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THE DEVELOPMENT OF TOWNSHIP, VILLAGE, AND
PRIVATE ENTERPRISES: RURAL INDUSTRIALIZATION
IN CHINA, 1979-1989.

By
Shin-Ray Lee

A THESIS
Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

MASTER OF SCIENCE

Department of Sociology
1992

/t_//~\;_ "

ABSTRACT

THE DEVELOPMENT OF TOWNSHIP, VILLAGE, AND
PRIVATE ENTERPRISES: RURAL INDUSTRIALIZATION
IN CHINA, 1979—1989.

By
Shin-Ray Lee

The development of rural community enterprises (township, village, and
private enterprises) is a very important part of the economic reform in
China since late 1978. It has significantly increased personal income
among rural residences, improved the structure of rural economy,
absorbed a large number of rural surplus labours, and made an increasing
important contribution to the national economic growth.

With the decentralizing macro-economic policy and its cellular
community characteristic, the community enterprises are deeply attached
to the interest of the community as an economic unit. Local governments
and local enterprises thus are very close and rely mutually. On the one
hand, it followed the route‘ of rural industrialization rather than
urbanization. On the other hand, the community as a whole will face a
rather harder budget constraint which changes the basic principle of
enterprises management and that is extraordinary in the socialist

economic environment.

TABLE OF CONTENTS

Introduction

Chapter 1 Historical Background of Rural Industrialization
in China

Chapter 2 The Social and Economic Achievements of the
Developments of the TVPE Sector
Increasing Personal Income
Absorbing the Rural Surplus Laborers
Improving the Structure of Rural Economy
Contributing to the National Economy

Chapter 3 Causes of the Rapid Development of Rural
Enterprises in China
1978-83 : The Initial Stimulus from Agriculture
1984-Present : Market Expansion and Self-
Supported Progress

Chapter 4 Decentralization: The Macro-economic Structures

For the Development of the TVPEs

The Decentralization of Material Allocation

The Growth of the Extrabudgetary Funds

The Bargaining Economy

Multichannel Allocation and Multitiered Prices
Structure

The Leakage of Decentralization

Chapter 5 Cellularity: The Local-Community Structures for
the Development of the TVPEs
Behind the Hierarchical Collective Ownership
Cellular Structure of the Rural Community

Chapter 6 Role of Local Government: The Formation of
Quasi-Planning System
The Contradictions in the TVPE Organizations
LihelFormation of Quasi-Planning System at Local
ve

Conclusion -- The Dilemma of "Dual Dependence",

Bibliography

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LIST OF TABLES

Table 1 The Development of the TVPEs in China, 1978- 1989
Table 2 Average Income Per Capital in China, 1978- 1987
Table 3 Leakage of the Decentralization

31

htroducflon

China, as a country with the largest rural population in the world, is facing
with difficulties to a typical developmental problem that almost every
developing country has to meet -- the transferring of resources from
agricultural sector to industrial sector. According to the experiences of
Western advanced countries and most other Third World Countries, to
transfer productive materials, including capital, labour, land and so on,
from the agricultural sector to the nonagricultural sector is the most
significant turning point in the course of economic development. They
always followed the route of "urbanization", by which the industry sector in
the urban areas extracts the agricultural surplus values and absorbs the
rural surplus labour as its primitive accumulation to promote the
development of urban industry. However, this "dual economy" strategy --
urban industry and rural agriculture -- always produced some polarized
tensions of structural inequality. The urban unemployment was getting
serious while the rural sector met a shortage of labor. The distribution of
wealth was further worsened both in the urban and rural areas. Therefore,
unstable urban city and declined rural village seemed to be the unavoidable
outcomes.

China, under its specific historical conditions, took another way to
overcome this difficulty. That is to industrialize its broad rural areas. The
development strategy emphasizing planning command, heavy industry,
ideological mobilization, and egalitarian distribution has proved failure to a
large extent. The leaders in China acknowledged that for China, without
the modernization of rural areas, the modernization of the country is
impossible. And without the enthusiastic peasant participation, the

agricultural production is by no means to feed themselves and not to

mention to support the industrial development. Political and ideological
mobilization can not work any more. The rice bowl everybody eats from has
to be broken up.

The introduction of the production responsibility system in agriculture1
since 1978 was the first and most important step on the way. The basic
production unit turned back to the family household. Peasants were much
more willing to work hard just because they could retain most outcomes of
their labor inputs. They thus had the motivations to produce more and to
accumulate for their better lives. The first mechanism of rural development
has been triggered. '

Next problem was how to transfer this agricultural accumulations,
which included the surplus laborers, the funds, the purchase power and so
on, to the industrial sector. China did not follow the way of urban
industrialization but to industrialize the rural villages. Non-agricultural
enterprises collectively owned by the rural communities are proliferating.
They are pooling capital accumulated from the agricultural production and
hiring labor from the large pool of surplus agricultural workers in the
countryside to pursue industrial, building, service or commercial activities.
Although they work at relatively low technological standards and with a
rather small scale, these non-agricultural establishments constitute a new
and vital social force in the Chinese countryside, likely to play an
increasingly. important role in rural development and to contribute to the

national economic development.

 

lA practice in agricultural production by which the production team contracts all
its farmland to individual households for separate cultivation. The contracted part
of the output goes to the production team for unified distribution among the
membership, and the rest is either share between the team and the contractor or
granted to the latter as a bomus that they could sell on the local market.

In addition, China is probably the only major socialist country left after
the collapse of Soviet block. The economic reforms in socialist countries in
the past decade could be seen as the catalyst for the end of the communist
regimes from certain perspective. However, so far, China seems to be the
only exception. As a matter of fact, China has just begun to show its strong
and vital strength in the world economy in recent years. An examination of
the mechanism of this experience in general and the development of the
non-agricultural enterprises in specific without any doubt is necessary and
worthwhile.

This paper will first describe the historical background of the rural
industrialization in China and the major contributions the local non-
agricultural enterprises achieved in recent years. Then it will discuss the
macro-economic environment and local-community structure for the
development of those enterprises. Finally, focusing on the important role of
local government, it will analyze the contradictions rooted in the
organizational pattern of the development of these enterprises and indicate

the possible alternatives for the development in the future.

Chapter 1 WW ofRural Industrialization
in China
First of all, there are three levels of rural communities in China. The
township (formerly the communez), presently the lowest level in China's
government hierarchy, has an articulated government structure. The
typical township has a population of 15,000-30,000. The village (formerly the
brigade) is not a separate level of government but has certain governmental
functions and a community structure. Villages generally have a population
of LOGO-2,000. The production team is purely a loose community
organization. As a result of the implementation of the production
responsibility system in agriculture in the early 19808, the production
teams have lost most of the administrative functions. The average
production team consists of about 30 households with a total of 150 people.
There are some ambiguities in the delineation of the TVPEs (Township,
Village, and Private Enterprises) in China, but the broadest definition,
which is increasingly popular, encompasses all nonagricultural activities
in rural areas and small towns other than those on state farms. Some of
them owned by community governments are referred to as community
enterprises , and the others owned by individuals or partnerships are

termed private enterprises . Community enterprises owned by township

 

2The people's commune, with production brigades and production teams as its
subdivisions, constituted a system of collective ownership of the means of
production at three levels: the commune level, the production brigade level, and
the production team level. It was an economic organization and an agency of the
state at the grass roots. During the period of 1979 to 1984, this system had been
dismantled by the establishment of the agricultural production responsibility
system. In 1984, the commune system was abolished officially. The
administrative and economic functions were separated formally with the
reestablishing of the rural administrative organization; and the commune and
brigade enterprises were renamed the township and village enterprises as well.

and village are referred to as township and village enterprises (TVEs)3.
Government units at the township level which are responsible for
supervising township enterprises are referred to as township industrial
corporations 4. They function like a board of directors in western
enterprises. The headman of the village or production team, however in
general, takes responsibility directly of the enterprises owned by village or
production team.

Since the founding of the People's Republic of China there have been
three stages of rural industrialization in China. The first came in 1958,
when the people's communes were established and a nationwide
industrialization campaign was launched. China, dizzy with the "victory of
transformation" (nationalization and socialization of the economy), adopted
the Great Leap Forward strategy and attempted to reach the "paradise" of
communism by building the "golden bridge" of people's communes. Rural
people's communes established a large number of commune and brigade
enterprises to mobilize the whole nation's manpower, funds and materials
to develop industry. By the end of 1958 commune and brigade enterprises in
China employed 18 million people and yielded a total output value of Y6
billion. In the following year that figure catapulted to Y10 billion (Byrd and
Lin, 1990b, p.9).

The second stage began in 1970 when the State Council, at a conference
on agricultural development in North China, called on rural areas to speed
up the mechanization of agriculture. Farm machinery factories set up by
rural community governments spread all over China, further boosting the

 

30ccasionally township and village enterprises are discussed separately.
4They go under a variety of names, including township industrial corporations.
township industrial and trade corporations, and township industrial association.

development of commune and brigade enterprises. Meanwhile, many
urban plants, absorbed in the Cultural Revolution (1966-76), had stopped
production. Market shortage became worse with each passing day, and
some rural communities took advantage of this opportunity to set up firms.
The output value climbed from Y9.25 billion in 1970 to Y27.2 billion in 1976
(Byrd and Lin, 1990b, p.10).

