Transcript Development Economics – Econ 682

Chapter 19
Stabilization,
Adjustment,
Reform &
Privatization
CHAPTER 4
©E.Wayne Nafziger Development Economics
1
Stabilization, Adjustment, Reform
& Privatization


Economic adjustment (sometimes used
broadly) can refer to structural or sectoral
adjustment, macroeconomic stabilization,
& economic liberalization & reform.
Adjustment often requires LDCs &
transitional countries to borrow from &
meet conditions set by the World Bank &
IMF as a last resort.
CHAPTER 19
©E.Wayne Nafziger Development Economics
2
Scope of chapter






Adjustment & stabilization (especially by
World Bank & IMF) in LDCs.
Public enterprises & role of public goods.
Importance of government sector.
Concept of state-owned enterprises (SOEs).
Size of SOE sector.
Arguments for public enterprise.
CHAPTER 19
©E.Wayne Nafziger Development Economics
3
Scope of chapter (continued)





Performance of private & public
enterprises.
Determinants of public enterprise
performance.
Privatization.
Pitfalls of privatization.
Public enterprises & multinational
corporations.
CHAPTER 19
©E.Wayne Nafziger Development Economics
4
Scope of chapter (concluded)


Adjustment, stabilization, &
liberalization in economies of
transition, especially Russia, China, &
Poland.
Lessons LDCs can learn from Russian,
Polish, & Chinese transitions to the
market.
CHAPTER 19
©E.Wayne Nafziger Development Economics
5
World Bank

Interest subsidy account for poorest
countries [International Development
Association (IDA)].
CHAPTER 19
©E.Wayne Nafziger Development Economics
6
Balance of payments equilibrium

International balance on the goods and
services balance over the business
cycle, with no undue inflation,
unemployment, tariffs, and exchange
controls.
CHAPTER 19
©E.Wayne Nafziger Development Economics
7
Chronic external deficits
require borrowing


Often from International Monetary Fund
(IMF) as lender of last resort.
A member borrowing from the IMF (in
excess of member’s reserve contribution)
agrees to certain performance criteria, with
emphasis on long-run international balance
and price stability.
CHAPTER 19
©E.Wayne Nafziger Development Economics
8
IMF conditionality (i.e., conditions)




The borrower adopts adjustment policies to attain
a viable payments position.
Conditionality involves a quid pro quo for
borrowing.
IMF requires adjustment policies as necessary for
preserving the revolving nature of IMF resources.
Policies may require that government reduce
budget deficits through increasing tax revenues
and cutting back social spending, limiting credit
creation, achieving market-clearing prices
liberalizing trade, devaluing currency, eliminating
price controls, or restraining public-sector
employment and wage rates.
CHAPTER 19
©E.Wayne Nafziger Development Economics
9
Internal & external balance



Internal balance – Balance or equilibrium
in the domestic macroeconomy, including
full employment and price stability.
External balance – An international
balance on goods and services balance.
In Figure 19-1, you switch (change
exchange rate) or reduce expenditures so
that S-I intersects with X-M at full
employment.
CHAPTER 19
©E.Wayne Nafziger Development Economics
10
CHAPTER 19
©E.Wayne Nafziger Development Economics
11
Critique of World Bank & IMF
Adjustment Programs







Excessive emphasis on austerity programs: contractionary
monetary & fiscal policies.
Emphasis on short term rather than long-term structural
change.
Too little emphasis on maintaining growth.
Too little emphasis on protecting underprivileged or
vulnerable (although sometimes this may be the fault of the
domestic government’s priorities).
Programs frequently do not improve external accounts.
National adjustment plans superior to World Bank and IMF
initiated plans.
Sequence of liberalization may worsen adjustment and
growth.
CHAPTER 19
©E.Wayne Nafziger Development Economics
12
Adjustment and Liberalization in
Eastern Europe, the Former Soviet
Union, and China

IMF, World Bank & European Bank for
Reconstruction & Development (EBRD),
which loans to Eastern Europe & former
Soviet Union, indicates that virtually all
developing & transitional countries need
to adjust & reform.
CHAPTER 19
©E.Wayne Nafziger Development Economics
13
IMF Managing Director Jacques
de Larosiere (1987)


“Adjustment is now virtually universal
[among LDCs]. . . . Never before has
there been such an extensive yet
convergent adjustment effort” (IMF
Survey, February 23, 1987, p. 50).
Since communism’s collapse, the IMF
would add transitional countries to other
LDCs.
CHAPTER 19
©E.Wayne Nafziger Development Economics
14
Socialism collapsed in Eastern Europe
about 1989 & the Soviet Union in 1991


All faced painful transitions to a market
economy, with falling real GDP, high
unemployment, high inflation, & increased
poverty & inequality in initial years of
transition, before positive growth &
improvement in other key variables.
Transition is like a valley between the 2 hills
of communism & capitalism
(Fig. 192).
CHAPTER 19
©E.Wayne Nafziger Development Economics
15
CHAPTER 19
©E.Wayne Nafziger Development Economics
16
Sequence of turning points


Poland (1991), Slovenia (1992), Hungary
(1992-94), Czech Republic (1992-94),
forming a W with later growth reversal),
Slovakia (1993): only countries to recover
to pre-1989 GDP levels by 2001.
Russia attained its turning point in 1998,
about the time of ruble devaluation.
CHAPTER 19
©E.Wayne Nafziger Development Economics
17
Russia



Adjustment for black market may mean
1994 GDP was 67 (not 48), with
1990=100.
But consumption/income increased,
consumers had greater choice of goods, &
less waste of central planning.
Schleifer (2004) sees Russia as a “normal”
middle income country, almost recovering
1990 GDP levels by 2001.
CHAPTER 19
©E.Wayne Nafziger Development Economics
18
CHAPTER 19
©E.Wayne Nafziger Development Economics
19
Table 3-1. Annual Rates of Growth of Real GNP per Capita
(percent), 1870-1998
6
4
5
3
4
5
1870 to
1913
1913 to
1950
1950 to
1973
1973 to
1998
1870 to
1998
Multiplication of
1870 GNP per
capita in 1998
Japan
1.48
0.89
8.05
2.34
2.63a
27.6a
United States
1.82
1.61
2.45
1.99
1.90
11.2
Germany
1.63
0.17
5.02
1.60
1.81
9.8
Argentina
2.50
0.74
2.06
0.58
1.53
7.0
United Kingdom
1.01
0.92
2.44
1.79
1.39
5.9
Australia
1.05
0.73
2.34
1.89
1.35
5.6
Russia-USSR
1.06
1.76
3.36
 1.75
1.11
4.1
China
0.10
2.86
5.39
1.70
8.70
India
0.54
1.40
2.91
0.89
3.10
 0.62
 0.22
Maddison 2001:186, 196, 216, 265.
CHAPTER 19
©E.Wayne Nafziger Development Economics
20
Former Soviet Union (FSU) people
misinterpreted pauperization


Dudrick et al’s (2003) characterization of the
people of Georgia:
“The fact that the . . . economy collapsed
after the actual political breakup of the
Soviet Union led [many people] to attribute
their pauperization to the demise of the
Soviet state . . . rather than its inherent
economic weaknesses. They continued to
associate the Soviet Union with economic
stability.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
21
Evolution vs. “shock therapy”



Should transition to the market be gradual
or abrupt?
Sachs (1999), advisor to Poland’s Lech
Walesa & Russia’s Boris Yeltsin argues for
an abrupt transition to the market.
Popov (2001) contends that shock
therapists emphasized “introducing the
whole reform package at once to ensure
that it became too late and too costly to
reverse the reforms.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
22
Wachtel, an evolutionist (1992)



Shock therapy downplays the creation of a
small-scale private sector, small independent
banks, market reforms in agriculture, “safety
net” for social programs, & full employment.
Poznanski (1996): institutions form at
relatively slow pace.
By mid-1990s, electorates in Poland, Russia,
& Hungary, disillusioned with market
reforms, voted the former Communist Party,
refashioned as social democrats or democratic
socialists, to parliamentary plurality in place
of economic reform.
CHAPTER 19
©E.Wayne Nafziger Development Economics
23
Sachs’ rejoinder (1994)



