BOFIT Viikkokatsaus / BOFIT Weekly 2018/51

The milestone was celebrated on Tuesday (18.8.) in the high level meeting in Beijing. The meeting, however, offered nothing new concerning the future of reforms.

In 1978, the Chinese economy was in bad condition when party leader Deng Xiaoping announced that the country was embarking on reforms. The command economy used resources so inefficiently that it had become an obstacle to the country’s economic development. In terms of GDP per capita, China ranked with some of the world’s poorest countries, including Burundi, Guinea-Bissau and Malawi.

From the beginning, Deng’s reforms focused on improving productivity by giving workers and firms new operating possibilities and by opening the Chinese economy to the rest of the world. Under the “household responsibility system” farmers were allowed to farm their own plots of land and after making their quota to the local collective allowed to sell whatever was left. Agricultural output rose rapidly. In the business world, the 1980s saw the government grant small firms increased freedom to operate. The first “special economic zones” were established. Within these zones the business rules were distinctly more flexible than elsewhere in China. The Chinese economy was further strengthened by the fact that decision-making power was devolved from the central government to provinces in the mid-1980s and local decision-makers were given incentives to stimulate economic growth.

The 1980s saw the introduction of a two-tier pricing system that allowed firms to sell production above their quota at market prices. The pricing reform was extended in the 1990s and markets were allowed to play an increasing role in price-setting. In 1994, China unified its dual exchange rates. Two years later, the yuan became fully convertible under the current account. State-owned enterprises were also reformed extensively during the 1990s. Restructuring of the weak banking-sector started and continued well into the 2000s.

China’s opening up to the rest of the world began in the 1980s. In order to strengthen the economy, it was necessary that domestic firms got modern machinery and production methods from abroad. Foreign direct investment was allowed in certain fields. China’s opening to the world was further boosted by the country’s accession to the World Trade Organization (WTO) in 2001. Globalisation got a huge boost as hundreds of millions of Chinese workers were integrated into global production chains. By the end of the decade, China had become the world’s largest goods exporter.

Efforts to reform the economy began, however, to wane. As a result, many of the reforms launched over the past ten years in the spheres of monetary policy and financial markets have only been partially implemented. Although the People’s Bank of China officially ended interest rate regulation in 2015, commercial banks today still do not compete on rates. While rules on capital movements have been eased, outward capital movements are still highly controlled. The fixed peg of the yuan to the US dollar was abandoned in 2005, but in practice the PBoC still plays a key role in guiding the yuan rate to desired levels. Half-finished reforms have created a messy hybrid system in which participants seek to exploit the advantages of the old and new systems, with a variety of unintended consequences.

Decades of rapid economic growth have lifted hundreds of millions of Chinese out of poverty. China is the world’s second largest economy after the United States. In 2017, China’s GDP per capita was on par with Mexico and ranked in the same class of upper middle income countries as Russia.