somewhat pessimistic. The following paper by Nicholas Lardy, assessing many of the same problems raised in this paper by analyzing the short-run developments within the more recent past, yields conclusions which tend to be much more optimistic. The individual authors of the papers in this volume were chosen on the basis of their expertise in the subject matter they were asked to investigate; not on the basis of their point of view. Thus, different interpretations of China's economic development and policies in both the past and in the future can be found in the papers that follow. That is as it should be. In their campaign to develop their scientific and technical capabilities so as to catch up with the West by the end of this century, the Chinese have adopted Mao's slogan to "allow 100 flowers to bloom, 100 blossoms to contend." That same motto holds true for our search for the truth concerning China's economic evolution in this and the papers that follow.

PAST PERFORMANCE AND THE ECONOMIC PROBLEMS OF THE MID-1970's

During a very few years after the Second World War, the Chinese Communists emerged from their guerrilla bases, rapidly seized control of large portions of Manchuria and North China, crossed the Yangtze, swept through the south, and in 1949 announced the creation of their new government for all China-the People's Republic of China. The economy they inherited included over 500 million people who were poorly fed, clothed, and housed and who had a per capita GNP that was probably less than US$50. The economy's productive capacity had suffered severe damage during the Civil War. Moreover, after the Second World War the Russians had dismantled and removed over 50 percent of the industrial capital in China's largest industrial and railroad base, Manchuria. Even in the 1930's, industrial output had accounted for only 10 percent of China's GNP, but in 1949 the absolute level of output in industry fell to only one-half its prewar peak. That same year was little better for agriculture: grain and cotton outputs were, respectively, about 25 and 50 percent lower than the prewar peak levels.

In addition to commodities production being at a very low level, the underdeveloped and partially destroyed transportation system made regional distribution of both goods needed for production and processed goods a serious problem. The rampant inflation that had been underway since 1936 had also seriously distorted business incentives (by leading to speculation, et cetera) and had prevented the rational allocation of resources to meet China's basic needs (rational being the use of resources in their most effective and beneficial way, which by definition can occur only in a noninflationary economy). Moreover, with domestic shortages limiting China's export capacity, the state treasury's holdings of foreign exchange reserves having been removed by Chiang Kai-shek to Taiwan, and the small likelihood of foreign aid and assistance from a hostile Western world, China's capacity for alleviating those shortages by imports was severely limited.

The length and scope of this analysis do not permit a description of how skillfully fiscal and monetary policies were used in the reconstruction program that restored production to its peak levels of the prewar period by 1952. Those enterprises that had been owned by the Nation

alist government or by bureaucratic capitalists were taken over by the state, but private enterprise was allowed to remain in operation, as was a market system for the allocation of resources. The state budget was balanced, and revenues were used for investment in the public sector. State trading companies were created to dominate both internal and external trade in key commodities, but rationing was not yet introduced, nor were price controls. Furthermore, this remarkably successful rehabilitation program was carried out with limited Soviet aid while China was fighting the world's largest military power in the Korean war and at the same time carrying out a sweeping redistribution of economic, social, and political power by means of land reform in the countryside.

Between 1949 and 1952, the new government restored price stability, increased industrial output 2.5 fold and agricultural output by 50 percent, brought the balance of payments under control, and more than doubled imports, with producer goods accounting for over 90 percent of the total imports. Most important, GNP per capita, in real terms, in 1952 was 35 percent higher than it was in 1936.

Institutional Reorganization of the Economy'

Having successfully consolidated their control over the population and economy and revived production to roughly the levels obtained before the war, the Chinese launched their program of institutional change and economic development to achieve the transformation of China into a modern industrial power. The agricultural sector was reorganized into elementary producers' cooperatives, into advanced. cooperatives a few years later, and finally into People's Communes in 1958. The communes were intended to replace the lowest level of government in political administration and were to be the essential decisionmaking and accounting unit in production in the rural areas. This experiment proved unsuccessful, however, and political administration was returned to the county governments and production and income distribution decisions were decentralized to the level of the team, approximately equal to the size of the earlier elementary producer's cooperatives, following the economic crises of 1959-61.0 Although the team, consisting of 30 to 40 households, has remained the basic decisionmaking and accounting unit in Chinese agriculture, recent discussions in the Chinese press indicate that the radical goal of making the brigade, equivalent in size to the former advanced producers' cooperatives, and then the commune the decisionmaking and accounting unit remains as a longrun goal. In addition, with the spread of rural small-scale industry and farmland reconstruction projects operated by the commune, that high-level organizational unit is regaining some of its former role in determining the allocation of resources in the rural areas of China. Nonetheless, the most fundamental and enduring institutional transformation introduced by the Chinese

State Statistical Bureau, "Ten Great Years," Foreign Languages Press, Perking, 1960. For a discussion of the general economic model, i.e., institutional and functional, organization and policy priorities, pursued by the Chinese Communists in their economic development efforts over the past 25 years, see Alexander Eckstein's paper in this volume, "The Chinese Development Model.'

