1990s was a decade in which many regulatory changes were put in place for the development of the non-state sector as part of the efforts to establish a modern enterprise system. These changes include the passing of the Company Law and Accounting Law in 1993, Partnership Law in 1997, Provisional Guidelines for the Development of Urban Employee Shareholding Cooperatives in 1997, Contract Law in 1999, and Securities Law in 1999.

In the rural non-agricultural sector, conditions became less conducive for the rural enterprises than in the 1980s. For example, as a result of the shift in developmental focus in the 1990s, rural tax burdens were increased substantially while charges for basic services, such as education and health were also raised (Huang, 2008). At the same time, credits for private entrepreneurs were curtailed. Through such measures, resources were diverted from the rural sector to support high-growth development in the urban sector. As the policy environment turned less conducive for the development of rural private enterprises, large number of peasants became available and many began to migrate to cities in search of jobs. The situation faced by the peasants was accentuated by land grabs by local officials in the name of development. 1990s therefore saw a great influx of migrant workers to the cities in search of jobs. The abundant supply of the migrant labourers weakened their bargaining power and many were poorly paid or exploited.

As Huang (2008) professed, in the 1980s, rural entrepreneurs went to the cities and were rewarded for their entrepreneurship. In contrast, in the 1990s, rural laborers flooded the cities in search of jobs and were compensated for their labour. The result was an urban boom epitomized by the rapid buildup of skyscrapers and urban amenities in cities like Beijing and Shanghai. To many observers, a visit to these cosmopolitan cities was enough to convince them the great stride China has made on its road of economic reform. 1990s is a period when Chinese policy makers switched strategy and opted for urban-based state-led growth underpinned by massive inflow of FDI and persistently high state-led fixed investment. While the urban sector flourished, the rural sector languished. The plights of the peasants were succinctly summarized as the “three rural crises” (三农问题) — the crisis of agriculture, the crisis of rural governance, and the crisis of the peasantry.

Nevertheless, despite the change in policies making conditions unfavourable for rural entrepreneurship, growth of rural industrialization continues in the 1990s, with one difference from that in the 1980s. The phenomenal rural industrialization since the early 1980s has been widely portrayed as being led by rural collectives. In the 1990s, the rural private enterprises played a growing role. The number of rural collectives declined from 1.57 to 1.07 million from 1985 to 1998 while that of rural private enterprises climbed from 10.7 to 19 million. During the same period, the share of the rural collectives in the work force, value-added, and sales of all rural enterprises (i.e. rural collectives and rural private enterprises) dropped from 59%, 74% and 60% to 41%, 45%, and 43%, respectively.

Politically, despite frequent criticisms of market-oriented reforms from the conservative statesman and theorists, policy makers continued to make adjustment on government’s position on private enterprises in recognition of the private sector’s growing contribution to the national economy. Among other things, reform-minded political leaders argued that the essence of socialism was the realization of common prosperity, not absolute and total state ownership. China’s character of socialism was not determined by the share of the state sector in its economy. In short, China should totally break away from the Soviet model expounded in the textbook of Political Economy.

More importantly, the views of the reform-minded prevailed over the conservatives during the 15^th National Congress of the CPC in 1997. The Congress adopted a resolution that pronounced keeping public ownership as the mainstay of the economy and allowing diverse forms of ownership to develop side by side as part of the basic economic system in the primary stage of socialism for at least one hundred years. The new resolution removed ideological impediments and laid down the political foundation for the development of non-state sectors. In 1998, the fundamental change was incorporated into the Amendments to the Constitution of the People’s Republic of China. For the first time, the lawful rights and interests of the individual business sector and private sector were protected by the state.

The change in government’s position on state ownership in effect helped to improve the business environment for the private sector. As the guidelines of the 15th National Congress of the CPC was implemented, readjustment of the layout of the state sector meant that the state was withdrawing from many industries that were non-critical. This in effect, left more room for private enterprises to grow.

Indeed, since 1998, the share of non-state sectors in the national economy has grown rapidly. Government’s support for development of non-state sector was growing partly because of the more than ten million SOE employees laid off every year as a result of the withdrawal by the state sector from non-critical industries. The employment situation was aggravated by the hundreds of millions of migrant workers seeking employment in the non-agricultural industries. To prevent social unrest, new jobs had to be created quickly. The State Council made prompt decisions to implement measures that support the development of small and medium non-state enterprises which were the main engines of new job creation. (See Table 5.1).