The Soviet Union’s production was in
decline, inflation rates were surging, & the
black market value of the ruble was falling
in the immediate years before Yeltsin’s
transitional government came into power in
late 1991.
U.S. & IMF disbursed aid too slowly.
“Shock therapy” never failed because it
was never tried.
CHAPTER 19
©E.Wayne Nafziger Development Economics
24
Popov (1996): Russian reform was
inconsistent shock therapy


Failed in macroeconomic stabilization,
eliminating subsidies, & shutting down
loss-making enterprises.
Pressure of interest groups & lack of
consensus: Russia had little choice but to
tolerate a high rate of inflation in the early
1990s (Table 19-2).
CHAPTER 19
©E.Wayne Nafziger Development Economics
25
CHAPTER 19
©E.Wayne Nafziger Development Economics
26
Inflation costly for those
on fixed incomes

A Ukraine woman: “When I retired, I had
20,000 rubles in my savings account. . . .
But what the government did with it – the
government we trusted with our money!
They’ve indexed savings so that inflation
ate it! That money is now not enough for
bread and water” (World Bank 2001).
CHAPTER 19
©E.Wayne Nafziger Development Economics
27
Reddaway & Glinski,
Market Bolshevism


Yeltsin & his advisers promoted shock
therapy in late 1991 as part of a “Russian
historical pattern of ‘revolutions from
above.’”
They resisted opposition to the encrusted
Soviet party and state leadership, the
nomenklatura.
CHAPTER 19
©E.Wayne Nafziger Development Economics
28
Soviet Union net material product
(NMP)


Fell 3% 1981-1990.
Collapsed in early to mid-1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
29
What brought the Soviet Union down
(Gorbachev, 1985-1991 Soviet leader)



“What happened to the Soviet Union happened
mainly for domestic reasons. It was a failure of the
model based on a command economy and
dictatorship.
The rejection of freedom and democracy, the decision
making monopoly of one party, and the monopoly of
one ideology all had a chilling effect on the country.
That model turned out to be incapable of making
structural changes. It did not open up ways for
initiative and was overly centralized.” (Gorbachev
2003).
CHAPTER 19
©E.Wayne Nafziger Development Economics
30
What were the reasons for the
collapse of the Soviet state and the
slow growth of Russia in the 1990s?

Distorted incentives & price signals: Soviet
material balance planning, the detailed
allocation by central administration of the
supply and demand for basic industrial
commodities, was slow, cumbersome,
lacked clarity, and distorted incentives.
CHAPTER 19
©E.Wayne Nafziger Development Economics
31
Distorted incentives &
price signals




Targets unclear.
Toward end of period, firms sometimes
“stormed” to reach target.
At other times, units deliberately slowed
down operations so as not to increase
targets too much for the subsequent period.
Management’s motivation: to hide the true
capabilities of the plant from planners.
CHAPTER 19
©E.Wayne Nafziger Development Economics
32
1. Distorted incentives & price signals


Problems of overordering & hoarding labor
& raw materials.
Incentives rewards managers for
maximizing output not profit. Or if profit
used, poor guide when prices are set
without reference to supply & demand.
CHAPTER 19
©E.Wayne Nafziger Development Economics
33
2. The party & state monopoly


Communist Party (CP), with its
interlocking & overlapping authority over
the Soviet government, had monopoly over
political & economic power.
“Redness” (political correctness) more
important criterion than expertness in
making decisions.
CHAPTER 19
©E.Wayne Nafziger Development Economics
34
CP controlled the state



CP bore full burden of economic
management.
CP’s interest: gained from concentration &
limiting competition, as managers &
workers reap rewards from increased
enterprise profits & revenues.
Those dissatisfied with economic
performance were a challenge to the
political order.
CHAPTER 19
©E.Wayne Nafziger Development Economics
35
CP controlled the state




Reforms encouraging entrepreneurial activity
meant Old Guard received advantages in
obtaining permits & access to funds.
Under reform, managers, bureaucrats, & party
apparatchiks gained control of the more viable
socialist enterprises through privatization.
In many instances, government officials looted
the enterprises, either controlling the newly
privatized firms or leaving no assets for others.
Much privatization involved large-scale giveaway to insiders.
CHAPTER 19
©E.Wayne Nafziger Development Economics
36
Soviet leadership fused
state with economy




Built-in bias against change.
State socialism in post-Stalin period
became softer, leakier, & less oppressive.
Soviet leadership did not recognize greater
autonomy of decentralized unit.
Sequestering of surpluses reduced by
central government, eroding revenue
collection.
CHAPTER 19
©E.Wayne Nafziger Development Economics
37
Is state socialism reformable?


Kaminski (1992): no. Direct controls
essential for party & state to defend
privileged position.
Party officials & apparatchiks opposed
reform because it reduced power & ability
to solicit kickbacks & other benefits.
CHAPTER 19
©E.Wayne Nafziger Development Economics
38
Nomenklatura system



Party & state used nomenklatura system,
power to recommend & approve managers.
Millar (1994): the “party” is over, but
nomenklatura lives on. Nomenklaturs
repositioning itself to control new private
economy.
Reddaway & Glinski (2002): Yeltsin favored
commercialized nomenklatura & supporters
in West, at expense of middle class &
democrats: road toward market bolshevism
or authoritarianism.
CHAPTER 19
©E.Wayne Nafziger Development Economics
39
Decision making in Soviet Union
highly centralized


CP, President, Politburo (CP’s policy
setting body), Gosplan (State Planning
Committee reporting to Politburo).
Gorbachev (1985-1991) removed Gosplan
& central management, decentralizing units
were free to do what they thought best,
destabilizing the economy.
CHAPTER 19
©E.Wayne Nafziger Development Economics
40
Gorbachev sequenced Perestroika
(restructuring) wrongly



Decision making decentralized without
introducing market.
Enterprises made deliveries at state
agencies at set prices, not adjusted to
reflect supply & demand.
Number of centrally distributed
commodities fell from 13,000 (1987) to
618 (1989).
CHAPTER 19
©E.Wayne Nafziger Development Economics
41
State made production decisions



No longer disaggregating these decisions at
enterprise level.
Enterprises stopped producing low-profit
items, reducing machinery, metals,
chemicals, & wood produced.
Russian leaders did not replace abolished
socialist institutions with capitalist
institutions (Kotz 1992).
CHAPTER 19
©E.Wayne Nafziger Development Economics
42
Ruling stratum in Soviet-type
economies maximized economic rents





CP used nomenklatura to achieve goals.
Appointments based on loyalty not management.
Russia’s economy “nomenklatura privatization”
(Goldman 2003).
Economic oligarchs from nomenklatura, former
factory managers, & marginal persons operating
outside the law during communism (Goldman).
After 1991, planning & distribution changed
names but still goal of market competition
(Afanasyev 1994).
CHAPTER 19
©E.Wayne Nafziger Development Economics
43
Nomenklatura privatization



Much of country’s wealth transferred into
hands of CP’s senior officials (began in late
1980s).
Masqueraded as liberalism.
Ironically capitalist nomenklatura &
nouveau rech allies oppose CP, committed
to nationalization.
CHAPTER 19
©E.Wayne Nafziger Development Economics
44
3. Contradictions under decontrol




1970s & early 1980: central authority fell.
Shadow economy (black market) grew from 6%
(1960) to 23% (1988).
Gorbachev thought problem in 1970-85 was
“relaxation of discipline.”
Gorbachev’s solution: excess increase in machine
building, anti-alcohol campaign, undermined
black market (essential to circumvent rigidity of
material balance planning), reduced economic
rewards & punishment, attacking bureaucrats
(demoralizing them).
CHAPTER 19
©E.Wayne Nafziger Development Economics
45
Perestroika (economic restructuring)
and glasnost (openness)
delegitimized authority



Late 1980s & early 1990s: murders,
bribery, corruption, & other registered
crime increased considerably.
Organized crime controlled 20% of new
enterprises in the 1990s (Eaves).
Mayor Sobchak (St. Petersburg): country
out of control, because old structures
destroyed & new ones not emerged (Eaves
1992).
CHAPTER 19
©E.Wayne Nafziger Development Economics
46
Decontrol of economic activity





