A History of China’s Economy

During my senior year at Cornell, I thought it would be a great idea to take an upper-level Econ course about the history of China’s economy. Let me just say that taking this course pass-fail was one of the best decisions I made that year.
This is a little dry, but give it a shot. It’s not as bad as some of the other crap I’ve put on this site,
and there’s a reasonable chance you might learn a little bit.

Jason Carter
Economics 469
December 4, 1997
Topic #2

During the period from 1984 to today, the development of the Chinese economy can be split into two different stages of reform: the new economic model and the socialist market economy. Although both types of reform sought to change the economic structure from planning to markets, the nature and success of the reforms that were implemented varies significantly between the two periods. In general, the reforms of the new economic model failed on many fronts because of difficulties with implementation. The socialist market economy turned these failures into successes through a more complete package of reform based on price rationalization and marketization.

The intent to develop the new economic model was expressed in the Chinese Communist Party document of 1984. The new program called for a wide range of reforms in the agricultural and industrial sectors. In the industrial sector, the state sought to implement similar reforms used in agricultural reform. In order to reduce the level of government control over industrial enterprises, the state allowed the enterprises to retain a greater amount of profit. During the new economic model, this took the form of the tax-for-profit system. This system eliminated firm profit remission to the state and focused on taxation instead. The state also sought to move from mandatory planning to guidance planning during this period. This change meant that the state would give the firms recommended output goals and encourage the firms to adhere to these goals by manipulating the price and tax levels.

Out of the 1989-1991 retrenchment period came another push for reform through the implementation of the socialist market economy. The most important aspect of this period of reform is that the markets are the primary means of resource allocation. The government no longer uses guidance planning or price manipulation to influence the economy. Through major reforms of the price and tax systems, the state lets the markets determine the price levels and establishes a level playing field for all enterprises.

One of the most striking differences between these two periods is the degree of success of price and tax reforms. During the new economic model, the government attempted to implement a wide range of reforms to reduce the state-s control over enterprises. These reforms failed to live up to their potential because the government did not simultaneously reform the price structure. During the socialist market economy, the government made a complete transition to market determination of prices, which enabled other reforms that depended on a rational price system to take effect (such as reform of tax system).

In the new economic model, a majority of the firms fall under the category of guidance planning, not the free market. The government attempted to control the activities of the firms by manipulating prices and taxes. Under the tax-for-profit scheme, the state attempted to move away from profit remittance towards a system of taxation in order to influence the actions of enterprise managers. However, this level of control was implemented without first reforming the price system. During the new economic model, the economy took the form of a dual-track system, with planned and market sectors, and different prices for each sector. This pricing system would cause huge variations in profit rates between firms. These differences in profit rates would result in some firms retaining a huge amount of profit while others would be left with zero profit. In order to decrease the amount of profit retained by certain firms, the state implemented an adjustment tax, which was more or less arbitrary and subject to negotiation. Therefore, the government’s goal to produce a level playing field had failed because the faulty price system created an arbitrary tax system.

During the socialist market economy reform, the government again attempted to reform the tax system. However, the government first set out to change the price system through full implementation of market determined prices. This helped eliminate the dual-track system, which used market prices for outside-plan production and state influenced prices for inside-plan production. The end of the dual-track system led to reforms in the tax system by eliminating wide variations in firm profitability. As a result, tax rates are applied more consistently between firms, and the degree of taxation is no longer subject to negotiation. This reform levels the playing field for all types of firms because taxes are applied evenly to all ownership systems.

Another key difference between the two systems is the varying level of control of the central and local governments. During the tax-for-profit program of the new economic model, taxation authority and tax revenue were divided into central and local portions. Frequently, local governments would have complete control over tax collection and remit a certain amount to the central government. The main goal of this system was to provide incentives for the local governments to improve revenue collection and take a more active role in promoting firm profitability, and therefore increased tax revenue. In contrast to this system, the tax collection system during the socialist market economy is much more centralized, with the central government collecting a majority of the taxes. To accomplish this re-centralization, socialist market economy reformers have to provide incentives to the local government to relinquish their taxation authority. These incentives are often in the form of decreased interference by the central government and increased tax revenue due to a more efficient collection system.

Another key difference between the two reform periods is the level of importance of markets. During the new economic model, markets are only incorporated into certain segments of the economy. Enterprise managers were actually opposed to the reforms because they were used to the planned economy system. The new economic model is a period of transition from a planned system to a market system. As a result, the two economic systems often overlap and conflict with each other, as is the case with the dual-track system. This incomplete switch to a market economy is the main cause of the irrational price structure and arbitrary tax system. The goals of the new economic model failed to be realized because of these problems.

In contrast, the period of the socialist market economy is characterized by a complete switch to a market system. The government first allowed prices to be determined by the market, and as a consequence, reforms in the tax system and an overall leveling of the playing field took place.

The new economic model and socialist market economy reform periods both sought to decrease government intervention through a transition to a market economy. However, a partial transition combined with inadequate reforms of the price and tax structure caused the new economic model to fail and lead to economic retrenchment. The reform efforts of the socialist market economy were more successful because marketization and rationalization of the price system occurred before other reforms were undertaken.