Table 5.1 : Employment By Ownership (%)

Year	State	Non-State	Collective	Nonpublic
1997	53.1	46.9	13.9	33.0
1998	41.9	58.1	9.1	49.0
1999	38.2	61.8	7.6	54.2
2000	35.0	65.0	6.5	58.5
2001	31.9	68.1	5.4	62.7
2002	28.9	71.1	4.5	66.6

Extracted from Wu (2005, p.199).

By the end of the twentieth century the non-state sector had becoming the largest sector driving the national economy. Not only were the non-state enterprises huge in size, they were also superior in performance. Regions where non-state sector accounted for a larger share also experienced faster GDP growth rate. A number of TVEs had also grown rapidly, despite market competition, to become leaders in their respective industries.

As for the foreign sector, with the lessons learned during the experimenting phase in the 80s, China’s policymakers also began improving the regulatory environment governing FDI. For example, in 1991, China granted more preferential tax treatment for Wholly Foreign Owned Enterprises and contractual ventures and for foreign companies that invest in selected economic zones or in high-priority projects encouraged by the state, such as those relating to energy, communications and transport. They also further relaxed the restrictions on the establishment of joint ventures, provided assurances against nationalization, and allowed foreign partners to chair joint venture boards.

FDI growth in China slowed briefly after the events at Tiananmen Square in June 1989, but resumed and quickly grew in the 1990s. The real pick up in FDI came in 1992 after Deng Xiaoping’s tour of Southern China when policies of openness and market-oriented reforms introduced earlier were reaffirmed (See Figure 5.2). From US$4 billion in 1991, FDI inflows increased sharply to US$11 billion in 1992 and US$28 billion in 1993, with growth rates of over 150% in both years. FDI growth, however, began to moderate by late 1990s because of government policies to cool down overheating in the Chinese economies after the high growth in the early 1990s. FDI inflows leveled off in 1998 and dipped slightly in 1999 also because of the Asian financial crisis.

Figure 5.2 : China’s FDI Inflows (1984 – 2006)

During this phase, foreign investments also began to overflow into the centers of China’s (state-owned) heavy industry manufacturing and finance. Of these, Shanghai and the neighboring provinces were the clear beneficiaries and they become the next-largest recipient area by 1995.

Notably, investments by large Western and Japanese MNCs constituted only a small portion of total FDI flows into China during much of the 1990s. As in 1980s, a significant portion of FDI flows into China originated from small and medium enterprises (SMEs) operating simple and labour-intensive production and assembly processes. They were typically from China’s neighbouring regions, such as Hong Kong, Macao, and Taiwan and other Southeast Asian countries all of which are predominantly ethnically Chinese economies.

By the turn of the twentieth century, China looked increasingly unstoppable, having successfully surmounted various obstacles including challenges from remaining remnants of the old-guards to slow down or turn back reforms as well as the Asian financial crisis.

In addition to the changes in the five subsystems, there was also a major shift in approach on how the state enterprises could be reformed. Prior to this, the most commonly used reform policies towards the SOEs were either delegating power or contracting the operation to the management in the hope of providing incentives to raise productivity and profitability. This approach reflected government’s strategy of invigorating every state-owned enterprise. The outcome had not been favourable because, without proper monitoring and control measures in place, these policies encouraged the management to engage in short-term thinking and illicit activities, such as distributing funds as bonuses instead of investing for future growth, making loans with no repayment plans, embezzling public property, and engaging in high risk stock market and property market speculation use company’s fund. These activities were detrimental to the enterprise in the long term. In recognition of the weaknesses of the old approach, during the Third Plenary Session of the 14^th CCCPC in 1993, the overall strategy changed from invigorating all SOEs to one of “letting go of small enterprises” either by restructuring them into shareholding cooperative enterprise or selling them to collectives or enterprises. Wu (2005), for example, recounted the experience of Shunde County of Guangdong Province that started in 1993. By the end of 1994, the Shunde County succeeded in transforming 896 SOEs and TVEs into 2 listed joint stock companies, 7 unlisted joint stock companies, 32 joint ventures, 124 joint state-private enterprises, 431 public-owned private-run enterprises, 78 shareholding enterprises with shares held by employees, and 22 enterprises sold through auction. More importantly, the transformation improved the performance of the enterprises and some emerged as flagship enterprises within their industries a few years later.