New opportunities shielded illegal activity, such
as asset-stripping & favorable buyouts under
rubric of privatization.
Thousands of mafia gangs had connections to
major sections of government bureaucracy.
Mafia increased cost of business & discouraged
foreign investment.
Will liberalization contain mafia & shadow
economy or make it difficult for Russian
entrepreneurs to survive?
Boundary between criminal & legal business
activity is hazy.
CHAPTER 19
©E.Wayne Nafziger Development Economics
47
4. Distorted information



Late 1980s, culminating in 1991: rulers no
longer collected information about
economic opportunities, enforced planning
preferences, or received feedback on
performance.
Why? Officials & subordinates withheld,
distorted, or manipulated information for
their own advantage.
Scarcity of information during 1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
48
Enterprise monopolies





1991: 77% of 7664 product groups produced by
single firms. Average Russian firms employed 800
workers, much larger than West or Poland.
To avoid turnover taxes, Russian firms highly
vertically integrated & plagued by gigantimania.
Suppliers were monopolists, bargaining with other
monopolists.
Critics argue that transitional authorities should
have demonopolized, breaking up large industrial
concentrations, but difficult to split up.
Popov (1996): foreign trade deregulation &
currency convertibility would have undermined
monopolies.
CHAPTER 19
©E.Wayne Nafziger Development Economics
49
5. Lack of scarcity prices



Soviets allocated resources inefficiently,
disregarding scarcity prices.
Planners allocated funds bureaucratically,
ignoring interest rate in allocating capital.
In late 1980s, Russia used 15 X steel, 9
times rubber, & 6 X energy that U.S. did
per unit of GDP.
CHAPTER 19
©E.Wayne Nafziger Development Economics
50
Industrial output value subtractor



Meaning, e.g., factories used rubber tires
whose world market prices were less than
value of raw material embodied in them!
No boom in Russian manufacturing since
1991.
Russia’s adjustment of industrial output
unable to compete at world prices. Russia
adjusted less than East-Central Europe,
where prices were closer to world level
(Popov 1996).
CHAPTER 19
©E.Wayne Nafziger Development Economics
51
Why wage arrears?




Firm negative value added.
Demand for hard budget accountability.
Many firms returned to barter, paying
workers with, e.g., caskets, lingerie, or
bricks, the final product.
Firms sometimes forced into arrears
because other units (government was the
worst offender) did not pay their creditors.
CHAPTER 19
©E.Wayne Nafziger Development Economics
52
Administered prices

-

Losing farms received subsidies.
State farms paid wages similar to
factories.
Giant state monopoly, Agroprom, which
received incredible subsides, hampered
agricultural output growth.
Wrong (non-market) wage & price signals
don’t motivate increased productivity.
CHAPTER 19
©E.Wayne Nafziger Development Economics
53
6. Overvalued ruble




1991-98.
Before 1998, much capital flight
In August 1998, ruble lost > 60% of value,
triggering immediate inflation and
reduction in real output.
August 1998 debt default not necessary if
Russia had changed exchange rates with
inflation.
CHAPTER 19
©E.Wayne Nafziger Development Economics
54
7. Negative real interest rates


Inflation, often > than 100% yearly, was in
excess of cost of borrowing.
Positive real interest rates would have
raised cost of financing stocks &
inventories, making rubles worth more
than goods, encouraging selling of stocks.
CHAPTER 19
©E.Wayne Nafziger Development Economics
55
8. Consumer sector as buffers



Food & basic consumer goods, which
could be reduced, were buffer under
planning when higher priority sectors
(steel & defense) scarce.
Prices at less than market meant long
lines, shortages, & low quality,
dampening personal incentives & worker
productivity.
Has taken many years to recover from
Soviet lack of investment in food
production.
CHAPTER 19
©E.Wayne Nafziger Development Economics
56
Distortions from inflation




Inflation increased 112,000-fold from
1990 to 1994.
Inflation driven by excessive credit
creation (at 10% interest yearly) to state
enterprises.
Subsidies were 24.5% of GDP in 1992.
Government saved credit system, creating
perverse incentives & numerous
distortions (but as Popov claimed,
inflation & distortion are preferable to
civil war).
CHAPTER 19
©E.Wayne Nafziger Development Economics
57
9. Soft budget constraint

-
-
Lack of financial penalties when enterprises or
projects fail.
Virtually no firm penalized for losses.
Few experienced market’s creative destruction,
where industry’s old, high-cost producers are
replaced by new, low-cost producers.
Banks continued to loan to fellow nomenklatura.
Firms entered & exited in no relationship to
profitability (Kornai).
CHAPTER 19
©E.Wayne Nafziger Development Economics
58
How does socialism’s legacy soften
firm’s budget limitation




1/ Government grants soft subsidies in response
to lobbying or bargaining by influential
apparatchiks or officials.
2/ Rules for taxation not uniform. Tax payments
can be reduced by pressure & pleading.
3/ Banks tend to loan to firms in trouble or whose
managers complain.
4/ Contracts between buyers & sellers are not
free, especially when ministries are involved.
CHAPTER 19
©E.Wayne Nafziger Development Economics
59
Meaning of soft budget constraint


Hardness means serious consequences
form deficit.
Softness arises from external help to
protect firm from loss of jobs,
redistribution of resources to weak
enterprises, & guarantees of security and
survival to influentials.
CHAPTER 19
©E.Wayne Nafziger Development Economics
60
10. Inability to collect taxes

-
-
-
After 1991, Russia had difficulty raising
revenue.
1/ no longer turnover tax or monopoly
from foreign trade earning.
2/ growing size of shadow economy (1/3
of GDP).
3/ refusal of many firms to pay taxes
essential for legitimacy & public services.
CHAPTER 19
©E.Wayne Nafziger Development Economics
61
Revenue decline as proportion
of GDP in Russia


Tax revenue/GDP declined from 47.2% in
1990 to 26.1% in 1995, lower percentage
than in Hungary, Estonia, & Ukraine, and
much lower than OECD countries.
Although health care, education, other
social spending, & defense were cut
dramatically in 1990s, most government
programs were kept half-alive, halffinanced, & barely working (Popov 1996).
CHAPTER 19
©E.Wayne Nafziger Development Economics
62
11. “Torn” safety net



Soviet legacy of “company town,” in which
Russian employers provides apartment
space, land for house & vegetables, medical
care, schools, specialized advanced
education, subsidized cafeterias & buffets,
recreational facilities, travel, vacation
sanatoria, & food, clothing, & hardware
stores.
Welfare system was linked to the enterprise.
After communism’s collapse, firm owners
reluctant to dismiss employees.
CHAPTER 19
©E.Wayne Nafziger Development Economics
63
12. Increase in inequality &
poverty



After 1991, inequality increased greatly
(Gini=45.6 in 2000).
Wage earners, pensioners, & government
officials without access to wealth in private
sector were hurt in shift to market,
especially with hyperinflation.
Tuberculosis, typhoid fever, & cholera,
virtually eliminated, reappeared in early
1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
64
13. Lack of market institutions



Collapse of state & non-state institutions
without replacement.
Reflection of collapse of institutions:
dollarization, barterization, poor
enforcement of contracts & law,
increased crime (Popov).
Land property rights poorly established.
Farming population resisted privatization.
CHAPTER 19
©E.Wayne Nafziger Development Economics
65
14. Neglect of services


Soviet Union overindustrialized,
neglecting services.
Services replaced slowly.
CHAPTER 19
©E.Wayne Nafziger Development Economics
66
15. Lack of technological progress



Soviets’ low (negative in late 1980s) total
factor productivity growth because of
exhaustion of input growth.
Khrushchev: bureaucrats do not want to
change from old nag to race horse, as he
might tear away on turn & spill them out of
the sleigh.
Soviet managers resisted innovation, as
resources for it threatened plan fulfillment.
CHAPTER 19
©E.Wayne Nafziger Development Economics
67
16. Military-industrial complex


Unprecedented peacetime cost of military
expenditures in 1970s, 1980s, & early
1990s.
Russia’s military contributed twice the
share of GDP of U.S. in late 1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
68
17. Environmental degradation



