 1990 by importing new production lines from Italy. The expansion was fueled by interest-bearing loans from the banks. By then, however, the controls on the large state polyester fiber producers were relaxed and the market turned increasingly competitive. The situation was accentuated by the increasing saturation of demand in the textile industry and Polyester Fiber Factory began to incur heavy losses in the early 1990s. By 1995, the unprofitable enterprise was dissolved under unbearable pressure from interest payment. (Lin 2001, Pg 64)

The story of No. 2 Polyester Fiber Factory demonstrated a common phenomenon in the 1980s that could be attributed partly to changes in government policies. In many instances, inflexible policies constricted supply from state enterprises, creating an artificial shortage of supply in the market. The shortage attracted existing firms to expand and new firms to enter the market. In due course, however, policies changed and eventually market became more saturated with rapid increase in supply. Competition would eventually set in and only those with sustainable competitive advantage would survive the competitive onslaught. Such stories of cycle of artificial shortages in supply, rapid expansion of firms, increase in supply,  saturation in demand, and eventually consolidation of the industry were abound over the course of China’s three decades of economic reform.

Windows of opportunity frequently existed for only a brief moment because of the rapid pace of change in the environment during the 1980s. A window closed every time a hole in the regulatory structure was patched or when new competition emerged. More importantly, the exploitation of such opportunities required possession of privilege resources that were available to only some. It usually did not require proprietary technology or much value-add and constituted a quick way of making money for favoured enterprises. Because of the brief moment the opportunity existed and the low value-add, little investment in infrastructure, human resources or technological R&D were needed. Such opportunities provided a short term gain to the enterprise but did little to enhance its long term position in its primary area of activities. On the contrary, in the long term, it actually created more harm because attention of the management as well as precious resources, such as time and capital, had been diverted from otherwise long-term development of the company to build core strength.

To exploit these fleeting opportunities, many non-state enterprises sought to build relationship with SREs that possessed privileged resources or with government agencies that had allocation rights over such resources. Indirectly, success depended more on their ability to compete in the political market than in the product market. Also, the success of many such enterprises produced a demonstrative effect to other enterprises which also began to be on the lookout for such opportunities. As the mentality becomes more widespread and entrenched, the industry and the economy will be weakened in the long term.

Of course, the rapid changes in external environment were a crucial factor that contributed to the demise of many enterprises. But internally, the inherent defects of the non-state enterprises could be another major contributory factor. Despite the success stories about TVEs and private enterprises, many failed to build long-lasting competency. They grew quickly through opportunistic behaviours when the market was expanding rapidly. Without building export capability, they were basically producing the same type of products all destined for domestic national or localized markets. In industries where entry barriers were low, many new entrants emerged and the market became increasingly competitive. As the industry matured, price became the major competitive factor. Firms therefore expanded rapidly to reap economies of scale so that their low cost could enable them to compete based on price. However, many grew big too fast without growing strong. They lack the managerial experience and expertise in establishing systems and procedures to run the expanded operation. As their scale of operations expanded, their personal weaknesses became limiting factors for their organizations. For these private enterprises, their performance depends greatly on the qualities and abilities of the founder in recognizing their inherent weaknesses. If these weaknesses could not be overcome by improving themselves, then the solution would be to bring in professional managers to complement them in their areas of weaknesses. Unfortunately, such professional managers were a rare species in the 1980s. Hence by the late 1980s, many TVEs reached their limit and fell by the wayside, when the macroeconomic environment worsened.

From the perspective of evolutionary science, building competitive strength helps to fortify the DNA so that the enterprise can respond effectively to any adverse changes in environment. Capitalizing on such short-term opportunities, on the other hand, does little to improve the DNA of the enterprises. It only allows the company to exploit opportunities that exist in the environment using current strength of the DNA. When the environment changes or when the opportunities cease to exist, the enterprise may not be in the position to change and compete since it does not possess new skills that it otherwise could have developed had it not gone for the short-term opportunities.

Of course, in a closed environment, the impact may be less felt when all or most of the enterprises engaged in such short-term practices and disparity in performance could be explained by accessibility of privilege resources but not strength in core competency. But in an environment where external players are injected to compete with the local players, the foreign enterprises may come with core competencies that domestic enterprises do not possess. These foreign enterprises will triumph over the local enterprises in terms of market performance in their primary areas of activities because of their fundamental strengths. The same logic applies to Chinese enterprises that export their products and thus have to compete with foreign competitors. Chinese enterprises will be at a disadvantage because of their weaker organizational DNA. This probably explains why many Chinese enterprises still relies on low value add processing trade.

	State –run Enterprises	Non-State Firms
External Environment	Faced aggressive competition from the TVEs and the private enterprises. Because of existence of duplication, SREs also faced strong competition from other SREs that have become autonomous. Control from state-apparatus transferred to local government or other state supervisory agencies. Emergence of a political market in addition to a product market. Success in political markets crucial in obtaining access to limited resources or winning favours which put them ahead of other state enterprises. Success in product market therefore depended on success in political market. Ideological debates were still on-going with regards to role of SREs. By the end of the 1980s, the market became very crowded with many firms in both state and non-state sectors producing similar products for domestic markets. Barriers between regions erected by regional government to protect industries within their jurisdiction, and hence their source of revenue.	Relaxation of controls over entry of firms in most industries. Growing income led to higher demand but supply of SREs could not be adjusted rapidly. These presented the non-state sector with an opportunity to grow quickly in areas of consumer products. The local governments, which were now less encumbered by rules from the central government, provided strong support to the non-state enterprises in an effort to develop local economy in order to expand their revenue base and to gain credits for promotion. Also, as productivity in agricultural sector grew, redundant farm labour increased. To supplement their agricultural income, many chose to start a sideline business. Policies were generally favourable though ideological debates about non-state ownership pose a great concern for many non-state enterprises, prompting some to wear a ‘red cap’ in times of crisis.
Intra-Organzational Environment	Restrictive and political despite increasing autonomy given to the factory director. Power increasingly gravitated towards the top management. Compared to the TVEs, they were better organized based on established systems of operation.	Enterprises, including the community-owned TVEs, were mostly run by private entrepreneurs with relatively little interference from the state actors. Because of their smaller size, they were also structurally simpler which made them very flexible but less systematically organized. Workers were generally less-skilled.
Strengths	Still had access to resources which were not available to the TVEs and the private enterprises. These resources were available to them at state-determined prices which were lower than the market prices. Soft-budgetary support also helped them to absorb losses. They also had better quality human resources, technology and better machinery. Key industries were still out-of-bound to non-state enterprises. SREs in key industries were protected.	Flexibility and low costs made them very competitive. Besides competing on prices, many were able to customize their products based on customer’s requirements. Enterprise leaders were entrepreneurs with high drive, motivation, and initiatives. Strong support from local government provided them with the initial means to grow rapidly to a certain size.
Weakness	Rigid and inflexible. Administrative interferences from local government of supervisory agencies increased the complexity of the operations. High cost of providing to all the needs of the state employees. Dependency on state apparatus bred complacency and inertia to change. Generally, SREs were inexperienced in the running of a market-based system. Lack of past success Chinese business models that they could emulate.	Enterprise leaders lacked training and experience in growing an enterprise. Many were opportunists and failed to build core competency. There was also a shortage of experienced middle managers to help them run the enterprise. Since there were little funds for R&D, non-state enterprises did not possess proprietary technology. Most had to work with SREs through licensing and sub-contracting. Many, however, managed to seek out proprietary rights which were not yet marketized but owned by professors or research institutes. Machinery was generally outdated or less sophisticated than those in the SREs. Funding for expansion was hard to come by since banks were more inclined to lend to SREs.
Opportunities	Their endowment of privilege resources provided them with the opportunities to exploit short-term gains by arbitraging those resources. For SREs with progressive management, they were in a better position to build core competency and to move ahead of their competition.	Opportunities for growth were immense especially in the early phase of reform when the SREs were still slow in adjusting. Favourable conditions as a result of favourable government policies and incomplete regulatory structure also accelerated the increase in number of non-state enterprises.
Threats	Inflexibility in operation made them less competitive than firms in non-state sector. Pursuit of short-term gain diverted attention and resources from building core competency which threatened their existence in a pending market shakeout. Rapid policies and environmental changes also threatened to make them obsolete and irrelevant. Corruption became more widespread and systemic as a result of collusion between the state agents and the SRE managers.	By the mid-1980s, many SREs became more autonomous and became nimbler. Markets became increasing crowded as a result of competition not only from financially stronger SREs but also many new non-state entrants. Their ambiguous statutory status in an environment that was still ideologically socialist made them vulnerable to unilateral political actions from the state. They also faced unfair competition from SREs, many of which were in a better position to work in collusion with state agents.
Strategy	Most started with a passive strategy of managing assigned resources to meet production plans. As they became more autonomous and local governments became more involved in their operation, many switch to a more active strategy of securing favours and privilege resources in order to put them ahead of their peers. Others engaged in short terms strategy of going for quick gains or working with the non-state enterprises.	To help overcome their weaknesses, many entrepreneurs started their operations as collectives to gain support from local governments. At the same time, many sought to work with SREs in order to use and learn their technology and to use the latter’s established brand names to gain immediate market recognition for their products.
Outcome	Overall, 1980s was a decade which SREs were experiencing labour pains and many were forced to reorgzanized, restructured or dissolved. Its share of gross value of industrial output declined from 77.6% in 1978 to 54.6% in 1990 (Wu 2005, p. 66).  The favoured enterprises especially those in the protected industries emerged stronger. The weaker ones became less competitive and were made redundant.	Overall, the non-state sector grew rapidly during the 1980s. Its share of gross value of industrial output increased from 22.4% in 1978 to 45.5%. (The share of collectives increased from 22.4% to 35.6% while the private enterprises and FIEs increased from none to 9.8%.)  The growth of non-state sector, however, slowed in the late 1980s because of poor macroeconomic conditions which prompted government to impose policies to slow market-based reforms. In the aftermath of the Tiananmen Incident, many also chose to wear a red-cap for survival. Despite so, 1980s was still a decade during which non-state sector experienced phenomenal growth.

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[i] This phenomenon is known as ‘ratchet’ effect. It describes the tendency for output quotas to rise during good years but not fall during bad years.

[ii] The scope of mandatory planning system in production and pricing declined from 95% of its output in 1980 to 10% in 1990.

[iii] To see more examples of such star enterprises in the state sector, read Lin (2001) Pg. 178.

[iv] This point will be discussed in-depth in the later section that explores the strategic responses of collectives and private enterprises.

[v] They could receive much higher pay than that from their regular work units. Some of them eventually quit their state jobs and joined the weekend employer permanently.

[vi] One good example is the introduction of contract responsibility system in the urban industrial sector 1984 which gave SREs more autonomy and they started producing more.

[vii] A synthetic material that can be blended with wool and cotton for sale to weaving factories.

Contents

Click the following subdirectories under “China” on the Menu bar to read the following articles:

Subdirectory : “1949 – 1978”

1.0 Economic Developments before 1979
1.1       Construction of a Society of New Democracy (1949 – 1953)
1.2       Socialist Transformation (1952 – 1958)
1.3       Anti-Rightist Campaign (1957 – 1958)
1.4       First Economic Reform & Great Leap Forward (1958 – 1963)
1.5       Lushan Meeting & Anti-Right Deviation Campaign (1959)
1.6       Corrective Measures : Recentralizing and System of Three-Level Ownership (1960)
1.7       Practice of ‘Responsibility Plots’ & Conference of Seven Thousand Cadres (1961 – 1963)
1.8       Socialist Education Campaign (1963 – 1966)
1.9       Cultural Revolution (1966 – 1976)

2.0 Comparative Analysis of Reforms During and After Mao’s Era
2.1       Problems of Central-Command System
2.2       Government’s Decentralization Drives in 1958 and 1970
2.3       From Administrative Decentralization to Economic Decentralization After 1979
2.4       Market Economy with Chinese Characteristics

Subdirectory : “1979 – 1990”

3.0 Economic Developments in the Late 1970s and the 1980s
3.1 Reforming the Agricultural Sector – Contract Responsibility System
3.2 Growth of the Rural Industrial Sector – Emergence of TVEs
3.3 Growth of the Foreign-Invested Sector in SEZs and Coastal Cities
3.4 Reforming the Urban Industrial Sector – The Languishing State Sector
3.5 Summary

4.0 Strategic Responses and Organizational Evolution of Chinese Enterprises in the 1980s
4.1 Responses and Evolution of State-run Enterprises
4.2 Responses and Evolution of Non-state Firms

To summarize, during the 1980s, the demise of the people’s commune system unlocked a tremendous burst of productive energy in the rural areas with the resultant conversions of the enterprises under the people’s commune and brigade into rural collectives. At the same time, many households also sought to increase their non-agricultural income by starting small business. The growth of non-state sector, however, slowed in the late 1980s because of poor macroeconomic conditions due to rapid fixed asset investments and high inflation. In the aftermath of the Tiananmen Incident, government imposed policies that slowed the pace of market reforms and many non-state enterprises chose to wear a red-cap for survival. Despite so, 1980s was still a decade during which non-state sector experienced phenomenal growth. Its share of gross value of industrial output increased from 22.4% in 1978 to 45.5% in 1990. The share of collectives increased from 22.4% to 35.6% while the private enterprises and FIEs increased from none to 9.8%. From Figure 3.3, it can be seen that collective enterprises grew rapidly during 1980 to 1985. After which, the growth of private businesses and foreign-invested enterprises enjoyed a higher rate of growth than the collectives.