The third came afier the Third Plenum of the Eleventh Central
Committee in December 1978. It shifted the nation's focus to the reform of
the economic system. Community enterprises entered a new era of rapid
growth. Since 1978 the rural economic reform characterized with the
production responsibility system was launched nationwide. Agricultural
productivity increased rapidly. It provided a much better environment for
the development of commune and brigade enterprises. Meanwhile, a great
amount of rural surplus laborers need to be absorbed by the expansion of
the nonagricultural sector. The output value was increased from Y43.9
billion in 1978 to Y101.67 billion in 1983. The average annual growth rate
was 15.6 percent. Governments at all levels set up administrative bureaus
to strengthen the management of these enterprises. In March 1984, the
Central Committee and the State Council agreed to rename commune and
brigade enterprises as township and village enterprises since the peeple's
commune system had been abolished and a large number of partnerships
and individual enterprises had come into being. Since then China's TVPE
have flourished more than ever. In 1984 the output value of TVPE totaled
Y171 billion, and the figure rose to Y273 billion in 1985 and Y845 billion in
1989. It was even more than Y1,000 billion in 1991.

Table] The ofthe'I'VPEsin 1978-

s oyment tput ue
million ' n ° )

1989

         

Chapter 2 The Social and EconomicAchievements of the
Developmentofflre TVPE Sector

The proliferation and growth of the TVPEs have significantly increased
personal income among rural Chinese people, absorbed a large number of
rural surplus laborers, improved the structure of rural economy, and made
an increasing important contribution to the national economic growth.

Increasing Personal Income

As a result of the reform in the rural areas since 1978, mainly the
establishment of the production responsibility system together with the
increasing the procurement prices of agricultural products, the income of
peasant has begun to increase in an unprecedented speed. This first wave
of income increase, as a necessary accumulation, made it possible to
accelerate the growth of the TVPE. And the rapid development of the TVPE
further pushes forward another wave of income increase.

During the first ten years of the economic reform, the personal income in
rural areas has increased from Y134 in 1978 to Y463 in 1987. The average .
increase rate is more than 27 percent every year, while that figure in urban
areas is only 21.1 percent. The rural-urban income gap has been reduced.
Obviously, this is a rather successful case about income increase and

distribution among the developing countries5

 

5Adelman. and Sunding (1987) has presented Lorenz curve estimates for Chinese
income distribution by period, 1952-1986. They concluded that the level of
inequality in China is one of the lowest in the world. Although rural inequality
increased after 1978, national inequality fell, due to a reduction in the rural-
urban income gap.

Table 2 Average IncomePer Capita
(Yuan)

ears area

 

1988.

From 1980 to 1983 the total wage of TVEs increased Y5.64 billion, which is
equal to 5.3 percent of the total net income increase in the rural areas
during the same period. That index rose to 12.9 percent in 1984 and 24.8
percent in 1985. If we calculated the total wage of the whole TVPE
sector(including the private enterprises), the range of increase will be
greater. The total wage of TVPE increased Y58.28 billion from 1985 to 1989,
which is equal to 48.42 percent of the total net income increase in the rural
areas. The TVPE sector becomes an increasing important resources of the
personal income in the rural areas. It is estimated that in some areas,
where the TVPE are developed well, more than 70 percent of personal

income are came from the TVPE sector.

Absorbing the Rural Surplus laborers

Although the fast increasing productivity of agricultural work is a welcome
process, the accompanying phenomenon of mass unemployment yet seems
to be unavoidable. In the pro-reform collective economy the over-population

of villages remained a hidden fact. The commune provided employment for

all the adult population in the villages, although at a low productivity level
and low living standards. However, since the beginning of the reform, the
strong financial interest of the family farm, and the relatively free labor
market are bringing the redundant labour to the surface. Most intensive
'production will finally release labour who would seek employment in the
nonagricultural sector or even immigrate to urban areas.

China is known for its large labor force. It was estimated that 534 million
people would still be engaged in agriculture by the year 2000 of which
perhaps 200 million will be surplus to rural needs (Li, 1986; Zhang, 1987).
Such huge pressure to create new jobs is a major motive for the
development of rural nonagricultural economy.

According to the experiences of Western advanced countries and most
other Third World Countries, to transfer productive materials, including
capital, labour, land and so on, from the agricultural sector to the
nonagricultural sector is the most significant turning point in the course of
economic development. They always followed the route of "urbanization", by
which the industry sector in the urban areas extracts the agricultural
surplus values and absorbs the rural surplus labour to promote the
development of urban industry. However, this "dual economy" orientation --
urban industrial and rural agriculture -- was not always successful. On
the one hand, the urban industry was not necessarily able to absorb the
rural surplus labour. The problem of urban unemployment was getting
serious while the rural sector met a shortage of labor at the same time. On
the other hand, "urbanization" itself has certain external costs as well.

China took another way of overcoming these difficulties -- which is to
"industrialize" the small towns and villages, more specifically, to develop

the TVPE sector. Based on the experience of the 19808, between 46 million

10

people (Han, 1987) and 52 million (Yu, 1987) transferred out of agriculture,
and especially out of cultivation activities. Han estimated that some 64
percent shifted into rural industries located in villages and small towns, 19
percent into building and construction, 5 percent into transport activities,
and close to 8 percent into services and commerce. By the end of 1978, 28.27
million rural surplus laborers in China were employed by TVPE. That
figure increases with the average growth rate of 22.98 percent to 87.76
million at the end of 1987 (see Table 1). According to some estimates, during
1979-84, TVPE increased their total value of output by Y83.6 billion. In so
doing, they used 6.9 million rural surplus laborers, which in effect,
comparing that in the state-owned enterprises, substituted for Y28. 1 billion
of investment in fixed assets (Development Research Institute, 1986, p.11).

With continued economic reforms the future of rural enterprise in China
is considered to be bright. Although there is a recognition that its capacity
to provide employment is not unlimited, however, rural enterprises might
absorb at least 25 to 35 percent of the surplus labor force constantly (Wu and
Xu, 1990).

Improving the Structure of Rural Economy

Although the agricultural productivity has increased rapidly at about 8
percent a year as a result of the reform, the proportion of the gross
agricultural output value to the rural gross social product value decreased
significantly. There is a dramatic change in the composition of gross social
product in China's rural areas. The share of crop cultivation dropped from
almost half in 1980 to less than one-third in 1986. The share of other
agricultural activities remained more or less constant. And the industry

rose from less than one-fifth to more than 30 percent, nearly equal to the

11

share of crop cultivation. In 1987 the rural gross value of industrial output
exceeded the value of agricultural output for the first time (Byrd and Lin,
1990b, pp.13-4). Construction, transport, and commerce rose modestly as a
share of the total. The goal of "Industrializing" the small towns and
villages in the rural areas has been achieved to an impressive degree.

Contributing to the National Economy

TVPE also made a great contribution to the development of national
economy. In 1980, the output value of TVPE only created 15. 15 percent of the
GNP. However, with the rapid development of the TVPE, it grew up to 32.75
percent at the end of 1985 and 53.59 percent in 1989 (see Table 1).

TVPE also played an important role in the process of Chinese
industrialization. The industrial output of the TVPE created only 10.4
percent of the national gross industrial output value in 1980, but it grew up
to 18.8 percent in 1985, 23 percent in 1986, and almost 30 percent in 1989.

In addition, the contribution of the taxes from the TVPE to the national
financial revenue is also getting magnified. It increased from Y2.2 billion
in 1978 to Y36.46 billion in 1989, which is equal to 13.4 percent of the total

taxes revenue of that year.

12

Chapter3 Causes of the Rapid Development of Rural

Enterprises in China

Although the development of the TVPEs was generally rapid, there were,
however, sharp ups and downs. The output of TVPE industry as a whole
rose and declined twice since 1979 (Du, 1990, p.47). The fluctuations were so
large and the cycles so short that the stability of the entire urban and rural
economy was afl'ected. These swings were obviously related to the changes
in government policies toward rural industries and the situation of the
urban and rural economies.

The development of rural industry in recent years can be divided as two
phases by the critical year of 1984: 1978 to 1983 and the period since 1984.
There were important changes in government policies, economic reforms,
and the urban and rural economies between the two phases.

First, there were constant arguments as to whether the unfettered
growth of TVCEs would be efficient and compatible with socialism until
1984 when all the government institutions, from the highest authorities
down to grass-roots departments, decided to fully support TV PE
enterprises. Second, the household production responsibility system in
agriculture was universally implemented by 1983, and by 1984 new reforms
were needed in rural areas. In addition, the output 'of agricultural products
increased greatly after 197 8. By 1984 there was even small trade surplus in
grain and cotton. Since 1984 crop production has stagnated (Du, 1990, p.48).

In the period before 1984, the growth of TVPE industries was initially
stimulated by the development of agriculture. After 1984, depending upon
the expanding market, a self-supported progress of TVPE industries began.

1978-83: The Initial Stimulus from Agriculture

13

The growth of rural industry has all along been closely related to the
conditions in agriculture. For example, the growth of township and village
industry has been in inverse proportion to the amount of rural arable land
per person“. It is clear that shrinking agricultural resources were the
initial force behind the development of TVPE.