Major contributor to fall in life
expectancy: 70 in 1978-92 to 65 in 19942003.
Feshbach-Friendly: Soviet Union died by
ecocide through plundering rich natural
resources & systematic neglect &
poisoning of Soviet people.
Chernobyl (1986) & seas & lakes
poisoned.
CHAPTER 19
©E.Wayne Nafziger Development Economics
69
18. Collapse of trade among
communist countries




Russia’s trade with Eastern Europe fell by 1989
(when most East-Central European countries
started transition) to 1990 by > 50%.
Inter-republic trade in former Soviet Union
(FSU) fell by 46% from 1991 to 1992.
Popov (1996) argues that the collapse of interCOMECON & inter-republican trade was a
result of changes in relative prices, meaning
fuel importing countries could no longer
finance trade deficits with Russia.
Popov estimates supply shocks triggered 40%
decline in GDP.
CHAPTER 19
©E.Wayne Nafziger Development Economics
70
Initial Conditions: Liberalization,
Institutions, & Democratization:
A Summary

Angjellari’s econometric analysis (2003)
identifies initial conditions, institutional
development, democratization, &
liberalization as major variables explaining
differences in real GDP growth among 25
transitional countries (5 growing & 20
declining) of the former Soviet Union &
East-Central Europe in the 1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
71
Russia’s legacy of the Soviet
period: initial conditions in 1991






Distorted incentives & price signals.
Party & state monopoly.
Inconsistencies under openness &
decontrol.
Distorted information.
Enterprise monopoly.
Lack of scarcity pricing.
CHAPTER 19
©E.Wayne Nafziger Development Economics
72
Russia’s legacy







Consumer sectors as buffers.
Soft budget constraints.
Lack of market institutions.
Neglect of services.
Lack of technological progress..
Burden of military-industrial complex
Degraded environment.
CHAPTER 19
©E.Wayne Nafziger Development Economics
73
Important factors affecting Russia’s
economic performance by period



Initial conditions important in early
1990s.
Slow progress in liberalization &
marketization important in early &
middle 1990s.
Slow institutional development
important in later 1990s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
74
Little progress in institutional
development in late 1990s in Russia










Development of markets:
antitrust protection.
demands for high budget constraints.
creative destruction of inefficient firms.
alternatives to nomenklature leadership.
capacity to raise taxes.
Development of alternative institutions for health &
welfare:
Institutions to foster technological innovation.
Development of accurate data sources.
Government agency to support environmental
protection (Angjellari 2003).
CHAPTER 19
©E.Wayne Nafziger Development Economics
75
Democratization important in affecting
structural reform (liberalization) &
institutional reform (Angjellari 2003)


Freedom House (2003) ranks Russia as “partly
free,” noting the “powerful oligarchic interest and
wide discrepancies in income that have an impact
on the rule of law & equal political participation.
“Russia has lost considerable ground in its
protection of basic political rights & civil liberties
over the last seven years, . . . experienc[ing] an
overall decline since 1997 in . . electoral process;
civil society; independent media; governance; and
constitutional, legislative, and judicial
frameworks.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
76
Russia as “illiberal democracy
(Cornia & Popov 2001:17)

Moscow-based journalist Masha
Gessen (2003) characterizes the Russia
of President Vladimir Putin (2000- ) as
a “managed democracy.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
77
William Smirnov, Deputy Head,
Institute of State & Law, Russian
Academy of Sciences (2003)

Russia, rather than being a “fully-fledged
democracy,” is an “electrocracy,” in which the
political and business elite isolated themselves
from the unwanted part of society. Other
stratums became isolated despite their will,
mostly because of destitution. Small layers of
the elite privatized not only most of the public
property, but also huge chunks of state, justice
and legal systems. Regional “czars” adopted
their own constitutions and decrees.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
78
Lack of democratization &
development of civil society


Civil society: Institutions independent of
the state – private and nongovernmental
entities such as labor unions, religious
organizations, educational and scientific
communities, and the media.
This lack hampered market &
institutional reform, leaving Russia well
behind such rapid reformers as Poland,
Slovenia, and Hungary.
CHAPTER 19
©E.Wayne Nafziger Development Economics
79
Poland’s Transition to the Market



Poland’s transition from socialism to the market
was more successful than Russia’s and may
have been more successful than any country of
the former Soviet Union and East-Central
Europe.
Polish success underlines the importance of
initial conditions and institutional development.
Poland was the earliest transitional economy to
stop its slide in output, in 1992, and the first to
attain pre-transition GDP, in 1996 (Figure
19-2).
CHAPTER 19
©E.Wayne Nafziger Development Economics
80
Poland compared to Russia



Poland’s history under socialism, only
since World War II, was shorter than
Russia’s.
Russia’s socialism was more centralized
and totalitarian than Poland’s was.
Poland had sources of opposition to
communism in the Roman Catholic
Church, (and after 1980) the Solidarity
labor union (led by Lech Walesa), and the
intelligentsia.
CHAPTER 19
©E.Wayne Nafziger Development Economics
81
Changes in Poland before 1989


Since 1970, Poland had a gradual
disintegration of planning and a parallel
reemergence of capitalist markets,
changes that made the post-1989 reforms
less momentous (Poznanski 1996:ix).
Poland’s businesses faced fewer
government restrictions and fewer
deamdns by bureaucrats for bribes (Raiser
2001:232).
CHAPTER 19
©E.Wayne Nafziger Development Economics
82
Changes in Poland before 1989

Reforms during the 1980s failed to
increase productivity and contributed
to a “cataclysmic” balance-ofpayments crisis, but created market
institutions that were further
strengthened after 1989.
CHAPTER 19
©E.Wayne Nafziger Development Economics
83
Poland’s changes in 1989




Central planning ended.
Prices decontrolled.
Legal system established to support
decentralized actions of private
property owners.
Commercial code, company law, and a
system of judicial enforcement of
contracts from before World War II
were established (Sachs 1993:35-78).
CHAPTER 19
©E.Wayne Nafziger Development Economics
84
Poland’s private sector




Agriculture was never collectivized.
Outside agriculture, private sector share of
GDP was about 35% in 1989 (Raiser
2001:232).
By 1991, most of the private sector was
indigenous new enterprises and expanded
private entities rather than state-owned
enterprises that were privatized (Poznanski
1996:240).
In the first 30 months after mid-1991, the
beginning of stabilization, 700,000 new
businesses were started.
CHAPTER 19
©E.Wayne Nafziger Development Economics
85
Poland’s private sector (cont.)


At the end of 1993, half the employment
and GDP was in the private sector (Sachs
1993:xii).
By 1997, there were 10 legally registered
enterprises per 100 persons, close to the
Western average, but compared to less than
2 in Russia (Popov 2001:45).
CHAPTER 19
©E.Wayne Nafziger Development Economics
86
Macroeconomic stabilization


Inflation in 1989, with generous wage
indexation and credit expansion, was 638%.
Deputy Prime Minister Leszek Balcerowicz
undertook a plan of macroeconomic
stabilization, with a tightening of credit, raising
of the discount rate, cessation of cheap credit to
industry, devaluation of the zloty, and
liberalization of international trade to provide
competition to monopolies as prices were
decontrolled (Sachs 1993:44-66).
CHAPTER 19
©E.Wayne Nafziger Development Economics
87
Poland stabilized monetary policy
and zloty currency in 1989




Stabilization encouraged trade with Eastern
Europe, the Soviet Union, & the West.
Prices began to stabilize in 1990-91.
Poland reduced the length of transition to
world prices, so that the initial depression
from changing trade patterns was shorter.
Poland’s opening of the market to foreign
trade, together with the slashing of subsidies,
improved domestic efficiency (Sachs 1993).
CHAPTER 19
©E.Wayne Nafziger Development Economics
88
Safety net and mass support

Social safety net, which included price
stabilization, unemployment benefits, job
training, health car, and pension
guarantees, contributed to greater mass
support for reform than in Russia (Sachs
1993).
CHAPTER 19
©E.Wayne Nafziger Development Economics
89
Debt reduction & stabilization fund