In contrast, the 1980s was a decade of labour pains for the state sector. Many SREs were forced to reorganized, restructured or dissolved. The favoured SREs, especially those in the protected industries, emerged stronger. The weaker ones became less competitive and were made. The state-sector’s share of gross value of industrial output declined from 77.6% in 1978 to 54.6% in 1990.

Figure 3.3 : Share of Gross Value of Industrial Output

Year	1978	1980	1985	1990
State sector	77.6	76.0	64.9	54.6
Non-state sector :	22.4	24.0	35.1	45.4
Collective sector	22.4	23.5	32.1	35.6
Non-public sector*	0.0	0.5	3.0	9.8

*Non-public sector include all non-state and non-collective enterprises, such as individual businesses, private enterprises, and foreign-invested enterprises.

Source : Extracted from Wu (2005, p.66).

The dynamism of the non-state sector in the 1980s was a sharp contrast to the slow dawdling pace of economic reforms in the urban industrial sector. Reformation for SREs, which had hitherto been the mainstay and bedrock of the centrally-command Chinese economy, was sluggish. The slower pace could be attributed to several factors, some of which were legacies of the centrally-command system based on the Soviet developmental model while others could be attributed to idiosyncrasies of the Chinese leadership under Mao.

Firstly, there was higher organizational complexity involved for the urban industrial sector. After the withdrawal of the Soviet technical assistance, China embarked on its own industrialization program, though the focus remained to be heavy industry biased. In 1970, based on assessment of international environments, Mao’s anticipated the coming of another world war. To prepare for a full-scale invasion against China by a foreign enemy, the country was divided into ten cooperation regions. Within each cooperation region, every province and city was to establish an independent and integrated industrial setup that could provide for all its needs to fight the war (Wu 2005). As a result, there was lots of duplication of efforts between regions. Also, the Chinese heavy industries were moved inland and were geographically dispersed so that they would not be easy targets of aerial bombardment. Some were even located within mountainous regions and were difficult to access. All these factors contributed to inefficiency, wastage and high costs for the state. Reforming these industries therefore required a lot of rationalization, re-organizations, relocation, and even closures.

In addition to the organizational complexity involved, such actions would also tread on the deeply-entrenched vested bureaucratic interest, not to mention the millions of state employees which had depended on the SREs for all their needs thus far. Any measures of reform would certainly draw strong response or even resistance from disgruntled state agents and the hapless state employees.

Another factor which generated inefficiency could be the innate defects of the Soviet’s model of centrally-planned system. As mentioned previously, the socialist system based on equalitarian principle was fundamental flawed because of information and incentives issues which cannot be resolved by mere measures of decentralization. The futile reform efforts of Stalin, Khrushchev and Kosygin for Soviet Union stand testimonial to that fact. To introduce marketization to the state sector, all these innate defects of state enterprises need to be addressed.

Next, after three decades of running a socialist state, the central planning authority had absolutely no experience of implementing and running a market-based system. The Constitution would have to be re-written to protect the rights of private enterprises and to allow the state enterprises to play a different role than was required in a socialist system. Also, there was neither a market-based regulatory structure nor institutions that could ensure the effective running of a marketplace where transactions could be conducted in a fair and just manner and information could flow efficiently and unabridged. There was no capital market, for example, where enterprises could raise funds. The banking system was comprised solely of state banks functioning as policy instruments. They acted more like money banks for the state and funds were being distributed to enterprises through these state banks based on allocation priority rather than on risk and profit considerations. Reforming the state sector therefore requires a fundamental transformation of roles of not only the central planning authority but the entire state apparatus which include all the supervising agencies and local governments at every level.

There was another ideological perspective to the economic reform. The implementation of marketization required a radical change of mindset not only of the leaders and policy makers but also all the state agents. This change would have to reach the root of their political belief and question their very fundamental socialist ideological conviction that the sole base of economic development must always be the state. The proposed changes involved not merely decentralization but also introduction of market elements that would conflict against the very foundation of socialism and result in an increasingly diminished role of the state in the industrialization process. For the first generation leaders who had fought the Nationalists, Japanese and even the Americans (in the Korean War), the change in mentality questioned their very fundamental core beliefs. They have fought a lifetime with the conviction that socialism was the only way that China could be made powerful and the humiliation of being a semi-colony to the foreign imperialists would never be repeated. It was easy for Deng, the chief architect of the reform, to accept the change because he had been a pragmatist in economic development all along despite his strong conviction in socialism. However, for many hard-core communist party leaders to discard their lifelong convictions and beliefs, the ideological struggles must be understandably grueling. Even though they accepted the need for change, they questioned the radical nature and the pace of the reforms. There was also a very genuine fear among the conservatives that any changes to the socialist system would undermine the very root of legitimacy of the communist rule. Such fear was amplified with the eventual collapse and disintegration of Soviet Union. This again added another dimension of complexity to the reformation of the state sector. Indeed, during the course of the reforms over the ensuing decades, the conservative statesmen and theorists remained a powerful opposing force that threatened to slow down, derail, and even reverse the reforms especially at times of national crisis.

Finally, down at the enterprise level, the task of reformation was equally daunting. The entire organizational structure of the enterprise had been oriented towards the fulfillment of quotas set by the SPC. Input materials were allocated, so were the investment and working capital, as well as the human resources needed. Enterprise leaders’ roles were reduced to ensuring that quotas were met and decisions made were mainly short-term operational and tactical in nature, never long-term or strategic. Since resources input and products output were allocated and distributed by the state at state-determined prices, there was no surplus value that the enterprise could retain for investment. To ensure that all enterprises conduct their activities according to the official party lines, every enterprise was planted with a party secretary whose authority reigned above that of the enterprise leader. Ideological indoctrination sessions were regularly conducted for all employees. Promotions were based on political and ideological correctness rather than on merits. Financial rewards were shunned and deemed political incorrect. There were therefore little incentives for workers to work a little harder since all received comparable pay. More importantly, the need to look after every social and economical need of all its employees laden every state enterprise with an exceptionally high cost structure that was unrealistic of a business enterprise. Enterprise had not been exposed to the vagaries of market forces and had neither the experience nor mechanism for analyzing problems and forming decisions based on market considerations.

The combination of the aforementioned factors contributed to a higher perceived risk and difficulty for reformation. Hence, even though industrial reform was initiated in 1978, programs introduced before 1984 were mainly pilot measures for testing at selected factories and limited localities. Nevertheless, these pilot measures did pave the way for full-scale reform to start in the industrial sector in 1984.

In fact, discussions about the reform started in 1976 after the end of the Cultural Revolution. At that point in time, the central theme of the urban industrial reform was receding state control over the SREs through progressively granting autonomy to the enterprises, as purported by Sun Yefang’s view. The line of thinking was therefore still an extension of administrative decentralization to the enterprises. In October 1978, for example, Sichuan Province initiated a program of delegating power and sharing profit with six selected enterprises. The experiment was later extended to one hundred SREs. In July 1979, all local governments and central departments were encouraged to conduct similar experiments with selected enterprises. The number of experimental enterprises increased to 4,200 by the end of 1979 and 6,600[i] by 1980.

However, the reform soon ran into problems. Due to a lack of experience, the growth targets of industry were set too high. In order to achieve those targets, there were excessive investment in fixed assets which in turn led to soaring aggregate demand and fiscal deficits. Unsurprisingly, economic disorder ensued once again. These problems were indeed manifestations of an old malaise that had plagued the socialist’s centrally-controlled system all along. The root cause was an absence of a market within which the partially autonomous SREs could compete. At the same time, the centrally-controlled administrative pricing system failed to reflect the scarcity of commodity, leading again to inefficient allocation of resources. In short, there was an absence of a market system within which enterprises could make decisions based on stimulus of market forces instead of on centrally-planned administrative guidance.

By early 1980, debates on the fundamental direction of the reform for the socialist state arose between reformists and conservatives. While the reformists advocated deepening market-oriented reforms, the conservatives fought to maintain the dominance of the planned economy. The ideological tussle ended with the conservative statesmen and theorists emerging as the victors. It was decided that the planned economy would remain as the mainstay while market sector took a supplementary role. Leaders headed by Deng decided to shift the focus of the reform from the urban state sector to the rural non-state sector, culminating in the aforementioned phenomenal growth of TVEs in the 1980s. During this period, the rural non-state sector, comprising of market-oriented enterprises, and the joint ventures between foreign investors and the SREs in the SEZs became the main drivers of economic growth. Meanwhile, growth in the urban state-sector languished.

Despite the focus on the non-state rural sector and the foreign sector, however, experiments with several industrial and commercial enterprises in the urban state sector continued. Measures to lay the groundwork for increased marketization and modernization of the urban industrial sector were progressively introduced. In 1980, a measure called “substitution of loans for fiscal appropriations” (拨改贷 bo gai dai) was introduced. The measure dictated the turning of fixed asset investment in state and urban collective enterprises into bank loans. In 1983, the central government followed with a decision to make state banks the main source of supply and supervision of SRE’s working capital, thus diminishing the state’s role in fiscal allocation to the SREs. The banking system itself underwent a fundamental role change in the ensuing years. Instead of functioning as a sheer policy instrument, it was decided that banks need to be profit-making too. In line with the change, interest rates were raised to reflect the true cost of capital. In the mid-1980s, the introduction of bank branch director responsibility system tied the rewards for bank branch officials been tied to the performance of their lending activities (Zhang Yichun 1994; Zhao Haikuan 1993). In tandem with the change, the local branch had also been given more autonomy in determining the recipient, amount, and duration of loans. Interest rates adjustments were also allowed within or even beyond a centrally authorized 20-30% range above the official rates. All these changes in the banking system had a direct impact on the SREs which now had to assume loans on their balance sheets and pay interest for their funding needs.

In 1983, another measure called the ‘tax for profit scheme’ (利改税 li gai shui)was introduced. Instead of handing over profit, state enterprises paid taxes at a rate that was negotiated between the enterprise and its supervising agency. As an incentive to increase productivity, enterprises had discretion over the use of surplus funds.

Meanwhile, in October 1984, against the success of the reforms in the rural sectors, the landmark “CCCPC Resolution on Economic System Reform” (中共中央关于经济体制改革的决定) was adopted at the Third Plenum of the Twelfth CCCPC (十二三中全会). The resolution called for an expansion of the reform from the rural to the urban sector. The reform of urban industrial enterprises (i.e. SREs and urban collectives) was placed at the center of Party work. At the same time, the resolution also proposed three measures towards the development of a socialist commodity economy. Firstly, it asserted that price system reform was the key to the success of the reform of the economic system. Adjustments must be made to the price system to reflect changes in social labour productivity and relations between supply and demand. Next, there should be separation of government administration from enterprise management to improve the vitality of enterprises. Finally, the economic system should accommodate the active development of diverse economic forms and business modes (Wu 2005).

After that meeting, reform was fully unfolded in the urban industrial sector. With the successful experiences in the rural sector, the contract responsibility system and the dual price system were now introduced to reform the urban sector. In 1985, the “factory director responsibility system” (厂长责任制 changzhang zeren zhi), was implemented to give more autonomy to the managers and to tie rewards of the employees and managers to the performance of their enterprises. By the end of 1988, the system was adopted by 95% of state enterprises (RMRB, January 5, 1999). Both the responsibility system and the dual-track price system mirrored similar earlier developments in the agricultural sector and were aimed at providing incentives to raise productivity.

As for price system reform, administrative control had already started to ease progressively since 1981 over pricing of both consumer and capital goods. Control of pricing and sales of consumer goods, for example, were relaxed in 1981 and removed by 1983. In 1984, pricing for extra-plan output of capital goods was first capped at no more than 20% higher than the state-determined prices. That restriction was removed in 1985, effectively resulting in the creation of the “dual-track price system” comprising of a state-set price for the amount of capital goods produced according to the state-plan and a market-determined price for the extra-plan output.

The implementation of dual-track pricing was important not only for the SREs. They were also instrumental in driving the growth of the non-state sector. During the early phase of reform, allocation of inputs and distribution of outputs for the state-sector were still tightly controlled. By allowing the SREs to sell their off-plan output at market price, an avenue was provided for non-state enterprises to obtain materials from the open market. In other words, the dual-track system created an alternative distribution system to the state allocation system. Without such a system, non-state enterprises would face great difficulty in sourcing for materials. Despite the instrumental role it played in driving growth of the non-state sector, critics argued that the dual-track pricing system bred corruption by encouraging people with connections to pursue rent-seeking activities, thus hindering the healthy development of marketization reforms. In addition, such corrupt activities by a small group of privileged people could elicit public resentment that could in turn lead to social unrest. Finally, another criticism of the dual-track system was that it created an operating environment that was inequitable to the non-state enterprises which had to pay market prices for the materials while SREs paid only the subsidized state-determined price.

Another critical area of change around this time involved the antiquated and previously sacred practice of ‘iron-rice bowl’ for workers in the state enterprises. In September 1986, the State Department issued changes pertaining to labour law. Among other things, these changes allow state enterprises to conduct open recruitment of new employees based on merits. More importantly, these new employees could be offered to work based on contract that do not provide the same forms of lush benefits as the tenured workers. The changes also gave state enterprises the rights to dismiss employees. Historically, the majority of the laborers in state enterprises employed before the start of the reform have been tenured workers (固定工 guding gong). They are supplemented with contract workers (合同工 hetong gong) and temporary workers (临时工 linshi gong) employed during the reform. Prior to the reform, dismissal of employees was virtually unheard of. The new changes ameliorated the deteriorating financial conditions of the state enterprises by allowing them not only to employ the best workers from the open market at lower costs. They also permitted the state enterprises to shed deadweight by dismissing non-performing or redundant employees. Furthermore, according to He Guang (1990), some of those employed before the reform as tenured workers were turned into contract workers. All these measures therefore directly helped to raise the competitiveness of state enterprises by lowering their labour cost which constituted a major part of their expenses. This is a big boost to many ailing state enterprises in the face of rising competition from the nimbler private enterprises which were not burdened with the heavy social burden of providing a social safety net for their contract workers.