In the twenty-five years between 1952 and 1977, China's rural population
grew by 55.6 percent, whereas the total area of arable land fell by 130 million
mu7. Arable land per member of the rural population dropped from 3.29
mu to 1.85 mu. During the same period, the agriculture's share of the
national income fell from 57.7 to 37.1 percent. Yet the proportion of
agricultural labor in the national total increased from 82.6 to 84.2 percent.
The productivity of peasants and land in rural areas thus worsened instead
of being improved.

The most conspicuous change in China's rural areas since 197 8 has been
the adoption of the production responsibility system. It is a reform that
greatly increased farmers' enthusiasm and stimulated agricultural
production. As a result, the production suddenly increased. It has been
growing by about 8 percent a year, far exceeding the population increase
which has been slowing down. In Wuxi county, for example, the
agricultural productivity increased 1.7 times from 1980 to 1985. This not
only resulted in the suddenly increased peasant income, but also in the food
supply of the cities. Basically, the difficulty of feeding the huge population
has been overcome.

This policy, however, aggravated the situation of surplus agricultural

labor. New rural economic policies that encouraged a diversified economy

 

68cc Du (1990). p.48.
71 mu = 0.0667 hectares.

l4

in the countryside were as significant as the production responsibility
system. Policies that disencouraged rural labor from shifting to
nonagricultural activities were basically abolished, and the movement of
farmers into nonagricultural activities was accelerated.

The transfer of rural surplus labor to nonagricultural activities involved
several important factors, especially the capital, labor, materials and the
marketing activities by enterprises.

(1) Capital

Initially, the accumulation of funds for investment in nonagricultural
activities was related to the unusual growth of agricultural income. This
growth stemmed partly from the increase of agricultural production and
partly from the rise of procurement prices which in fact meant a return of
industrial profits to agricultural sector. During the years between 197 8 to
1982, the state procurement prices for agricultural products rose by 50- 100
percent. In 1978-80 alone the rise in procurement prices enabled farmers to
reap Y46 billion in additional net income (Du, 1990, p.51).

From 1978 to 1983, farmer's average per capita income in China
increased 132 percent from Y133.6 to Y309.8. In Wuxi county during the
same period, it rose from Y124.4 to Y412.7, an increase of 232 percent. An
increase in farmers' bank savings accompanied the rise in their income.
In Wuxi, a county with high income, the total amount of rural bank
deposits increased by 486 percent and individual deposits rose by 600 percent
between 1978 and 1983. The growth of rural deposits therefore helped
expand local banks’ supply of funds and has been a positive force in the
development of TVPE. For the country as a whole, the year-end outstanding
balance of loans extended to TVCEs increased from Y1.5 billion in 1977 to

15

Y7.35 billion in 1982, a rise of 390 percent. The growth of farmers' income
also added directly to the supply of funds for TVPE industry (Du, 1990).

(2) Labor

In rural China the basic unit of economic accounting is the household.
When land was contracted according to head count, it did not matter
whether a household member was engaged in agricultural activities or not,
since the land could be farmed by other members of the family. As a result,
the opportunity cost of a farmer's turning to industrial activities was
practically zero (Du, 1990., p.53).

There were also large discrepancies between personal income from
agriculture and from work in TVPEs. In 1980 rural per capita income from
agriculture was Y166, whereas per capita income in TVPEs was Y398. In
1985 these figures rose to Y351 for agriculture and Y726 for TVPEs. At the
same time, the per capital income in the urban areas was only Y685. This
comparative advantage of income in TVPEs to a large extent mitigated the
pressure of migration from the rural areas to the urban cites. TVPE
industry at this stage thus faced an abundant supply of labor, which

promoted its development.

(3) Materials
After 1978 the planned procurement of agricultural products by the state
shrank even while farm output grew. This situation stimulated the growth
of TVPEs that used agricultural raw materials. Between 1978 and 1983 the
output value of such type of TVPEs increased by 254 percent.

Meanwhile, the adjustment of the country's national industrialization

strategy also enabled TVPEs to receive some materials subject to monopoly

16

distribution under the state plan. TVPEs were also allowed to get some
semi-finished products by sub-contract with state enterprises.

(4) Marketing

All along, TVPEs have been sensitive to market trends because they have
had no access to state commercial channels. Consequently, the TVPE
industry has to place strategic emphasis on sales. On the one hand, they
encouraged the widespread participation by enterprise staff in obtaining
supplies and promoting sales. On the other hand, the salaries of sales are
generally several times higher than the average salaries for all other
employees and may even exceed a factory director's salary because of large
bonuses.

In addition, TVPEs face an environment in which structural reforms in
state enterprises are just starting. It provides an opportunity for TVPEs to
shift part of the state enterprises' profits into their own hands by means
such as giving sales commissions, paying sales agents, and making out
blank invoices. These factors have enabled TVPEs to occupy a substantial
share of the market for many industrial goods. Furthermore, because of the
widespread of the shortage of the factors of production and the consumer
goods, the entrepreneurial TVPEs have thus taken this opportunities to
take up the slack, meet the demands, and get their market share (Gold,
1989).

1984-Present: Market Expansion and Self-Supported Progress

The TVPE development in the early stages depended heavily on the
financial support from agriculture and on the extraordinary growth in the
supply of production inputs from agriculture. But by 1984 agriculture could

17

no longer effectively support the growth of the TVPE. Community
governments began to take part of TVPE industrial profits to subsidize the
prices of agricultural products. Competition for labor also became a serious
problem in some areas. The impetus given to TVPE industry by agriculture
has obviously fallen short of needs.

Despite all these problems, TVPE industry not only did not shrink but
achieved even higher growth rates after 1984. The main factors pushing the
growth during this period were the self-development of TVPE industry and
the changes in the microeconomic policies which institutionalized the
support of local governments to the TVPE industry. There are three
phenomena worth to note: the burgeoning of private economy, the changes
of the supply of funds, and the changes in the products market. A

(1) The Burgeoning of Private Economy.
The Central Committee's Document No. 1 of 1984 allowed private firms to
hire workers and relaxed restrictions on them, the private economy thus
became an important element in the rapid development of TVPE industry.
By the end of 1988, 91.58 percent of the total number of TVPEs has been
private enterprises although most of them are very small in size. 48.73
percent of the employees of the TVPEs was hired by the private enterprises
among them. The proportion of the value for the output of private industries
to that of the total TVPE industries was 24.25 percent. But the weight of
private enterprises in transport and commerce sector in the total TVPEs
has reached 76.55 percent.

First of all, the development of private enterprises can improve the
emciency of resource allocation. Since private enterprises are more likely

than community enterprises to employ labor-intensive production

18

techniques, their substitution of labor for capital is even more evident. This
processes also contribute to the geographically balanced development (Lin,
1990, pp.173-7 5). Some local authorities in economically underdeveloped
regions, in drawing up their development scenarios, have pinned their
hopes on relaxed political controls and on encouragement of the private
economy. In the first few years after 1978, the government depended almost
solely on community enterprises to push rural industrialization. But the
gaps among different regions, instead of narrowing, widened alarmingly
as a few relatively developed areas took advantage of their rich financial
resources, abundant human talents, and favorable geographic conditions
and enjoyed rapid rural industrialization while the backward areas could
hardly get ofl‘ the ground. The blossoming of private enterprises in all areas
since 1984 has helped narrowing the gaps among regions and has offered
new hope for solving the problem of regional imbalances as the rural

industrialization progresses.

(2) The Changes in the Supply of Funds.
The second element that spurred the rapid development of TVPE industry
after 1984 was the changes in the supply of funds. The 1984 policy of
supporting the growth of TVPEs led to a considerable relaxation of
restrictions on bank loans and a consequent credit inflation that directly
augmented the supply of funds to TVPEs. The national rural loans in 1984
and 1985 increased almost by 60 percent.

In 1985, the central government tried to control the bank loan quotas in
rural areas to moderate the pressure of inflation. This policy seriously
affected the volume of credit extended to TVPEs. TVPEs began to search for

new sources of funds, including local residents and cooperative

19

investments. According to statistics made available by Wuxi's Agricultural
Bank, 65 percent of the money pooled by local TVPEs was obtained by
squeezing bank savings. It meant that even if the bank's loans were
tightened, the funds from local residents were still reaching TVPEs
without passing through the banking system (Du, 1990, pp.58-59).

The self-accumulation capacity of TVPEs was also expanding. Between
1980 and 1985, the total profits used to expand production in TVPEs rose by
68.5 percent. And the share of this investment on total profits rose from 49.7
to 51.4 percent. Despite the reduction of agriculture funds in the capital of
TVPEs in 1984 and 1985 as well as the returning of part of the profits of
TVPEs into agriculture, the total supply of funds was enlarged owing to the
improvements in the functioning of financial markets and greater self-
accumulation by TVPEs. In 1985, TVPEs all over China mobilized more
than Y10 billion from these sources.

(3) The Changes in Product Market.
The changes in product markets were perhaps a more important factor in
the speedy development of TVPE industry during this period. First of all,
the inflation caused by the loss of macroeconomic control in 1984, which
created an excessive growth of demand for investment and consumer
goods, provided an important stimulus to TVPEs. Meanwhile, reform in
the system of mandatory purchases and sales by the state in urban areas
allowed TVPE products to enter urban commercial channels on a more
stable basis.

