Management in China
China today is an economic powerhouse. Fuelled by a near limitless supply of cheap labor and a long-term trend of economic liberalization, China has grown from a poor, agriculture-based economy as late as the 1970s to the world’s third largest economy (IMF, 2008). This transformation did not come easily for China. Economic reform was something sought by Mao Zedong when the Communists took over in 1949 (BBC, 2005). Mao’s reforms ultimately failed. When Deng Xiaoping took over in 1978, he instituted sweeping economic reforms intended to modernize the Chinese economy. After Deng stepped down, reforms accelerated, bringing us to the China of today.
This paper will examine China’s economic reforms, both during the Mao era and the post-Mao era. Economic management during these eras will be considered, in particular with respect to deriving motivation while simultaneously maintaining strong central control. The success and failure of the different reforms will be analyzed, and conclusions formed about the policy directions that led to success and those that did not.
Mao
In 1949, when Mao Zedong and the Communist party took control of China, forcing the Kuomintang into exile on Formosa, China’s economy was in shambles. China had been underdeveloped for several decades at this point. Chinese society, at several points in history the world’s most developed, had been reduced to a peasant agricultural state. Mao sought to modernize the economy. Unfortunately for China, Mao believed that Communism was the one true economic and social philosophy to which all nations would gravitate (BBC, 2005).
After stabilizing the country, Mao launched his first Five-Year Plan, modeled after the economic policies of the Soviet Union. Stalin had send China money and engineers to help build the Chinese industrial base. Thus, Mao’s first Five-Year Plan set goals with respect to the production of industrial commodities — steel, coal, cement and pig iron among them. The first five-year plan was for the most part a success, with goals met in terms of the production of most commodities, oil being an exception (History Learning Site, n.d.)
Emboldened by the modest successes of the first Five-Year Plan, Mao then launched into the Great Leap Forward. The underlying principle of the Great Leap was that steel production was the key to economic growth. Targets were set — China was to overtake Britain in steel production within fifteen years. Peasants were conscripted to make steel in their villages with coke ovens, and had quotas to fill. They smelted down everything, eventually including farm implements. This, of course, did not yield steel, which cannot be produced in such a crude fashion. The peasants, unable to grow and having what little crops they did produce hauled away to the cities, died by the million. The Chinese government accelerated the objectives — the 15-year objective was shortened to one (Harms, 1996). The steel story illustrates why the Great Leap Forward failed in the most catastrophic fashion. Mao had devised his economic policy based on unrealistic assumptions, and the misguided belief that he could attain an outcome simply by dreaming it up. The total absence of any serious thought in the Great Leap Forward set the country back decades.
The Great Leap Forward represented an abject failure of the Chinese system of governance and oversight. Mao and his advisers were utterly ignorant of economics, production and commerce. They dictated output levels without consideration how those might be achieved. Instead of heeding the advice of dissenters, Mao had them executed, over half a million in all (Harms, 1996). If China had had any system of oversight, the tragedy of the Great Leap Forward could have been avoided.
Liu Shaoqi, Mao’s successor as Chairman, moved to restore pre-Leap economic policies and rural land practices. This retrenchment was an admission that the Great Leap Forward strategy of irrational goal-setting, no oversight and execution of dissenters was a failure. It was not, however, a move away from socialism. The reforms were successful, which following the Great Leap was not exactly a difficult task.
The Four Cleanups Movement was an attempt by Mao to restore what he viewed as ideal ideology to China, including in economics. This movement had no lasting impact, however, and was soon followed by the Cultural Revolution. The Cultural Revolution was more a social and political event than an economic one. Economic reforms came to a standstill during this era as the power struggle within the Communist party raged. Economic activity was still centrally planned, but there was little thought given to non-revolutionary activity.
Post-1978
After the end of the Cultural Revolution and Mao’s death, one-time Mao adversary Deng Xiaoping took over. With Deng’s arrival, China began the process of transforming its economy into today’s modern powerhouse. One of the first reforms was that rural families were able to work family plots, removing the most communistic aspects of the economy. Deng worked to improve infrastructure, including an overhaul of the education system. The Chinese people were allowed to purchase consumer goods and international investors were courted. His reforms culminated in self-sufficiency in food
and successful negotiations with the British for the return of Hong Kong, the economic engine of Southeast Asia (CNN, 2001).
Another major reform was the creation of special economic zones, where tax breaks were given to encourage export business and foreign investment. These zones were the earliest drivers of the modern Chinese export economy.