To implement the reforms stipulated in the “CCCPC Resolution on Economic System Reform”, a proposal for the Seventh Five-Year Plan (1986 – 1990) was drawn up and approved at the National Conference of the CPC in 1985. The idea was to establish the dominance of the new system in 1987 and 1988 by establishing the market system and to practice indirect control to enable enterprises to really assume full responsibility for profits and losses and to compete on a more or less equal footing. This was to be achieved by focusing on a coordinated reform over price, taxation, and fiscal systems according to a plan drawn up by the new Economic System Reform Program Design Office set up in April 1986. The new office drew up various programs to be implemented during the early phase of the Seventh Five-Year Plan, focusing on price, taxation, government finance, banking, and foreign trade. The programs were approved by the State Council in August 1986.

Around this period, in mid-1980s, however, a debate on the reform strategy emerged between two camps, one arguing for focusing on enterprise reform and another on overall and coordinated reform. In the former camp, there was a prevailing view that because China’s economy was in a stage of disequilibrium, price reform would produce only limited effect. A better option would therefore be to focus on ownership reform first, and then build on its success to carry out market reform.  Hence, ownership reform should precede market reform. This viewpoint was not shared by economists in the overall coordinated reform camp. Their qualm was that because the dual-track system was an internally conflicting system, its continued existence would lead to economic disorder. The solution was therefore to tackle the root of the dual-track system which was the state’s resource allocation system whose inherent defects in information and incentive mechanism led to inefficient allocation of resources. As long as the root cause of market inefficiency was not addressed, any ownership reform would be doomed to failures. Therefore, the resolution was to create a market system so that allocation of resources could be carried out based on interaction of market forces. The market system would comprise three integral parts: enterprises with full management authority and full responsibility for profits and losses, a competitive market system, and a macro-economic control system that would allow regulation to be carried out through the market. Since these three parts were interconnected, reforms needed to be carried out simultaneously in a coordinated way.

In October 1986, Zhao changed his mind about the coordinated programs and instead chose to focus on the reform of the SREs. In 1987 and 1988, he implemented the “five contracting/responsibility systems“, namely, the enterprise contracting system, the department contracting system, the all-round fiscal responsibility system, the all-round foreign trade responsibility system, and the responsibility system of credit quota by region.

Despite the reform to give SREs more autonomy over their operations, they increasingly began to feel the heat of competition from the rural enterprises which were seeping into the cities, in search of a wider market. They were still ill-prepared for the mounting competition coming from the non-state sector. In fact, it was the sluggishness of reform and change within the state sector that presented a window of opportunity for the rapid expansion of the rural industrial sector.

Up till 1985, because of the rigidity of policies in the state enterprise system, supply of goods could not increase quickly to meet the growing demands for consumer and capital goods. The emphasis of the state-sector on heavy industries during the pre-reform years meant that supply of consumer goods could not be increased quickly. As a result, there were immense growth opportunities for non-state enterprises.

Also, the negative effects of the sluggish reform of the state sector and the coexistence of the two tracks began to surface in the late 1980s. Financial conditions of SOEs started to deteriorate. Despite reform measures to give SREs more autonomy in their operations, efficiency improvement was limited and output growth was supported mainly by vast input of resources. The implementation of power-delegating and profit-sharing was not accompanied by establishment of effective control measures, leading to insider control and softening of budget constraints over the SOEs. The poor financial performance of the SOEs also contributed to a persistently huge fiscal deficit which in turn created inflationary pressure. While fiscal revenue collected from the SOEs stagnated, fiscal expenditure rose. Furthermore, the coexistent of the state and non-state sectors made macroeconomic control of the economy tedious and complex. Monetary authorities, for example, found it hard to achieve monetary policy goals in order to maintain macroeconomic stability. Inflation hit 9.3% in 1985 when GDP growth exceeded two figures, then recovered in 1986 and 1987 before rising rapidly to an alarming 18.8% in 1988 and 18.0% in 1989. (See Table 3.7)

Table 3.7 : GDP Growth and Inflation Rate 1978 – 1990

Year	GDP Growth (%)	Inflation (CPI) (%)
1978	11.7	0.7
1979	7.6	1.9
1980	7.8	7.5
1981	5.2	2.5
1982	9.1	2.0
1983	10.9	2.0
1984	15.2	2.7
1985	13.5	9.3
1986	8.8	6.5
1987	11.6	7.3
1988	11.3	18.8
1989	4.1	18.0
1990	3.8	3.1

In short, in the second half of 1980s, the decision to adopt deepening enterprises reform over overall coordinated reform resulted in the loss of the opportunity to correct market inefficiency at its roots. Intense conflicts between the invigorated non-state sector and the sluggish state sector occurred. The failure to switch to overall coordinated reform resulted in economic disorder, exemplified by the astonishing high inflation rate in the late 1980s which in turn led to the political disturbances of 1989 known as the June Fourth Tiananmen Incident. In the aftermath, there was a resurgence of conservative thinking which put the blame of the national crisis squarely on market-reforms.

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[i] These 6,600 enterprises accounted for 60% of the national budgeted industrial output. (Wu 2005, p. 60)

While domestic reforms were set in motion, Chinese policymakers also recognized that, given China’s limited internal resources, it had little choice but to open up itself to attract foreign capital, technological knowhow and export linkages. It also needed managerial expertise to help run the new system based on market considerations. In return, China offered two things of value to foreign businesses: its abundant supply of low cost labour and the largest remaining untapped consumer market in the world. So, in addition to its focus on the rural sector during the initial phase of domestic economic reforms, China also took major steps in opening its door to the world for external help to reform its antiquated economic system. Two key elements in Chinese strategy on the foreign sector were the relentless drive to attract foreign direct investment and the fervent pursuit of export-led growth. It was a strategy that China had decided on after a careful study of the successful experiences of Japan and the Asian newly industrializing economies (NIEs) namely, Korea, Taiwan, Hong Kong, and Singapore.

Between 1949 and 1979, China adopted an import-substitution strategy which was in line with the political objective of enabling the country to be self-sufficient. During this phase, FDI was prohibited. The import-substitution strategy, however, put in place a relatively complete industrial base and a large number of trained engineers and skilled workers which, together with the low wages, collectively made China an ideal base for low-cost production.

The opening of China to FDI started in 1979 with the setting up of four coastal “special economic zones” (SEZs) namely, Zhuhai, Guangzhou, Shenzeng and Xiamen in southern China as experiments. A new Law on Chinese-Foreign Equity Joint Ventures was passed in 1979 to provide a basic framework under which foreign firms were allowed to operate. Restrictions on external debt and equity finance were relaxed, and controls on foreign trade were reduced.

To contain the influence of foreign investment, these zones were located outside the state’s industrial centers. Their natural advantages such as convenience for shipping also made them obvious choices. But a more important reason for their choice was their proximity with Hong Kong, Macau, Taiwan, and even Southeast Asia, all of which had a large population of successful Chinese businessmen who were prepared to give a hand by investing in their motherland while taking advantage of the abundance supply of low-cost labour. This explains why FDI in the 1980s had been overwhelmingly dominated by Hong Kong and Taiwan-based investors who shifted their assembly plants to the SEZs for export processing. These experiments in attracting FDI were determined to be largely successful and in 1984, fourteen additional areas known as “open coastal cities” were established to speed up the inflow of FDI.

The next major regulatory change in FDI came in 1986. With the change, FIEs could enjoy reduced business income tax rates regardless of location, and were given more managerial autonomy. Tight controls on the remittance of profit in foreign currencies were lifted. Another important aspect of the change is that FDI in two designated categories were eligible for additional special benefits. These two categories were “export-oriented” projects (defined as projects exporting 50% or more of their production value) and “technologically-advanced” projects (defined as projects which upgrade domestic production capacity through the use of ‘advanced’ technology).

The second element of China’s foreign sector strategy is trade, or in particular, exports. Trade has always been a very important component of China’s economic strategies since its opening. FDI helped to create jobs but because of limited purchasing power of its people, China had to pursue an export-led strategy instead of an import-substitution one. As such, China had to open up itself for trade in order to accommodate for more FDI inflows. At the same time, by exporting more than importing, trade allowed China to earn and accumulate much-needed foreign exchange reserves. FDI and trade therefore became the twin engines that propelled China to become a dynamic production base and an export powerhouse that we see today.

During the initial phase of reforms, Chinese policymakers were inexperienced with issues relating to an export-led economy due to the autarkic economic policies adopted before the start of the reform. To experiment with the economic reform, they initially limited trading through the four SEZs and later the fourteen “open coastal cities”. Trading could be conducted only through national trading agencies and there was strict control of foreign exchange. It was only in January 1999 that trading was liberalized and the first batch of twenty private enterprises was free to conduct its exports and imports.

Because of its lack of technology during the early phase of reforms, China started by focusing on processing trade.^[i] To spur growth, China’s processing trade policies were made very favourable. Tariff and value–added tax were exempted from imports and exports in processing trade, helping to boost such exports tremendously. FIEs made up an overwhelmingly large proportion of the companies involved in processing trade.

As a result of foreign investments in processing trade, the ratio of total trade to GNP rose from 9.9 in 1978 to 31.9 in 1990 (See Table 3.6). The high ratio shows the increasing importance of trade to the Chinese economy. At the initial years of the reform, ratio of import to GNP was higher than the export to GNP. However, by 1990, ratio of total exports to GNP exceeded the ratio of imports to GNP, indicating that China’s external trade had turned from a deficit to a surplus.

Table 3.6 : Ratio of Trade to GNP

Year	1978	1985	1990
Ratio of total exports and imports to GNP	9.9	24.2	31.9
Ratio of total imports to GNP	5.2	14.7	14.8
Ratio of total exports to GNP	4.7	9.5	17.1

Source : The National Bureau of Statistics, China Statistical Yearbooks (中国统计年鉴 zhongguo tongji nianjian) Beijing: China Statistics Press, various years.

Overall, FDI and trade brought many more benefits, some of which helped to speed up domestic economic reforms. Although processing trade typically yields narrow margins because of its low value-add, it did, during the early phase of Chinese reform, provided jobs and the much needed impetus for economic development to take off.  In addition, by participation in international market, business managers were exposed to good business practices and were forced to improve in order to compete. Since more flexibility was needed to survive the competition, Chinese enterprises involved were given more autonomy in the management of their operations. Next, to reflect the price structure of imports and exports, the domestic price reform was accelerated to bring it closer to international norm. Finally, it was hoped that as the processing trade developed, more and more FIEs would transfer their processing activities with higher technology level and value-add content to China, bringing about technology and management spillover effects for Chinese companies.

In the 80s, with the pace of globalization picking up, a unique opportunity emerged for China to integrate itself into the world trading system. To start with, China was a founding member of the GATT when it went into effect in 1948. It withdrew from GATT in 1950 as part of the strategy of economic autarky. In 1986, China decided to rejoin the world trading system by applying to resume its membership. In November 1991, China joined the APEC group which promoted cooperation in economic, trade, investment, and technology issues.

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[i] There are two kinds of processing trade: processing with imported materials (PTI) and processing trade with materials supplied by clients (PTS). PTI pattern involves domestic enterprises importing intermediate materials themselves and then exporting the finished products after processing and assembling. PTS pattern involve FIEs providing domestic enterprises with intermediate materials and paying them processing fees for the work done.

With the decreasing role central planning played in the rural economy, the people’s commune system was eventually replaced in 1984 by township and village governments. At the same time, the commune and brigade enterprises[i] under the commune system were converted into rural collectives managed by the local governments. However, since the SREs were the mainstay of the national economy, collectives’ economic contribution was considered relatively marginal. In 1978, the total value of fixed assets of the collective sector in rural China was RMB 72 billion. This amounted to less than RMB 240 per laborer and was equivalent to merely 2.56% of RMB 9,400, the average value of fixed assets per laborer of state-owned industry (Wu 2005, p. 117). Despite their humble beginning, these collectives, also known as township and village enterprises (TVEs), grew rapidly and became the most vibrant part of the Chinese economy since the start of the reform. In 1980, there were 1.4 million TVEs with 30 million employees (Huang 2008). By the end of 1986, there were 15.1 million rural collectives employing 80 million workers and contributing 17 billion yuan in tax revenue to the government. In total, these enterprises accounted for about 20% of China’s GDP (Wu 2007, Pp 162). Their phenomenal growth was, in Deng’s words, ‘by no means anticipated’, by the policy makers (Deng 1993, P. 238).

Besides the rural collectives, rural private enterprises also began to grow quickly in number. With the successful implementation of the contract responsibility system and the resultant growth in productivity in the agricultural sector, a large number of farmers became redundant. Many started sideline self-employed businesses to supplement their agricultural income. Due to government’s ambiguous position towards private businesses at that time, these activities were often carried out cautiously and in ways that were acceptable to local policies and conditions. The Constitution of the People’s Republic of China adopted in December 1982 explicitly mentioned individual business sector as a supplement to the socialist public sectors but left out private enterprises totally.[ii] The atmosphere in early 1980s was therefore at best accommodative towards the private sector. In 1983, some conservative statesmen and theorists questioned the growing signs of capitalism and demanded a crackdown. Deng, however, chose to adopt a policy of ‘no argument’ and exhorted officials to ‘try bold experiments and blaze new trails’. Discussions were therefore held off for three years, during which the private sector continued to develop rapidly. Unlike the conservatives statesmen and theorists, local officials were protective and supportive of private economic activities for practical reasons. Nevertheless, to be politically ‘safe’ and to gain support from local governments, many entrepreneurs affiliated their businesses to collective enterprises or state-owned enterprises to become “red cap enterprises”, even though in reality, they were privately managed by the entrepreneurs. This partly explains why the number of TVEs grew so rapidly in the 1980s. In ‘normal’ circumstances, many of these TVEs could have been just private enterprises.