Beginning in 1990, US & Western
governments, & commercial banks, wrote
down debt.
DCs established stabilization fund to
defend zloty, allowing a fresh start, despite
Poland’s external economic crises of the
1980s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
90
Poland’s integration into EU



Membership in EU in 2004 provided additional
incentives and support for market and
institutional reforms in Poland (and Hungary,
Czech Republic, & Slovakia).
Poland’s GDP PPP 38% of EU 15 in 2001,
Hungary 51%, & Czech Republic 56%
(Economist 2001).
Recently EU acceding countries hope
convergence within EU will occur as fast as that
of Greece (1981), Portugal, and Spain (1986).
CHAPTER 19
©E.Wayne Nafziger Development Economics
91
China’s Economy












Long-term growth
Brief Summary of Mao’s Economics, 1949-1976
The Transition to a Market Economy, 1979Agricultural Reforms
Township & Village Enterprises (TVEs)
The Individual Economy
Industrial Reforms
Poverty, Undernourishment, & Inequality
Banking Reform
Globalization, International Trade, and Exchange
Information Technology
Comparing China’s & Russia’s Transition
CHAPTER 19
©E.Wayne Nafziger Development Economics
92
China’s long-term growth



In 0 CE, China comprised about 26% of the
world’s gross domestic product (GDP), the
world’s total output of goods & services
(Maddison 2001:263).
In 1000 CE, 23%; 1500 25%, 1600 29%, 1700
22%, 1820 33%, 1870 17%, 1913 9%.
China only surrendered the world’s lead in GDP
to the U.S. in the 1890s, when China had the
world’s largest population of 380-400 million
(Maddison 1997: 114, 182, 190).
CHAPTER 19
©E.Wayne Nafziger Development Economics
93
China’s long-term growth



Currently (2004), China’s GNI or GNP (N for
national), at $7,170 billion (purchasing power
parity equivalent, PPP), ranks second to the
U.S.’s $12,151 billion (PPP), while Japan is 3rd
with $3,838 billion, & India 4th with $3,347
billion (World Bank 2006:292-293).
Nafziger (2006:73) projects that (assuming 2%
annual growth for the U.S. and 5% for China,
including Hong Kong) China will become first
again in GNP PPP in 2020.
China’s 2004 GNP per capita (PPP), at $5,530,
ranks 63rd among 134 countries (with data).
CHAPTER 19
©E.Wayne Nafziger Development Economics
94
Growth since liberation (1949)




China, in 1949, was among the poorest
countries in the world, with a per capita income
estimated to be lower than Africa, India, and
the rest of Asia (Maddison 2001:264).
China was in the same position in 1973 (ibid.).
But by 1998, after two decades of economic
reform, China had a higher per capita income
than Asia (excluding Japan), & a per capita
income more than double those of India &
Africa.
See slide 20’s table for annual growth in GNP
per capita (PPP).
CHAPTER 19
©E.Wayne Nafziger Development Economics
95
Summary of Mao’s Economics

Mao stressed prices determined by state; state
or communal ownership of means of
production; international & regional trade and
technological self-sufficiency; noneconomic
(moral) incentives; “politics” (not economics)
in command; egalitarianism; socializing the
population toward selflessness; continuing
revolution (opposing an encrusted
bureaucracy); & development of a holistic
Communist person.
CHAPTER 19
©E.Wayne Nafziger Development Economics
96
Maoists vs. pragmatists


From 1952 to 1966, pragmatists, primarily
managers of state organizations and enterprises,
bureaucrats, academics, managers,
administrators, and party functionaries, vied with
Maoists for control of economic decisionmaking.
But during the Cultural Revolution, from 1966 to
1976, the charismatic Mao and his allies won
out, purging moderates from the Central
Communist Party (for example, Deng Xiaoping)
to workplace committees.
CHAPTER 19
©E.Wayne Nafziger Development Economics
97
The Transition to a Market Economy, 1979







After Mao’s death (1976), Chinese leadership, led
by Deng, recognized that despite rapid industrial
growth under Mao, imbalances remained from the
Cultural Revolution, such as:
substantial waste amid high investment
too little emphasis on consumer goods
lack of wage incentives
insufficient technological innovation
too tight control on economic management
taxing of enterprise profits & full subsidy for losses
(soft budget constraint)
too little international economic trade & relations.
CHAPTER 19
©E.Wayne Nafziger Development Economics
98
What took place?


Annual real (inflation adjusted) growth in
GNP p.c. (1973-1998), 5.4%, fastest in the
world, continuing through 2005.
Wong (2003:113) indicates that China’s
annual growth faster than South Korea,
Taiwan, Singapore, and Malaysia.
CHAPTER 19
©E.Wayne Nafziger Development Economics
99
Quality of China’s income data
Western economists are skeptical about
Chinese data. Summers & Heston
(1991:327-368) indicate: “Chinese growth
rates are overstated as they are heavily
based on growth in physical output figurers
rather than deflated expenditure series.”
What are the confidence intervals for
China’s gross product PPPs? Firebaugh
(2003:111) assigns an “F” to Chinese data,
with the error rate 50 percent!
CHAPTER 19
©E.Wayne Nafziger Development Economics
100


Rawski (2001:347-354), using energy, industry,
and agricultural production figures, estimates
GDP growth, 1998-2001, at 0.1-2.7% yearly
rather than the official 7.7%. Managers &
provincial officials understate capacity &
overreport production to superiors to receive
greater reward received by those who meet or
exceed plan fulfillment.
Premier Zhu Rongji (2000) complained that
“falsification and exaggeration [of economic
statistics] are rampant (ibid.).
CHAPTER 19
©E.Wayne Nafziger Development Economics
101



Young (2003:1220-1261) contends that with
“minimal sleight of hand,” you can transform
China’s growth from extraordinary to mundane:
understatement of industrial enterprise inflation
should require downward adjustment by 2.5%
yearly, 1978-1998.
Maoist China’s health care system, universal
albeit at a basic, minimal level, broke down,
giving way to a marketized system providing
excellent care for the privileged but sometimes
very little for the masses (Bhalla 2002:184).
Still most economists believe China’s growth
under market reforms was rapid but uneven.
CHAPTER 19
©E.Wayne Nafziger Development Economics
102
Early reform was “socialism with
Chinese characteristics,”
not capitalism




No grand blueprint but 7-8 years of
experimentation.
Reform step by step, through trial & error,
drawing on incremental changes from past.
Chinese proverb: “Keep touching stones
while walking across a river.”
Incremental building in contrast to Russia’s
more abrupt strategy (Wang 1994: 14-15,
27, 113).
CHAPTER 19
©E.Wayne Nafziger Development Economics
103
Chinese characteristics meant:






Shrinking state industrial, corporate boards
limited in firing managers.
Party committees in private enterprises.
Entrepreneurs as members of Communist Party.
Growing entrepreneurial activity both private &
public sectors.
Household management of farm plots under longterm contracts with collectives.
“Massive changes in economic policy dictated
without consultation” (Waldron 2002).
CHAPTER 19
©E.Wayne Nafziger Development Economics
104
Agricultural Reforms


During Maoist era, agricultural growth slower
than industrial growth. State transferred
surplus from agriculture to state by
underpricing agricultural products &
overpricing industrial products sold to peasants
(Lippit 1987:224).
Post-Maoist agricultural reforms had greatest
impact on Chinese people, concentrated
primarily in countryside.
CHAPTER 19
©E.Wayne Nafziger Development Economics
105
China’s agricultural reforms, 1979-84




Decontrolled (increased) farm commodity
prices.
Virtually eliminated farm compulsory
deliveries to state.
Reduced multi-tiered pricing.
Relaxed interregional farm trade
restrictions.
CHAPTER 19
©E.Wayne Nafziger Development Economics
106
China’s agricultural reforms, 1979-84



Encouraged rural markets.
Allowed direct sales of farm goods to urban
consumers.
Decollectivized agriculture, instituting
individual household management of farm
plots under long-term contracts with
collectives & allowing farmers to choose
cropping patterns & nonfarm activities
(system used previously in 1956 & 1961-64.
CHAPTER 19
©E.Wayne Nafziger Development Economics
107
Results of agricultural reforms,
1979-84




