Chinese Economy: History, Issues and Policies

Introduction:

The Chinese economy has been quite flexible for some time now. Even during the global financial crisis, the Chinese economy was found to be resilient and attempted to balance the global demand. However, Foreign Direct Investment (FDI) policy still remains an extremely challenging situation for international brands as the Chinese economy has its own constraints regarding FDI. On the other hand, the planned economic system is considered to be not compatible for sustainable growth in the long run concerning Chinese economy. The current essay is attempting to evaluate these two scenarios concerning Chinese economy. Thus, the study would first analyse the statement that China remains a challenging market for FDI. Accordingly, the essay would investigate the extent to which China has been transiting from a planned economy to a market economy.

FDI and Chinese economy:

The Chinese economy has been benefitting from the FDI ever since the policy has been applied in the early 1990s. Over the last two decades, the country has received approximately 20% of overall FDI in developing economies and reports of the year 2008 suggested that estimated amount of the FDI inflows within the economy was $100 billion (Mankiw et al. 2005). Several analysts believe that the size of market along with the growth prospect and the investment opportunities have influenced major market players to invest in the economy. When it comes to share of GDP, the FDI concerning Chinese economy has been accounted at 2.5% of the last decade or so. Although the statistics might not indicate some significant contribution of FDI in the economy but considering the size of the Chinese economy the FDI contribution has been pivotal. As per Robert (2006), China is considered as the third largest economy in the world and FDI has played a significant role for growth of Chinese economy for the last two decades.

The inbound FDI has played a crucial role in Chinese economic development while ensuring export success. In reference to the reports of MOFCOM (Ministry of Commerce), enterprises employing FDI account half of China’s overall import and export. Adding to that, FDI has helped in enhancing the Chinese industrial output by 30%, generating 22% of the overall industrial profit and employing 10% of the overall working professionals (Taylor et al. 2008). Despite such significant contribution, the Chinese economy still remains a challenge for optimum utilisation of FDI policies. The challenge for the country is to attract the right sort of FDI.

China is currently trying to rebalance the economy and moving up the value chain while at the same time improving the environment. As a consequence, the country has taken the recent FDI strategies keeping in mind an ethically sustainable industrial strategy (Young et al. 2006). Therefore, it would be difficult for business organisations to satisfy the industry benchmarks and at the same time investing in the economy. As mentioned by Kim and Hwang (2004), stiff industry benchmarking could create barriers for foreign investments. However, the global economic ranking of China helps the country developing a certain level playing field for all international and domestic firms.

Furthermore, China is trying to be quite open for FDI in manufacturing and service industries. On the contrary, Ewing et al. (2006) argued that China was found very much circumspect in the gradual approach to move into the liberalisation. As a consequence, the synchronisation of the Chinese economy with the development of the institutional capacity could become affected in the future. However, several arguments have been made and it is proven that this disagreeability has served the China to forecast its financial crisis. In near future, further liberalisation of backbone services such as finance and telecommunication services can be observed.

 In the year 1980s and 1990s, the market institutions were not totally in place and at that time China had experienced a lot with the FDI in some selected coastal cities. Furthermore, Fan (2008) stated that special economic zones were also focused to attract export oriented manufacturing FDI. China has made a balancing economic growth with accordance to its shift into the new development goal. Not only this, China has also made ridiculous commitment towards the service liberalisation with combined accessibility to the WTO. As a consequence, China has shifted the contribution of FDI to the services industries. Past report shows that at the end of the year 2009, FDI in service industries has increased three times as compared to the year 2000. On the other hand, FDI in the manufacturing industry in the China had made an increment of 81% in the year 2009.

The overall growth in the service and manufacturing industry has improved the alignment ratio of regional production networks in the Eastern Asia along with the China. Not only this, thousands of investors and multinational companies have invested in China (Wong and Chan, 2004). The report of UNCTAD shows that China holds 15th position in the top most investing location within the global ranking list. However, it has been observed that the presence of investors from the Japan, Europe and the USA are found increasing gradually not in a rapid pace.

China is trying to follow highly decentralised approval in its operational process. As stated by Vind (2008), the reason is to provide opportunity to the policy implementation and it would create healthy competition among the local authorities. Although China is doing almost decentralised approach, it might become the cause of heavy red tape and corruption that might destroy the dignity of the administration. Considering the fact, China has involved regular and open communication between the government and business community for creating special importance.