With the development of TVPE industry and the expansion of
nonagricultural activities in rural areas, a new process of income

generation has emerged in rural areas. The number of families who earn a

20

'dual income' (Kornai and Daniel, 1986) is growing: part of it coming from
agriculture, another part from TVPE sector.

The growth of farmers' income further brought about an increase in
consumption and changes in the consumption structure. Between 1978 and
1989 the total value of retail sales in rural areas of China grew by 463.61
percent. The annual growth rate of the consumption level of rural residents
was even 8.3 percent higher than that for urban residents.

The growth of farmers' income since 1978 has enabled them to enter the
consumption goods market. Rural growing demand stimulated the growth
of TVPEs that manufacture consumer goods or provide services, thus
creating a new source of income for rural residents and further spurring
' their demand again. Rapid production increase in TVPEs that produce
consumer goods also stimulated the development of firms that
manufacture investment goods and further increased rural income as
well. While creating income for the rural population, TVPE industry was
building up an ever wider market for itself. These chain effects have

become more and more conspicuous since 1984.

21

Chapter 4 Decentralization: The Macro-economic

Structures for the Development of the TVPE:

China's planning and supply system differs from those in other socialist
countries in several ways. First, the scope of Chinese central planning is
limited. Local rather than central authorities control the production of
many key materials. It results in a number of separate planning and
allocation subsystems. Second, an increasing proportion of China's
industrial output is allocated through the local governments rather than
the central plan. Meanwhile, enterprises are often allowed (or forced) to sell
some of their products on the market. Third, the proportion of
extrabudgetary funds is growing dramatically during the past decade. And
the fourth, multiple channels of supply give rise to multiple prices for the
same product. This is one of the most unusual features of the Chinese
system which reinforced the characteristic of bargaining economy.
However, the discretional power is not decentralized into the individual
enterprises directly. Sometimes there are "leakages" through that process -

- local governments rather than the enterprises gain more power.

The Decentralization of Material Allocation

In the 19508, as part of its planning model, China adopted the Soviet
material-allocation system. Under this system, production materials are
divided into three categories. Category I comprises the widely used, key
materials under direct allocation by the State Planning Commission.
Specialized key materials under Category II are allocated by central
industrial ministries responsible for their productions. These two
categories, along with manufactured consumer goods allocated by the

Ministry of Commerce, constitute the centrally planned industrial

22

productions. Category III goods include less important goods that are
subject to allocated by local governments (Tidrick, 1987, p.176).

China allocated fewer goods centrally than the former U.S.S.R. In 1981,
there were 837 category I and II products in China, compared with about
65,000 in the U.S.S.R. Some of this difference was due to the broader
categories that Chinese used. However, although Soviet and China might
cover similar proportions of industrial outputs, without any doubt, Soviet
planning was much more detailed and correspondingly comprehensive
and complex than Chinese.

In fact, the scope of Chinese central planning is even narrower because
not all goods in Category I and II were entirely controlled by the central
government. In general, materials flowed downward to production
enterprises according to their level of administration. Therefore, although
Category I and II are supposed to be allocated by central government, they
are in fact distributed by difi'erent level of local authorities.

The first round of decentralization came with the rash "Great Leap
Forward" movement in 1958. It was dramatic but rather brief: 87 percent of
the enterprises were decentralized to local (mostly provincial) control. More
importantly, since its extremely ambitious but scattered programs of
development, the system was changed from unified allocation at the
national level to coordination at the provincial level (Wong, 1985, pp.257-59).

During the Cultural Revolution period (1966-1976), the dismantling of the
planning apparatus and attacks on bureaucracy and "economisim" further
weakened central planning. The disruption of planning work was
extremely serious during the Cultural Revolution. Because of political
struggles in the State Planning Commission, annual plans were not even

formulated for 1967 and 1968. In June 1970, nine central government

23

control agencies were merged into the "State Planning Revolutionary
Committee" which had 610 staff members, only 11.6 percent of the staffing
level of the original separate agencies (Deng et al., 1984, p.131).

Furthermore, in accordance with the policy of self-reliance and self-
sufi‘rciency, the central government had to make a number of concessions
in the material allocation system to encourage local investment which put
control over very substantial amounts of resources into local hands. This
policy of self-reliant industrialization at the local level had a fundamental
impact in China's economic system. By the end of the Cultural Revolution,
the Chinese economy was very much decentralized. With the balance
between center and localities, the power has shifted significantly toward the
latter.

Because ownership or administrative control of enterprises normally
confers the right to allocate their outputs, local governments, for example,
allocated the following shares of category I products in 1980: coal, 46
percent; steel, 42 percent; nonferrous metals, 36 percent; lumber, 18
percent, and cement, 71 percent (Tidrick, 1987, p.176). China thus deviates
markedly from the ideal central planning model in which all productions
in categories I and II are under central control and outputs would allocated
in blocks to local governments for distribution to their categories III
producers.

Increasing use of the market has also narrowed the scope of central
planning in China. Beginning with the period of adjustment and reform in
late 19708, many products originally subject to central allocation were
allocated through market sales by enterprises (self-marketing). This is
partly the first step toward the market reform and partly a practical

response to the imbalance of supply-demand after adjustment policies

24

which slowed the growth of heavy industry and expanded investment in
light industry.

The Growth of the Extrabudgetary Funds

China's highly centralized public finance system dates back to 1950. In
March of that year the Central Committee issued two resolutions
containing detailed regulations for the state financial management system.
Except for some local taxes and a few small income items that could be
retained by local governments to offset certain expenditures, all income was
concentrated in the hands of the central governments. Similarly, all outlays
(except local supplementary expenditures) were included in the state
budget. In subsequent years this "uniform income and outlay" system
underwent several changes, but it was not until 1980 when China began to
break away from overcentralization and excessively strict control and to off
more financial autonomy to local governments.

Even under the centralized system, some local governments funds were
mobilized and utilized outside the state budgetary controls. At first these .
extrabudgetary funds included only a few items and were very small. Some
townships, villages, and departments of local government tried to use their
own production and business operations to help finance rural education,
cultural activities, administrative expenditures, and the like.

In 1953 extrabudgetary funds in China as a whole were equivalent to only
4 percent of the state budget, but the figure climbed to 8.5 percent in 1957
and‘to 20.6 percent in 1960. Readjustments by the state caused the figure to
drop to 14.5 percent by 1966, but it then rose again and reached 31.0 percent

in 1978. A8 economic reforms and decentralization of authority took hold,

25

the figure jumped to 59.1 percent in 1981, 83.3 percent in 1985, and 89.7
percent in the end of 1987.

The Bargaining Economy

The primary objective of the economic reform in China is to "break the habit
of enterprises eating from the 'big rice pot'." According to the economics of
shortage developed by Janos Kornai, socialism is, in its "classical" form, a
resource-constrained system (Kornai, 1979). It is the bottlenecks of
production and not the buyers' demands that delimit production. If one of
the resources proved to be a bottleneck momentarily, other resources will be
idle at the workshop. There is shortage of the resource presenting the
bottleneck, and slack of the complementary resources. Therefore, shortage
and slack are not mutually exclusive phenomena, considering the whole of
production and a long period, but are necessarily concomitant.

This shortage phenomenon occured in the socialist countries was caused
primarily by a particular kind of collective working attitude by which since
the rewards have nothing to do with the efforts, the workers doesn't care
how to use resources efficiently. Therefore there is no financial discipline at
all. This is about whether a firm's budget constraint is "hard" or "soft".
The budget constraint is "harder" if the growth of the firm depends on its
own financial position. And the budget constraint is "softer" if the growth of
the firm is not tied to its present and future financial situation. In the latter
case there is no failure; the firm survives even when investment entails
grave losses. It is because the losses are almost automatically compensated
by the state since its paternalistic role of the state under socialism.
Therefore the firm's demand becomes almost insatiable and the resultant

inflationary pressure generated by this uncontrollable expansion drive have

26

necessitated administrative interventions. With this political guarantee,
whether the firm performs good or not is not important any more. This
formulates a vicious circle of shortage (Wong, 1986) --so long as shortage
persisted, exercise of financial discipline was unlikely, and so long as
enterprise operated in the absence of a hard constraint, autonomous
mechanisms were in gear to drive the economy toward shortage.

Furthermore, compared to other socialist countries, plans in China are
often ill-defined, with slack or negotiable targets. Under the origin
economic system, plan targets are the subject of protracted negotiation.
Unlike the former U.S.S.R., Chinese output targets are generally set below
the production capacity. Chinese enterprises have considerable room for
maneuver.

On the one hand, because the enterprise has no objectives of its own and
only passively completes those set by the state, it often adopts two methods to
complete the ordered assignment easily: first, it conceals its production
capability fi-om the state or underreports it. And second, it asks the state for
more inputs. As a result, either the state-set goals are met, but with added
inputs, or the higher goals that originally could have been met now cannot
be.

On the other hand, in China, with the introducing of self-marketing
policy, enterprises may be given production targets with no guarantee that
their outputs will be allocated through plan. And materials supplied
through plan allocation may fall far short. Therefore, although Chinese
production output targets may be taut with respect to material allocations,
the supply channels outside the central plan usually enables enterprises to
obtain enough supplies to meet their targets (Tidrick, 1987).