Deng’s reforms offered baby steps towards capitalism, in that Chinese citizens were now allowed to earn their own money and make decisions with respect to how to spend that money. The economy, however, remained subject to intense central planning. Deng had kept the Communist Party’s authoritarian system of governance. The major change of Deng’s reforms, therefore, was to step back from the micromanaging of the economy that Mao had deigned to undertake. This was in part due to the lessons of the Great Leap Forward, where local politicians routinely lied about production numbers in order to save themselves or their regions from punishment. The system of motivation utilized in the Great Leap — fear — did more harm than good. In the 1980s, corruption was a major threat to these reforms (BBC, 2005). Deng’s reforms did not have a strong system of governance. The tendency of managers and low-level politicians towards corruption and incompetence remained, even though they had the profit motive dangled as a carrot in front of them. Social control was kept strong by Deng, and this may have provided some degree of control over the nation’s most important economic actors. But the degree of governance remained poor, and contributed to significant economic difficulties in the latter part of the decade, when the government was forced to retrench on some of its reforms.
Further Reforms
Deng had restarted the pattern of Chinese economic growth in 1992 and pushed harder for foreign investment than he had in the past. It was at this point in time that China began to dismantle the centrally-planned economy in earnest. Although Deng had realized in the 1970s that the Soviet-styled planned economy had failed to meet any of its objectives, he also realized that a transition period was going to be needed. By the 1990s, he was convinced to take the next step. Central banking was instituted and capital markets created.
Uneasy about the transition process, the Chinese government was slow to dismantle its state-owned enterprises. These had been run under the centrally-planned economy, and were neither competitive in their cost structure nor did they product goods of value to Chinese consumers. By the end of the 1990s the state-owned enterprise system began to collapse. Viable businesses found themselves with foreign joint venture partners, non-viable business closed. The decline of the state-owned enterprise was precipitated by poor performance in key economic measures. Productivity decreased, particularly with respect to returns on capital (Jefferson, 1999). This was a function of an underdeveloped financial sector and weak governance.
Shoddy governance continued to dog the Chinese economy. The financial sector was inefficient. There were few systems that could effectively protect enterprises or their property rights. China, for all its reforms, still ran its economic system like a third world country. A further problem compounding the difficulties of reform in this sector is that of incentives. The incentives offered by the central planners were not congruent with improved efficiency (Cauley et al., 1999).
Property rights continue to be a major bottleneck for China. In the past ten years, the country has made tremendous strides with respect to its economic development. The government has little influence on business activity, focusing strictly on exercising control over the macroeconomy. The end to central planning is admirable, but property rights, or lack thereof, are reducing the potential rate of further economic growth and reforms.
At this point, the remaining presence of SOEs is another key bottleneck. The SOEs were subsidized until 2003, when China was forced to end subsidies as a result of their ascension into the World Trade Organization. Most of the remaining SOEs by this point were unprofitable, but were being propped up by the Chinese government because of the jobs they represented in economically important exporting provinces (Eckaus, 2006).
The most recent trajectory for China’s economy has been notable for its absence of emphasis on heavy industry. Mao’s original plans focused on heavy industry the major driver of Chinese economic growth. Deng, too, had wanted to build out China’s capacity in steel and heavy manufacturing industries. In recent years, service industries and light manufacturing have taken a more prominent role in the Chinese economy. The sense is that during the first years of the reforms, it was essential for China to build out its industrial capacity. Having done that, the only role left is to leverage the heavy industry infrastructure in order to help build out the fledgling service industry.
It was the heavy industry that facilitated productivity growth in China in the past couple of decades. Productivity has contributed 13.5% of China’s economic growth since the early 1930s (Wu, 2003). Substantial improvements in infrastructure and technology were able to reverse the sluggish productivity growth of the 1990s. Between 1995 and 2002, productivity in China improved an average of 17% per year (Mauldin, 2004). Indeed, this increase in productivity was coupled with decreases in manufacturing jobs.
Conclusion
The first 30 years of the PRC saw little in the way of economic progress, despite some sweeping attempts at reform. The first Five-Year Plan was a good idea — increase production of key industrial commodities. The Great Leap Forward that followed was disastrous policy made with zero governance, ultimately setting the country back by decades.
Deng’s reforms and those of his successors have sparked a phenomenal increase in productivity and the end of the centrally-planned economy. China has had some growing pains. They use social control as a means of economic control, but the country has at times been subject to significant corruption and managerial incompetence. The Chinese government remains in a process of transitioning out of the economy. They do not, as of yet, have an answer for governance. It is governance issues that are the final bottleneck for China. Investors need to feel confident in the protection of their rights. The rule of law needs to become more developed in China as well, in order to facilitate the next stage of China’s economic development. Corruption needs to be eliminated. China at this point in time has weak controls over incentives and governance. Better control over economic actors and the installation of a robust legal system will break the bottlenecks and allow for Chinas to continue to grow its economy.
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