REFORM OF CHINA'S RURAL INDUSTRY: THE DISADVANTAGES OF RAPID GROWTH

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00794R000100630001-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 26
• Document Creation Date: December 22, 2016
• Document Release Date: June 10, 2011
• Sequence Number: 1
• Publication Date: March 1, 1986
• Content Type: REPORT

Directorate of
Intelligence
Reform of China's Rural
Industry: The Disadvantages
of Rapid Growth
EA 86-10008
March 1986
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 Directorate of Confidential
Intelligence
of Rapid Growth
Reform of China's Rural
Industry: The Disadvantages
Division, OEA,
This paper was prepared byl Office of
East Asian Analysis. Comments and queries are
welcome and may be directed to the Chief, China
Confidential
EA 86-10008
March 1986
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Confidential
Summary
Information available
as of 15 February 1986
was used in this report.
of Rapid Growth
Reform of China's Rural
Industry: The Disadvantages
The development of rural industry-a key element in China's economic
reform program-is proceeding much too rapidly for Beijing to control or
sustain, and is causing serious economic and political problems for the
regime. Spurred by government incentives, eased credit restrictions, and
enhanced business opportunities, rural enterprises-ranging from shoe
repair stalls to small coal mines and factories-grew nearly 45 percent in
1984, and about the same rate in 1985. At the beginning of last year, the
sector was already producing more than one-fourth of the nation's coal,
40 percent of its garments, and three-fourths of the output of building
materials. This hyperactivity, however, has drawn resources away from
grain production, contributed to inflation, weakened Beijing's efforts to
control the economy, and facilitated corruption among rural officials.
sector, and long-neglected rural consumers.
China's reformers have long viewed rural industrial development as crucial
to China's modernization. In general, it is intended economically to link
agriculture to industry, and specifically to benefit China's food-processing
industry, the state's transportation network, the much-needed services
output, and responding to nascent market signals.
Politically, the program is part of an effort to transfer successful reform ex-
periences from the countryside to the cities. Some reformers appear to
believe that it will also prove the practicability of loosened central controls
and greater market influence over economic activity. Rural industry does
indeed appear to be the sector most responsive to free market reforms. Free
of excessive bureaucratic controls, rural industrial entrepreneurs have been
aggressive in establishing new products and services, marketing their
small-scale rural industries.
Most important, however, Beijing's rural industrialization policies reflect
demographic necessities. The success of agricultural reforms since 1979
has given China excess farm labor. Over 160 million peasants have left
farming to work for other enterprises on at least a part-time basis, and Chi-
nese officials expect that over 200 million more will do so before the end of
the century. Beijing intends to prevent this potentially migratory labor
force from moving to China's already overcrowded cities, and instead to
channel it to small satellite cities, where former peasants will engage in
Confidential
EA 86-10008
March 1986
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Confidential
In our view, runaway growth began in the rural industrial sector during
1984-85 as a result of unchecked peasant enthusiasm for establishing
small-scale businesses, driven in part by the government's claim that rural
industry was a way to "get rich through labor." Poorly developed credit
policies and insufficient understanding of government goals by local
officials were also major factors in the problems that developed. Beijing
has responded belatedly with measures to limit rural credit and punish
corruption, but the continued high growth rate for rural industry indicates
that the problem is not under control. We believe that new problems will be
exposed as inefficient and poorly managed rural enterprises begin to go
bankrupt.
But, at the same time, the expansion of the rural industrial sector has
raised the quality of life for many of the 800 million inhabitants of rural
areas. The income of families engaged in rural enterprises averages 24
percent higher than those specializing in agricultural production, and rural
industry throughout the country is beginning to provide peasants with a
greater variety of consumer goods and services. In addition, rural enter-
prises have helped ease critical economic bottlenecks, particularly in
energy and transportation.