27

Furthermore, enterprises know that in the end they can always change
unreasonable targets. Such targets have been changed even in the last week
of December. Sometimes, they have been eliminated altogether. However,
bargaining over plan targets is not completely one- sided. Targets may also
be raised in the last few days of the year, usually to offset a shortfall by
another enterprise. In such a case, the enterprise understands that it is
doing its superiors organization a favor to be reciprocated in the future
(Tidrick, 1987, p.183).

After 1979, according to the policies of reducing the scope of
administrative control, devolving decision-making authority to lower-level
units and improving incentives of enterprises, the number of plan targets
handed down has been reduced further. However, the rate of "profit
remittance", which is a device to link bonuses and. workers' welfare
expenditures to enterprises profitability, remained highly negotiable. This
was culminated in the "profit-contracting system", where "contracts" were

set each enterprises through annual negotiation (Wong, 1986).

Multichannel Allocation and Multitiered Prices Structure
Enterprises in China are able and forced to obtain such goods as steel and
coal through channels other than central allocation. These other channels
are fed from two sources--the production of local enterprises outside the
central system, and the self-marketed outputs of state enterprises within
the system. Obviously the importance of these two channels is getting more
and more significant.

Multiple pricing is an inherent feature of the multiple sources of supply.
For most key producer goods, there are several prices (usually in ascending

order): the centrally controlled allocation price, the floating price for self-

28

marketed outputs, the locally controlled allocation price, and the negotiated
price in markets of various localities. Thus the prices of the final products
are also negotiable because the proportion of inputs that an enterprise buys
at each price is flexible to some extent.

It is clear that, as low-priority claimants in the hierarchical system of
material allocations, local enterprises faced serious shortfalls in meeting
production requirements and had to turn to market channels for much of
their supplies.with higher prices. Meanwhile, because most of their
outputs were not included into the state allocation plan, these local
enterprises had to sell their products on the market with higher prices.

The result is an "abnormal" situation where "whatever is under state
control is sold at unified state allocation prices, which are fairly low, and
whatever is not state-controlled is inferior but sold at high prices." (Wong,
1985). When supply exceeds demand and prices are falling, small plants
are cutting prices to compete, while large state plants operating with fixed
state prices again find their hands ties. Therefore, high-cost production by
small, inemcient outside-plan production will be more profitable.

As a result, multiple prices create a strong incentive to divert goods from
low-priced state allocations to higher-priced market sales. This will leave a
rather large room for the enterprises of corruption or other forms of
behavior that may discredit reforms or harm long-term development.

However, multiple pricing is a first step to full market allocation. First,
the higher market prices will provide an incentive for the enterprises to
respond the demand-supply situation as soon as possible. On the other
hand, this system also provides a more competitive environment for the

state enterprises to enhance their efficiency. It also enables enterprises that

29

have failed to obtain enough materials because of mistakes in allocation to
buy critical inputs although with higher costs.

In summary, with the demise of the central control and the growing of
the extrabudgetary funds, the fundamental qualifications for market
transaction were initiated. The lower the level of administrative hierarchy,
the weaker the influences of the central government and the smaller the
wight of the plan budget in their operation. Meanwhile, the more
autonomous the local governments and enterprises enjoy, the more
pressure they feel about the profits and losses, and much the "harder"
budgetary constraint.they have to deal with That is, a majority of local
enterprises have to sell their products in a buyers' market but face a sellers'
market for the raw and semifinished materials they want to buy (Zhang
and Zhang, 1987). This is a major feature of the environment of the

macroeconomic structure for the development of the TVPEs.

The Leakage of Decentralization

For the reform planners, the problem faced in China was how to
decentralize and give greater autonomy to microeconomic units for
responding the objective economic situations immediately while retaining
essential political control and ensuring that social and ideological
constraints are not violated. However, given the multiple levels of decision-
making, decentralization is a complex process (that can generate a number
of possible outcomes. A reduction in the scope of central planning does not

necessarily mean a shift to market allocations.

 

8See Wong (1987).

30

Defining decentralization as a shift of decision-maln'ng power from the
top toward the bottom, with "+" indicating gains an "-" indicating losses,
Wong enumerate five different outcomes in a three-level economy as

follows:

Tables leakageoffireDecenn-alizafion

 

 

ent units - - - - -
Intermediate units - + + +
(Local government)
Primary units + + + -

 

 

 

 

, (Ente rises) _
Sburce: Wong, (1987). pp.95-96.

In the best case (type 1), decision-making power is transferred from both
the central and local governments to the enterprises. In the worst case (type
5), "positive intermediation" occurs, where the intermediate units of
governments gain at the expense of both the central government and the
enterprises. Between the best and worst cases are scenarios where
"leakage" occurs, with local governments usurping some or all of the
decision-making power passed down by the central government (types 3 and
4).

Previous decentralizations of the Chinese economy (especially during
1958 and 1970) were of type 4 ("administrative decentralization"). While
post-Mao reforms have broken decisively from that tradition by transferring
much greater decision-making power to enterprises, there has also been a
good deal of "leakage" to the intermediate units. In fact, Wong argued that
decentralization through 1983 was closer to type 5 than type 1 In the more

recent period, market pressures have eroded local control in some respects,

31

but much remains to be done to ensure that reforms continue to make
progress toward the objective of increasing enterprise autonomy. However,
decentralizing reforms, which originally aimed to sever the particularisitc
ties that bound enterprises to administrative units and to break down the
barriers to resource flows, have had the paradoxical efi‘ect of strengthening
the ties between enterprises and local authorities.

The community governments not only have all the administrative
functions, but also have some actual autonomy and represent to a great
extent the common interests of their community members. They are thus
akin in many ways to nation-states, albeit tiny in size. But they differ in one
fundamental point from national governments that their financial means
for functioning are virtually limited. One of their main economic policy

instruments is to establish and develop community enterprises.

32

Chapter 5 Cellularity: The Local-Community Structure for the
Development of theTVPEs

There are two local structural conditions for the development of the TVPEs
should be noticed: their ownership structures and their cellular
community characteristics. These significant features are, on the one
hand, the consequences of certain historical legacies and local policies
before, and, more importantly, they are the conditions of the effects for the
implementation of further reform policies in the future on the other hand.

Behind the Hierarchical Collective Ownership
In general, there are three broad categories of TVPEs: community
enterprises, partnerships, and individual proprietorships. The former two
are defined as collective enterprises by the government. According to
Marxist analyses of capitalism, the contradiction between the effective
socialization of production on the one hand and private ownership on the
other was the most general and fundamental contradiction of the capitalist
mode of production. Therefore, the collective sector was seen as a
transitional form from originally private to finally state ownership9

The direction of policies in China from 1949 to 1978 was consistent with
this approach. However, since 197 8, there has been a shift in thinking to the
extent that many economists and policy-makers no longer see the collective
sector as just transitional, but as an enduring form with distinct
advantages in certain areas of the economy. They justified collective
ownership as a component of public ownership system which is the essence

of the socialist mode of production. To develop TVCEs was even considered

 

9See Lockett (1988)

33

as a mean to consolidate and advance public ownership and further to
realize socialism in China. Ironically, from the standpoints of many
"capitalist economists", the operation of community enterprises system
was seen as an important concession to market economy, and proved that
the capitalist economy is somewhat superior to the socialist economy.
However, according to the oficial explanations, the existence of market was
an acceptable part of socialism, and it did not equal to capitalism. These
arguments partly came from the diverse "versions" of different socialist
who used the same terms to implied difi‘erent meaning, and partly reflected
the government's efforts to ideologically justify some of its policy
implementation.

In addition, the line between state ownership and collective ownership is
also ambiguous. In China, theoretically, state enterprises belong to the
whole people of the country, provincial enterprises belong to the whole
people of the province, county enterprises belong to the the people of the
county, and township enterprises belong to the members of the township.
However, in fact, the enterprises (except private enterprises that
mushroomed in recent years) belong to administrative structures at
various levels. In this respect, there is no difference between state-owned
and collective enterprises. Those TVCEs are essentially "ministate"
enterprises, but the "state" to which they belong are community
governments, which supervise the enterprises through their industrial
corporations.

According to the official classification, the line between these two types of
enterprises is set by where the funds come from. If the funds of the
enterprises are supplied by the central government's budget, then those

enterprises are defined as state-owned enterprises. If the funds are

34

collected by the local governments, no matter they are provincial, county, or
township governments, those enterprises would be defined as collective
enterprises. In general, the proportion of enterprises included in the
central plan declines as moving down the administrative hierarchy. In
other words, the lower the level of administration, the smaller the weight of
state-owned sector. At the level of township, which is the lowest level of
local administration, there is almost no enterprises received flmds directly
from central government, and all those owned by township governments
will be collective enterprises.

Since each category of firms is attached to a unit in the administrative
hierarchy which has a clearly defined rank, there is also a hierarchy of
firms. The higher the grade of a firm, the more preferential treatment and
resources it gets from the government and hence the stronger feeling of
security it has. The lower the status of the enterprises, the more directly is
the firms' profits linked to the performance of the firms and the "harder"
the budget constraint they face. State enterprises and their employees enjoy
the most privileges--preference in the allocation of material inputs and
bank loans at low interest rates, lifetime employment, and so on. The
collective enterprises are treated, in contrast with private enterprises,
preferentially with respect to taxes, interest rates, and fiscal assistance.