It was not until 1987 that a policy of actively encouraging the growth of the private sector was officially adopted at the 13^th National Congress of the CPC. In 1988, an amendment to the Constitution was passed to officially recognize the private sector as a supplement to the socialist public sectors. Policy makers also began to adjust the ownership policies in order to accommodate the development of larger-scale and higher-level non-state enterprises.

Private business growth was also encouraged in the cities, especially in the form of self-employment. A large number of educated urban youth (知青 zhiqing) who were sent to work in the rural areas during the Cultural Revolution years were returning to the cities and faced unemployment.  In response, an August 1980 circular of the CCCPC on Labor and Employment declared that “the development of the urban individual business sector should be encouraged and fostered”. However, self-employment was more prevalent in the rural area. Data from Bureau of Industry and Commerce Administration revealed that rural/urban ratio of self-employed businesses increased from 1.1 in 1981 to 3.2 in 1986 and 4.5 in 1988. By 1986, for example, there were 9.2 million registered rural self-employment businesses as compared with 2.9 million urban ones.

The change was not only in terms of numbers of businesses. Before the advent of reforms, the operations of “commune and brigade enterprises were highly restricted by administrative orders known as “three-locally principle” which stipulated that they must obtain raw materials locally, process locally, and market their products locally. Their activities took place within a self-contained economy so that they would not pose as any form of competitive pressures for the urban-based state-enterprises. With the demise of the people’s commune system, the TVEs were no more laden by such restrictive policies. Many of these rural entrepreneurs conducted their business operations in urban areas, indicating easy mobility between the rural and the urban areas. In a 1991 research on urban operators, 55% of the respondents came from a rural background (Huang 2008).

Several factors contributed to the phenomenal growth of the non-state sector. The first was certainly the indispensable role played by the local governments. The latter provided overwhelming support to the new enterprises that fell within their jurisdiction for several reasons. Firstly, as a result of the administrative and fiscal decentralization, the career advancement of the officials as well as the revenue base of the local government depended heavily on the performance of local economy. The policy of fiscal decentralization also meant that local governments could keep a larger portion of the tax revenues collected from local enterprises. There were therefore strong incentives for local governments to actively support the growth of rural collectives. Secondly, it was hoped that the successful TVEs would increasingly shoulder more social responsibility of developing the towns and villages and in the process relieving some of the pressures shouldered by the central and local governments (Wu 2007).

Thirdly, the redundant labour released from the agricultural sector as a result of the success of the household responsibility system became a concern for the government. The cities were facing similar problems of redundant labour and were not in a position to accept mass influx of rural migrant workers. One solution was therefore to encourage the growth of the rural industrial sector so that the redundant peasants stayed within the rural areas. As a result these surplus rural labourers that had been released from their underemployment under the people’s commune system became an abundant supply of low-cost labour that helped to propel the development of TVEs. At the same time, many of these surplus labourers discovered their spirit of innovation and became entrepreneurs. The surplus which they accumulated from their household agricultural income became the capital that they needed to start an industrial or agricultural-related processing enterprise. Another factor that contributed to the phenomenal growth of TVEs was the increasing demand for consumer goods from the rural residents who are enjoying higher living standards because of rising income. The demand, which could not be satisfied by the urban enterprises in the state sector, became a pull factor that attracted many rural entrepreneurs to set up businesses (Wu 2005, P. 119). Finally, it was also the hope of the policymakers to let some rural entrepreneurs to grow rich first. The success stories of these entrepreneurs would serve not only to reinforce the government’s credibility in promoting economic reforms. They would also provide a very powerful demonstrative effect for others to emulate.

There were many ways the local government could help selected TVEs to develop and expand their competitive edge. These include lowering or removing entry barriers, facilitating factor supplies, relaxing or bending existing rules and regulations, offering tax reductions and exemptions, and improving local infrastructure. To give an example, since the start of the reform, borrowing for non-state enterprises like TVEs had not only become more expensive but also more difficult. In 1985, the State Council issued the borrowing contract regulation (jiekuan hetong tiaoli 借款合同条例) which stipulated that organizational borrower must show evidence of adequate self-owned funds and collateral. Failing so, a third party guarantor must be provided by the borrower. Many TVEs failed to meet this condition especially at the early stage of their development. As such, many TVEs depended on their local governments for capital needs. Local government could provide the necessary capital from the large pool of “extra-budgetary funds” that had been accumulated through levies and charges collected from business enterprises. Alternatively, many local governments became the guarantors for TVEs under their jurisdiction.[iii] In addition, many local governments also acted on behalf of their favoured firms to press for favourable borrowing terms from the state bank branches (Shang Ming 1989). Even though the administration of these branches fell within the purview of each bank, they were under the influence of the local government which control or regulate the supply of various local social services to bank agents (Chen Yuan 1994). Finally, another way local governments could help the TVEs start up was to reduce their capital need by providing free resources such free land and resources within their allocative power (Lin 2001).

Besides the support of the local government, another reason for the rapid expansion of the non-state sector in the 1980s was the bountiful opportunities that emerged as a result of success in agricultural reforms. With a rapid income growth in the rural areas, demand for consumer goods and services from the farmers also increased correspondingly. This hike in demand could not be met by the rigid centrally-planned urban economy still reeling from the after-effects of the Great Leap Forward and the political shocks of the Cultural Revolution. According to Huang (2008), in a planned economy, the urban centers were more state-owned than the rural areas. As a result, the shocks of the ideological campaigns were felt more in the urban where the SREs were located. Furthermore, the SREs were more oriented towards the production of heavy industry goods. Their rigid governance structure of the centrally-planned economy also prevented them from adjusting quickly to capture the emerging opportunities. In contrast, the non-state rural enterprises were nimbler and were less handicapped by the administrative interference from the state. The massive supply constraint of consumer goods caused by the sluggishness of the SREs therefore provided an invaluable opportunity which the rural enterprises promptly seized.

Thirdly, the affirmative actions and policies from the central government during the 1980s provided a conducive environment that helped to fuel the growth of rural entrepreneurship. With improved access to bank credits, small and impoverished rural entrepreneurs started businesses easily and could even operate their stalls in urban areas with freedom. For example, credit was readily available through rural credit cooperatives (RCCs). The increase in rural income also made available a growing pool of surplus funds for investments. In addition, many rural enterprises established in towns near the cities were also allowed to operate in the cities where the market was bigger and the residents had more purchasing power. Overall, the greater operating freedom and more liberal policies provided a conducive environment within which small-scale but broad-based market-oriented non-state enterprises thrived. As a result, the number of TVEs and private enterprises grew rapidly. The number of TVEs, for example, increased more than seven times from 1.5 million in 1978 to 12.2 million by 1985. By 1990, there were 18.5 million TVEs. The number of employees also rose rapidly from 28.2 million in 1978 to 69.7 million in 1985 and 92.6 million in 1990 (See Figure 3.1). Migration from rural areas to the cities in search of job reached a historical high in the mid-1980s because of rapid growth of the TVEs. From 1984 to 1988, TVEs absorbed an average of 12 million farmers every year to work in the non-agricultural industries.

Figure 3.1 : Number of TVEs and Their Employment (1978 – 90)

Source: Wu 2005, P.120

Typically, most TVEs in the inland regions were located in the rural areas with their employees “leaving the farmland but not the village home”. In contrast, TVEs in the coastal region were usually built near cities and towns so that they could be closer to their market. In the latter case, many of the small towns where TVEs were concentrated eventually developed into new cities (Wu 2005).

By late 1980s, rural industry contributed an increasingly larger share to the total rural output while that of agriculture declined. Between 1978 and 1988, the share of the rural industry in the gross rural output value increased 18.7% from 19.4% to 38.1% while that of the agriculture dropped 21.8% to 46.8% (See Table 3.4).

Table 3.5 : Change in Structure of the Gross Rural Output Value (%)

Sectors	1978	1988	Change
Agriculture	68.6	46.8	-21.8
Industry	19.4	38.1	18.7
Construction	6.6	7.1	0.5
Transport Services	1.7	3.5	1.8
Commerce	3.7	4.5	0.8

Source : Wu (2005, p. 116)

In addition, number of specialized household engaging in rural industry, construction, transport services and commerce increased rapidly from almost none to 25.6 million in 1984. By 1988, there were 386,900 enterprises in various ownership forms employing 3.85 million employees. These enterprises had original value of fixed assets of RMB 7.154 billion and net income of RMB 780 million.

As mentioned earlier, total rural output value of the rural economy increased four times from RMB 162.7 billion in 1978 to RMB 634 billion in 1985. During the same period, per capita net income of rural household doubled from RMB 191 to RMB 398 (Wu 2005).[iv] With higher non-agricultural income supplementing the already higher agricultural income, rural poverty declined dramatically in the 1980s. Number of rural poor declined from 250 million in 1978 to 96 million in 1988, a reduction of 154 million (Huang 2008).

Figure 3.2 : Per capita Annual Total Income and Annual Net Income of Rural Household (RMB)

Source: Wu (2005), P.116

The 1980s therefore saw the rise of rural industrialization led first by TVEs and then by private enterprises. By the mid-1980s, the economic and industrial landscape in China was teeming with enterprises of different ownership forms stratified along four lines: the privileged but rigidly-controlled SREs, the community-owned collectives or TVEs, the small but entrepreneurial private enterprises[i], and the joint ventures between foreign investors and local enterprises which usually involved a SRE or a collective.

Notably, despite the growing contribution of the non-state sector, its status did not receive official recognition until the First Plenum of the Seventh People’s Congress in 1988, when the Provisional Ordinance on Private Enterprises was adopted. [七届全国人大一次会议。会议通过了《宪法修正案》] It was determined that the non-state sector was an important supplement to the socialist public sector. Their activities would be guided, monitored and managed by state agencies and that the right of the private enterprises would be protected, for the first time since the start of economic reform, by the Chinese constitution. Law on Enterprises under Township Authorities, on the other hand, was enacted only in 1996.

The fact that market development preceded policy formulation was indication that the rapid growth of rural industrialization was not a result of premeditated and elaborate planning by the state (Huang 2008). In fact, the robust growth of the private enterprises in the non-state industrial sector was largely unanticipated. One reason for the lack of ex-ante detailed planning could be the vehement opposition from the conservative political leaders who still held on to the belief of the central role of state ownership in the development of a socialist state, not to mention the vested interests of various parties involved. Any proposition to weaken the position of the state ownership was likely to be faced with a strongly challenge.

In response, the pragmatic reformist leaders, led by Deng, adopted a tactic of gradual loosening of the traditional mentality with regard to the issue of ownership. It involved adopting a series of pragmatic and flexible broad policies to provide a conducive environment in which business opportunities could be created. It was believed that once the opportunities emerged, people would exploit them by starting businesses in ways that conforms to local rules and conditions (Wu 2005). Once growth of the non-state sector started, however, policy makers were quick to introduce ex post policy changes that fueled their growth. As mentioned, such policies included improving credit accessibility through the network of rural credit cooperatives (RCCs) and allowing private enterprises to hawk their products in the cities where the markets were bigger and the residents had higher purchasing power (Huang 2008).

The impressive growth of the non-state sector was therefore built on the peasants’ free-spirited entrepreneurism driven primarily by poverty and hardship. All that was needed for nurturing that entrepreneurism was for the government to provide a conducive environment and reduce its administrative interference. In fact, authorities even chose to overlook when rules were broken. One such rule concerned the employment of labour. Based on Marx’s assertion in The Capital, any enterprise employing more than eight workers would be considered exploitative. It was therefore decided that self-employed businesses could employ no more than eight employees.[ii] One of the earliest entrepreneurs to test this rule was Nian Guangjiu (年广九). Nian ran a self-employed enterprise (个体户getihu) selling his “Dumbo’s Melon Seeds” (傻子瓜子). When sales began to grow, Nian expanded his operation, employing eventually more than the statutorily-permitted eight employees. His case was brought up all the way to Deng’s attention. In order not to setback the government’s credibility and people’s confidence in the government’s conviction in the introduction of a market economy, Deng instructed that no action was to be taken (Wu 2007). The situation Nian faced was certainly not isolated. Many private enterprises employed more than eight employees as their operations expanded and were running foul of the laws.

The rapid growth is also evidence that the ember of free-spirited capitalism never did die-out among the less-ideologically indoctrinated peasants who were far removed from the urban centres where political campaigns raged. There was more breathing space at the rural areas and even at the height of the Cultural Revolution, the ember of capitalism remained smoldering in the rural sector. The private market of Shishi County in Fujian Province mentioned earlier was a case in point. With the right environmental conditions, the ember of capitalism simply rekindled. Chinese capitalism in the first decade of the reform was therefore heavily rural in origin, supported by favourable policy environment instituted by the central government towards the rural sector.

The good times for private enterprises, however, did not last long. By 1989, driven by high inflation and corruption, students took to the streets in Beijing demanding for reforms. The unrest elicited a strong response from the government which was growing increasing worried that the unrest would spread to other parts of the country. On June 4, military moved in to clear the Tiananmen Square where the students had amassed. In the aftermath, there was a resurgence of conservative thinking which put the blame of the national crisis squarely on market-reforms. As a result of the economic austerity measures meted out, several million TVEs were closed down or taken over by other TVEs (Zou and Sun, 1998). In contrast, despite the rising losses among SOEs, only a small handful actually went bankrupt as a result of help from a 120 billion yuan credit relief operation launched in the fourth quarter of 1989 to write off non-performing inter-enterprise credits in particular among SOEs (Portyakov, 1991).