Conservative critics of the rapid pace of economic reform, led by Politburo
Standing Committee member Chen Yun, have seized upon problems
related to rural industry-including the credit binge, corruption, and a
drop in grain production-to step up their attacks on the reformist
leadership. Implications that the reformers have mishandled rural econom-
ic policy-the very area where they have achieved their most impressive
success in the past-have been more damaging than charges that the
reforms are ideologically suspect. Although the reformers are on the
defensive, they have been able to hold their ground and are insisting that
the programs will be continued.
We believe rural industrial policies are so important to China's reform-
ers-who have invested so much political capital in the program-that
they have little choice but to continue. Rural industrial growth, therefore,
is likely to continue to lead other sectors of the economy, at least for the
short term. Rather than stimulate the sector any more, however, we believe
Beijing will stress controlling the growth through financial institutions,
reducing the waste and corruption through disciplining local officials, and
guiding the output of rural industries through regulatory means.
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In our view, Beijing will find it difficult to control rural enterprise growth
through its normal administrative policies without resorting to heavyhand-
ed methods that would dampen economic activity excessively. Although a
"socialist commodity economy" under free market controls may be
ideologically unpalatable to some conservatives, that is the direction in
which China's rural economy is moving, and we believe it is too late to turn
back without serious social, political, and economic consequences. We
believe that the reformers are preparing for a "shakeout" period of market
discipline, during which some of the rural industries will be allowed to fail.
This is likely to be a politically difficult period, as the government attempts
to insulate the rest of the economy and society from the effects of large
numbers of bankruptcies.
In the longer run, however, we believe rural industrial policies will
accomplish most of the goals reformers have set for them: creating a more
diversified, efficient, and active economy. China hopes that an increasing
share of its light industrial products and foodstuffs will be exported. The
United States undoubtedly is viewed as a major potential market for these
goods, and Beijing's efforts to develop trade links and join international
organizations, such as the GATT, may be partially motivated by its future
plans for the export of light industrial goods. In general, however, small-
scale industries will have less of an impact on trade than on the
development of the domestic economy.
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Summary
iii
Rural Industry: Spurring Modernization and Absorbing Labor
1
Market Towns Become Key Link
2
Reasons for Rapid Growth
3
Available Financing
3
Were the Policies Too Successful?
5
Trying To Control Growth
7
Beijing Clamps Down
8
Turning to Administrative Controls
9
Problems in Production and Consumption
9
Worsening Income Distribution
9
Beijing's Next Moves
13
Continuing Economic Constraints
15
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Figure 1
Beijing's View of the Development Stages
of Rural Industrial Integration
=Technology flow
Under Mao Zedong's leadership, collectives were allowed
to develop only a very small.rural industrial sector for
processing agricultural produce for urban consumers and
repairing and maintaining agricultural machinery. China is
currently entering stage two of its plan, as rural industry
begins to show a degree of sophistication and differen-
tiation, and to supply components and products to the
urban industrial sector. Agriculture is also becoming
more closely integrated with rural industry as, for example,
peasants process and market more of their crops and begin
holdings more than one job.
We believe that China's final goal is for the difference in
products and quality between the two industrial sectors to
largely disappear. The development and integration of rural
industry will theoretically increase the incomes of the
agricultural sector, simultaneously providing a market for
the further expansion of the industrial sectors.
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Reform of China's Rural
Industry: The Disadvantages
of Rapid Growth
Rural Industry: Spurring
Modernization and Absorbing Labor
China's economy for the past two years has generally
been hampered by a problem of unbalanced growth
and overheating. Although the urban industrial sector
has been the focus of most Chinese as well as Western
attention (with an overall growth rate in 1985 of about
18 percent), rural industry has been leading the
economy with 45-percent growth in 1984 and an
estimated similar rate for 1985. This frenetic growth
has contributed to several of China's more serious
economic problems, including inflation, shortages of
capital and construction materials, and lowered grain
production. Because the hyperactivity in the rural
industrial sector is a direct result of deliberate govern-
ment stimulation, the burgeoning problems have gen-
erated political controversy as well.