However, The transfers and changes in enterprise ownership forms also
occurred in recent years”. As a consequence of the production
responsibility system, community enterprises in difiiculty can now be sold
or leased to private industrialist. Owners of private enterprises can also sell

their enterprises or have them raised to community enterprise status. For

 

IOSee Luo (1990).

35

example, some local governments, especially those in the relatively
backward areas, encouraged private industrialists to help start or manage
firms that are nominally registered as township enterprises. Some
successful private industrialists also felt pressure to abandon their
ownership rights of their firms and let them become township enterprises
(Luo, 1990, pp.162-64). By this process the local government could have a
profitable community enterprise and increase the employment. For the
employees, it could secure their jobs. And even for the owners themselves,
they want their enterprises to be promoted to collective status partly because
they believe they would not be able to maintain true ownership of the assets
anyway and partly because the consequences of change in enterprise is
advantageous for the founders and their families. For example, the
founders may become government cadres, and their families are oficially
recognized as permanent urban residents and are able to enjoy many
privileges not shared by rural residents. Similarly, a township enterprise
may, through transfer of its assets to the state, have its status raised to that
of a state enterprise operating under higher level of authorities. Under
such circumstance the status of enterprise workers will be raised
correspondingly. However, the ownership of a TVCE cannot be transferred
to another government of the same rank because workers of all enterprise
are residents of the same township or village and therefore cannot be
transferred.

In addition, a host of enterprises jointly run by township or village
governments and private industrialists has emerged recently. The
establishment of these joint public-private enterprises was motivated by a
common desire for mutual benefit based on contracts of equality rather

than on responses to political pressures. This is an event of tremendous

36

importance in China's rural industrialization. In certain areas, some
private industrialists have even established joint operations with state-
owned enterprises. This tendency of joint ventures among different type of
ownership are expected to be more prevailing in the near future. The

ideological insistence of ownership thus will be less and less important.

Cellular Structure of the Rural Community

The most important traditional characteristic of China's rural
communities is their "parcelized" and "close" structure. It was G. William
Skinner's important early work on traditional Chinese marketing system
that had first given currency to the idea of a cellular pattern of organization
of the rural periphery“. Skinner had used this insight to emphasize not the
discreteness of the rural cells he sketched, but rather the means of their
linkage into quite far-flung networks, which, through commerce and social
intercourse, brought about an integration between urban and rural
socioeconomy before the revolution.

Audrey Donnithorne (1972) later revived the concept of cellularity to
characterize what she saw as the relative fragmentation of the Chinese
economy in the wake of the Cultural Revolution's attacks on the central
party/state bureaucracies.

Shue (1988) further clarified and elaborated this notion of cellularity or
parcelization of the peasant periphery. She plotted an argument that state
penetration and control of rural society under Mao was more uneven and
less complete than is often imagined by scholars. In the sphere of political

and administrative integration, it appeared that the center's seemingly

 

”See Skinner (1964; 1971).

37

deepest penetration of the periphery was in fact buffered through a
crisscross network of horizontal and vertical offices that actually
institutionalized, within the state structure, the segmentation of the rural
periphery. And the very tension between center and locality continued to
pervade Chinese society. In the sphere of economic integration, it appeared
that the state center itself deliberately pursued policies strengthening the
vertical segmentation of the periphery, finding in the ideal of self-reliant,
comprehensive, but locally bounded economies, with the campaign slogan
of "dividing the kitchen to cook and feed yourself', a possible way out of its
awesome economic development dilemmas.

In 1958, the people's commune movement swept all over rural China.
The economy and administration of a given area were put under a single
organ, the commune, which was invented to fulfill all the functions of
everyday lives such as production, distribution, and socialization. This
utopian experiment did not make economic sense and eventually led to
disastrous consequences. Between November 1961 and February 1962 the
basic economic unit was degraded first from the commune to the brigade
and then to the next lower level, the production team, which normally
contained twenty to thirty households. This is to restore order in the
economy while retaining the commune framework. Two aspects of this
pattern of local governance worth pursuing”. First, it saw a continued
fusion of political authority, economic power, and social status within a
small, highly integrated rural community. Second, it permitted only a very
localized sphere of influence and authority to be exercised by any individual
of rural elites. This parcelized but complete pattern of local governance is

 

128cc Shue (1988), p.114.

38

the basic feature of the cellular structure of rural community during Mao's
era“.

Recent reforms have changed this system somewhat by restoring the
township as the lowest level of government in rural areas and by allowing
much greater scope for economic activities and for the accumulation of
assets by private individuals. However, local community retain their
cohesiveness and have a significant role in the local economy. It was partly
the legacy of the commune system, and partly was the result of the
incapability of the central government to control the resources in the local
areas.

This structure are also manifested in and reinforced by the financial
relationship of the township. The revenue of township governments falls
into two categories. Budgetary revenue, which are allocated by the next
higher level government, belongs to the government fiscal system and is
generally used for specified purposes such as salaries of state employees,
administrative expenditures, and operating expenses. Extrabudgetary
revenue, which is generated by the business operations and other activities
of township governments included supplementary industrial and
commercial taxes, supplementary agricultural allowed by the central
government, and so on, is at the disposal of the township governments. As

the state budget can only provide subsistence to township governments,

 

l38hue further traced back to the local social and economic context in the imperial
China to make an insightful contrast between the old Chinese gentry and the
contemporary rural cadres. From their structural similarities, Shue suggested that
the traditional features of segmental but self-sustained rural community had been
remained and reinstitutionalized as a cellular pattern in a different form to fulfill
the similar functions, that is, to extract agricultural surplus and to maintain the
political and social order. See Shue (1988). pp.73-121.

39

extrabudgetary revenue becomes the guarantee for their effective
functioning.

During the people's commune period and even earlier, the community
government collected funds locally for the central government. In return,
the central government allocated budgetary funds to community
government through a top-to-bottom process. In this sense the township
government could not be regarded as having independent finances and
budget. But as a grass-roots organ of state power, if it did not have some
discretionary resources at its disposal, it could not function effectively. So,
during the prereform period the township government always tried to
control some resources for meeting local needs, and it used them for
exchanges with lower-level communities - brigades and production teams.
This kind of exchange brought the township government some financial
income outside the state budgetary system. But this primitive financial
relationship could hardly meet the needs of ambitious township
governments, which strove to organize production themselves or to control
some profitable entities. Rural industrialization was considered the best
choice to achieve that goal.

When agricultural property was dispersed under the production
responsibility system, most township governments experienced a short-
term "anemia" in their extrabudgetary finances (Song and Du, 1990).
Therefore, they did not use the same principle to their subordinate
industrial assets which was operated in the form of commune and brigade
enterprises. On the contrary, they encouraged their development under the
base of community ownership. The share of commune and brigade
enterprises in the assets of rural communities thus did not decrease but

increased to varying degrees. One important consequence is the enlarging

4O

proportion of industrial wealth in township property. Income from
industrial production is thus the chief source of township revenue in most
areas, and it is estimated that the income from agriculture only accounts
for 19. 1 percent on average of sample townships' extrabudgetary revenues
(Song and Du, 1990, p.348). This was a critical turning point both for the
rural industrialization and the relationship between the local governments
and local enterprises. There began a funds self-support circulation --
township governments got revenues from township enterprises and then
reinvest in those enterprises. According to a sample survey conducted by
World Bank, direct and indirect investment by township governments
accounted for more than 30 percent of the startup funds for township
enterprises. And the profits handed over by township enterprises
constituted more than 38 percent of township government revenues (Song
and Du, 1990, p.349). The community enterprises have became a
indispensable part of local financial structure. Meanwhile, it also facilitate
to achieve to goal of financial self-reliant and independence.

The strict residential regulation system also has had an obvious effect to
prevent large-scale rural-rural or rural-urban migration for further
strengthening this structure. After 1988, the government began to relax the
strict controls over residential change. Those peasants who could provide
their own staples and who could prove that they had resources to establish
an enterprise, could gain permission to move to towns, especially at the
areas where the government can not handle the surplus laborers floating
out of the agricultural sector. As a result, many individuals shifted to
towns and cities to start up individual enterprise. The organized.
recruitment of workers from the villages by enterprises located in the urban

areas was also occurred (Wu and Xu, 1990). However, mainly because the

41

close financial relationship between local governments and their
community enterprises, the government, especially at the level of township
government, will do as much as possible to reserve all the resources,
including the human resources, for the development of their own
community enterprises. In the previous years of the reforms, local
protectionism flourished in some places. To protect their backward
industries, some regions have blocked the inflow of products from other
regions. Certain raw materials (such as tobacco) of a given region must
first be used by enterprises in that region, with restrictions on their
transfer to other regions, and so on.

In theory, if the productive resources are still impeded by local
governments, the areas with more resources, which included better
geographical position, longer experiences of industrial development, more
natural and human resources, and even more technological and market
information, the rural industrialization will be much successful. Those
areas without such advantages of resources thus will develop much slower.
The regional imbalance will be worse.

However, the mushrooming of private enterprises in local areas since
1984 has had a positive impact on the regional structure of China's TVPE
sector and has begun to contribute toward reducing regional imbalances in
the development of TVPEs (Lin, 1990; Wang, T., 1990). For those
economically backward areas, although the proportions of TVCE
employment and gross revenues in the whole TVPE sector dwindled, those
of all TVPEs expanded since the prosperous growth of private enterprises.

