The Economics of Mao’s China

1. The Economics of Mao’s China Planning and Markets Michael Smitka Washington & Lee University Economics 274, Spring 2004

2. Overview • Genesis of Planned Economy • Logic of Formal Planning • Problems and politics of planning • Price Reform • Agriculture First • Dual Track System • Remaining issues • SOE reform - including pensions • Financial sector reform

3. Logic of Formal Planning • Genesis • USSR outperformed the US, Europe and Japan: 1930-1950 • KMT (Kuomintang “Nationalists”): Chiang Kai-shek trained in Moscow, had already nationalized industry! • Socialist ideology of state ownership • Inequitable, plus Instability, Inappropriate output. • Plus belief in economies of scale, modern management

4. Formal Process • Put major productive resources under State control • Manage through “Five-Year Plan” with annual increments & targets • Materials Balance • Calculate inputs needed to obtain target output • Iterate to get consistent & feasible plan • Set up accounting to handle residual market transactions; money otherwise irrelevant

5. Contrasts of plan and market • Role of Markets • Emphasis on physical quantities - prices are irrelevant • Markets discouraged except for discretionary consumer goods • Labor allocated by State: university grads, for example, are assigned jobs • Role of Money (What is “money”?) • Unit of account but • Not means of exchange • Thus not a store of value

6. Banking under the Plan • Since prices are artificial…. • …. profits (and losses) are also artificial. • Banks thus merely conduits for subsidies when “plan” prices didn’t cover costs • Paying bills really wasn’t necessary - as long as an enterprise met its quota

7. Problems of Formal Planning • Incentives: • Labor mobility is discouraged • Career is thus within the firm / bureaucratic • Bureaucratic Games: budgeting • Ratchet effect: success doesn’t pay • Micawber effect: but don’t fail, either!

8. The Economics of Scarcity • Budget constraints are “soft” (Janos Kornai) • Micawber effect again: hoard goods! • Firm structure also reflects • Vertical integration • Exacerbated in China by local autonomy • Ditto due to local self-sufficiency ethos • True of China also? • Much less articulated economic structure • Constraints on size of urban sector

9. Kornai: bureaucratic games pervasive • Excess demand is thus pervasive • Hence “fixers” are needed to get goods • In China, guanxi “connections” • Inefficient firms are allocated comparatively more resources, not penalized! • Planners know this • Use of “taut” budgets / hard-to-achieve targets • Tolerance of high inventory levels • Experience and competence make a big difference (as in any business context!)

10. Input-Output Planning • Planners gain technical knowledge, esp. within their sector / ministry • Hence they can predict inputs needed to gain desired outputs • But aggregation issues: an increase in steel targets shifts ore demand and railroad needs and hence steel demand • Maintaining consistency - material balances - is a real challenge

14. Matrix Algebra • The final equation lets one check for consistency • But it also permits optimization • Convert to an inequality • This defines a convex set and the system thus has a clear maximum • Linear programming permits solutions • Optimization however has numeric limits • In the sophisticated USSR, only 1000 goods...

15. Formal Procedures • Mathematical models help - used in Russia. • “Simplex” method and other linear algebra techniques developed there. • Each industry is a row in a matrix, with inputs needed per unit of output • Matrix algebra then makes it easy to calculate needs and check consistency

16. Planning in Action • Technical Change and Coordination • Vertical structure: • Change requires getting Ministries to agree • Few rewards for improving a good • Bias towards large projects • Easier to expand than to change • Diminishing returns set in quickly • Plan relies on investment, not productivity • Bias toward heavy industry and tangible goods over consumer goods and services

17. Planning is Inexact • Fragility: Plans are never perfect • Annual cycle does not guarantee timely inputs • Mistakes are amplified / cascade to other firms • Hoarding is necessary • Hence “fixers” are necessary, even desirable! • What is “corruption”?? • Disaggregation • Even with supercomputers, only 10,000 goods • China “planned” about 600 items • In agriculture, State determined what crop you planted: grain first • System must grant discretion to operating level

18. Planning is Political • Bureaucrats decide goals, not consumers • Emphasis on what is tangible • Guns and tanks are good • Consumer goods are bad • Services (especially merchants) are parasitic • Emphasis on big over small - easier to manage

19. Planning games, continued • Bureaucrats: power! • Nomenklatura: in China, little separation of “party” and “government” • Infighting has huge social & economic impact • Great Leap Forward & Cultural Revolution ... • “Taut” plans can backfire • Ambitious targets counter political games • But infeasible targets generate chaos • Hence an investment and inventory driven business cycle! -- instability just like in market systems?

