First of all I will discuss China’s historical background and its need for reform and also how economic reform started out in 1978. Then I will go on to cover the four major economic institutions that needed to be reformed in order for China to become a market economy. These four major economic institutions will then be discussed in detail. This paper will then go briefly into China joining the WTO and will conclude with China’s economic situation at present.

Chinese economic policies and institution have undergone a number of extreme changes since the establishment of the Communist regime in 1949. After the Communist Party took national power in 1949, the disorder caused by the imperialist invasions and domestic wars were put to an end and China began to strive for development by following Russia’s example in pursuing Leninist and Marxist doctrine. By following this doctrine they would replace free market and private ownership with socialist planning and public ownership. In order for this to become a reality China had to pursue radical revolutionary domestic and foreign policies to overcome the resistance to the Chinese Communist movements. After closing its doors to western concepts of capitalism and free market economy it seemed like China was doing well but it was soon evident that the rigid planning and the command market economy was becoming inefficient. In contrast to the western economies China was indeed falling behind. Even China’s neighbors such as Taiwan, Singapore, Korea and Hong Kong were growing rapidly after adopting market economic systems.

At the Third Plenum of the Eleventh Central Committee in 1978, the realist Party leaders headed by Deng Xiaoping formally adopted a series of important measures to save China from crisis. These were later known to become the open door policies. So, it could be said that the reform process was put into momentum when Deng Xiaoping took over control of the Communist Party in 1978. It was also a time where there was public discontent and the party members knew that they needed to move away from the old regime and make changes in order to earn the support of the Chinese people.
China has used a dual track system to reform. Dual tracking refers to adopting some aspects of a market economy while at the same time operating under the old planned economy. Transition from a planned economy to a market economy through the dual-track system reflects the most fundamental characteristic of Chinese economic system reform. It works by developing the elements of a new system side by side with the old unreformed system and then by looking at the results it will then implement the new system gradually by phasing out the old system. It was a system that would experiment as it went. As Deng Xiaoping put it, it was like “grope stones while crossing the river”. This system may seem very time consuming and slow as compared to “big bang reforms” or shock therapy used in Russia and Poland, but it was a way the Chinese government could avoid political conflict that rapid reform may generate.
Chinese economic reform began when agricultural reform was introduced under the household responsibility system. Before this system of reform was introduced Chinese agriculture under the commune system was not efficient. Farmers had no incentive to produce more than the required quota as this did not benefit them at all under the commune system. The work point system that the farmers worked under made sure that the farmers were not rewarded in any way for any extra production therefore increased productivity was non existent. The household responsibility system was a system that was made to improve the income and output of rural households. The idea was that once the government agricultural output quotas were fulfilled, the farm households could sell their agricultural surplus in the private market. The new system was proven to be effective as it created incentive for the farmers to work harder and increase productivity. There was a rapid increase in agricultural output and also in the incomes of the farmers which provided ongoing support for the household responsibility system. The success of this system was a stepping stone to reform other areas in order to move forward in creating a market economy.

After the agricultural reforms, the Chinese government then set out to reform its state owned enterprises (SOEs). In the command economy, the SOEs served merely as a means of production where raw materials are turned into industrial products. The planning commissions in national or local governments decide for each SOE what needs to be produced and how much. In such a system, the government agencies plan what to produce, supply resources, and distribute the products. This is known as the centralized command economy. As there is no free market, there are no free enterprises either. Reform of SOEs was not as successful as agricultural reform as it is much more difficult to reform large state enterprises compared to small farm households. Members of the communist party believed in control of these major means of production. They were reluctant to give up power as they did not want non government officials to profit from the state owned enterprises.
It was becoming obvious that the preliminary stages of reform of SOEs were limited in success and in October of 1984, the communist party adopted some major elements to reform. Firstly, firms were allowed to produce more than the plan quota, and sale the extra to the market. Part of the profit resulted from the extra products were kept by the firms. In addition, the firms were allowed to divide their profit with the state. In general, the firms were given more freedom regarding to making management decisions (production, marketing, investment, and profit distribution). This resulted in the increase of productivity and efficiency of the firms. They also allowed for the prices of more products to be determined by the forces of demand and supply as for the reform of SOEs to succeed the whole price system had to become more market determined. Later on firms were even allowed to get involved in international business, and built joint-ventures with foreign companies.
To further reform the SOEs two additional steps were taken and in 1987 the contract responsibility system was introduced. Under this system, the manager of a firm signed a contract with a state agency. Under this new system the SOE would pay a fixed annual tax and would be permitted to retain all other profits. The contract system proved to be a fairly successful strategy in increasing the productivity and efficiency of SOEs. However, even under this new and revised system problems emerged. The managers in negotiating their contracts with the state agencies always tried to hide the real base figures of production, revenue, and profits, in order to gain benefits. In general, by mid 90s, it became apparent that the reform of SOEs had resulted in several major political economy problems. A free market economy modeled after western industrialized systems with a group of substantial state-owned players in many key industries, such as manufacturing, electricity, transportation, communication, petroleum, and finance and banking, seems to be the goal in their mind as they are working to build a “socialist market economy” but whether this picture will become a reality still remains a topic to be looked upon. (“Suggestion to the Writing of the Tenth Five-Year Plan”, published by Xinhua, 18 October 2000)