In our judgment, Beijing had a variety of motives
when it introduced new policies in 1984 to promote
rural industrialization. In practical economic terms,
the policies were designed to develop the much-needed
service sector, improve the food-processing industry,
make more consumer goods available to rural inhabit-
ants, and ease the burden on the state's distribution
and transportation networks. In a larger, more ideo-
logical framework, many Chinese leaders see rural
industry as the key to a socialist integration of the
country, linking agriculture to industry and cities to
the countryside (see figure 1). Some reformist leaders
appear to view the rural industrial sector as a proving
ground for the development of a "socialist commodity
economy," with heavy elements of free market ex-
change.
Principally, however, the rural industrial development
program has been driven by demographic necessity.
Agricultural reform policies introduced since late
1978 have been highly successful, more than doubling
Beijing defines rural enterprises as businesses owned
or operated by any of the following: townships,
villages, production teams, combinations of several
families, and individual households. The present-day
township is equal in size to what was called the
commune before its economic and political functions
began to be separated in 1982. Communes were made
up of brigades, which are now called villages or
towns. Production teams, the third tier of the former
collective accounting structure, have retained their
name and usually consist of roughly 20 to 30
families.
The term rural is somewhat misleading, because
many of the enterprises are in towns and may employ
as many as several hundred workers. Rural enter-
prise statistics are also an odd blend of agricultural
and industrial figures. For accounting purposes, Chi-
na in the past considered rural industrial production
below the commune level as agricultural output,
while commune level and above was considered as
industrial output. Starting in statistical reports for
1985, however, output value from the former brigade-
and team-run industries is included in industrial
output.
Rural enterprises were traditionally engaged primari-
ly in food-processing and agricultural machinery
industries, linking the rural areas to the cities. But
rural enterprises have expanded rapidly and now
include a myriad of light and heavy industrial,
transportation, and service enterprises.
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Peasant in Zhejiang Province who has given up
farming to open a street-side leather repair busi-
the value of farm production (see figure 2).' The
increased productivity and specialization of agricul-
ture have led to an excess of rural labor. Already
some 60 million peasants have left agriculture, and
Beijing estimates that an additional 100 million peas-
ants are working in agriculture only part of the year.
Xinhua, the official Chinese press, recently reported
that over the next five years 30 million young people
will enter the labor force, 10 million more will be
rendered redundant as the result of reconsolidation of
collective enterprises, and 100 million peasants will
leave the land to enter rural industrial and service
enterprises. In effect, it has taken only two years to
change the traditional role of Chinese agriculture
from being the employer of last resort for the urban
unemployed to becoming the source of labor to devel-
op industry. The Rural Policy Research Center in
Beijing estimates that by the end of the century 40
percent of the rural labor force will be involved in
' The new policies, usually referred to as the production responsibil-
ity system, raised agricultural prices and broke up the traditional
collective accounting structure. Contracts replaced strict produc-
tion and acreage quotas, communal land was divided among
individual families, and farmers were permitted to make their own
production decisions. Diversification of production away from grain
has also been encouraged, with families and collectives to specialize
in the product in which they have the greatest comparative
advantage. Families wishing to engage in rural enterprises are
allowed to sublease their fields to other families specializing in crop
Figure 2
China: Gross Value of
Agricultural Output
rural enterprises. This implies that in the next 15
years the number of peasants leaving agricultural
production will be roughly equal to the current popu-
lation of the United States.
flow.
Market Towns Become Key Link
Beijing has taken several steps to keep the peasants
leaving the farm from migrating to urban areas.
Cities can grant urban residency status to very few
peasants, and strict short-term residency standards
have been drawn up for peasants working in cities for
short periods. In our view, a system being adopted
that will require all citizens to carry a personal
identification card is partially motivated by the desire
to monitor and control the rural-urban population
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Beijing hopes instead to move peasants into smaller
"market towns"' whose development is to be directed
by local and regional officials. In effect, the policy
encourages the creation of a giant network of suburbs,
or satellite towns. Guidance on construction of the
towns has come from both national and provincial
levels, telling local officials to select and develop the
towns carefully in light of their resources and
potential.