More significantly, the unrest led to the downfall of reform-minded Chinese leader Zhao Ziyang and the rise of the Shanghai clique led by Jiang Zeming. This change in leadership eventually led to a switch in development focus from the rural to the urban areas by the mid 1990s.

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[i] The rapid growth of the rural collectives (TVEs) and private enterprises became the main drivers of Chinese economic reform. Their stellar economic performance persisted well into the mid-1990s when their inherent limitations and the changing environment began to work to their disadvantage.

[ii] At the start of the reform, private businesses were further divided into self-employed businesses (个体户 geti hu) and private enterprises (私营企业 siying qiye).

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[i] Their origin can be traced to the Great Leap Forward campaign when large numbers of rural industrial enterprises were formed to boost output growth and accelerate China’s industrialization.

[ii] There were two categories of private businesses: self-employed individual businesses (geti qiye) and private enterprises (siying qiye). The only difference between the two laid in the number of workers employed by the enterprise. A self-employed individual business could employ only fewer than eight employees. The line between the two types of private enterprises was drawn based on Marx’s assertion in The Capital that an individual business owner hiring fewer than eight workers could still be considered an individual worker because the main source of his income was still generated from his own labour.

[iii] It was not until 1995, when the Guarantee Law was enacted, that local governments were effectively banned from acting as guarantors.

[iv] This is a great improvement for the farmers when compared to the increase in net income per capita during the twenty-one years from 1957 to 1978 which went up by less than RMB 3 per year. If the increase in commodity prices was factored in, the actual annual increase per capita during that period was only RMB 1 (Wu 2005).

The crux of the agricultural reform was to release the latent productivity of the peasants from the straitjacket of the egalitarian people’s commune system through a contract responsibility system. It involved dividing land into plots which were then leased to individual household under contract. The state contracted to buy a portion of their produce at a state-determined price. The surplus of the produce could then be sold on a free market at unregulated market-determined prices, giving rise to a dual-price system in the agricultural sector.[i] As an incentive, the contracted quota was lowered and the contracted price raised. The system resolved the issues of free-riding and supervision and the surplus that each household could get provided incentives to increase production.

The practice spread quickly and by the end of 1978, the number of production teams practicing the contracting system in Anhui Province reached 1,200. In 1979, this number increased to 38,000, accounting for about 10 percent of the production teams in the province. The same zeal in adopting the contracting system also engulfed farmers in Sichuan, Guizhou, Gansu, Inner Mongolia, and Henan and the practice soon expanded to a fairly large scale.

Despite the radical nature of the HRS which directly challenged the commune system still in place, the rural-oriented reform leaders were quick to accommodate such innovations from the grassroots. In June 1979 after a visit to Fengyang County, for example, Wanli acknowledged the merits of the household responsibility system and ordered that the system be implemented throughout Anhui Province, even though the people’s commune system was still officially in force (Wu 2007).

The CCCPC, however, did not demonstrate the same enthusiasm. This was because under the leadership of Hua Guofeng, Mao’s tenet of the “Two Whatevers” still prevailed. The intricate political climate meant that only a few provincial committees of the CPC, in particular those from Sichuan and Anhui, expressively supported the contracting system. In September 1980, only three provincial Party secretaries supported the implementation of HRS (Rural Economy Research Team 1998). It was only in the autumn of 1980 that the HRS was implemented on a large scale in rural China. In August 1980, at a meeting of the Political Bureau of the CCCPC, Hua Guofeng was criticized for maintaining his “Left” stance even after the Cultural Revolution and Deng Xiaoping took over control of the leadership. In September of the same year, the CCCPC issued the document Some Issues Regarding Further Strengthening and Improving the Responsibility System for Agricultural Production which expressly dictated that the responsibility system should be allowed and promoted according to local conditions. With the official position now in support of the contracting responsibility system, the practice spread rapidly. According to the 1982 No. 1 document [ii], 90% of the production teams in the villages nationwide had by then entered into some forms of contract responsibility system of production. Examples of these different forms include ‘job contracting’, ‘output-quota contracting’, and ‘responsibility contracting’.

This period also saw the dissolution of the people’s commune system which had become practically irrelevant with each household now responsible for its own production. The dissolution process started in 1979 when government administration was separated from the commune management during reform in Xiangyang Commune in Guanghan County of Sichuan Province.  By 1984, more than 99% of the people’s communes across the nation had completed the similar process, marking the end of the biggest political and social engineering program during Mao’s era. In place of the commune system were 91,000 township/town governments and 926,000 villagers’ committees that sprouted up all over the country (Wu 2005, p. 102).

Table 3.2 : National Output of Grain, Cotton, Oilseeds and Sugar Crop in 1984.

Products	Output in 1984 (mil. Tons)	Nos. of time higher than that in 1978
Grain	407.3	0.34
Cotton	6.3	1.89
Oilseeds	11.9	1.28
Sugar crop	47.8	1.01

Source : Zhu Rong (1992)

The agricultural reforms of contracting responsibility system had an immediate impact on output (See Table 3.2). Total national grain output increased by 33.6% to 407.31 million tons between 1978 and 1984. During the same period, total cotton output was 1.89 times higher, oilseeds 1.28 times higher, and sugar crop 1.01 times higher. Between 1978 and 1988, the share of cash crops increased by 6.5% while that of grain crops fell to 58.2%.

Tremendous growth was also seen in animal husbandry and fishery (See Table 3.3). In 1988, the national output of pork, beef and mutton increased by 1.56 times as compared with 1978, registering an annual growth rate of 9.9%. That was 2.75 times the average annual growth rate during the twenty-six years prior to 1978. In the same year, total output of diary products was 3.3 times while that of aquatic products was 1.26 times higher than that of 1978.

Table 3.3 : National Output of Meat, Dairy and Aquatic Products in 1988.

Products	Output in 1988 (mil. Tons)	Nos. of time higher than that in 1978	Av. Annual Growth Rate
Pork, beef & mutton	21.936	1.56	9.9%
Dairy products	4.189	3.3	15.7%
Aquatic products	10.61	1.26	8.6%

Source : Zhu Rong (1992)

The change was not only in terms of numbers. The agricultural production structure was also evolving as farmers began to diversify their activities. For example, the proportions of forestry, animal husbandry, side-line production, and fishery increased considerably. By 1988, the share of cash crops in crop cultivation was 18.4%, an increase of 6.5% over 1978 (NBS, 1989).

As a result of the rapid gains in agricultural output, the overall strength of the rural economy in China improved substantially. Total rural output value of the rural economy increased four times from RMB 162.7 billion in 1978 to RMB 634 billion in 1985.

However, consecutive years of bumper harvests soon resulted in falling prices and difficulties in selling all their harvest around 1984. To protect the farmers, government stepped in by purchasing agricultural products at protective prices. As a result, per capita net income of rural household doubled from RMB 191 in 1980 to RMB 398 in 1985 (Wu 2005). By 1990, it reached RMB 686 (See Table 3.4).

Table 3.4 : Per Capita Annual Total lncome and Annual Net lncome of Rural Households (RMB)

Year	1978	1980	1985	1990	1995	2001
Total Income	152	216	547	990	2,338	3,307
Net Income	134	191	398	686	1,578	2,366

Source : The National Bureau of Statistics, China Statistical Yearbook (Zhongguo tongji nianjian), Beijing: China Statistics Press, various years.

Besides the increase in income, farmers also began to accumulate personal assets. Before reform, they each had household property of less than RMB 500. With the advent of reform, Chinese farmers acquired three personal property in the forms of bank savings, private houses, and private means of production. In addition, they acquired land-use right which enabled them to generate and accumulate even more wealth. For those who started a business, their wealth also included assets which they acquired for the business. More importantly, farmers had regained their freedom to travel and seek employment to improve their livelihood. Many left home to work with the rapidly growing TVEs in the towns and cities. Once the surplus labour was liberated by the contract responsibility system and travelling to work in the cities was no more prohibited, migration of this surplus labour was inevitable. For the farmers, the migration provides another means of generating non-agricultural income.

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[i] The dual price system was later extended to the industrial sector.

[ii] 《全国农村工作会议纪要》（1982年中央“一号文件”）

3.0.2 Why Reforms Started with the Rural Agricultural Sector

3.0.1 Guiding Ideology, Model of Growth, Critical Events
3.0.2 Why Reforms Started with the Agricultural Sector

3.0.1 Guiding Ideology, Model of Growth, Critical Events

Table 3.1 : Guiding ideology, model of growth, critical events during the 1980s and their impacts on the evolution of organizations.

	Late 70s and 1980s
Guiding Ideology / Model of Growth	Deng Xiaoping’s Ideology – “Four Modernizations” 四个现代化 Socialism with Chinese characteristics  建设有中国特色的社会主义 Deng’s model of growth – “Crossing the river by feeling the stones” 摸着石头过河 Strategy of Incrementalism and Experimentalism
Main Events / Efforts / Initiatives	Delegation of power to the local governments Started with reform in agricultural sector. Increasing marketization Relaxation of state control over allocation of resources (land, prices, production, labour) to support increasing marketization and industrialization Explosive growth of new enterprises in non-state sector.1 Rise of rural-based entrepreneurial capitalism Weaning the SOEs off government supports. Adjustment in policies and government functions. Adoption of “CCP Central Party Committee Resolution on Economic System Reform” during the Third Plenum of the Twelfth CCCPC in 1984 and full rollout of reforms in urban industrial sector. Tiananmen Incident and change of top leadership in 1989. Rise of Shanghai clique.
Evolution of SOEs 国有企业的进化	Weaning off the governmental support in terms of resource allocation. Funding switched to bank loans instead of administrative allocation to reflect true costs of capital. Pay taxes instead of submission of profits to government. More autonomy under the responsibility system but still rigid. Political influence still predominant within enterprise with the enterprise’s party secretary having more power than the factory director. Face increasing competition from the collectives and private enterprises.
Evolution of Collectives 集体企业的进化	With the demise of people’s commune system, rural collectives emerged from the production teams and brigades. With the support of the local government, rural collectives experienced rapid growth during the 80s.
Evolution of Private Enterprises 私有企业的进化	Rapid rise of private enterprises especially from the rural sector. Driven by poverty as well as success in agricultural reform. Moved in to capitalize on the shortage of consumer goods due to inflexibility in the state sector. Policy environment generally conducive for their growth. Strong support from local government in eager pursuit of economic growth. Gained market share at the expense of state sector even though starting from positions of weaknesses.
Evolution of FIEs 外资企业的进化	Mainly from Hong Kong, Taiwan, Macau reflecting the cultural root and geographical proximity. Mostly in low value-add processing trade.
Key Regulatory Changes	Agricultural :  Household responsibility system (1978); Dual-track price system for agricultural products (1978); Demise of people commune system (1984) Industrial /  Commercial : Introduction of ‘loan for grant scheme’ (80) 2 Constitution regarding Land rights enacted (82). Labour Contract System introduced (83) “Tax for profit” scheme introduced (83) 3 Price control and sales of consumer goods lifted (83) Industrial reform in cities fully unfolded (84) 4 Factory Director Responsibility System (85) Dual Track Price System for Capital Goods (85) Trial for shareholding system began (86) Dual exchange rate system adopted (86) 5 Provisional Ordinance on Private Enterprises adopted (88) 6 Foreign Sector Setting up of 4 SEZ in southern coastal cities. (80) Opening up of 14 coastal cities (84) GATT membership application (86)

Notes

1.     New enterprises in the nonstate sector fall into five categories: newly formed urban and rural collectives, private enterprises, foreign capital enterprises, and joint ownership enterprises
2.     In 1980 a measure called ‘substitution of loans for fiscal appropriations’ (拨改贷bo gai dai) was introduced to turn fixed asset investment in state and urban collective enterprises into bank loans. This was followed by a central government decision in 1983 to reduce the role of the fiscal authority in the allocation of working capital and to make state banks the main source of supply and supervision.
3.     “Tax for profit” scheme (利改税  li gai shui) – Replacement of profit hand-over with taxes.
4.     “CCP Central Party Committee Resolution on Economic System Reform” adopted during Third Plenum of the Twelfth Central Party Committee held in Oct 1984. After that meeting, reform was fully unfolded in the industrial sector.
5.     China adopted a system of dual exchange rates – the yuan for domestic transactions and Foreign Exchange certificate (FEC) for foreign investors.
6.     For the first time, the rights of private enterprises were written into constitutions. Private enterprises were regarded as important supplements to public ownership in a socialistic economy.  3月25日~4月13日，七届全国人大一次会议举行。会议通过了《宪法修正案》，将“国家允许私营经济在法律规定的范围内存在和发展，私营经济是社会主义公有制经济的补充。国家保护私营经济的合法的权利和利益，对私营经济实行引导、监督和管理”以及“土地的使用权可以依照法律的规定转让”等规定载入《宪法》。

The watershed event that signaled the start of China on its path to economic reforms is without a doubt the Third Plenum of the Eleventh Central Party Committee (中共十一届三中全会) in December 1978. After consolidating his power, Deng began to focus on reforming the ruined economy. One of the most important resolutions adopted at the meeting is the decision to set aside development based on classless ideology and focus all efforts on economic development.

Even though the objective of the economic reforms was to modernize China through industrialization, reforms were set to start in the rural agricultural sector first for several reasons.

Firstly, at the start of the reform, China was essentially still an agricultural country with about 70% of its population still residing in the rural area. Reforms in the agricultural sector, if successful, would bring immediate reliefs to the majority of the masses who were living in extreme poverty attributed to decades of economic mismanagement.