Furthermore, the reason of following decentralised approach is to provide “One stop facilities” to the investors.  It has been made aiming to allow all investors conducting all procedures in one place. It has helped China to maintain integrity in the process of FDI. On the other hand, several arguments have been made on FDI and TFP growth in the China. As cited by Wang and Blomström (2006), TFP growth did the acceleration in the coastal region of the China, while the bulk of FDI acceleration had been occurred in other places apart from China.

Finally, the need of the changes in the FDI policy comes into the account. China might receive better benefit from the FDI which is concentrated more on exporting activities and it would help maintaining the position of prime foreign investment segment in China. However, several critics identified that this type of FDI cannot be differentiated from the import substituting FDI. As mentioned by Blaine (2008), the investors from Western and Japanese MNCs did not reveal better comparative advantage in manufacturing and service industries. However, this discussion does not suggest that China would never have comparative advantage in these sectors.  The potential issue is to identify whether the investment is able to create efficiency transforming those sectors into a single one. As cited by Weil (2005), this efficiency could significantly create future competitive advantage to the Chinese economy.

Another major issue is that Chinese FDI requires competitive enterprise to invest in. Furthermore, the social assurance along with the employment level also needs to be marinated to exhibit a balancing economic situation across the country. However, a strong disparity between the per capita incomes is observed in the overall economy starting from the FDI fuelled coastal provinces to the sluggish interior provinces. This disparity could lead to the social tensions and it could further breakdown the social order of China which has already happened in the past history of china. However, FDI in the interior region is found mostly to be characterised by takeover of the existing enterprises and the amount of Greenfield investment in the coastal area would be found less.  As cited by Blaine (2008), this type of takeover can be considered as ineffective and blocked. Hence, the policies need to be maintained to manage the balancing economical condition within the country.

Analysing the above condition, it is clear that the regional disparity needs to be improved by making few changes in the FDI policies of the Chinese government. To achieve the same, special attempt needs to be made for preserving present industrial structure in the interior places. On the disrupters of this structure, destabilisation might occur which could again destroy the economic strength of China. Along with the domestic control, foreign control also needs to be checked as both could create higher level of resistance in the process with the existence of gaping between the same. Hence, appropriate initiatives needs to be taken in order to maintain flexible economic growth and reducing the disparity in the overall economy of China.

Transition from planned economy to market economy:

China’s economic reform has gone through two full decades by the end of 1990. The process of transition from the planned economy to the market based economy in the case China is very gradual. As mentioned by Chernoĭ (2002), the overall transition phase of China’s economy can be sub-divided into two periods: the first stage spanned about fifteen years between 1978 and 1993 (Griffith et al. 2006). On the other hand, the second phase has begun in 1994. The differences between the two phases are very much prominent. In order to understand the importance of the reform, the nature of reform needs to be analysed. The reform in the first stage was done in order to allocate the resources optimally. In this context, Marer et al. (2008) mentioned that the reform achieved more success outside the state sector rather than inside of the state sector. The reform has achieved a huge success. The living standards of the people China has improved drastically, the shortages of the resources were eliminated. However, the significance was understood only after reviewing the similar sort of reform in the Eastern Europe (Kustin, 2004). The second phase of the reformation witnessed unification of the exchange rates and convertibility in the current account. Moreover, in this stage, the privatization of the small sectors was encouraged.

Nature of reform in the first stage (1978-93):

In spite of the failure of economic reform in the other countries, the economic reform in China was quite successful. During the first phase of reformation, China’s GDP grew at a rate of 9% or 7.5% on a per capita basis. The living standard of the common people of china has improved. For instance, the consumption of the necessary commodities likes vegetable oil, pork and eggs have increased almost three times. In this context, Ricardo (2001) mentioned that per person living space has doubled in the urban areas and more in the rural areas. The bank deposits have increased from 6% in 1978 to 40% in the year 1993. The number of people lived under the poverty line has reduced significantly from 250 billion to 100 billion. The second stage reform has improved the overall economic condition of China.