The third important economic institution which needed to be reformed was the price system. The price system in China was controlled and the reform was put into place to decontrol the prices gradually allowing the prices to be market determined. As mentioned above this process of decontrolling was also crucial in SOE reform. However there were many problems to implementing a market determined price system immediately. The solution that the Chinese government took was to introduce a “two-tier price system”. Under this system one set of prices would remain the same as before and a second set for the same goods would be determined by the market. Under this system, state enterprises in China, once they had fulfilled their production quota specified in the plan, were allowed to sell any above-quota output at the free market price. They were also allowed to purchase inputs in quantities above the plan quota at free market prices. This two-tier price system was an economically efficient system. Slowly but surely the administered prices were becoming increasingly the same as the market prices and by the 1990’s the two tier system was no longer needed as most of the products in China were being sold at the market determined price.

Lastly, it was obvious that the banking system had to be changed. The old banking system only consisted of the People’s Bank of China and a modern banking system had to be established in order to maintain a market economy. “The People’s Bank of China was a monobank” which only had the authority to issue currency and to extend loans to the SOEs and even this needed to be approved by the planning authority. In practice it had no authority as a bank. In 1983 the People’s Bank was transformed into a central bank. Specialized banks such as the Industrial and Commercial Bank of China, the Agricultural Bank of China and the People’s Construction Bank of China were also established and given some autonomy in extending credits to SOEs. By giving these specialized banks the power to extend credits, it increased the supply of currency and China was facing a bad case of inflation by 1985.
In 1993 the Communist party decided to reform the financial sector by giving more independence to the People’s Bank and also transforming the specialized banks into commercial banks. The central bank was to function like the Federal Reserve Bank in the United States and the commercial banks were to function much like the modern commercial banks in other countries.
The two significant dates are March 18 and May 10 of 1995 when the People’s Congress passed the Law on The People’s Bank of China and the Commercial Banking Law. Even though it states that more independence will be given to the People’s Bank it was still a central bank under the direction of the executive branch of the Chinese government and did not have the independent authority exercised by the Federal Reserve Bank in the states. Another difference is that the banks capital is entirely supplied by the state and is owned by the state whereas in the U.S the Federal Reserve Banks generate their own income, primarily from interest earned on government securities that are acquired in the course of Federal Reserve monetary policy actions. Another crucial difference in banking reform is that the United States has a two party system whereas China does not which means that prior to a presidential election the administration tends to pressure the Federal Reserve Bank to adopt an expansionary monetary policy to increase aggregate demand whereas in China, political pressure can come from the desire of a political leader to seek more rapid growth, or to stop inflation rapidly for the fear of public discontent. In China the state council conducts monetary policy. It believes that if macroeconomic planning is an important responsibility of the State Council then the conduct of monetary policy should be a part of its responsibilities as well. In the U.S Monetary policy is made by the Federal Open Market Committee, which consists of the Board of Governors of the Federal Reserve System and the Reserve Bank presidents. Banking reform in China has changed the Banks in China since 1980’s to make them suited to a market economy, but by looking at the differences in the central banks of China and the United states, it is still lacking as the central back is not given enough autonomy and independence from the government.
The current economic situation for China is bright and Chinas economy has progressed a great deal since the Qing Dynasty. Foreign trade and expansion of businesses have continued by joining the World Trade Organisation in 2001and although China will have to change many of it policies such as tariffs on imports and agricultural products and open up to foreign competition by joining the WTO China will also benefit as it will be able to bring in much needed foreign investment and also be able to bring desired new technology or help enhance China’s own capabilities for technological development. International trade is expected to nearly double, and increases in efficiency are expected to increase average gross domestic product. Trade will increase in both directions and Chinese tariffs will be lowered and Chinese goods will have better access to world markets open to members of the WTO. Chinese products will be open to competition and this will in turn improve quality by stimulating the domestic economy. We can expect that private enterprises, joint ventures and foreign owned enterprises, under a better legal system and in an improved economic environment with China a member of WTO, will contribute positively to growth in the next two decades. To go into all the benefits and the possible disadvantages of China’s entry into the WTO is not within the scope of this essay.
In conclusion, the economic reforms that China had undergone have dramatically enhanced its economy today. The planned market economy was successfully transformed into a free market economy and by joining the WTO China has seen considerable benefits and increased efficiency in the economy. Since China opened up to market forces both domestically and internationally in 1978, China has experienced extraordinary development performance in terms of rapid economic growth, the rise of efficiency in economic sector and accelerated urbanization. The open door policy adopted by Deng Xiaoping in 1978 truly did improve the economic situation for China. China’s economic reform was slow but sure.