Secondly, within the echelon of its first generation leaders, many had roots that were linked to the agricultural sector. Unlike the Russian Bolshevik Revolution which was urban-based, the Chinese communist revolution had its power base rooted in the countryside during its formative years. Under the leadership of Mao, the CCP won the heart of the peasants through land reform programs, relieving the peasants from the suppression of the exploitative landlords and warlords during the Nationalist era. Millions of peasants subsequently joined the revolutionary army and many became the cadres and leaders of the state bureaucracy after the victory of the revolution in 1949 (Song Defu 1994). Despite the proclaimed goal of catching up with the developed countries through urban industrialization after 1949, the source of CCP’s power remained rooted firmly with the peasants in the rural areas. It was therefore natural that leaders within the CCP had the welfare of the peasants close at heart. The proximate affinity between the CCP and the peasants was visibly reflected in the CCP’s choice of leaders to be at the helm of the economic reforms. Leaders in the 1980s, such as Zhao Ziyang and Wan Liwere predominantly rural-oriented. Before they were brought to Beijing to be the premier and vice premier, Zhao and Wan led Sichuan and Anhui provinceswhich pioneered agricultural reforms. It was therefore not surprising that reforms started in the rural agricultural sector.

Thirdly, unlike industry, agriculture is harder for the government to plan and manage. This is because agricultural harvest depends very much on natural conditions such as soil quality and weather, which the government has little control over (Huang 2008; Wu 2005). As a result, the central government was less directly involved with the agricultural production than they were with the industrial sector. This meant that structurally, there was therefore less organizational complexity involved and reforming it was simpler. It also required less resources from the central government. There was therefore ahigher chance of success with agricultural reforms. In contrast, reforming the urban industrial sector involved tampering with the entire state apparatus comprising of input allocation, production and output distribution systems. The process would require intricate coordination among the various government agencies, each with strong vested bureaucratic interests (Shirk 1993). Furthermore, under the central planning system, the decision chains were long-stretched, intertwined, and teemed with interpersonal rivalries and factional politics (Harding 1981; Lampton 1987; Lieberthal and Oksenberg 1988; Walder 1986). The perceived risk of failure of reforming the urban industrial sector was thus much higher.

Finally, there was another push factor that could explain why the rural agricultural sector became the initial focus of economic reform. At the end of 1970s, China was still reeling from the devastating effects of the Cultural Revolution which officially ended only in 1976 with the demise of Mao and the subsequent arrest of the Gang of Four. Agricultural production was still based on the commune system which started in 1958 during the Great Leap Forward years. Under the socialist egalitarian approach, all members of a commune received the same share of output regardless of the effort each put in. The lack of incentives for hard work resulted in low motivation and morale that translated into declining crop yields. The poor harvests in some areas were also exacerbated by periods of drought leading to mass starvation and poverty. Many ended up begging when not working on the fields. There was a pent-up demand for changeat the grassroots level because of the acute hardship that the peasants were experiencing. In desperation, peasants in some areas were driven to self-action. On November 24, 1978, a month before the Third Plenum of the Eleventh Party Congress, farmers from twenty households in the Xiaogang Village of Fengyang County in Anhui Province took it upon themselves to devise a better way of agricultural production. At the advice of an elder who had experienced the effectiveness of contract responsibility system when it was implemented in 1961 as a correction measure for the disastrous Great Leap Forward policies,  the farmers decided to sign a pact to bring it back, leading to the spontaneous rebirth of the radical household responsibility system (HRS) (家庭责任制 jiating zerenzhi).[i] Given the ideologically-charged and intense political environment still prevailing at that time, it was an immense risk that one would not lightly take, unless out of sheer desperation.

Based on aforementioned factors, it was not surprising that the main thrust of the reform was the rural agricultural sector. Rural reform was the genuine starting point.  The success in the agricultural sector stimulated growth in the rural industrial sector, culminating in the extraordinary development of the township and village enterprises (TVEs), spearheaded and supported by local governments. From 1980s to the mid-1990s, the TVEs phenomenon contributed immensely to the growth of Chinese economy at a time when reforms in the state-sector was bogged down by vested interests and the rigid centrally-command governance structure. Therefore 1980s was irrefutably a decade of rural entrepreneurism. It was rural entrepreneurism that started China off on its road of economic reforms.

As for the urban industrial sector, pilot industrial reform programs were developed and carried out in selected factories and limited localities during the initial years of the reform, paving the way for full-scale urban-based industrial reform in the future. At the same time, the economic activities of the foreign sector supported by the inflow of FDI were restricted to the special economic zones at the coastal areas. The amount of FDI received was low and the investments were mainly for low-skilled processing trade. Parts were imported from overseas and the finished products were re-exported.

The 1980s ended with the Tiananmen Incident, an event of mass social disorder, which threatened to deliver a severe blow to the reformation process. In its aftermath, policy makers led by a new central leadership instituted policy changes which fundamentally changed the course of the economic reform. As a result, the new decade marked the start of a new phase in which the focus of the economic reform switched from the rural to the urban sector. Even though China persisted on its road of economic reform, the policy changes delivered a great shock which radically changed the ecological environment and the strategic responses of the economic actors.

The discussion in this section covers the evolution of the economic development in the 1980s. It pays particular attention to the regulatory and institutional changes covering four sectors: the rural agricultural sector, the non-state industrial sector(including the TVEs and the private enterprises), the foreign sector at SEZsdriven by FDI, and the state industrial sector involving the state-run enterprises. This is followed by another section exploring in-depth the strategic choices of economic actors in response to particularistic actions of state agents in each of the four sectors.

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[i] Also called the household contracting system (家庭承包经营制 jiating chengbao jingyingzhi), the responsibility system in agricultural production (农业生产责任制 nongye shengchan zerenzhi), etc. Notably, the household contracting system is not a new innovation in the of the reform era. In fact, it had been practiced during the Mao era.

2.2 Government’s Decentralization Drives in 1958 and 1970.

Contents

2.1       Problems of Central-Command System
2.2       Government’s Decentralization Drives in 1958 and 1970
2.3       From Administrative Decentralization to Economic Decentralization After 1979
2.4       Market Economy with Chinese Characteristics

2.1       Problems of Central-Command System

For a planned economy to work, two premises must be fulfilled. Firstly, the central planning organ needs to have complete information on all economic activities taking place within the society. Secondly, the interests of the whole society must be integrated so that no separate interests or different judgments of value fall outside the scope of the plan as divisive elements of both the society and the plan (Wu 2005; 18).

In reality, however, such assumptions are hard to fulfill because of two mutually-interacting and reinforcing macro-trends: rapid technological advancement and globalization. Production processes today are intricately complex with the concept of distribution production network. Technological advances have become more diffused and are no more in the hands of the privileged few. This lowered the entry barriers for new entrants in the global market, each seeking to offer products with better quality, more features and lower costs. Choices of product have increased as a result of such competition and along with that, consumptions patterns vary and shift rapidly. These changes in today’s environment increase infinitely the amount of information that needs to be processed prior to making plans, making predictions worthless and impossible, not to mention the huge investment needed to build an extremely flexible and power information system. The huge information costs as well as the opportunity costs arising from the inflexibility once the plans have been made thus render insurmountable difficulties to the continuation of the centrally-command system.

Even if plans are well made, the execution phase presents further opportunities of complications that may bring about deviations from the plans.  Every economic agent has his vested interested that may not conform to the greater common goals. This divergence of interests may result in distortions and deviations at every link of the implementation phase.

A final problem relating to a centrally-command system is the issue of incentives and accountability. As pointed out by Wlodzimierz Brus, an exponent of the Polish school of market socialism, such issues led to defects, such as the “ratchet effect”[i], neglect of economic results, and lack of a system to hold people accountable (Wu 2005; 16).[ii]

In short, a centrally-command system had proven itself a system fraught with inefficiencies  that reflect the innate defects of a centrally-control allocation system. In times of abundant resources, such inefficiencies were masked by rapid economic growth.  However, when resources turned scarce, such innate defects overwhelmed the system and doomed it to failure. Efforts by Soviet leaders Stalin, Khrushchev and Kosygin to reform the Soviet system failed because these innate defects of the system were not addressed (Wu 2005; 20 – 24). Their experiences served as invaluable lessons to the Chinese policymakers to avoid similar pitfalls when embarking on economic reform. The deep-seated issues of high information costs, divergence of interests and lack of incentives and accountability must be addressed for the reform to be fruitful. However, that was not obvious to the Chinese policy makers during Mao’s era, without the benefits of the hindsight that policy makers today have.

Hence, before 1978, the ideological creed of state ownership as the sole basis of economic development prevented any reform that was market-based. As a result, reform was restricted to mainly decentralization during which power was delegated to the lower levels of government and to the state-run enterprises.

There were two decentralization drives which happened in 1958 with the formation of the people’s commune system in the rural areas and then again in 1970 when a large scale economic management system reform was launched under the slogan “decentralization is a revolution and the more decentralization, the greater the revolution”.

The two decentralization efforts were similar in that administrative functions were transferred to lower levels although the political situations were different. The former happened during the Great Leap Forward campaign when Mao wanted to accelerate industrial development to catch up with the West. In the case of the latter, Mao anticipated the coming of another World War and divided the country into ten cooperation regions with the objective that each had the industrial setup to develop capability for fighting its own war.

Despite the difference in objectives, both ended with similar disastrous consequences. During the Great Leap Forward campaign, millions died of starvation when fields were left unattended and farming tools were smelted to produce poor-quality steel. In the case of the 1970 decentralization, competition for resources at the local levels to go into industrialization in a big way sank local economy.

There was therefore a pattern in the administrative decentralization efforts during the first three decades of communist rule under Mao. Firstly, centralization led to stagnancy which prompted decentralization. When decentralization ended in economic chaos, recentralization ensued. The cycle of centralization, stagnancy, decentralization, chaos, and then recentralization failed simply because they were motivated by political and ideological considerations at the expense of economic efficiency. To achieve ideological and political goals, economic efficiency was often sacrificed.

Perhaps, China’s failure in reforming its system before 1978 could be rooted in the “path dependency” concept applied by Douglass C. North on institutional change. North professes that an institution’s present choice set of actions is limited by choices made in the past. Therefore, once an institution has chosen a certain path, it will evolve along a certain direction which can only lead it to a certain set of goals available only for that path. The risk is therefore as changes evolve, an institution becomes increasingly locked in by its earlier choices. The leaders of China, just after 1949, had chosen to be on a socialist path that came with inherent defects that we know today with the benefits of hindsight. Regardless of what changes it chose to make, the defects manifested themselves along the path on every choice it made and limited the effect of the change.

In fact, criticisms about the strategy of administrative decentralization were voiced as early as 1961, in an internal research report submitted by Sun Yefang, a distinguished economist. Not only did his opinions fell on deaf ears, Sun was persecuted as a revisionist just for presenting his viewpoint. According to Sun, the central issue of reform was not about the relationship between the central government and local governments. Instead, it should be about the autonomy of enterprises in the management of their operations. In other words, reform of the economic management system should focus not on the division of power among administrative authorities at different levels but on the relationship between the state and the enterprises, with the focus on empowering the enterprises so as to provide them with the incentives and motivation to shoulder the responsibilities accorded to them by the state.

Sun’s view failed to explain theoretically why delegating power to and sharing profit with enterprises would raise the efficiency of the national economy (Wu 2005). The missing element is the free-market environment. Or to use the “path dependency” concept again, Sun’s view involved making a different choice but still along the same path.

Indeed, current reforms went one giant step ahead of Sun’s theoretical framework of power delegation and profit sharing. Not only have the enterprises acquired autonomy that Sun suggested, economic reforms since 1978 have also created an increasingly free market environment that autonomous enterprises of different ownership types can conduct their economic activities and compete based on market forces.

Therefore, changes after 1978 were not a mere difference in choices along the same path. It was a quantum jump from one path to another which would lead it to a different set of goals and, along with it, different constraints. In other words, Chinese policy makers after 1978 have chosen to jump to a different path, from socialism to “state capitalism”. It was probably hard for Sun to imagine how far the central government, within the framework of a socialist state, was willing to go in reforming the economic management system, given the dogmatic ideological environment prevailing at the time he formed his opinions.

2.3       From Administrative Decentralization to Economic Decentralization After 1979

Or, as Wu (2005) noted, quoting Herbert Franz Schurmann and Morris Bornstein, there were two types of decentralization: economic decentralization and administrative decentralization. The former was market-oriented and focused on creating a market economy within which decisions could be made based on free market forces of supply and demand. The latter, on the other hand, worked to maintain the framework of a planned economy by improving the existing administrative measures.

Before mid-1980s, China’s economic reform was predominantly based on administrative decentralization, focusing on the various levels of government within the state apparatus. One good example of such measures is the revenue sharing system (分灶吃饭fenzaochijan) introduced in 1980. The measure brought initial benefits as it provided incentives to local officials to increase revenue collection and reduce expenditure. Over time, however, the defects of the measure became more apparent when local government introduce protectionist measures to support local industries in order to protect its revenue base, leading to the creation of a “vassal economy”.

This example illustrates another point made by Wu (2005) that in a planned economy, decentralized control produced less desirable results than centralized control. The reason being that for administrative allocation of resources to work, centralized calculations by a state planning body followed by strict enforcement of the plans are needed. Decentralized control would only result in divided leadership each with its vested interests and was therefore not ideal for a planned economy. This led the Chinese economists to the conclusion that economic decentralization, focused on creating a free market within which independent market players could make decision based on market stimulus, was the only right direction.