1977-84: growth in food output per capita, 4.6%
yearly, even outstripped by growth in oilseed,
livestock & cotton output.
Gross ag output increased 9% 1977-84.
Reversed pre-1979 dependence on imported
grains, exporting corn, other coarse grains,
soybeans, & raw cotton, competing with U.S. in
Japan & Asia.
Achieved without increased farm inputs except
chemical fertilizer (World Bank 1986: 104-06;
Lichtenstein 1991:60-61).
CHAPTER 19
©E.Wayne Nafziger Development Economics
108
Dalian harbor corn barge
CHAPTER 19
©E.Wayne Nafziger Development Economics
109
Yangtze-Jialing Rivers’ farm trader
CHAPTER 19
©E.Wayne Nafziger Development Economics
110
Chongking farm produce trader
CHAPTER 19
©E.Wayne Nafziger Development Economics
111
Technical efficiency (total factor
productivity, TFP) in China’s agriculture



Output per combined factor input fell 1952-1978,
but increased 1978-1984, becoming major source
of growth.
Why? Decollectivization, household
responsibility system, linked reward to output, &
modest price decontrol increased resource
productivity.
Work monitoring & incentives improved,
agriculture was diversified, & families allocated
more labor to highly remunerative noncrop or
nonagricultural activities.
CHAPTER 19
©E.Wayne Nafziger Development Economics
112
After 1984: agricultural growth
decelerated
1.
2.
3.
Minister of Agriculture He Kang (1989):
“situation in agricultural production is grim”
(Lichtenstein 1991:61).
Most rural areas already captured onetime gains
from household accountability.
In late 1980s, government reduced massive
subsidies, reducing procurement price state paid
farmers.
In mid-1980s, many farmers awoke to profitable
opportunities in rural (township & village)
enterprises [TVEs] in industry & trade.
CHAPTER 19
©E.Wayne Nafziger Development Economics
113
Agricultural growth deceleration
4. Farmers (based on previous volatility &
5.
6.
uncertain future) feared reversal in land tenure
system.
Rural banking infrastructure underdeveloped &
politicized, so few loans available at market
interest for flourishing households.
1970s government distributed right to communal
land in fragmented plots on basis of household
size rather than farm management ability, so few
highly productive farmers had opportunity to
expand (Hardt & Kaufman, Lichtenstein,
Putterman, Fewsmith).
CHAPTER 19
©E.Wayne Nafziger Development Economics
114
In 1990s


Agricultural productivity grew rapidly,
even when adjusted for gains
exaggerated.
WTO accession in 2001 increased
pressure for further domestic
agricultural reform.
CHAPTER 19
©E.Wayne Nafziger Development Economics
115
Rural population density


China population density 10.2 persons per
hectare of arable land, twice the EU & 7 X
US, but less than Japan & Korea.
China’s agricultural comparative advantage
in “labor-intensive crops such as fruits and
vegetables and a disadvantage in . . . landextensive crops such as grains and
oilseeds” (OECD 2002:62).
CHAPTER 19
©E.Wayne Nafziger Development Economics
116


2003: 61% of China lived in rural areas,
partly legacy of Maoist era when migration
to urban areas was discouraged.
Globalization & structural shifts with
economic growth accelerating fall in
agriculture’s share of China’s export &
migration of surplus farm labor to urban
areas, where China has comparative
advantage. Also liberalization means
farmers face adjustment with competition
from other regions (OECD:60-63).
CHAPTER 19
©E.Wayne Nafziger Development Economics
117
Long-term property rights


Are Chinese farmers going to invest
& innovate when unsure that their
rights to the land are secure?
However, in 2004, China’s national
legislature amended the constitution
to formally protect private rights.
CHAPTER 19
©E.Wayne Nafziger Development Economics
118
Township & Village Enterprises
(TVEs)


1980s TVEs, organized as cooperatives,
produced 60-70% of rural output.
Enjoyed cheap production factors,
primarily cheap labor (with no lifetime
employment guarantees as in SOEs),
startup capital from collective
accumulation, banks, & credit cooperation,
& free (sometimes almost unlimited) land.
CHAPTER 19
©E.Wayne Nafziger Development Economics
119
TVEs



Cheap products catered to market, giving TVEs
advantage over other sectors (private sector not
fully accepted & SOEs not reformed).
Business & government functions overlapped &
TVEs had no government burden.
Flexible: contracts or leasing with other entities,
joint-stock cooperatives, limited liability
companies, shareholding companies,
conglomerates, foreign joint ventures, or
conglomerates; or in a few instances privatized.
CHAPTER 19
©E.Wayne Nafziger Development Economics
120
TVEs




Production helped correct price distortions,
& pushed reform forward (Lin, Cais, & Li
2003).
Outstripped SOEs in productivity
(Jefferson 1999:168).
1996: TVEs & other urban collective
enterprises comprised 39% of industrial
output, growing share since 1985 (Jefferson
& Rawski 1999:27).
Shared surpluses with workers.
CHAPTER 19
©E.Wayne Nafziger Development Economics
121
Individual economy



Reform included small entrepreneurial
activity (individual economy).
Cooperatively run enterprises, e.g., TVEs,
requiring far less capital per worker than
SOEs, precursor of individual economy.
After 1976, trigger to urban reform dealing
with urban unemployment from youths
returning from being “sent down” to learn
from peasants in the countryside during the
Cultural Revolution.
CHAPTER 19
©E.Wayne Nafziger Development Economics
122






Youths could not be absorbed in SOEs,
overstocked with underemployed workers.
Youths & others opened small restaurants, repair
shops, other retail outlets, or became pedicab
operators (Lippit).
Income higher than state sector jobs.
Urban consumers could buy produce from
farmers coming to cities.
China’s privately self-employed in cities &
towns (mostly services, commerce, handicrafts,
& catering grew from 150,000 in 1978 to about
5-10 million in 1998.
In 1996, individual owned firms were > 80% of 8
million enterprises but less than 16% of
industrial output (Jefferson & Rawski).
CHAPTER 19
©E.Wayne Nafziger Development Economics
123
CHAPTER 19
©E.Wayne Nafziger Development Economics
124
Industrial reforms: greater
specialization

Mao’s self-reliance fostered provincial
protectionism. 1979 reforms contributed
to substantial gain to specialization from
reducing regional protectionism.
CHAPTER 19
©E.Wayne Nafziger Development Economics
125
State-owned enterprises (SOEs)
reform

Initially SOE reform emphasized more
effective state control rather than
efficiency, profitability, or privatization.
CHAPTER 19
©E.Wayne Nafziger Development Economics
126
Management responsibility system
(MRS) failed to achieve goals

MRS: manager’s task carefully defined &
performance determines managers’ &
workers pay; reforms were to give
enterprise management much autonomy in
suppliers, hiring & firing labor, setting
prices, raising capital, & contract with
foreigners. Management responsible for
success or failure of enterprise. Producers
undertake initiative & decisions, not
government
CHAPTER 19
©E.Wayne Nafziger Development Economics
127
Few managers opt for MRS
(early in 1980s)



Not enough discretion to have
responsibility for success or failure.
Not enough food & consumer goods to
reward higher productivity of managers &
workers.
Central planners and banks (later regional)
made decisions of amount of output,
inputs.
CHAPTER 19
©E.Wayne Nafziger Development Economics
128


Multiple levels of controls at different levels of
govt, numerous overlapping authorities for
project control, & fragmented administrative
control: Chinese terms “too many mothers-inlaw” (SOE, Qingdao Forging Machinery Plant
(1980s), responsible to national Ministry of
Machine Industry, city materials board, county
for material supplies, municipal machine industry
office for plant production, country planning
agency for output value, county agencies for
supplies from the plant, two separate county
agencies for personnel, & county committee for
petty matters, immersed in implementing policies
(Guangliang).
What room did manager have left for rewards and
incentives for performance?
CHAPTER 19
©E.Wayne Nafziger Development Economics
129
Managers little control over
performance in early reform
planning system