10 For a more detailed discussion of these institutional changes in the agricultural sector, see the discussion in Robert F. Dernberger, "China's Economic Future," op .cit., and the sources cited in that article.

Communists in the agricultural sector has been the change from household farming which had existed for centuries to collectivized farming by production teams and there is little evidence to indicate this institutional organization will be changed by the new leadership."

State ownership in industry was already significant in 1952, accounting for over 50 percent of the gross value of industrial output, due to the takeover of enterprises owned and operated by the Nationalist government and the bureaucratic capitalists, that is, those capitalists with close ties to the Nationalist government. The remaining privately owned firms were soon subjected to numerous taxes, fines, and labor problems so that in a short time their owners took advantage of the state's offer to buy them out with bonds equal to half the value of the assets of the firm. By 1956, all private enterprises had been absorbed into the socialist sector, with the joint state-private firms accounting for 30 percent of the gross value of industrial output. These joint state-private firms were completely taken over by the state during the 1960's.

Initially, ownership and control of the state enterprises were highly centralized under the economic ministries of the central government, with their input and output quotas being determined in the state's economic plan, Since the late 1950's, however, considerable decentralization has occurred; only key industries being directly under central government control, the largest of the remaining industrial enterprises being owned and operated by municipal and provincial governments. In the rural, small-scale industrial sector, the largest number of enterprises are owned and operated by communes and brigades, that is, are in the collective sector, but the largest share of output in this sector is accounted for by those rural, smallscale industrial plants owned and operated by county governments, that is, those rural, small-scale plants in the State sector.

The production decisions of all these plants, regardless of the level of ownership and control, are incorporated into the state's economic plan and are subject to the next higher level of government's approval. Despite the considerable relaxation of this official centralized control over industry during various periods in the past, recent articles in the Chinese press make it clear that the new leadership intends to reassert the central governments control over the production planning and output allocation of the state enterprises at all levels, Nonetheless, the existing hierarchy of ownership and operation of the state enterprises and the rural, small-scale industries in the collective sector should remain as the organizational characteristic of China's industrial sector.

In the absence of a market system for the allocation of inputs and outputs and of a profit maximization criteria for plant management, these allocation decisions are determined by administrative decisions and included in the state economic plan. After a brief period in which

11 At the present time, these units-communes, brigades, and teams-in the cooperative sector are not integrated into the detailed State economic plan. They determine their own production plans, are allocated inputs by the State, pay taxes and sell goods under negotiated contracts to the State, distribute income and provide education and health services to their members. Individual households are allocated small plots and can consume or sell the output of these plots in rural markets that exist for that purpose. If sold on the market, however, key commodities must be offered first for sale to the State trading companies. State farms do exist and are the most mechanized farms in China. Nonetheless, they are not very important in terms of either total acreage or production. Recent statements in the Chinese press indicate the new leadership supports the individual household's private plot production activities and participation in trade on the rural free markets. Recent reports also hint at the possible expansion of state farms and, perhaps, even the incorporation of some of the collective units' economic activity within the State plan.

the Soviet system of highly centralized planning was tried, the Chinese implemented a much more decentralized system of planning which increases the participation of the masses at the lower levels of government and economic administration. Over the past decade or more, the state's economic plan has been a combination of decisions made at various levels, with considerable initiative coming from the lower levels. Nonetheless, the central government has always retained its right of final approval of the production and allocation decisions included in the economic plan. This system of decentralized planning has allowed for considerable flexibility and lower level initiative in economic problem solving; a unique feature of Chinese planning. The central planners, of course, have not been passive participants in the process of resource allocation, reacting to suggestions from below by exercising their veto power when necessary or by making only marginal adjustments in the proposals they received. They directly control and operate the key industries, the transportation network, internal trade in key commodities, and all external trade. Most important, however, is their ability, through their control over the State budget and the banking system, to control financial flows in the economy and to transfer all profits of State enterprises above those retained earnings approved for working capital, workers' fringe benefits, and small investment projects, into investment and expenditure categories determined by the central planners.12 This ability of the central planners to control the rate and direction of China's economic development will undoubtedly be significantly increased in the future. Recent reports in the Chinese press emphasize the need to reestablish greater central control over production and allocation decisions, that is, planning, in an effort to eliminate the inefficiencies and wastes resulting from the poor coordination and implementation of decentralized planning decisions over the past decade.