In 1994, the Chinese government announced a new strategy of “grasping the big ones and letting go of the small ones” in its effort to establish a modern enterprise system. The strategy meant concentrating effort on the large and medium-sized SOEs that were essential to the national economy while releasing and invigorating small and medium SOEs by means of merger, leasing, contracting, offering for sale, or bankruptcy.  In 1995, out of a total of 87,900 industrial SOEs with independent accounting, 72,200 were considered small according to the standard of National Statistics Bureau (Wu 2005).

During this period, however, the increasing dominance of the non-state sector led to the emergence of a hot debate regarding ownership structure. The debate lasted till 1997. The process of “letting go of small enterprises” did not gain momentum until the second half of 1995 and the new strategy was only formally endorsed by the 15th National Congress of the CPC three years later in 1997.

Notably, when responding to the criticisms of the conservative statesmen and theorists, the reform-minded policy makers maintained that “whether a country has the character of socialism is not determined by the share of the state sector in its economy. . . . As long as the party has correct policies to prevent the polarization between the rich and the poor, China’s socialist character is securely guaranteed.” They further professed that China should totally break away from the Soviet model expounded in the textbook Political Economy and that the essence of socialism was the realization of common prosperity, not absolute and total state ownership. The state should therefore withdraw from ordinary competitive industries and focus on strategic industries. During the process, the state should accept that a decline in the share of state-sector in the national economy would not alter the socialist character of China.

The debate eventually led to the jettisoning of the traditional socialist position “the higher the proportion of the state sector in the national economy, the better” during the 15^th National Congress of the CPC in 1997. Instead, a resolution was adopted which pronounced keeping public ownership as the mainstay of the economy and allowing diverse forms of ownership to develop side by side as part of the basic economic system in the primary stage of socialism for at least one hundred years. The mainstay status of public ownership referred to the fact that state-owned and collective-owned assets dominate in assets of the whole society, the state sector controlled the most vital part of the national economy and played a leading role in the development of the economy. The new resolution removed ideological impediments and laid down the political foundation for the development of non-state sectors. In 1998, the fundamental change was incorporated into the Amendments to the Constitution of the People’s Republic of China. For the first time, the lawful rights and interests of the individual business sector and private sector were protected by the state.

At the same time, in line with the strategy of “advancing in some areas while retreating from others”, the central government would reduce the scope of the state sector by retreating from non-critical industries while advancing to control key industries vital to the national economy and security. Policy makers embarked on a process of readjusting the ownership structure of the national economy in two ways: the strategic layout readjustment of the state sector, underpinned by the strategy of “grasping the big ones and letting go of the small ones”, and the promotion of the healthy development of non-state sectors (Wu 2005, P. 191).

According to estimates by the Development Research Center of the State Council in 1997, state assets committed in production and business sector amounted to 3,000 billion, spreading over 291,000 enterprises in a whole range of industries. That averaged out to only RMB 10 million for each enterprise, a grossly inadequate amount for achieving economies of scale and for building sustainable core competency through innovative research and development. The state could choose to increase investment in all state enterprises to strengthen their operations but doing so required at least RMB 2,000 to 2,500 billion, not to mention the trillions needed for replenishing the pension funds. During those days, these were astronomical sums. The viable alternative is therefore to restructure the state sector by withdrawing from non-critical industries so that resources could be better focused on strategic industries. This entailed strengthening state enterprises to be retained, merging those that have the potential to grow and become profitable, divesting those that are in non-critical industries, and closing down remaining that are unprofitable.

In the following years, during the process of letting go of small enterprises, some malpractices emerged that resulted in what many economists claimed as the loss of state assets. The key issue was in the valuation and transfer price of the enterprise’s property. In many cases, the management decided on the transfer price without the valuation from a fair third party. As a result, many state enterprises were sold at very low price either to the management (i.e. seller and buyers are the same party), or to friends or relatives. The root of the problem was that the capital market was not yet fully developed, making it difficult to determine the true value of the enterprise through open market competition.

By the mid-1990s, significant progress in establishing a macroeconomic control system and adjusting the ownership structure had been made. With the continued growth of the non-state sector, the state sector no longer monopolized the whole economy. Its share in the national economy was significantly reduced. The non-public sector’s share of the GNP exceeded that of the state sector by 1997. By year 2000, the non-public sector accounted for 46.2% of the GNP (See Figure 5.1). In terms of national total industrial output, the SOE share had also fallen from 77.6% on 1980 to 28.5% by 1996 (SSB, 1997: 413).

Figure 5.1 : GNP By Ownership (%)

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

Extracted from Wu (2005, p.66).

