China's Economic Reform and Policies at the Beginning of the 21st Century

Gregory CHOW

Perspectives, Vol. 2, No. 1

(Author's Note: This essay is an invited speech to be delivered at the Fourth International Investment Forum on September 8, 2000. The author would like to thank a "Perspectives" reviewer for thoughtful comments on an early draft.)

I am pleased and honored to have been invited to speak before this Fourth International Investment Forum held in the city of Xiamen and sponsored by the Chinese Ministry of Foreign Trade and Economic Cooperation. I will speak about China' economic reform and policies at the beginning of the 21st century and make a proposal for increasing China's foreign investment and trade.

Since economic reform started in China in 1978, there has been a remarkable growth in GDP, to the order of 9.5 percent per year on average. What accounts for this tremendous success? To answer in one sentence, the Chinese government has adopted institutions and policies that enable the resourceful Chinese people and foreign friends to unleash their energy to develop the Chinese economy. The farmers became energetic and productive since the 1979. The township and village enterprises were the most dynamic element for growth in the 1980s and early 1990s. Many private and foreign enterprises flourished. By 1996, state enterprises accounted for only 28.5 percent of total gross industrial output value, while collective-owned, individual-owned, and other types (including foreign) of enterprises accounted for 39.4, 15.5 and 16.5 percent respectively (see China Statistical Yearbook 1997, p.411). The secret of success of China's economic reform is to allow the non-state sectors to develop in the setting of a market economy.

The open-door policy is an essential element of the economic reform process. It encourages foreign investment and promotes foreign trade. Foreign investment has provided capital, new technology, managerial skill, and training for labor to China. It has introduced modern managerial system, business practices and a legal framework for conducting business transactions. In addition it has provided competition in the domestic market, and competition has forced domestic enterprises to become more efficient. Foreign trade has enabled the low-cost and high-quality labor in China to produce goods to be sold at higher prices in the world market, thus increasing the compensation to Chinese labor. It has also enabled the import of technology and high-quality capital goods for use in production in China, as well as the import of high-quality consumer goods. The availability of high-quality capital goods improves productive efficiency. The availability of high-quality consumer goods not only increases consumer welfare directly; it also acts as an important competitive force in the Chinese consumer market that stimulates the improvement of the quality of domestically manufactured products.

China's entry into the WTO will make China's door even more open. Both foreign investment and foreign trade are expected to increase. Foreign firms will begin to penetrate China's financial and telecommunication sectors. Trade will increase in both directions and Chinese tariffs will be lowered and Chinese goods will have better access to world markets open to members of the WTO. Using foreign competition to stimulate the domestic economy is a major objective in seeking to join WTO, as explicitly stated by Premier Zhu Rongji. The Chinese government is well aware of the economic and social-political costs and benefits of joining WTO. While it is pursuing institutional reforms in state-owned enterprises and the banking and financial sectors, it is aware that the reforms and the accompanying globalization of the Chinese economy have to proceed in an appropriate speed. If foreign competition enters China too rapidly, adjustments by Chinese producers and enterprises may be too severe to be socially desirable. The harmful effects of foreign competition are monitored by putting into practice gradually the reduction of import tariffs and the admission of foreign competition in the financial and communication sectors.

What are the prospects of continued reform and progress in the future? There are three sets of forces that determine institutional changes in China. These are the role of the government, incentives generated in the market sectors and inertia inherent in economic institutions. In the last twenty years the government has guided the changes in economic institutions. In the future the government will remain active, especially in the following areas. First, science/technology and education for the betterment of the economy was stated to be the main theme of his tenure when Premier Zhu Rongji responded to a question raised during his first press conference in March 1998. Second, the building of infrastructure, in connection with the plan for Western development in particular, will be of top priority. Other areas of serious government attention include the improvement of technology in agriculture, environment protection, social welfare system, health care and housing reform. There will be plenty of opportunities for foreign investors to invest in all these areas.

Secondly, concerning the market forces we can expect that private enterprises, joint ventures and foreign owned enterprises, under a better legal system and in an improved economic environment with China a member of WTO, will contribute positively to growth in the next two decades. These enterprises will play the role of township and village enterprises in serving as the most dynamic sector of the economy. They also will provide competition to the state and collective enterprises, making them more efficient.

Thirdly, inertia will prevent economic institutions from changing rapidly. Institutional inertia come from lack of information, lack of knowledge, social and political pressure affecting economic decisions and simply persistence of customs and habits. Inertia explains the difficulties encountered in reforming the state enterprises and the banking system. One most important problem common to both institutions is the lack of well-trained managers and staff. The second element of inertia is the tendency to retain the old ways of doing things. In many state-enterprises which have been changed to share-holding companies, the share holders still elect the same governing people to the new board of directors and there is no change in management. One can explain this partly by political and social pressure, another element of inertia I have just mentioned. Therefore we cannot expect that Chinese state enterprises and banks can be changed to modern institutions in a few years simply by enacting new laws. The reform of these institutions will be a slow and gradual process as it has been in the past, but continued progress there will likely be.

When the above three sets of forces are balanced out, the Chinese economy will continue to grow at a substantial rate, say over seven percent annually, in the next two decades. I have come to this conclusion by observing the growth experience of the past twenty years. The negative factor, namely institutional inertia, has not prevented the economy from growing at an average rate of about 9.5 percent per year. There is no need to have "perfect" institutions to grow rapidly as long as important market incentives are allowed to operate in important sectors of the economy. Foreign investors can take this continued growth into account in their investment decisions.