Planning not integrated or coherent.
Targets not consistent.
Investment decisions bureaucratized &
politicized (not based on returns or
profitability).
State gave managers production plans &
designated product recipients – little room
for initiative or innovation.
CHAPTER 19
©E.Wayne Nafziger Development Economics
130




Redeeming feature: plan not as rigid in practice
as in theory – prevented Chinese state sector
from grounding to a halt.
Manager spent time negotiating special deals
with planning bureaucracy & other managers.
Premium on “back door” deals not organizing
labor & other inputs more efficiently.
Manager saving money of little use for success
because manager could borrow money cheaply
from the People’s Bank or take funds from
enterprise’s net income.
CHAPTER 19
©E.Wayne Nafziger Development Economics
131


Managers tried to increase profits in instances
when they could keep a larger & more predictable
portion of them and use them for bonuses for
them & workers, rather than turning profits over
to the state budget (Perkins).
Profits can guide enterprise behavior efficiently
only if they are determined by prices reflecting
true economic scarcity. When prices set
incorrectly (in early 1980s), they gave wrong
signals to enterprises, spurring them to produce
too little of what was short and too much of what
was in surplus.
CHAPTER 19
©E.Wayne Nafziger Development Economics
132
For market to have meaning











Enterprises must be able to buy productive inputs & sell products on market.
Enterprises must be able to retain profits for capital; instead in early 1980s
capital was allocated administratively rather than by interest payment or rates of
return.
Multiple prices by regions should correspond to cost of distances traveled.
Enterprises must compete rather than have monopoly control of particular
markets.
Central planners should not allocate key inputs administratively.
No “iron rice bowl,” with enterprise managers little control over paying or hiring
labor or firing unproductive workers (lack of safety net increased reluctance to
fire workers).
“Hard budget constraint” – not negotiating or bargaining for profit & output
targets during output year.
No subsidizing losses; no politicized bank lending or bank distribution of loans
or tax breaks to troubled & powerful enterprises (reality was that successful
firms with surpluses infused life into failing firms).
Enterprises need scope to search market for cheapest input cost combination.
Firm free of fear of worker unrest & widespread wage pressures & agitation
from increased food prices & craving for consumer goods.
No “whipping the fast ox” – enterprise deliberately slowing down operations to
avoid increased target in subsequent year.
CHAPTER 19
©E.Wayne Nafziger Development Economics
133
Later improvements in reforms
1.
2.
3.
4.
5.
6.
By late 1980s & 1990s, more managers adopted reforms:
Wrenching industrial recession of 1980-81 & observation that
smaller & private firms took advantage of opportunities offered
by the market (Jefferson & Rawski 1999a:84).
Buyers’ market from increases in supply of light industry &
consumer goods.
Key management reform expanded right of firm to increasing
share of profits. By 1990s, profit not plan fulfillment became
SOE’s prime motivator (as government reduced industrial
products subject to compulsory planning).
Slowdown in revenue growth hardened budget constraints of
officials & bankers, “sending enterprises to market” (Jefferson
& Rawski 1999).
Increasing right to sell products outside plan. Increased
competition shown by industrial concentration ratios lower in
China than in Japan or US (ibid.).
Contract responsibility enabled firms to retain all or increasing
share of above-quota profits.
CHAPTER 19
©E.Wayne Nafziger Development Economics
134
Overall increased competition in 1990s
& early years of 21st century




SOE reforms plus competition and increased share from
joint ventures, private enterprises, & collective enterprises
increase efficiency. SOE share of industrial output fell from
80% in 1978 to 55% in 1990 to 43% in 1994 to 28% in
1996 (ibid).
Still SOEs dominated heavy industry, industry employment
(35%), and bank loans (50%). Most SOEs were still losing
money in 2004-06.
Can China change ownership rights without experiencing
waste from privatization by insiders, creating billionaire
oligarchs, as in Russia? Privatization slower in China than
Russia.
Nolan thinks China lacks truly competitive global firms so
that, from a global perspective, China’s “industrial policy
of the past two decades must be judged a failure.”
CHAPTER 19
©E.Wayne Nafziger Development Economics
135
Poverty, inequality &
undernourishment


Mao’s rhetoric emphasized egalitarianism
& building up “weakest link,” but
inequality in range comparable to
Bangladesh & Sri Lanka.
China’s rural & urban inequalities were
low, but urban bias policies widened ruralurban inequality so it was higher than
India’s.
CHAPTER 19
©E.Wayne Nafziger Development Economics
136
Deng Xiaoping: “To get rich is
glorious”



Repudiation of Mao.
Urban inequality rose from 1988 to 1995,
primarily where economic reform
increased income & widened inequality in
coastal regions & in nonstate sector.
Rural inequality increased because of wage
& business income’s increased importance
(Knight & Song (2001:117-18).
CHAPTER 19
©E.Wayne Nafziger Development Economics
137
China high in income inequality


1980s & 1990s: China one of the more
unequal countries in Asia & among LDCs
(Riskin, Renwei, & Shi 2001:3).
Gini coefficient of household income per
capita rose from 38% to 45% 1988 to 1995
(Knight & Song 2001:84).
CHAPTER 19
©E.Wayne Nafziger Development Economics
138
Poverty fell




Rural poverty: 1978 (33%) to 1984 (11%).
Urban poverty: 1981 (1.9%) to 1984
(0.3%).
Poverty reduction from 1984 through early
1990s stopped falling in rural, & slowed in
urban China, despite rapid growth.
Income inequality increased 1985 to 2001
in both rural & urban areas, but largest
contributor was widening rural-urban gap.
CHAPTER 19
©E.Wayne Nafziger Development Economics
139
How to reverse increasing income
inequality & end of significant poverty
reduction in late 1980s & 1990s.
1. Pay more attention to rural economic
development.
2. Social security policy for unemployed,
sick, & aged.
3. More investment in basic education &
human capital.
CHAPTER 19
©E.Wayne Nafziger Development Economics
140
Affecting income inequality &
poverty
4. Personal income taxes to redistribute
income (small percentage of urban
workers pay tax). Improve tax collecting
capacity.
5. Reduce subsidies & benefits for highincome groups in urban areas.
6. Increase labor mobility, especially ruralurban (Renwei 2001:40-42).
CHAPTER 19
©E.Wayne Nafziger Development Economics
141
Gender inequality


“Missing women” – female deficit (94
female, 100 male) because of bias in
nutrition & health care favoring males;
& job, education, & economic
discrimination.
Only small fraction due to female
infanticide & fetal sonogram
identification.
CHAPTER 19
©E.Wayne Nafziger Development Economics
142
Food in China


During the Chinese Cultural
Revolution (1966-76), some Western
economists accepted the official claim
that the country had no malnutrition.
Imfeld (1976:157) maintained that “in
contrast to India, China has eliminated
hunger.
CHAPTER 19
©E.Wayne Nafziger Development Economics
143
China v. India



Food production per capita in China fell more
than 12% between the 1930s & late 1970s.
Food production per capita in China grew slightly
faster than in India, 1952-84.
However pre-reform (1954-77), India’s average
food output (0.4% p.a.) grew faster than China’s
(0.3% p.a.), although China’s absolute level was
higher, & the percentage malnourished was
lower, than India. Post-reform China’s food
output per capita growth outstripped India’s 4.6%
to 3.0 p.a., 1977-84.
CHAPTER 19
©E.Wayne Nafziger Development Economics
144
Annual figures based on 5-year moving average that
avoids influence from abnormal change.
CHAPTER 19
©E.Wayne Nafziger Development Economics
145
Nobelist A.K. Sen: India v. China



Having enough to eat depends on society’s
system of entitlement (rights & opportunities a
person possesses).
One-third 1/3 of Indian population goes to bed
hungry every night & suffers regular deprivation;
India takes nonacute endemic hunger in stride.
India, however, provide entitlements to avoid
severe famine through food imports,
redistribution, & relief. India’s democracy means
that crusading newspapers or effective political
opposition pressure prevent severe famine.
CHAPTER 19
©E.Wayne Nafziger Development Economics
146
Food: India v. China

