When the history of the 20th century is chronicled, the year 1979 will assume special significance. While the world was gripped by the Iranian revolution, the Soviet Union’s invasion of Afghanistan, and Margaret Thatcher’s rise as prime minister, a seismic change was afoot in distant China. In the post-Mao nation, new leadership was heralding an economic transformation that would catapult a backward agrarian communist dictatorship into an economic superpower in under 50 years.
China's economic trajectory: an overview
Statistics published by the World Bank and China’s National Bureau of Statistics estimate that since 1979, China has lifted 800 million citizens from abject poverty. In that period of great reform, China’s economy has grown at an average of 7% annually. In PPP terms, the World Bank estimates that Chinese per capita income has risen from $965 to $19000. In our parents’ generation, China was known as the manufacturer of low-quality clothes and toys; today, it is known for its prowess in high-speed rail, artificial intelligence, and telecommunication. The title ‘factory of the world’ is often used to describe China. Most interestingly, while economic consensus prescribes institutional reform, inclusivity and openness, China has achieved tremendous progress under the aegis of the dominant Chinese Communist Party (CCP), leading to economists pondering the ‘China puzzle’. In this essay, China’s growth and reform journey, specific policy solutions and their consequences which led to instilling market orientation into a command economy are chronicles. This essay is written in a strictly normative sense: it is not a commentary on China’s political system or geopolitical ambitions.
China’s reform approach is popularised by the phrase ‘crossing the river by feeling the stones’. While former Soviet republics favoured a ‘shock therapy’ approach, China has followed a gradualist transition, allowing it to maintain both economic and political stability. Following this spirit, every successful Chinese policy has begun as a regional experiment, tried and tested at a provincial level before a national level rollout. In his seminal paper, Xu (2011) posits that the fundamental institution through which to understand China’s rise and limitations is the Regionally Decentralised Authoritarian regime (RDA). While economic power is devolved to the regional level, political power is undiluted and centralised.
After Mao’s death, it was clear to the party leadership that a mere transplantation of the Soviet economic model was economically catastrophic. Increasingly, the party leadership grasped that their legitimacy was derived not from sticking to the communist orthodoxy but delivering a higher standard of living to their citizens. Under the able leadership of Deng Xiaoping, China began its reform journey.
Source: World Bank
Rural reforms
Mao Zedong’s tyrannical experiments during the Great Leap Forward and Cultural Revolution had left the countryside in distress. Chinese agriculture – the dominant sector in the economy- was plagued by famines, food shortages, surplus unproductive labour, and obsolete techniques. Communalised agriculture had deprived farmers of an incentive to work hard and innovate. To that end, the first brush of reforms was doled out in rural China.
Prior to 1979, Chinese agriculture was organised in communes and all farm output was confiscated by the state; land reform was a taboo subject. The Household Responsibility System (HRS) began the pivot towards a household-based approach.
Beginning as a regional experiment in Fenyang County, Anhui Province, the HRS system revitalised Chinese agriculture. Households were allowed long-term land contracts and were empowered to make their own production decisions, bearing both the risk and the rewards. They were also permitted to sell surplus output at market prices, providing them with an incentive to increase production and efficiency. The World Bank estimates that between 1979 and 1984, grain production increased by 42%. In the same period, the rural poverty rate fell from 53% to 12% (Lin, 1992).
The success of the reform emboldened the Chinese leadership to be more ambitious: to unleash the latent talent and economic potential of Chinese countryside. In that spirit, the idea of Town and Village Enterprises was conceived (TVEs), which proved crucial to China’s development.
Town and Village Enterprises (TVEs)
Having transplanted the Soviet model of heavy industry dominated by state-owned enterprises (SOEs), Chinese industry was plagued by inefficiencies, shortages, unproductivity, poor management and a lack of responsiveness to market signals.
TVEs were rural enterprises owned by communities that produced labour intensive commodities to meet domestic and international demand. TVEs embraced market reform; they also tapped the surplus agricultural labour and potential of China’s vast rural areas. These industries included labour-intensive manufacturing such as textiles, toys and accessories; food processing and construction. Most significantly, TVEs provided employment, reduced rural poverty, and unleashed the entrepreneurial talent of Chinese citizens and instilled in them an orientation to the market. Owing to TVEs, China’s exports rose from $1 billion in 1978 to $50 in 1988 (Zhang & Li, 2003). TVEs' share of China’s total employment rose to 50% in 1988 (Naughton, 1995). Embracing Hayek’s philosophy of ‘local information’- a lack of which plagues command economies- TVEs fostered economic decentralisation, allowing local communities to establish their needs, and fulfilling them.
Buoyed by these successes, Chinese leadership set out to reform China’s dominant state-led industry sector (SOEs).
SOE reform
While SOEs provided the industrial base to the Chinese economy, they were widely inefficient, unproductive and uncompetitive. They were fiscally undisciplined and overly reliant on government subsidies and bailouts. To reform the SOEs, managers were firstly given powers; they were picked on merit rather than patronage. Additionally, managers were allowed to retain profits and invest them; they were allowed to sell a share of the output at market prices, embracing China’s dual track approach. Moreover, SOEs were encouraged to part with uncompetitive sectors, and private players and foreign investors were allowed in.