In the ideal model, production responsibility and material allocation are
hierarchical. In China, there is a contrasting cellular model of separate,

almost self-contained industrial systems at several levels (Tidrick, 1987,

42

pp.176—77). Therefore the Chinese system is a amalgam of hierarchical
planning, cellular planning, and markets. Both the hierarchical and
cellular models have a build-in tendency toward autarky. In the
hierarchical system, ministries strives for self-suficiency. In the cellular
system, each geographical planning unit tries to be self-contained.
Ministerial self-sufficiency, or departmentalism, is a feature of most
socialist economies, but regionalism to this degree appears to be a

distinctive Chinese phenomenon.

43

Chapter 6 Role of Local Government: The Formation of Quasi-Planninng
System

These decentralized and cellular conditions gave birth to China's mode of
rural industrialization: "leaving the land but not the village, entering the
factory but not the city." TVPEs have not yet completed the split from
farming and as a result they keep in close contact with the traditional rural
social framework -- the community. Most TVPE workers still maintain the
right to own and control land. Many are still engaged part-time in
agricultural production. This incomplete shift of farmers to
nonagricultural activities is characteristic of China's rural
industrialization. Industrialization has moved ahead while urbanization
has lagged behind. The newly created industrial organizations are still

clinging to traditional agricultural structures.

The Contradictions in the TVPE Organizations

There exist deep-rooted contradictions in the organizational structure and
the ownership systems of TVPEs. First, since the system of community.
ownership inherently inhibits the flow of labor and capital, communities or
regions with full employment will ignore the opportunity cost for the whole
society and turn to capital-intensive investments, high social welfare, and
high consumption, thus reducing the efficiency of capital utilization and
making a fair distribution of income impossible in the national sense. The
standard of living enjoyed by people in some of the townships and villages
has approached or even exceeded that of local urban residents. This may
contribute to fair distribution of income within these areas, but it means a
greater inequality between them and rural regions that lack opportunities

for industrial development. Large investments in scattered public facilities

44

and infrastructure also reduce the potential economic benefits from
urbanization and concentration.

Under the status stratification system of TVPEs, many leaders of grass-
roots units work as government ofiicials and simultaneously represent the
owners of community enterprises. This combination of two roles in one
person inevitably gives rise to serious political and economic interference.
Political pressure from the top often causes encroachment on economic
interests, which can lead to distortions of economic information, gross
violations of law and discipline, and widespread corruption.

The dependence of TVPEs on administrative organs and on
administrative protection of their interests and property rights also
hampers gravely the optimal development of their organizational structure
and makes it difficult to use organizational and technical innovations to
benefit from the expanded local economy and specialized production. Many
enterprises in recent years have been criticized for pursuing short-term
interest and taking advantage of loopholes in the system. Instead of striving
to raise productivity and lower costs in order to increase profits, many
enterprises resort to raising prices, lowering the quality of products, and
engaging in speculative trading, black marketeering, and even fraudulent
practices. Many enterprises also fail to fulfill their sales contracts with the
state in order to sell more in the free market or in the black market at
higher prices. In addition, as Walder (1987, pp.33-36) observed that some
enterprises distribute all their profits indiscriminately as bonuses to the
workers, thereby fueling "bonus inflation' while disregarding the need for
accumulation and reserve funds.

Meanwhile, the dispersed regional development pattern will lead to a

shortage of working capital and irrational distribution of industries, and

45

TVPEs in general will sufi'er the consequences of being uncompetitive and
uneconomically small in scale as long as the local governments still tried to
impede the flow of factors of production. It will further constitute the source
of investment failures and of destructive and excessive competition.

Some observers thus argued that the TVPE development, as a realistic
path to restructuring the rural production and transferring surplus
agricultural labor to nonagricultural activities, is only one phase in the
process of rural industrialization and is linked to particular historical
conditions._ From a long-term perspective, especially based upon the
assumptions of neo-classical economies, with the deepening of economic
reforms in urban and rural areas, a generalized market for factors of
production will emerge, and TVPEs will be included in the modern
economic system on the basis of an organized, rapid growth of
urbanization. And with the rapid development of TVPEs, the
administrative interference will affects those enterprises adversely.
Therefore, the township governments should cut down their management

and control of local township enterprises.

The Formation of Quasi-Planning System at Local Level

However, as Byrd and Zhu (1990, p.105) has suggested that the relevant unit
in the TVPE sector is the township or village rather than the enterprise.
The most basic organizational characteristic of TVPEs is their dependence
on the rural community, as reflected in the deep involvement of community
governments in enterprise management. For quite a long time it will be
necessary for the local governments to involve and control, directly or
indirectly, the operations of some enterprises and to realize community

goals through concerted efforts with enterprises.

46

In the process of rural industrialization the township government took
on twofold role. On the one hand, they are essentially ministates that
provide a whole range of public and social services and set policies and
regulations within their jurisdictions. The instruments available include
the establishment and ownership of TVCEs, decisions of community
government expenditures, a considerable degree of influence over the
lending decisions of the local banking system, and the encouragement as
well as support of difi‘erent types of private enterprises. However, they
cannot engage directly in deficit financing. That is, their expenditures may
not exceed available funds (which include transfers from higher levels of
government and from TVPE as well as the portion of locally collected taxes
allotted to them). Hence, they face a relatively hard budget constraint.

On the other hand, they are also profit-oriented economic entities that
might compared with holding companies, investment corporations, or
headquarters of loosely controlled multidivisional corporations. They tend
to be intimately involved in decisions on important investments, the
establishment or dismantling of firms, significant changes in product
lines, the appointment of enterprise management, managerial
compensation, and bonuses.

This organizational structure, along with the increased funds at the
disposal of community governments ans the weakening of central controls
have created a foundation for the establishment of local protective quasi-
planing system. These systems provide benefits for enterprises,
particularly those established by community governments, so that they can
be counted on to turn over taxes, fee, and profits. In a sense that the quasi-
planning system operates like a traditional planning system except their

size. It tries to infiltrate every link in the operations of the enterprise, from

47

personnel, finances, and materials to production, supply, and marketing.
But community governments can no longer impose inflexible
administrative restrains on enterprises as before. The extent to which they
can control or support local enterprises is limited by their own capabilities.
Regulations enforced by community government's quasi-planning i8
efi‘ective only where the administrative system is highly developed or where
the community government is skillful in organizing the economic
activities. The administrative capabilities of township governments vary
greatly, and so does the effects of their quasi-planning system.

In a macroenvironment where supplies of and demand for inputs and
energy are not balanced, community governments' desire for goods and
materials is a clear indication of their concern for the development of their
enterprises. In recent years the materials supply departments of city and
county governments have often obtained needed inputs through exchange.
The materials bureau of Wuxi County is outstanding in this regard. Of the
materials sold through the purchase and sales companies of the bureau in
1985, only 5 percent were from the state planning system (Song, 1990, p.398).
The rest were obtained by exchanging materials with or investing in units
that produce goods in short supply, such as steel and electricity. Although
raw materials obtained through exchange or investment are more
expensive than those assigned by the state plan, the costs are still lower
than buying on the market, and the supply is more regular. Therefore
firms under various forms of ownership try their best to be admitted into
the quasi-planning system.

It is almost impossible for the township governments to get inputs from
the central planning system, but they can obtain some materials through

their subordinate departments (industrial companies or administrative

48

offices for TVPE administration), through multilatera exchanges or
investments, or even through personal relationships. In addition, township
governments can obtain from the county materials department medium-
price raw materials -- inputs priced between the market price and the state
plan price.

The supply of favorably priced inputs by community governments to
subordinate firms is a mean of compensating for overtaxation and creating
a more favorable environment for them. But community governments need
additional control measures if they want their enterprises to keep bringing
in revenues and at the same time to have good prospects for development.
The allocation of workers and appointment of managers gives local officials
substantial leverage for influencing enterprise behavior. In addition, in the
absence of national capital markets, the local governments continue to
exercise significant control over the allocation of investment finance. Fiscal
decentralization has transferred the funds collected from enterprise profits
and taxes to local coffers. During 1979 to 1984, profit retention rates were set
at low levels of the bureaucracy, and the rates were subject to negotiation
between enterprises and their supervisory agencies. Under this system, the
welfares of workers and managers were determined by how much profits
the enterprise retained. And these welfares beMe very much dependent
on the goodwill of local omcials who held the authority to set profit-retention
rates for the enterprises.

Beyond setting the retention rates, local officials had a good deal of
control over the level of after-tax profits through their price and tax-setting
authority. In order to allow small-scale, local enterprises to cover costs,
which were always higher because their inputs were procured at higher

(market) prices, local governments were allowed to set higher "temporary"

49

prices for local products. And since the growing gap between market and
state prices during the first phase of reform, the price-setting authority of
local governments is increasingly significant.

While the rates for both income and industrial-commercial taxes were
standardized nationwide, local governments in fact had substantial power
to change them. When an enterprise ran into financial difficulties, it could
turn to tax authorities for help, by asking for temporary tax reductions or
even exemptions.