Disproportionate Growth and the Major Economic Problems of the Mid-1970's 13

Utilizing this reorganization of the economy, the Chinese Communists took an industrial sector, limited in size and considerably distorted in structure and location in 1949, and increased its output over the past quarter of a century by more than eightyfold. This remarkable

12 For the central government's ability to reallocate the profits of State enterprises by means of their control over the budgets of the lower levels of government, see Nicholas Richard Lardy, "Central Control and Redistribution in China: Central-Provincial Fiscal Relations since 1949," unpublished Ph. D. dissertation, The University of Michigan, 1975. It should be pointed out that there is a difference of opinion in the literature concerning the consequences of China's budgetary process and the considerable decentralization that has occurred in the economy since 1957. Some observers believe the effects of decentralized collection of budget revenue, revenue sharing, and local ownership and management of most enterprises led to the reappearance of cellular, or regional, autonomy over resource allocation in China. See Audrey Donnithorne, "China's Cellular Economy: Some Economic Trends since the Cultural Revolution," China Quarterly, no. 52, pp. 605-619, and several other articles by the same authors. The summary of the opposing view that considerable control was retained by the central government, presented in this paper, does-we believe-represent the conclusions of most observers.

13 Unless otherwise noted, the statistical data used in this section of the paper is taken from the such readily available sources as Nai-ruenn Chen, "Chinese Economic Statistics: A Handbook for Mainland China," Aldine, Chicago, 1967: State Statistical Bureau, "Ten Great Years," the statistics in the papers included in the previous compendium on China's economy released by the Joint Economic Committee. "China: A Reassessment of the Economy," U.S. Government Printing Office, 1975; or the most recent issue of statistical estimates for China's economy released by the National Foreign Assessment Center, CIA, "China: Economic Indicators," ER77-10508, October 1977. Unfortunately due to the deadlines scheduled for the submission of the papers to be included in this volume and the second volume to be issued later this year, it was not possible to incorporate the economic data presented in these other papers in this introductory paper. Inasmuch as these estimates are used to illustrate general trends or relationships, not as accurate point estimates; the use of one set of estimates rather than another should not change the arguments presented in this paper.

pace of development, the doubling of output every 5 years or a 13 percent annual rate of increase was interrupted twice in the 1960's due to the excess capacity created by the dislocations of the "Great Leap Forward" in the early 1960's and due to the disruptions of the cultural revolution in 1967. Industrial growth was again disrupted due to the turmoil associated with the succession crises in the mid-1970's. Nonetheless, industrial growth over the past 25 years has been rather continuous and rapid, obtained by the greatly increased rate of investment and large share of total investment allocated to this sector. The input bottlenecks and slow growth in other sectors due to this concentration of investment in and the resulting disproportionate growth of industrial production were problems the Chinese leadership had to accept as the price of rapid industrialization.

Their economic system, with a centralized budgetary system insuring State control over enterprise profits and a centralized supply system for key commodities providing plant managers their inputs and freeing them from the burden of marketing their output, enabled the State planners to create industrial capacity according to their own priorities, even though disproportionate growth may be a result of those priorities. Critical to this growth of industry, however, was the required supply of capital goods. Since the Chinese began with a small initial industrial base, they were forced to import most of their early requirements of machinery and equipment,15 one reason for putting a high priority on the rapid growth on the industrial sector rather than on agriculture. These imports, of course, had to be financed by exports of raw materials and processed agricultural products, especially textiles, or the products of those sectors which did not. receive a high priority in the allocation of the available investment funds.16

Therefore, changes in the structure of industry, and not just growth of total industrial production, was also important. Development of heavy industry, or the manufacture of producers goods for industry, was most crucial if China was to achieve greater self-reliance in its industrial development. As a result, the machine-building, energy, and metallurgy sectors increased at rates well above the average for industry as a whole." These increases in the industrial production of inputs for industry eventually led to serious problems of disproportionate development within industry itself, even within the producers goods sector, as well as throughout the economy as a whole.

For example, the emphasis on the expansion of the industrial production of inputs for industry came at the expanse of two other key producers goods industries; transportation equipment and producers goods for agriculture. Compared with the rate of industrial growth, the rate of track laid lagged behind and the rail network suffered from a shortage of locomotives, resulting in significant increases in traffic density and weight hauled per train. The Chinese have begun producing diesel locomotives to take advantage of their petroleum resources, but this has not significantly altered a situation of increas

14 An index of industrial production in 1957 and 1965-77 is estimated and discussed in Robert Michael Field and Kathleen M. McGlynn, "Chinese Industrial Production," part II, this volume.

15 See the discussion of the important role played by foreign trade in sustaining and developing the Chinese economy and the appendix tables for estimates of China's imports of producers goods in more recent years in Rich Batsavage and John Davie, "China's International Trade and Finance," part V, this volume. 16 In the 1950's, Chinese imports of producers goods from the socialist bloc were financed, in part, by some short-term commercial credit and long-term loans. But the Chinese had repaid these debts by 1965-a remarkable record for an underdeveloped country engaged in a large-scale program of industrialization. 17 For a more detailed discussion of developments in these three key industries, see Robert F. Dernberger, "China's Economic Future," op. cit., pp. 97-99; also see the four papers in part II, this volume, on the machine-building industry, the energy sector, the mineral sector, and the electric power industry.