Given this positive assessment of China's future, what policy change can I possibly suggest? I would like to make a simple proposal to improve foreign investment and trade. In recent years, the largest sources of direct foreign investment (as the termed is defined in official statistics) have been Hong Kong, Japan, Taiwan and the United States. Foreign capital from Taiwan that was actually used amounted to over 3.5 billion US dollars per year. Since there is no direct transport from Taiwan to the mainland, Taiwan investors have to travel through Hong Kong or Tokyo and are greatly inconvenienced in the process. The stop over through Hong Kong takes on the average about one extra day during a round trip from Taiwan to the mainland and is very costly for time is money for the investors. My simple proposal is for the mainland government to allow Taiwan ships and airlines to come to China directly, carrying passengers who are mainly or entirely residents of Taiwan. If the mainland government adopts this proposal, not only investors from Taiwan will be encouraged and facilitated, but the relation between people on both sides will be improved by more visits and exchanges.

We are all aware that agreements to open direct postal and transport services between the two sides of the Taiwan Strait have not yet been reached, but the lack of agreement should not prevent the Chinese government from adopting this proposal. Whatever the reasons for the government of Taiwan to be concerned about the opening of the island to direct postal communication and travelling from the mainland, it is to the interest of the mainland government to allow Taiwan residents to come to the mainland directly without having to go through Hong Kong or Tokyo. The proposal is likely to be welcome by the government and the people in Taiwan because they have something to gain and nothing to lose. They have complete control of the people travelling in their ships or planes.

There is no reason why the Chinese government would decide not to allow residents of Taiwan to travel directly to the mainland. It has indeed been the government's policy to give special privileges to travelers from Taiwan, as we have witnessed the special passages and lines at airports and points of entry to China reserved for the convenience of Taiwan residents. Allowing them to travel directly is simply to extend them more convenience. The fact that the government of Taiwan might not reciprocate this convenience to residents of the mainland should not matter because the policy by itself is good for China. It is not a concession to the government in Taiwan because it is not directed to the government. It is a policy for the people residing in Taiwan. The policy is not different from the policy allowing residents of Taiwan to travel directly to Hong Kong which is a part of China. The government in Taiwan will probably be involved in allowing ships and planes from Taiwan to come to other parts of China than Hong Kong, but the policy is a unilateral announcement on the part of the mainland government and does not require negotiation with the government of Taiwan.

The proposal submitted here is good for China as a whole. The only part of China which may incur some economic loss from it is Hong Kong but the benefits to the other parts of China and to promoting China's investment and trade surely outweigh the loss to Hong Kong. Historically the economy of Hong Kong has benefited from the port's being the only entry to China for many purposes. Under the open-door policy, Hong Kong's unique position cannot be maintained as direct access to other cities including Shanghai becomes easier. To pursue the open-door policy further, other parts of China should be open to direct travel by residents elsewhere, especially of Taiwan. In a sense the proposal being discussed is not a new policy because, ever since Hong Kong was returned to China on July 1, 1997, Taiwan airplanes and ships have been allowed to land or anchor in territory under the control of the mainland government already. In fairness to other ports and cities of China, they should be granted the same privilege that Hong Kong has, namely, the privilege of receiving airplanes and ships coming directly from Taiwan.

Of course, travelers have to obtain the necessary visa to enter. An office can be established in Xiamen, and possibly in other ports of entry as well, or the existing office in Hong Kong can be used, to process the visa applications by mail. To make it even more convenient for the traveler, the immigration officer at the port of entry can process the travel document as the traveler passes through the line. This would be done in the same way that a visa is swiftly granted to a traveler holding a US passport entering Hong Kong or Taipei. Another aspect of the detailed arrangements is the appropriate amount which China or the port of entry should charge the Taiwan airlines and passenger ship companies and the appropriate way of collection. The appropriate amount depends on how much the Chinese government is willing to encourage Taiwan residents to enter China. Charging less will encourage more travelling. It is strongly recommended that whatever the amount is, it should be collected through the airlines or passenger ship companies and not through the individual passengers. Collecting airport taxes directly from passengers travelling in China is a very bad practice and an annoyance to the traveler. If an airport tax needs be collected it should be included in the ticket which the passenger pays when he buys the ticket.

A major concern of the residents of China and of the entire world today is the relation between the governments on the two sides of Taiwan Strait. The relation affects all aspects of life including China's foreign trade and investment, the topic of this conference. If the relation can be improved, it will be of great interest to all of us. The proposal to allow Taiwan residents to travel directly to the mainland can only improve the relation, in addition to promoting more investment from Taiwan. It is a win-win policy. Since this policy is one-sided, it could be terminated at any time if the Chinese government should find it desirable to do so. There is no risk in adopting this policy.

If the experiment with this policy is successful, the next step is to allow Taiwan cargo ships to come to the mainland directly. An appropriate charge to the ship can be levied. This would improve trade across the Taiwan Strait. We all understand that direct shipping has been occurring through the fishing boats. Why not make the direct shipping by Taiwan ships legal and collect the rightful dues? This would lower the cost of shipping and reduce the risk of shipping by the fishing boats. Direct postal services is a by-product of the policy. Once airplanes and passenger ships come directly from Taiwan they can carry mails, thus speeding up postal service between the two sides.

Relation between the two sides of the Taiwan Strait is not making much progress at this time. One step forward is recognized to be the opening of direct postal service and transport. Even this step has been stalled for several years. Fortunately, the government in Beijing alone can take the initiative to accomplish this step. I sincerely hope that it will take such a step without delay.

(The author is Professor of Economics at Princeton University.)