Aside from the profits and taxes control mechanisms, local officials also
continue to exert substantial influence over bank lending, since the
regional structure of the banking system placed bank officials at the mercy
of local oficials. In general, township governments take the view that local
bank funds form part of the community capital base, and they participate in
important lending decisions. One example is that the township banking
system are not allowed to lend money freely to enterprises outside the
township

With local governments continuing to exercise control through these
informal mechanisms, economic reforms in the post-Mao period have left
enterprises with a "dual dependence." (Wong, 1987) Not only are
enterprises forced to be more responsive to market pressures, they also
remain highly dependant on the administrative bureaucracy to provide
vital support.

However, the contradictions are getting more and more evident. First,
the market represented by a single township or even a single county is far
too small to serve most manufacturing firms adequately, and restrictions
against "imports" or other trade barriers are difficult to enforce. Second,

community governments have limited financial resources and face a hard

50

budget constraint. TVPEs may be able to draw on community resources to
cushion the short-term impact of adverse changes, but this cannot continue
very long. Third, community governments with a significant number of
firms are typically in charge of a "conglomerate" of different activities and
lines of business, even though two or three of them may account for much
of total outputs. The asset specificity of these firms is low - that is the
capital assets can easily be switched to production of other goods. This has
given the enterprises great flexibility and allowed them to leave stagnating
or declining activities and move rapidly into the most profitable activities.
However, with the rapid growth of the TVPEs, they have become involved in
industries with higher asset specificity. If asset specificity indeed
increases, it will become more difiicult for TVPEs to engage in their old
method of adjustment. Other ways of adjusting to adversity will have to be
relied on to a greater extent, or the flexibility, efficiency, and profitability of
the TVPE sector will suffer. In this regard, capital intensification,
technological improvement, and acquisition of market information will
become greater and greater important.

Without any doubt, the Chinese rural communities are no long as
isolated cells as it was in the prereform period. A great amount of small
towns is emerging and prosperous as the centers of TVPEs on the one
hand, and as the mediations between the big cities and the villages in their
wide vicinities on the other.

Most liberal economists always considered the governmental
interferences as the very sources of the failure of the economy. The
economic reforms everywhere in the socialist countries in this decade as
reflected in the steps of marketization and deregulation seem to support

their arguments. However, in practice, the government support and the

51

market mechanism sometimes can function very well simultaneously
under certain historical circumstances. The successful developments of
Japan, South Korea, and Taiwan give us good examples about that. In fact,
contracts, property rights, commercial law, and the whole sphere of
privileges, rights, and freedoms relating to merchants are still relatively
absent in recent China, while these, in the modem or Western sense, are
the basis of market predictability and continuity. Under these
circumstances, together with the incomplete function of factor market,
government's activities did not impede the flow of resources, but rather
were very conditions of its circulation and predictability.

It is easy to criticize the system of Chinese TVPEs as backward by
making a simple comparison with the organization and property rights of
enterprises in Western societies. But China's unique cultural traditions, as
well as its specific societal conditions, are the legacy of its history. China
has no way out but to take these restrictions into account as it seeks the
right path and tactics for its advance toward modernization. Actually, so
far, taking its East-Asian neighbors as its model for development seems to
be a better choice than following the route of Western developed countries or
its East Europe counterparts.

52

Conclusion - The Dilemma of "Dual Dependence”
Early reformers in socialist countries, including China, advocated to
incorporate the market mechanism into central planning for more . The
government will regulate the market mechanism by manipulating
investment credits, amortization rates, depreciation allowances, interest
rates, prices, wage structures, and other macroeconomic controls. For
them, with the correct mix of plan and market, the market mechanism
would not generate spontaneous economic processes but instead would
serve as an instrument to reduce the transaction costs of central planning.
In short, early reformers believed that the most efficient governance
structure for socialist economic economies was a combination of market
and central planning. However, in practice, it is very hard to define what
the better combination between bureaucratic regulation and market
allocation is, especially in a concrete economic unit -- the enterprise.

According to the experience of Hungarian reform process, Kornai (1989,
pp.32-94) criticized this extreme confidence in the harmonious, mutually
correcting duality of plan and market. Instead, he suggested that partial
reforms both perpetuated problems of the prereform economy and created
new distortions and imbalances. The command economy was replaced by a
hybrid economy operating in a condition of "dual dependence" (pp.40-44) in
which the economy is coordinated by both vertical bureaucratic and
horizontal market relationships. Kornai concludes from the Hungarian
experience of partial reform the without a decisive shift from plan to a
structure of market governance, there can be no escape from the dilemma
of dual dependence.

Is this argument of partial reform by Kornai applicable for the Chinese

economic reform, especially with respect to the close relationships between

53

local government and local enterprises? What is the characteristic of the
"dual dependence " structure for the organization of the TVPE 8?

The essence of dual dependence, however, is the continued dominance of
hierarchical forms of coordination over the enterprises and the debilitation
of the market mechanism by persistent and pervasive bureaucratic
microinterventions. According to Kornai's analysis, despite giving a
greater role to the market, if some of the critical decisions -- entry, exit,
investment, prices and wages, output, credit -- still depend more on
processes internal to the planning structure than the market, the problem
of the soft budget constraint, shortage economy, and investment fever of the
prereform socialist enterprises which based upon the paternalism will
persist in the postreform economy. A

With this respect, the dual dependence structures of the TVPEs in China
are different. Since the decentralization of the resource allocation and the
hierarchical status of enterprises, the lower the level of administrative
hierarchy the enterprises attach, the weaker the influences of the central
government on the enterprises and the smaller the wight of the plan budget
in their operation. Meanwhile, the more autonomy the local governments
and enterprises have, the more pressure they feel about their profits and
losses, and much the "harder" budgetary constraint.they have to deal with.
In Kornai's model, because paternalist role of the government, the
enterprises will face a soft budget constraint. But in China, it is the local
community as a whole -- including the local government and local
enterprises -- to be a proper unit about budget constraint. The local
enterprises really depend on the local government. And the local

government really control the local enterprises to a great extent. But they as

54

a whole are conditioned in a rather harder budget constraint which made a
significant difference with Kornai's analysis of socialist economy.

First, the capacity of local government to allocate resources is limited.
Although protectionism has occurred in some places, local government,
with its limited resources and small jurisdiction, can not guarantee the
survival of all its community enterprises. The managers of the local
enterprises as the quazi-officials are rather conditioned by the budget
constraint and pushed to response it rationally.

Second, local enterprises are dependent on the local government in the
sense that local government, representing the interest of the whole
community, tries to obtain input materials and expand output market for
its subordinate enterprises. Without any doubt, local government can
coordinate the needs of most small-size local enterprises and have more
access to outside resources than the local enterprise itself.

Third, local government itself also feels the pressure of market
competition indirectly. Because the close financial relationship between
local government and local enterprises, the profitability of the local
enterprises will affect the revenue of the local government immediately.

Therefore, the dual dependence structure of the TVPEs in China is not
only in the sense that the resources are allocated both by planning and
market, but most importantly, the local government and local enterprises
have to depend each other to survive and prosper in the severe "harder"
budget conditions. If it is the case, this dual dependence, although still in
the form of the interweaving of polity and economy, has indeed take an
important step to break up the vicious circle of shortage economy.

Most liberal economists always considered the governmental

interferences as the very sources of the failure of the economy. The

55

economic reforms everywhere in the socialist countries in this decade as
reflected in the steps of marketization and deregulation seem to support
their arguments. However, in practice, the government support and the
market mechanism sometimes can function very well simultaneously
under certain historical circumstances. The successful developments of
Japan, South Korea, and Taiwan give us good examples about that. In fact,
contracts, property rights, commercial law, and the whole sphere of
privileges, rights, and freedoms relating to merchants are still relatively
absent in recent China, while these, in the modem or Western sense, are
the basis of market predictability and continuity. Under these
circumstances, together with the incomplete function of factor market,
government's activities did not impede the flow of resources, but rather
were very conditions of its circulation and predictability.

From a long-term perspective, especially based upon the assumptions of
neo-classical economics, some observers argued that with the deepening of
economic reforms in urban and rural areas, a generalized market for
factors of production will emerge, and TVPEs will be included in the
modern economic system on the basis of an organized, rapid growth of
urbanization. And with the rapid development of TVPEs, the
administrative interference will affects those enterprises adversely.
Therefore, the township governments should cut down their management
and control of local township enterprises.

However, rural industrial development will, for a fairly long time to
come, continue to be an essential part of China's rural development.
Nevertheless, as the experience of many other countries shows,
urbanization is a unavoidable and necessary process. A development

strategy that pushes rural industrialization as an entire substitute for

56

urbanization might prove costly. In view of the dificulties that face TVPEs,
it is necessary to consider how to speed up urbanization over the medium
term. A new urbanization policy is needed as the precondition for
reforming urban-rural relationships, the institutional system for urban
and rural enterprises, and other systems.

It is impossible in the near future to pull down the barrier between urban
and rural areas and effect a relatively free flow of population. Policy should
therefore focus on improving the coordination and management of TVPEs.
A pressing task is to set up new types of investment and monetary
institutions instead of personal relationships to serve as efiicient policy
instruments and means of coordination. China, a big country with a rich
cultural heritage, cannot indiscriminately copy the experiences of foreign
countries. Designing and realizing the TVPE system of the future will

require a fairly long period of experimentation.

57

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