Maoist China was opposite. In a normal
year, China’s poor were better fed.
However, during a famine that increased
malnutrition & mortality in China from
1959 to 1961 (fig. 7-2) , political pressure
for agriculture success made local officials
unwilling to report food shortages (Sen,
World Bank, Lardy).
CHAPTER 19
©E.Wayne Nafziger Development Economics
147
Banking reform


China no capital market before 1978: SOEs
& other firms financed investment from
retained profits, interest-free budgetary
grants, & loans from state-owned banks.
China’s banks were “appendages of
government” in which bank managers were
rewarded on party loyalty (Lardy 1998;
Economist 2004).
CHAPTER 19
©E.Wayne Nafziger Development Economics
148
Nonperforming loans/deposits
are 30%



Result of years of politically motivated
lending.
Lardy (2004) thinks government cannot bail
out banks yet, as they will soon return to an
unsustainable debt position unless “they can
operate on a commercial basis.”
Free convertibility of yuan will put pressure
on China’s banks, requiring higher interest
rates to prevent depositors from fleeing to
higher-yielding foreign assets (Lardy).
CHAPTER 19
©E.Wayne Nafziger Development Economics
149
Increasing international trade &
exchange

During Maoist period, China stressed selfsufficiency. In 1960, amid an ideological
dispute, the Soviets canceled contracts &
pulled out materials, spare parts, and
blueprints from aid projects & joint
ventures in China, leaving bridges &
buildings half built (although China
finished the projects).
CHAPTER 19
©E.Wayne Nafziger Development Economics
150
1977: China opened door toward
world market



Recognition of cost of technological self-reliance.
China stressed basic studies, application of
science & technology, & learning foreign
technology through sending students to foreign
academic institutions, absorbing foreign
production techniques suitable to China’s
conditions, & raising skills of Chinese workers,
technicians, & managers (Beijing Review 1998).
In 2001, China joined World Trade Organization,
which applies to countries where market prices
are the rule.
CHAPTER 19
©E.Wayne Nafziger Development Economics
151
Special economic zones (SEZs),
1979-80


Export processing zones for foreigners to
set up enterprises, hire labor, & import
duty-free goods for processing & reexporting.
Foreign investors received preferential tax
rates, reduced tariffs, flexible labor & wage
policies, more modern infrastructure, &
less bureaucracy than elsewhere in China.
CHAPTER 19
©E.Wayne Nafziger Development Economics
152
2001 foreign direct investment
(FDI) flows to LDCs




China $46.8 billion (also $23.8 billion to Hong
Kong) of $209.4 billion (UNCTAD 2003).
China overtook US as top ranking country in FDI
confidence (World Bank 2003).
Taiwan citizens heavy investors, especially in
electronics, taking advantage of language affinity
& cheap labor, usually by entering circuitously
through Hong Kong or Macao.
Asia Times (2003) estimates that Taiwanese firms
in China are responsible for 40% of China’s
exports.
CHAPTER 19
©E.Wayne Nafziger Development Economics
153
FDI composition


Overseas Chinese are even more
experienced & enterprising than overseas
Indians or overseas members of other
Asian nations.
China also benefited from the fact that
Western & Japanese investors feared
being excluded from what comprises
about 12% of world GNI PPP, & will
eventually be the largest market in the
world.
CHAPTER 19
©E.Wayne Nafziger Development Economics
154
FDI composition




85% of FDI flows in 1998 were to relatively
prosperous coastal areas, with largest amount in
Guangdong Province near Hong Kong (OECD
2001).
FDI flows account for about 15% of China’s
total capital formation, one of the highest rations
among LDCs.
1995: FDI controlled 47% of China’s
manufacturing exports & 53% of investment in
electronics.
FDI firms are much more profitable than
domestic firms, especially SOEs (Huang 2001).
CHAPTER 19
©E.Wayne Nafziger Development Economics
155
Is FDI linked to the indigenous
economy?


Not an isolated enclave.
“Foreign firms, especially “joint enterprises have
strongly influenced the process of industrial
reform by bringing . . . access to offshore pools of
funds & intimate knowledge of advanced
technology, market intelligence, & management
systems into partnership with Chinese enterprise.
[These innovations have] begun to ripple through
China’s business community through supplier
networks, competitive pressures, and the rotation
of Chinese personnel to and from foreign-linked
enterprises.” (Jefferson & Rawski 1999:40).
CHAPTER 19
©E.Wayne Nafziger Development Economics
156
Global production networks (GPNs)



China, even more than other LDCs, boosted
exports by participation in GPNs dominated
by DCs such as the US & Japan.
Exports of US affiliates as a percentage of
China’s exports were 36% in 1998.
Figure 15-8 shows US affiliate percentages in
other Asian countries, Mexico, Canada, & all
countries with US affiliates in 1982 & 1998.
CHAPTER 19
©E.Wayne Nafziger Development Economics
157
CHAPTER 19
©E.Wayne Nafziger Development Economics
158
China as source for FDI





US has both largest inward & outward flows of FDI
in 2001.
When Hong Kong is included, China ranked 2nd in
2001 in inward flows (or 1st in LDC inflows).
The world’s potentially largest markets & low-cost
labor intensive production in China has become the
world’s major industrial workshop, attracting many
MNCs.
Most of the world’s business community believes
that no one could afford to ignore the enormous
investment opportunities in China.
But China is a hard bargainer, demanding total
access to foreign technology in exchange for access
to its market (Kranhold 2004).
CHAPTER 19
©E.Wayne Nafziger Development Economics
159
CHAPTER 19
©E.Wayne Nafziger Development Economics
160
China in global production networks




GPNs enable production to be broken into
discrete stages, each performed in countries best
suited for the stages.
Frequently, China and other LDCs undertake
production activities requiring low-skilled labor, a
low-tech component of a high-tech good.
However, China has doubled global production
sharing from 1980 to 1998, as indicated by the
doubling of imported inputs into a unit of export.
China has negotiated favorable joint ventures &
technology transfers, enabling learning gains to
be captured in domestic enterprises independent
of the foreign MNC (World Bank Group 2004).
CHAPTER 19
©E.Wayne Nafziger Development Economics
161
China produces highest stages

In some instances, China, having begun
with the lower-added steps, has decided
to produce the highest stage in China.
CHAPTER 19
©E.Wayne Nafziger Development Economics
162
CHAPTER 19
©E.Wayne Nafziger Development Economics
163
Comparing China’s & Russia’s
Transitions to the Market

1.
2.
Nolan (1995) explains why China’s economic
growth and reforms were successful compared
to Russia:
China’s pursued economic reforms while
avoiding political liberalization (similar to East
Asian fast-growing economies; and
China’s step-by-step approach to economic
reform, rejecting “shock therapy,” especially as
practiced by the International Monetary Fund
and the World Bank.
CHAPTER 19
©E.Wayne Nafziger Development Economics
164
Nolan on Russia

Nolan shows how Russia’s efforts at
glasnost (openness) and democratization
destroyed the old state apparatus while
failing to construct an effective successor
state, thus engendering an economic
collapse.
CHAPTER 19
©E.Wayne Nafziger Development Economics
165
Ross’s (1994) rules for
liberalization
1.
2.
3.
Decontrol prices, marketize, & privatize
when you have competitive sectors, such
as China’s agricultural sector.
Maintain controlled prices where you
have monopolistic and oligopolistic
sectors, as in China’s industrial sector.
Only decontrol industrial prices when
you can provided international
competition.
CHAPTER 19
©E.Wayne Nafziger Development Economics
166
China’s success relative to Russia



In agriculture, China decollectivized much more
successfully than Russia, which stifled private
initiative and marketization.
In industry, China encountered many of the same
stubborn interests opposing liberalization. China,
while suffering from corruption, resisted Russia’s
asset stripping & favorable buyouts of state
industrial enterprises from apparatchiks.
Still China’s path toward reform by “touching
stones while walking across a river” could be
imperiled by instability during the early decades
of the 21st century.
CHAPTER 19
©E.Wayne Nafziger Development Economics
167
Lessons for LDCs


LDCs should not follow the path of
Russia or China to reform, although
LDCs can learn lessons from Russia and
China.
Each developing country needs to find its
own path toward adjustment and
development.
CHAPTER 19
©E.Wayne Nafziger Development Economics
168