The evolution of the economic reforms for China therefore happened along its own path, quite independent from that taken by the countries in the West. China did not adopt the economic models of developed economies and chose to learn its own lessons, knowing very well that domestic environment was radically different and China faced a different set of constraints. China was not only different from the capitalist developed countries. It was even different from other centrally-planned socialist economies because of its history and culture as well as the different paths it had taken under Mao prior to the start of the reform in 1978. Despite so, once the lessons were learned, the direction of China’s reform was unequivocally to build a market economy. What was different were the means it chose to use to achieve that. Deng aptly summarized China’s strategy with a single phrase “Crossing the river by feeling the stones”, an approach which has evolved into what many economists named it “Beijing Consensus” today.

2.4       Market Economy with Chinese Characteristics

Notably, Chinese efforts of economic liberalization took place without political liberalization or, “democratization” embodies in Washington Consensus as prescribed by Western economists, politicians and intellectuals. This economic liberalization program without democratization is perhaps better- and more aptly-known as “Beijing Consensus”.

The advent of the financial crisis triggered by the US subprime mortgage meltdown indeed demonstrates that far from being a hindrance to economic development, a somewhat tightly managed economic system, as in the case of China, may have caused the system to have not only avoided the same problems that arose in a Laissez-faire system like that of the US, but also managed the fallouts more effectively when the crisis started.

In an increasingly integrated global environment, competition is no more between corporations but more so between governments. For Western MNCs, many are indeed already bigger than the entire economy of individual developing nations. For the latter to develop their economies, especially their local enterprises, it is hardly a level-playing ground. China has a huge-domestic market and the local companies found niches to evolve before having to compete with the MNCs after its accession to WTO in 2001.

For many other smaller developing countries, however, their disadvantaged position is accentuated by their lack of a domestic market to provide room for growth of indigenous industries. Much of this has been discussed in great depth in many literatures on the pros and cons of globalization. But the point is that there is an increasingly greater role for government to play, not less. Government need to be more involved because the forces, especially the macro-economic ones, are too great for small companies to overcome.

Take China for example. Despite being the factory of the world, many low-cost producers at the coastal areas were hit by both inflation and higher exchange rate that ate into their profit. Many folded therefore not because of inefficiency in their production but because of macro-forces that are beyond their control. Hence, there is a role for government to play in managing such forces so that indigenous companies are not put at a disadvantage.

Governments today need to be less ideologically-oriented but more economically-oriented. It has to be so because any government that does not help to create wealth would be seen as an incapable one, without the cover and excuse provided by an ideological creed. With freely-flowing information, it is no more easy for governments to shut themselves up totally, even for rthe remaining diehard socialist states like Korea and Cuba. Unless they chose to shut themselves totally up, it is not possible for information flow to be stopped totally.

With the demise of the Soviet-led socialist bloc, the argument is no more between the ideological alternatives of whether centrally-controlled or free-market is good. Government should not be looked at from ideological perspective. In other words, the concept of ‘government’ should be ‘de-ideologized’. The role of every government, is determined increasingly not by ideology but by economics development.

Hence, the success of China’s economic development demonstrates that economic development needs to be apolitical. When Washington Consensus was proposed in 1989, China was still in the midst of reforming its SREs and it was unclear how successful China would be. Since then China has made such great progress that China Consensus has been offered as another alternative for developing countries.

The separation of politics from economics falls on the premise that the world has become an increasingly integrated one as a result of globalization. While politics is usually localized, economics has gone international or global. The separation of politics from economics therefore allows an economy to quickly integrate with the rest of the world without having to change its political system. In other words, any country can adopt a market-based economy and carry out economic reforms without switching political orientation.

Of course, China’s experience may not be applicable to all, given that there are many variables between countries. But at least, China success stands testimonial to the viability of that proposition. Also, most developing countries share many commonalities at the starting line: focus in primary industries, low productivity, low level of mechanization, absence of market, absence of financial market, illiterate population and low-skilled labour, poor institutional structural, poor private property rights, etc. In many instances, Chinese experience may still be relevant to other developing countries because of those commonalities. What remains to be studied is how China’s experience can form lessons for other developing countries to emulate.  In that regard, World Bank and IMF have an important catalytic and constructive role. The appointment of Chinese economist Lin Yifu as World Bank’s Chief Economist is a big step by World Bank towards fulfilling that role.

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[i] A ratchet is a gear that can run only forward but not backward. A ”ratchet effect” describes an enterprise’s effort to avoid higher future production quotas by making sure that current targets are not over-fulfilled.

[ii] Brus initially suggested combining centrally-planned economy with market mechanism. However, after migrating to Britain in the 1970s, Brus changed his mind and switched to supporting market-oriented reform. See Wlodzimierz Brus, “From Revisionism to Pragmatism: Sketches to a Self-Portrait of a ‘Reform Economist’ (1988),” Janos Matyas Kovacs and Marton Tardos (eds.), Reform and Transformation in Eastern Europe, London: Routledge, 1992; Wlodzimierz Brus and Kazimierz Laski, “From Marx to the Market: Socialism in Search of an Economic System,” Oxford: Clarendon Press, 1989.

1.1 Construction of a Society of New Democracy (1949 – 1953)

Contents

1.1       Construction of a Society of New Democracy (1949 – 1953)
1.2       Socialist Transformation (1952 – 1958)
1.3       Anti-Rightist Campaign (1957 – 1958)
1.4       First Economic Reform & Great Leap Forward (1958 – 1963)
1.5       Lushan Meeting & Anti-Right Deviation Campaign (1959)
1.6       Corrective Measures : Recentralizing and System of Three-Level Ownership (1960)
1.7       Practice of ‘Responsibility Plots’ & Conference of Seven Thousand Cadres (1961 – 1963)
1.8       Socialist Education Campaign (1963 – 1966)
1.9       Cultural Revolution (1966 – 1976)

Before 1949, the Chinese economy was dominated by the private sector which accounted for two-thirds of the total industrial output and more than 85 percent of total retail sales. State sector began to rise in dominance only after 1955 as a result of efforts to accelerate the pace of socialist transformation based on the Russian model.

Table 1 : Guiding ideology, model of growth, critical events before 1978 and their impacts on the evolution of organizations.

	Before 1979
Guiding Ideology / Model of Growth	49 – 76 Egalitarian ideology 49 – 56 Soviet Style Centrally-planned economic system.1 53 – 56 “General Guideline for the Transition Period” – Guiding principle for Socialist Transformation 58 – 63 “To surpass Britain in three years and to surpass America in ten years” – Great Leap Forward
Main Events / Efforts / Initiatives	Agrarian Reform (48 – 52) Korean War (50 – 53) First Five-Year Plan (1953 – 57) Socialist Transformation (52 – 58)2 from New Democracy to socialism Socialist transformation of agriculture (1952 – 58) Mutual-aid and co-operation campaign (52 – 55) Cooperative Transformation Campaign (1955 – 57) People’s Communes Campaign (1958) Socialist transformation of private handicraft industry (1953 – 1956) Socialist transformation of capitalist industry and commerce (1954 – 1856) “Letting a hundred flowers blossom and a hundred schools of thought contend” (56 – 57) Anti-Rightist campaign (57) Great Leap Forward (1958 – 63) First economic reform  (1958) Administrative Decentralization (1958) First Go-communism craze (58) Lushan Meeting and Anti-Right Deviation Campaign (59) Second Go-communism craze (60 – 61) Three-year Natural Disaster (60 – 62) (also known as “three-year period of hardships”) Correction of errors from Great Leap Forward (60) Recentralization (1960) Size of people’s communes reduced.  Production team became the basic accounting unit. (1960) ‘Responsibility Plot’ implemented in Anhui and other locations, against Mao’s objection. (1961) Conference of Seven Thousand Cadres. Mao took responsibility for his mistakes. (62) Socialist Education Campaign (63 – 66) Cultural Revolution (66 – 76) Second Administrative Decentralization (70 – 71) Passing of Mao. End of Cultural Revolution. (1976)
Evolution of SOEs 国有企业的进化	Focused especially on heavy industries, especially for production of military equipments.
Evolution of Collectives 集体企业的进化	–
Evolution of Private Enterprises 私有企业的进化	–
Evolution of FIEs 外资企业的进化	Non-existence
Key Regulatory Changes	–

Notes

1.     Soviet model of socialist command economy under Stalin was similar to Lenin’s theory of “State Syndicate”. Lenin likened a socialist economy to a super enterprise (i.e. a ‘State Syndicate’) monopolized by the state and state ownership was regarded as the sole economic base for socialism. (Wu 2005, Pg. 4) 苏联史大林时代列宁式的中央集权制度
2.     Under the guidance of “General Line for the Transition Period” adopted in 1953, this was completed in three phases. Socialist transformation of agriculture [农业社会主义改造(53 – 56)], socialist transformation of private handicrafts industry [手工业社会主义改造(53 – 56)] , and socialist transformation of capitalist industry and commerce [资本主义工商业的社会主义改造(54 – 56)].

The plan for the reconstruction of China was decided during the Seventh National Congress of the CPC in 1945 before the founding of the new state. It was dictated that realization of socialism should take two steps. First, there would be three years of preparation in the recovery period before another ten to fifteen years of construction of the society of New Democracy. This was to be followed by a transition towards the formation of a socialist society.

Under the leadership of Mao, Agrarian Reform was started in 1948 and was completed by 1952. By then, each rural resident had been allotted a share of land. Interestingly, according to Wu (2005), Mao was not against the concept of capitalism before the founding of the new China based on his thoughts outlined in two of his papers. In his 1940 essay entitled “On New Democracy”, he asserted that the economic base for the new democratic society would be a mixed economy which included a private capitalist sector that “cannot dominate the livelihood of the people” and the condition that big banks and the big industrial and commercial enterprises owned by the state. In another paper “On Coalition Government” which he delivered at the Seventh National Congress of the CPC in 1945, he stated that in the new democratic society, capitalism should have adequate room for development. What he objected was not domestic capitalism but foreign imperialism and domestic feudalism. He further professed that “development of capitalism in a vast scale under the New Democratic regime has no harm but only benefit”.

His stance began to shift, however, by 1949 just before the founding of People’s Republic of China (PROC), when he declared that the contradiction between the proletariat and the bourgeoisie had become the main domestic contradiction. During the initial years after the founding of PROC, however, because of the Agrarian Reform (1948 – 52) and the Korean War (1950 – 53), Mao reckoned that the timing was not right for an all-out attack on capitalism. In 1952, with the Agrarian Reform and the Korean War drawing to a close, Mao proposed the transformation from New Democracy to socialism immediately and dictated that the bourgeoisie as well as capitalist industry and commerce should be eliminated. Given the size of the country, however, he estimated that the completion of the process would take ten to fifteen years.

In June 1953, Mao put forth the “General Line for the Transition Period” which proposed making socialist ownership of the means of production the only economic base for China within a timeframe of fifteen years.  This was to be achieved by expanding state ownership and changing private ownership into either collective or state ownership. The proposal was accepted formally as the guiding principle for the party in August 1953.

1.2       Socialist Transformation (1952 – 1958)

Under that guiding principle, China embarked on its socialist transformation process along three lines: socialist transformation of agriculture (1952 – 58), socialist transformation of private handicrafts industry (1953 – 56), and socialist transformation of capitalist industry and commerce (1954 – 56).

In the long history of China, agricultural production for the Chinese had always been a household affair with family forming the basic social and economic cell of the agrarian society. There was a natural division of labour within the family unit with the elders making decisions while the rest carrying out the work with minimum supervision. All these helped to reduce measurement, supervision and transaction costs. Under the leadership of the Mao, however, the system of family farming was set to undergo fundamental change with the launch of the socialist transformation of agriculture in October 1952. It was declared that starting in December 1952, unified purchase and marketing (统购统销 tonggou tongxiao) of grain was to be implemented nationwide. Under that arrangement, all surplus grain would be purchased by the state at a state-stipulated price. However, because the compulsory price was lower than the market price, government met strong resistance from the farmers during the execution of the plan. The problem was accentuated by the fact that there were tens of millions of independent rural households which made control extremely tedious. There were mutual aid and cooperatives but these were elementary organizations that farmers could freely join and withdraw. Because of their voluntary nature, such cooperative numbered few. It was difficult for the government to implement unified purchasing and marketing of agricultural products. There was therefore a need to organize the farmers in order to exert better control over them. In 1955, the Cooperative Transformation Campaign was launched by Mao to turn these elementary mutual aid cooperatives into quasi-state-owned “advanced cooperative”. This time, participation was no more voluntary. By the end of 1955, five hundred advanced cooperatives came into being. Their member household accounted for 3.45% of the total number of rural household. Two years later, in 1957, the transformation from family farm system to advanced cooperatives was complete. All the 120 million rural household belonged to one of the 753 000 advanced cooperatives found all over China (Wu 2005, p.101).

Despite the astounding success of the transformation, there were still deficiencies in the advanced cooperative system. Each cooperative was relatively small with only one to two hundred households. More importantly, their organization was separate from the grassroots leadership making them difficult to control. In order to exercise effective leadership over the advanced cooperative, it was decided by the CCCPC on March 30 1958 that the cooperatives be consolidated into larger ones which Liu Shaoqi called communes.  For the party to have better control over the communes, the management of the communes would be integrated with government administration. In July the same year, the People’s Communes Campaign was launched nationwide to organize people’s communes on a large scale. The process was completed by October 1958. More than 740,000 advanced cooperatives had been reorganized into 26,000 people’s communes, with, on average, 28.5 advanced cooperatives merged into one people’s commune and more than 4,500 rural households in each commune. The entire rural China had switched over from the loosely organized voluntary elementary cooperatives to compulsory advanced cooperatives and finally to the integrated people’s commune system within only three years (i.e. 1955 – 1958). Altogether, there were more than 2600 people’s communes each with an average of 28.5 advanced cooperatives  comprising of 4,500 rural households. Within each commune, production brigades (later called administrative districts) were established as units of production management and economic accounting.