From 1978 to 1993, while the total number of industrial enterprises increased from 1.2 million to 10 million, the total number of state-owned industrial enterprises increased only from 83,700 to 104,700. Most of the new enterprises were formed outside the state sector. Non-state enterprises, especially those that are the private ones were increasing at a higher rate. Overall, it is indisputable that the developmental pace of the SOE sector in the 1990s still lagged behind that of the non-state sector. State enterprises were losing out not only in terms of number but in profitability as well. According to a World Bank (1997) report, about half of industrial SOEs made a loss in 1996, up from one-third in 1994. (Lin 2001, P. 35)

Moving into the twenty-first century, a socialist market system based on a mixture of ownership forms gradually began to take shape. There was no dispute that a market economy had developed in China.

 

Architect of Reformation of the Urban Sector

One key person whose contributions dramatically change the economic facade of China in the 1990s is Zhu Rongji. After succeeding Jiang Zeming as the mayor of Shanghai, Zhu won respect for the tremendous changes he brought to Shanghai. Among other things, his achievements included the development of Pudong as well as build-up of the city’s telecom, urban construction and transport sectors.

In 1991, Zhu became vice-premier of the State Council and director of the State Council Production Office. He job included tackling tough economic problems in industry, agriculture and finance. As the Governor of the central bank, Zhu was also instrumental in fighting inflation. He adopted the most direct way to cool economic activities: ordering the banks to cease lending. By 1996, bank credit disappeared and inflation fell below 8%, amid falling growth rate.

As an acclaimed reformer, Zhu was not afraid of making fundamental wrenching changes that China desperately needed.

In the 1990s, regulatory changes continued unabated as policymakers strived to improved the regulatory framework for the working of a market economy. Shanghai Stock Exchange began trading in 19 December 1990. Regulations pertaining to issuance of shares were introduced in April 1992 for enterprises to issue tradable and non-tradable shares and test sites for enterprises were established. For example, trials for joint-stock companies with listed shares were conducted in enterprises located in Shanghai and Shenzhen while those involving joint-stock companies with non-tradable shares were carried out in Guangdong, Fujian and Hainan. In addition, there were also experiments on shareholding by employees in many different locations.

However, as late as 1993, key issues relating to state sector still had not been resolved. Most scarce resources were still in control by government and SOEs even though the state sector accounted for less than half of GDP. For example, the sector consumed more than 70% of bank loans. This dominance of the government agencies and SOEs translated into a complex web of vested interests, thus accentuating the problem in reforming the sector and the economy.

Changes to fix these issues arrived progressively in October 1992 during the 14th National Congress of the CPC when the target of establishing a socialist market economy was set. In November 1993 at the Third Plenary Session of the 14th CCCPC, the Resolution on Issues Regarding the Establishment of a Socialist Market Economic System was adopted. Many important breakthroughs were made at the session. Guided by a new reform strategy of “combining overall advance with key breakthroughs“, it was decided that reform should firmly extend from the hitherto development in the non-state sector to the state sector so that an overall advance could be achieved. It was hope that a socialist market economic system would take shape by the end of the twentieth century.

To achieve the overall advance, major breakthroughs must be secured in five subsystems, namely the fiscal and taxation system, the banking system, the foreign exchange control system, the enterprise system, and the social security system.

First, the establishment of the fiscal and taxation system called for transforming the existing central-local fiscal responsibility system into a “tax-sharing system” based on a rationalized division of power and responsibility between the central and local governments. Through the 1980s and the early 1990s, the central government implemented a series of reforms to decentralize its fiscal system in order to provide more incentives for local government to promote economic growth (Lin and Liu, 2000). However, this fiscal decentralization led to widening fiscal disparity and shrinking central government revenues (World Bank, 2002). The introduction of this tax-sharing reform in 1994 was therefore meant to boost the central revenues and enhance intergovernmental transfers. At the same time, on the corporate side, a uniform enterprise income tax rate (33%) was adopted and a value-added tax (17%) was imposed on all industrial and commercial enterprises to replace the previous system of varied income tax rates for different types of enterprises.[1] The standardization of the taxation system not only greatly simplified the tax structure but also put in place an equitable system that would help to promote fair competition.

Second, for the improvement of the financial and banking system, the 1993 resolution stipulated the setting up of a central bank system to carry out monetary policy independently under the leadership of the state council.[2] In addition, the state-owned commercial banks would be kept as mainstay and diverse forms of financial institutions are allowed to develop side by side. To achieve that, the existing state-owned specialized banks would be commercialized and their policy policy-related businesses would be taken over by the newly set up policy banks. This separation of policy-related banking from commercial banking would help to establish a unified and open system of financial markets with orderly competition and strict regulation.