The changes can be treated as the incremental reform.  The inception of non-state sector was very much significant in the context of China. From the early 1980s, nearly 100% activities were organised by the households. In the case of, non-state sectors, a wide range of ownership types of enterprises such as co-operatives, private firms, and joint-ventures have evolved.  It has increased the level of competition in the market (Sklansky, 2002).  The non-state enterprises have become the main source of growth and industrialisation. In 1978, 78% industries were state governed and by the end of second stage reform the Government holdings has reduced to 43%. The share of state in the case of commerce was reduced to 40% in 1993 from 55% in 1978. However, Burpitt and Rondinelli (2008) stated that in this stage the higher amount of direct investment could have been improved the scenario a lot. Moreover, the domestic private firms were not that efficient.

The second stage reform has enabled the price reformation. The price were freed up to a certain range, on the other hand, the planned prices were maintained for planned quantities of product. According to the view of Gassmann and Keupp (2007), due to the reformation of the prices, the establishment of the domestic market prices was possible. The market development of China was also pushed up by the fast expansion of the foreign trade. The export to GDP ratio has improved by 20%.The expansion of the foreign market has helped the convergence of the domestic and foreign market.

The transition phase has also witnessed the contraction of the two different levels of Government. The impact of the transition was more prominent after the one year of the reformation. The impact of the transition was reviewed in the cases of fiscal reform, foreign trade and financial system. The role of the political parties during the phase of transition was very much significant. As stated by Michailova and Wilson (2008), the role of the geo-politics was also very important in case of the transition. The cultural revolution of China has helped the economic development. The cultural reform was initiated by the condition of the national economy and poor living standard of the people. The role of political leaders in the case of transition was very much important.

An evaluation of the transition progress during the first five years of second stage:

Considering the ongoing initiatives in January 1994, the Chinese administrative authority particularly focused on five different aspects in order to ensure effective transition process to a market economy. The five aspects prioritised at the point of time were financial reforms, foreign exchange, SOE reform, tax and fiscal reform and ensuring social safety net (Zhou, 2007).

Tax and fiscal reform:

Before January 1994, Chinese government used to follow fiscal contracting system and the strategy had turned out to be an effective approach in providing incentives to the governing bodies. However, one major problem of the taxation policies was that it supported ad hoc mechanism (Rialp et al. 2005). On January 1994, The Chinese government introduced some major changes in fiscal reforms and taxation policies. A clear differentiation had been made between local and national taxation policies. Later in the year 1995, further alterations in taxation took place and the new ‘Budget Law’ was introduced. The provision restricted central government to borrow directly from the central bank. The fiscal reform introduced in 1994 is considered as a comprehensive transformation in the Chinese economy (Doz, 2011). Although the fiscal reform helped stopping the government budgetary revenue, it was found to be incomplete and as a result, several issues like revenue transfer problem, sub-provincial tax and extra budgetary tax introduced remained unsolved.

The foreign exchange and external sector reform:

Before the year 1994, the foreign exchange market scenario followed a ‘dual track’ approach. While there used to be an official rate, a provision of swap rate was applicable (Griffith, 2010). However, on January 1st, 1994, the foreign exchange plan was completely eliminated and a single track approach was initiated in place of a dual track approach. In December 1996, China introduced the convertibility of current accounts into its currency. The approach perhaps helped China countering the Asian financial crisis effectively given the weak financial infrastructure of the nation (Hult et al. 2008). Majority of the analysts have appreciated the foreign exchange reform policy adopted by China during the early 1990s. Between the year 1994 and 1998, a stable foreign exchange rate had been maintained. Following the approach, both FDI and exports enhanced drastically and the foreign reserves enhanced from $21 billion to $145 billion. As a result, China managed to attract FDI despite the Asian financial crisis. During the Asian financial crisis, between 1997 and 1998, China attracted $45 billion in terms of foreign investment. The statistics promote stable foreign exchange rate in the country even in stiff economic scenario.  

The realisation of the political party to reform has flourished more reformation in China. As stated by Lages et al. (2008), the first phase of the reformation can be considered as emancipation of mind. The same kind of mentality has motivated the second phase of reform.

China has many opportunities to progress the growth in the upcoming years. However, the whether the country has a potential to progress the growth or not is a different issue. From the above analysis, it can be concluded the China has a wide challenges ahead. At the beginning of 2000, China faces the need for further reformation. First of all, the economic growth of China was slowed down due to the financial crisis and secondly, China’s high dependency on the WTO has caused the major problems. Moreover, the rigid mentality of the Government in order to adapt the exchange rate has caused major problems. The country has given enough importance to the local choices and preferences rather than giving preferences to the global context. However, the FDI has caused the economy to grow a lot.

 

 

 

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