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China: Avoiding The Pitfalls Of Economic Transformation

Hong Kong, 17 September 1997 (RFE/RL) - The International Monetary Fund (IMF) says that China has been able to avoid most of the economic transformation pitfalls, which the nations of Central and Eastern Europe and Central Asia experienced when they started their moves down the road to market reforms, while preserving its basic political system.

Explaining this development, the fund's semi-annual update of its World Economic Outlook report issued today notes that Chinese central planning was "somewhat less pervasive than in the former Soviet Union" and that Beijing did not start with the "severe macroeconomic imbalances" that the nations in East and Central Europe and Central Asia faced.

Michael Mussa, Economic Counselor and Director of Research at the IMF, says that China proceeded in stages which were "very effectively controlled" to "avoid the extremely negative consequences of the collapse of the economic and political systems" that occurred in the former Soviet area.

The report says the Chinese reforms, begun in the 1970s without a detailed blueprint of ultimate goals or description of ways to get there, were adopted in an "incremental and experimental way" with considerable responsibility assumed by local governments.

It says the reforms typically followed a two-track approach under which existing mechanisms were retained, while new ones were adopted at the margin and then came to assume an increasingly important role.

For example, it says, when China launched domestic price liberalization, firms were permitted to sell increasing quantities of their output at market-determined prices as the proportion sold at controlled prices was progressively reduced.

Mussa told reporters in Hong Kong today that a very important element of the reforms has been the flexibility with which they were implemented.

Individual farmers and their families were allowed to sell their produce on markets alongside state farms, avoiding the idea of privatization, he said. "That proved to be a successful reform effort that stimulated a massive increase in the productivity of the agricultural sector, freeing up workers to move to the industrial sector," said Mussa.

When reforms started in 1978, says the report, 70 percent of China's labor force was in agriculture and most of the population lived in rural areas. Now, about 50 percent of the labor force works on farms.

This shift of rural workers to industrial sectors is seen by the fund's report as a potentially important explanation for the growth in residual productivity improvements registered in the last decade or more. Quite simply, it says resources were reallocated from low to high productivity sectors of the economy.

Mussa says the second phase of China's reform involved liberalization within the industrial sector and this stage was marked by flexibility as well. Beijing allowed a variety of state firms to diversify into other activities, while for others cooperative organizations were created. These were often attached to local governments, he says, but at least they were free from the state enterprise system.

As importantly, says Mussa, these firms were given the flexibility to operate essentially as market enterprises "in an economy in which the price system was allowed substantially greater flexibility to provide both incentive and discipline."

Mussa says this has contributed to China's "remarkable growth." During 1978 to 1996, China's real GDP (gross domestic product, a measure of the size of the economy) grew by an average of over nine percent per year, says the report, "contributing to a near quadrupling of per capita income and the lifting of millions out of poverty."

Over the same period, it says, many of the distortions and rigidities of the old central planning system were eliminated and market forces came to play an increasingly important role in economic decision making.

China has avoided the large output declines and severe macroeconomic instability that tended to characterize the transition experiences in Central and Eastern Europe and Central Asia, says the report.

Despite the glowing picture, the IMF report says, the agenda is still unfinished and China has problems with recurrent economic cycles, weaknesses in state enterprises and the financial sector, and a poorly performing tax system.

In addition, it says, "despite initial progress, income disparities have tended to widen," especially between urban and rural populations and this has contributed to the emergence of what the report calls "a floating population that is officially estimated at around 100 million."

Mussa says that Chinese officials seem to understand that it is now essential to reform the major central enterprises, "most of which are relatively inefficient by world standards and have built up large levels of debt within the domestic financial system."

Mussa says that like its neighbors in East and Central Europe and Central Asia, China must continue to make "further opening and liberalization of its economic system" an important part of moving forward.