Third, for reforming the foreign exchange control system, the central government decided to abolish the dual exchange rate system in domestic and foreign enterprises. After the merging of the two exchange rates, the convertibility of RMB would be managed under the current account, with the objective of eventually abolishing controls over capital flow to make RMB a fully convertible currency at an opportune time.

Next, the 1993 resolution ordered the transformation of the operation mechanism of SOEs in order to establish a modern enterprise system characterized by clearly established property rights, well defined power and responsibility, separation of enterprise from government, and scientific management. In December the same year, the Company Law [3] was passed with the explicit goal of instituting a new governance structure for all newly established or reorganized enterprises. It was to take effect on July 1, 1994. The law discards the existing ownership labels and regroups economic organizations into two categories: limited liability companies and limited liability stock companies. Although the old classification still remained in effect, it would be phased out gradually and eventually, the Company Law would become the cornerstone of China’s “modern enterprise system” (RMRB, August 8, 1997).

Finally, the 1993 resolution announced the setting up of a new multi-layer social security system that include social insurance, social relief, social welfare, special care and placement, social mutual aid, and private saving security. The system would combine social pooling funds with individual accounts to provide old-age pension and medical insurance for urban workers.

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[1] Before the implementation of the unified tax rate in 1994, the official tax rate for state enterprises was up to 55%, much higher than the ceiling of 35% for the other enterprises. In reality, of course, the official rate was not necessarily strictly adhered to. According to an estimate by the State Tax Bureau (GWYYJSKTZ 1994: 17), in 1991 the actual average rate for state enterprises was 33.39% while urban collectives and private enterprises paid 28% 29.7% respectively, all lower than the official rates.

[2] Earlier in 1993, Vice Premier Zhu Rongji was made the head of People’s Bank of China which was became the central bank in 1983.

[3] Besides the Company Law, a growing number of related laws and regulations were also introduced progressively as part of the institutional framework for the modern enterprise system. Among these were Accounting Law in 1993, Partnership Law in 1997, Provisional Guidelines for the Development of Urban Employee Shareholding Cooperatives in 1997, Contract Law in 1999, and Securities Law in 1999.

In the aftermath of the political disturbances in 1989, another resurgence of conservative thinking occurred, led by the conservative statesmen and theorists who had all along been uncomfortable with the pace and direction of reforms. This bout of conservatism held sway until 1992 until Deng’s 1992 Southern Tour to revitalize the reform process and opening up.

	1990s
Model / Guiding Ideology	Establishment of the socialist market economic system (社会主义市场经济) – “Combining overall advance with key breakthroughs” strategy (93 – Third Plenary Session of the 14th CCCPC) Reforms to be firmly extended to state sector to achieve overall demand Breakthrough in five subsystems: fiscal and taxation system, the banking system, the foreign exchange control system, the enterprise system, and the social security system. Establishment of a modern enterprise system underpinned by Company Law. Strategies to reform SOEs “Letting go of small enterprises” (93) “Grasping the big ones and letting go of the small ones” (抓大放小)(94) “Keeping public ownership as the mainstay of the economy and allowing diverse forms of ownership to develop side by side as part of the basic economic system in the primary stage of socialism for at least one hundred years.” (97 – 15th National Congress of the CPC) Readjusting the ownership structure of the national economy (97) “Advancing in some areas while retreating from others” – Strategy for reform of the state sector and the promotion of the healthy development of non-state sectors Jiang’s “Three representatives” （三个代表) first proposed in 2000 and formally endorsed in 2002.
Main Events / Efforts / Initiatives	Opening of Shanghai Stock Exchange (90) Trials for enterprises to issue tradable and non-tradable shares conducted at various locations. (92) Deng’s Southern Tour Rapid Growth of FDI after 1992 Adoption of the Resolution on Issues Regarding the Establishment of a Socialist Market Economic System (93 – Third Plenary of the 14th CCCPC) Debates about declining role of state sector. (95 – 96) Adoption of new definition of state ownership (97 – 15th National Congress of the CPC) Amendments to the Constitution – Lawful rights and interests of the individual business sector and private sector were protected by the state for the first time. (98) Debates about loss of state assets (95 – 96)
Key Regulatory Changes	Industrial / Commercial  Regulation on issuances of shares (92) Company Law (93) Accounting Law (93) Provisional Guidelines for the Development of Urban Employee Shareholding Cooperatives Partnership Law (97) Contract Law (99) Securities Law (99)