What was impressive of the campaign was not only the scale of the exercise. It was also the speed with which the task was completed and the orderliness of the transition, despite requiring the people to make great personal sacrifices by giving up their assets and rights. More than anything else, it demonstrated the absolute faith of the people in its leaders.[1]

What was Mao’s objective in wanting to change from a loosely organized producers’ cooperative to a highly structured commune system, one may ask? Following Stalin’s model, Mao wanted to pursue industrialization at a rapid pace with priority given to heavy industry. This was to be done however, without first developing a light industry and hence without a strong economic base upon which the heavy industry could be built on. It was therefore impossible to create value first using light industry and the value could then by used to exchange for grain and agricultural raw materials needed for the development of heavy industry. There was a need to collect agricultural products from farmers using coercive methods. Without other methods of raising funds, such as using foreign borrowings, the adoption of a command economic model with state ownership was therefore inevitable and necessary. Given that China was still an agrarian country, the exploitation of the agricultural sector and the hapless farmers, in the name of national development, was inevitable.

Meanwhile, the socialist transformation of private handicrafts industry began in 1953. In October 1955, Mao turned to the owners of private industry and commerce, urging them to be ready for communism. Under the exhortation of Mao, private enterprise owners applied to the state for ‘socialist transformation” by switching to joint state-private ownership. By 1956, the transformation from New Democracy to socialism was complete. What was intended to be a fifteen year process took over three years (i.e. 1953 – 1956) to accomplish.

1.3       Anti-Rightist Campaign (1957 – 1958)

Despite the success in the transformation, inherent defects of the centrally planned economy soon began to emerge. For instance, the enterprises’ loss of autonomy resulted in noticeably decline of managerial initiative as well as a fall in the quality of products and services.

In Mao’s 1956 “On the Ten Major Relationships” speech, he summarized the defects of the system as over-centralization of power in the central authorities resulting in too little flexibility on the ground. To launch a rectification campaign against bureaucratism and factionalism within the party, Mao began to promote the policy of “letting a hundred flowers blossom and a hundred schools of thought contend” (百花齐放 百家争鸣 baihua qifang, baijia zhengrmng) during the autumn of 1956 to the spring of 1957. The public was invited to air their views freely.

Over the next two months, many unsuspecting intellectuals and officials voiced their opinions and criticisms. By the middle of 1957, the Chinese leadership was shocked by the criticisms against the party and socialism and ordered an all-out crackdown of these outspoken “bourgeois Rightists” in a campaign known as the “Anti-Rightist Campaign” (反右运动 fanyou yundong). Within a year, about 550,000 “Rightists” were persecuted.

More importantly, after Mao display of intolerance over criticisms, few dared to speak out against his policies thus sowing the seeds of calamities for the disastrous Great Leap Forward campaign that followed.

1.4       First Economic Reform & Great Leap Forward (1958 – 1963)

In 1958, in an effort to remedy the situation of sluggish economic growth, China embarked on its first economic reform. The central theme of the reform program was administrative decentralization so that power could be delegated to the lower levels of government. Reform measures implemented included the transferring of power relating to planning, control of enterprises, allocation of state resources, review and approval of capital construction projects, finance administration including tax collection and credit administration, and labour administration.

Unfortunately, the success of the socialist transformation and the transition to people’s commune system did not produce the desired results which Mao. Together with the reform program of administrative decentralization, however, the socialist transformation and the people’s commune system laid the institutional groundwork for Mao’s next campaign – Great Leap Forward – which was launched at the end of 1957 guided by the slogan “Surpass Britain in three years and to surpass America in ten years“.

In the rural areas, however, many serious problems were beginning to emerge as a result of the switch over to people’s communes. The administrative decentralization also led to large increase in number of capital construction projects supported by a huge increase in SRE employees. As an indication of the extent of the craze, the number of projects in any single year from 1958 to 1960 was more than the total number of projects initiated during the entire First Five-Year Plan period (1953 – 1957). During the same three-year period, fixed asset investments were 71% more than the total during the First Five-Year Plan period. The number of SREs employees increased from 24.51 million at the end of 1957 to 59.69 million by the end of 1960. The uncontrolled burst of activities led to wasteful consumption of huge resources and deteriorating efficiency. The economy was thrown into disarray even though local officials were reporting record-breaking production figures which were later found to be untrue.

In addition, Mao’s call to for China to surpass the West led to the first go-communism craze characterized by the tendency to exaggerate, the tendency to be authoritarian, the tendency to give arbitrary orders, and the tendency for cadres to behave as the privileged. All these did great harm to farmers. In response to Mao’s call to increase production of steel, for example, members of the commune even melted farming tools only to produce steel that were of low grade and usable. Cadres exaggerated the output results when production actually declined.

At the same time, as a result of the efforts to raise steel production, grain output declined by 15% in 1959 and then by another 10% in 1960. Because of the poor harvest, consumption per capita of rural grain in both the cities and rural areas dropped 19.5% from 203 kilograms in 1957 to 163.5 kilograms in 1960. Grain consumption per capita in rural areas dropped by an even greater margin of 23.4%. While malnutrition was prevalent in the urban areas, death from starvation numbered tens of millions in the rural areas. Officially, however, the death was attributed to natural calamities and this period of time (1960 to 1962) was known as “three years of natural calamities” (三年自然灾害 sannian ziran zaihai).[2]

1.5       Lushan Meeting & Anti-Right Deviation Campaign (1959)

In fact, it was already clear by 1959 that drastic measures had to be taken to redress the rapidly deteriorating situation. At the meeting of the Political Bureau and the Eighth Plenary Session of the Eighth CCCPC convened in Lushan (the Lushan Meeting) that year, leaders discussed measures to correct the “Left deviation”. Mao concluded that there had been over-delegation of powers and proposed taking back those powers. However, in response to criticism from Peng Dehuai, a member of the Political Bureau, Mao switched the theme of the meeting to opposing right deviation. The ensuing Anti-Right Deviation Campaign (反右倾运动 fanyouqing yundong) led to the continuation of the Great Leap Forward, accentuating the worsening the economic crisis. Between 1960 and 1961, the practice of extreme egalitarianism characterized by indiscriminate, unpaid-for transfer of resources among collectives at the same level or different levels led to the second go-communism craze.

1.6       Corrective Measures : Recentralizing and System of Three-Level Ownership (1960)

Corrective measures were also taken in the fall of 1960 with the implementation of the policy of “readjustment, consolidation, reinforcement, and upgrading“. In fact, rural fairs were reopened by the autumn of 1959. In the summer of 1960, private plots were restored and public canteens dissolved. Besides recentralizing the administration of government functions, enterprises that were transferred to local governments were also brought back under the central control and many were reorganized. Small iron and steel mills started during the campaign were dismantled and the workers were let go.

Meanwhile, changes were also made to the commune system in the rural areas. To increase accountability of results and to improve productivity, the size of the people’s communes was reduced and a system of three-level ownership, with the production team (instead of the production brigade) as the basic accounting unit, was instituted. The number of communes increased from 26 000 to 75 000 now that each was of smaller.[3] After 1961, commune members were allowed to operate small private plots and small-scale household production on the sideline. Temporary employment of surplus rural labours in the cities was also allowed.

From 1962 onwards, production teams, each comprising of twenty to thirty household similar to the earlier elementary producers’ cooperative, became the norm. The in-effect reversal to the elementary producers’ cooperative system happened just as quickly as the transition from the elementary producers’ cooperative to the integrated people’s commune system.

Despite the adjustments, however, the agricultural operation system and rural policies of the government still remained unfavorable to the development of productivity in the rural areas. There were several major problems for agricultural production as a result of the Cooperative Transformation Campaign and the People’s Communes Campaign.

Firstly, farmers lost control over issues like what to produce and how much to produce, even though they were the best to decide based on their understanding of the soil conditions and the changing weather patterns. After production plans were made by the governments, farmers had no choice but to passively accept them.

Secondly, farmers lost the claim to the surplus of their labour. The state implemented unified purchase and marketing through state-owned commercial enterprises and quasi-state-owned “supply and marketing cooperatives (公销合作社 gongxiao hezuoshe). These agencies extracted all surplus value during the process by offering a low unified purchase price. At the same time, farmers were allowed only limited rural fair trading while long-distance transport of goods for sale was forbidden.

Next, with the work-point system, measurement of effort was difficult and supervision cost was high. Free-riding was common especially when there were many households in the production brigade. Many commune members turned up for work but did little actual work since turning up was already enough to earn work-point and extra efforts were not amply rewarded. As a result of this lack of incentive and motivation for work, productivity plummeted.

Finally, the integration of government administration with commune management greatly limited farmers’ freedom of mobility. Farmers were laden by restrictive measures such as the residence registration system, the grain coupon system, and the grain rationing system. These policies restricted farmers’ freedom of mobility and prevent full-utilization of rural human capital.

In short, the farmers were short-changed by a leadership which supposedly had liberated them from the exploitative landlords and warlords. For all the hard work, farmers received extremely low income. From 1957 to 1978, the annual net income per capita increased merely from RMB 73.37 to RMW 133.57. That works out to an average increase of less than RMB 3 per year. If the increases in commodity prices were factored into the calculation, the actual annual increase in rural per capital income was a meager sum of RMB 1. From 1952 to 1978, 62.6% to 90.6% of the exports comprised of agricultural and their processed goods. As Wu concluded, most of the income created by farmers ended up with the state.

According to Wu (2005), because of its total control over the production, distribution, and pricing of agricultural products, the state had been able to extract a huge portion of its revenue from agriculture since the 1950s. Based on his research, the agricultural sector provided RMB 434 billion for industrialization. This huge amount came from RMB 98 billion of tax revenue plus RMB 512 billion of the price scissors between industrial and agricultural products minus the RMB 176 billion which the state invested in the sector. What was even sadder was that those surplus values extracted from the farmers were squandered in one political campaign after another, and in the process, driving the nation into social pandemonium and further economic chaos.

Because of their traditionally weak social position, peasants bore the brunt of the catastrophic policies implemented by the central government in the rural agricultural sector. As mentioned, Great Leap Forward and People’s Communes Campaign led to disastrous consequences, resulting in the death of millions during 1960 to 1962.

In response to the disastrous government policies, there were three waves[4] of efforts by farmers to practice “Contracting output quota to each household” (包产到户 baochan daohu – a term that is similar in practice to the household responsibility system implemented after 1979). However, the attempts by the peasants were suppressed by the central government which pronounced that these practices constituted efforts to restore capitalism.

1.7       Practice of ‘Responsibility Plots’ & Conference of Seven Thousand Cadres (1961 – 1963)

Even though the disastrous consequences of the Great Leap Forward and the People’s Communes Campaign forced Mao agreed to the system of “three-level ownership with the production team as the basic accounting unit“, he explicitly objected to the idea of contracting output to each household, regarding it as going against the principle of socialist collective economic organizations. Despite his objections, Anhui Province adopted the practice of “fixing output quota for each plot and designating responsibility for each person“. By March 1961, 39.3 percent of the total number of production teams in Anhui Province had implemented the practice of “responsibility plots“.

Anhui Provincial Committee of the CPC was criticized by Mao in 1962 for supporting the farmers to in the adoption of the practice of “responsibility plots”. But the leaders of Anhui were not the only ones in support of the contracting output quota to household. Leaders like Deng Xiaoping and Chen Yun voiced their support for it. To make his point, Deng quoted a saying by farmers in Anhui Province that “black or yellow, all are good cats so long as they catch mice”.

Meanwhile, in January 1962, at the “Conference of Seven Thousand Cadres”, Mao himself took responsibility for his mistakes in the Great Leap Forward campaign. The economy finally recovered by 1963.

1.8       Socialist Education Campaign (1963 – 1966)

Mao’s objection to responsibility plots stood on his conviction that contracting output quota to household would result in class polarization leading to the resumption of class struggle. The returning of the contract responsibility system in some parts of China led him to believe that serious class struggle had occurred in rural China. This belief prompted him decision to carry out a large-scale socialist education campaign across the nation. The campaign, lasting from 1963 to 1966, became the prelude to yet another even more tumultuous political campaign – the Cultural Revolution, plunging the already impoverished China and drained-out Chinese into another decade of extreme personal suffering and great social upheaval.

1.9       Cultural Revolution (1966 – 1976)

Pending.

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[1] Some would claim that the motivation could be more of fear that was commonly associated with a centrally command socialist system and police state. That was unlikely as China had just began its reconstruction and political campaigns such as Great Leap Forward and Cultural Revolution had yet to take place. The motivation was therefore likely to be reverence and (blind) faith rather than fear. To many Chinese, it was the communists who had succeeded in driving out the corrupt Nationalists and the foreign imperialists. Many aspired China to be great and strong again so that the humiliating history of semi-colonialism of China by foreign powers would not be repeated again.

[2] Some translated it as “Three-year Period of Hardship” (Wu 2005, p.102).

[3] Compared to using production team as basic unit of accounting, production brigade is less productive because there were more households and people in a brigade than in a team. In a bigger group, free-riding was easier to take place. By changing to using production team as the basic accounting unit, this problem of supervision and measurement of work was mitigated, though not eliminated. By 1962, after the disastrous consequences of the Great Leap Forward became obvious, the production team was made to be the basic accounting unit. With a small group of households in a production team, it is easier to account for efforts i.e. free riding became more difficult. As a result of the change, productivity went up.

[4] The three waves happened in 1956 (following the establishment of advanced cooperatives), in 1959 (following the founding of the people’s commune system), and in 1962 (following the havoc of the second go-communism craze in 1960 – 1961) (Wu 2005 Pg 105).