20. Reforms • “Big Bang” versus “Gradualism” • Partly political imperative in CSIS • Political reform came first • No ability to wait or control economic reform • Planning system collapsed with no coordinating institutions (markets!) to replace it • In China, markets developed first • Reforms to economics institutions followed • Only now are political reforms underway

21. Genesis of Reforms • Initial post-Mao policies focused on big-ticket projects, as in the USSR • To speed up growth, use foreign technology • How to finance? –– export oil! • But oil prices fell…..and the fell further • End result: crisis

22. China versus USSR— Further Comparisons — • In Russia, large state-run enterprises dominated the economy • Agriculture was less important • Planning was far-reaching & centralized • In China, agriculture was central • Industry & urban areas were less important • Planning was decentralized • Planning applied only to key commodities

23. China: Reform Agriculture First! • Grain prices were raised • Most of the population benefited immediately • Did not require elaborate administrative measures! • Large projects came on-line: fertilizer! • Serendipity…consumer goods output rose, too! • Rural markets were allowed • Vegetables, meats but initially not grain • Benefited areas near cities the most

24. Responsibility systems • Household responsibility system as model • Fiscal equivalent: local tax retention • Agricultural model from around 1982 • Industry contracting as well: profit retention • Impact hinged upon extent of discretion • Grain production (quotas) still emphasized • Industrial planning system still in effect • “Fixers” were natural entrepreneurs

25. Dual-track pricing • In agriculture • Fixed quota of grain as de facto tax-in-kind-cum-rent • Above-quota grain at higher price, now freely marketed • In effect a fixed-rent cropping system • Farmers saw big gains from increasing output • Once quota met, freedom to specialize in other crops • Tenure not guaranteed until very recently • Some abuse of assets / lower level of investment • Also decollectivization hurt mechanized wheat regions: these areas had (and lost) economies of scale

26. Dual-track pricing • In industry, formal plans / quotas persisted • But above-quota output could be marketed • Logic is similar to that of agriculture • Ditto county / township / village tax system that is highlighted in the Oi book • Allowed markets to gradually develop • In the meantime State-Owned Enterprises could obtain “plan” mandated inputs and maintain prior output levels • Enterprises with “free” inputs (small coal mines) were profitable, those needing purchased inputs suffered • Also huge variations in efficiency across space

27. Persistent problems • Dictates of State (plan) and People (markets) differed • Many SOEs have no or poor markets, e.g. the small truck factories present in each Province • Some goods no longer needed • we will see this in the Daqing “Working” video • But “iron rice bowl” obligations persist • Under Mao’s decentralized polity, SOEs were direct providers of social services, not the State • How finance deficits? - borrow from banks

28. China’s looming financial crisis • Historically banks in China weren’t “banks” • SOE’s functioned according to plan • Loans were an accounting convenience • SOE’s relied on loans as market expanded • But now banks are technically insolvent • Social security system must henceforth be run by gov’t, not by SOEs • Gov’t must nationalize the cumulative “loans” that represent past social security obligations • Banks then can start afresh, as real banks

29. Demographic changes, too • Social security needs aren’t funded • But the population is aging rapidly • The “baby boom” peaked 1965-70 • Labor force growth is already slowing • Capital markets are now crucial • Planning is dead! • Diminishing returns: more capital is needed to get the same increase in output • Private savings will replace / supplement SOE pensions

30. China: Opportunities Remain • Urbanization and household formation • Stimulates demand • Construction is labor-intensive • New households require new consumer durables • Cities pollute less than the countryside • Urban infrastructure enjoys economies of scale • Education levels still rising– full effect only when today’s youth hit middle age • Behind technically: productivity will rise!

31. The End