Up to this point, China’s exports were mainly labour intensive and low quality. With a degree of significant economic achievements under its belt, China was ready to open: to become the export-oriented economy it is today, with a high degree of trade openness.
Special Economic Zones (SEZs)
The idea of special economic zones (SEZs) was conceived after Deng’s historic visit to the coastal provinces of Fujian and Guangdong in 1992. The SEZs were a testing ground for market-based solutions, price and profit motives, and unleashing China’s creative potential. SEZs were deliberately created in coastal areas to attract foreign investment, which was lured by tax breaks, incentives and cheap skilled labour. To boost domestic capabilities, foreign companies transferred technology and vital skills to domestic manufacturers, often through setting up joint ventures. The objective was to create a competitive and export-oriented economy. Over time, the number of SEZs vastly increased. Between 1980 and 2022, they attracted over $1 trillion in foreign investment and created over 50 million jobs (Zhang & Zhang, 2014). To further China’s foray into high-technology areas, the idea of high-tech zones (HTZs) was conceived.
High Tech Zones (HTZs)
Special HTZs were created to attract investment in high technology ventures, research and development and production facilities. These zones fostered a collaboration between universities, foreign investment and domestic industry, bolstering China’s position in the global technology value chain.
Similarly, China created industry clusters for interconnected businesses and institutions facilitating sharing of information, infrastructure and resources, and enabling spillover effects. These clusters provide employment opportunities to China’s skilled workers and provide a base for innovation. The best example of this is Zhongguancun, dubbed as 'China’s Silicon Valley’.
China’s exceptional economic progress has come on the backs of economic and political stability maintained by the regime through maintaining the hegemony of the CCP, diluting economic power, adopting a gradualist approach to reform, maintaining a favourable exchange rate, and acceding to the WTO. But above all, China’s heavy investment in infrastructure development and human capital have paid rich dividends.
Infrastructural development
To achieve an astonishing growth rate and sustain economic progress, China had to upgrade its transportation facilities, factories and machinery, energy and telecommunication infrastructure. The infrastructure boom has enabled the vast country to be connected and has allowed for an exchange of capital, goods and labour. To that end, public-private partnerships were forged, and infrastructure banks were created. Today’s China has the world’s largest high-speed rail network, with over 35,000 km of tracks. China has been a pioneer in 5G and has the world’s largest internet base (World Bank, 2021).
Human capital
Secondly, since 1979, China has devoted significant resources to developing its human capital. China’s GDP share devoted to healthcare and education has risen steadily, as have literacy rates and college enrolments. To provide a safety net to its citizens, China has doled out generous welfare schemes, such as pensions and healthcare subsidies. Compared to rich Western economies, China devotes a larger share of income to R&D, building a strong base for productivity increases.
In the education sector, China has strived to achieve a balance between formalised schooling - having built excellent universities and allowed foreign universities to set up shop - and technical and vocational training schools. In the years after 1979, China sent scores of students abroad to Western universities to learn the ‘best practices' and employ those skills in China.
The road ahead
While China has made tremendous progress, its per capita income still lags behind its Western counterparts, leaving large scope for further growth. While China is a leader in important industries such as technology, artificial intelligence, computing, robotics and clean energy, it faces an increasingly hostile world. Chinese meddling in domestic companies discourages bold initiatives and innovation. A perennial fear - which emanates from China’s one-child policy - is of premature ageing: that China simply lacks the population dividend to achieve its economic ambitions. In the coming years, China’s economic trajectory will be keenly watched. Being the ‘factory of the world’, a slowdown in Chinese industrial production will hobble global supply chains, a trend to be closely monitored as the West seeks to decouple its economies from China. Despite the uncertainty surrounding China’s economic future, the country has made tremendous economic progress at an unprecedented pace, following its own economic model and reform path, unique to its sociopolitical situation, making it a subject worth studying.
Article by Mihir Joshi
Edited by Lara Gigov (Editor-in-Chief)
References
Cable, V. (2022) MONEY AND POWER: the world leaders who changed economics.
Lin, J. (1992) 'The household responsibility system in rural China: A reform model for the developing world' World Development, Vol. 20, No. 12, pp. 1613-1630.
Lin, J. (2011) 'China and the global economy' Proceedings, Federal Reserve Bank of San Francisco, pp. 213-229.
Naughton, P. (1995) The transformation of the Chinese economy. Cambridge University Press.
World Bank (2023) World Bank Open Data. Available at: World Bank Open Data | Data
World Trade Organisation (2023) Available at: World Trade Organization - Home page - Global trade (wto.org)
Xu, C., 2011. The fundamental institutions of China's reforms and development. Journal of economic literature, 49(4), pp.1076-1151.
Yueh, L (2013) China’s growth: the making of an economic superpower. Oxford, United Kingdom: Oxford University Press.
Zhang, J. & Zhang, Y. (2014) China's special economic zones: From experiment to model. Routledge.
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