Effective Demand, Enterprise Reforms and Public Finance in China

Abstract

Economic reform in China Athar Hussain and Nicholas Stern This paper examines some problems of transition from a command to a market economy through an analysis of the most important example to date – the reforms in the Chinese economy since the late 1970s. Our focus is on the links between enterprise reforms, effective demand and public finance. The reforms have created a curious and problematic hybrid of market and command economies with serious problems of coordination. They have concentrated almost exclusively on the delegation of decision-making to enterprises from the higher to lower tiers of the government without taking into account its implications for investment, consumption and public finance. An understanding of future policy and lessons for other countries requires a careful examination of the effects of these past policies. Granting discretion to enterprises over investment and wages has resulted in both an investment and consumption boom but, paradoxically, a fall in profits. There are strong reasons to suppose that the investment ratio has been too high in recent years, fuelling inflation and slowing additions to supply by prolonging the gestation period of investment. There has been a large increase in liquid assets in the hands of households, which makes their expectations increasingly important for macroeconomic policy. There is need for concerted financial innovation to diversify household wealth away from liquid assets. Finally, the changes in the composition of government revenue and expenditure are disturbing. There is an urgent need for a flexible and broad-based tax system and for reducing price subsidies and subsidies to loss-making enterprises.