Despite problems-the press indicates that, in the
haste of construction, most market towns are growing
haphazardly without any master plans-market
towns are important to Beijing's ideologues as well as
its economic planners. They represent the bridge to
integrate industry with agriculture, as well as cities
with rural areas. To develop successfully, rural indus-
try requires both labor, raw materials, and capital
from the agricultural sector and the technology and
markets provided by urban industry.
Reasons for Rapid Growth
Although the Chinese Government has always en-
couraged the development of small-scale industries by
rural production units, the rapid growth of the last
two years is, in our view, a direct result of new state
incentives and the ready availability of investment
funds. Equally important, however, was the political
support given to rural industrialization by high-level
party leaders, especially General Secretary Hu Yao-
bang. Party propagandists laid heavy stress on the
idea that peasants could "get rich through labor" by
engaging in rural enterprise development, and publi-
cized numerous examples of peasant families who
became "10,000-yuan households" through such
endeavors.
' There appear to be varying definitions of what actually constitutes
a rural market town-announcements of the current number of
such towns range between 20,000 and 60,000. In general, the cities
are government seats that are being developed into industrial,
social, political, and commercial centers. The cities are to be of
small and medium size but linked to large cities and other market
towns to facilitate trade and communications. The US Embassy in
Beijing reports that current plans are for 2,400 new market towns,
and for the rest of the peasants to be absorbed by raising the
population of existing small towns to 40,000, from an average of
Government Incentives. Government directives since
early 1984 have centered on encouraging the develop-
ment of rural enterprises and freeing marketing chan-
nels to allow them to operate freely and efficiently.
Some of the regulations since that time have allowed:
? The establishment of service and commercial opera-
tions in small towns.
? Liberalized loans for rural enterprises.
? Linking of managers' salaries to profits.
? Greater control of hiring, firing, and wages by local
managers.
? Increased access to relevant production technology
and management techniques.
The most dramatic example of Beijing's new attitude
toward small business has been its massive program of
divestiture. According to a Ministry of Commerce
announcement in August, the national government
has turned over the management of 55,000 business-
es-nearly 70 percent of its small, state-owned busi-
nesses-to collectives, groups, or individuals. The
entire ownership of 5,000 of these businesses has been
turned over to collectives, some of which are issuing
shares to their members, creating the equivalent of
employee-owned corporations. According to the Min-
istry of Commerce, these enterprises usually have
annual profits of less than 200,000 yuan (US $67,000)
and include enterprises such as general stores, snack-
bars, tailors, barbershops, hotels, and grain shops.
Available Financing. Chinese officials are pleased to
point out that rural industrial production has been
financed largely by local collective and individual
investments rather than central funds. A recent arti-
cle in the Peoples' Daily reported that the $2 billion
of state financial aid to town and township industries
from 1979 to 1984 was only one-fourth of the gross
taxes delivered by those industries to the state during
the same period.
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Developing Rural Enterprises: Small Coal Mines
The development of China's small mines illustrates
many of the successes, problems, and trade-offs being
made in the development of rural enterprises.
Small mines produce a wide variety of minerals in
China, but by far the largest product is coal. In the
Chinese press, small-scale mining refers to operations
by townships, cooperatives, and individuals. Opera-
tions by the last two levels are referred to as rural
mines, and it is in this sector that the most dramatic
growth has occurred, both in terms of the number of
? To increase energy supplies with a minimum of
state investment.
? To provide energy to rural areas and industries
where the state cannot or will not supply coal.
? To reduce the strain on the state's coal allocation
and distribution systems.
? To work small deposits not economically feasible
for large state operations.
? To increase the recovery rate for deposits already
partially worked out, which larger operations prefer
mines and in production.
The growth started in 1981, when small mines were
given subsidies, grants, and tax breaks. But, because
central government funding mainly benefited the larg-
er state-owned mines, small mines were developed
mainly with funds from local governments and bank
loans. As other rural industries developed and the
price of free market coal was allowed to rise, incen-
tives for mining increased. The US Embassy reports
that the number of small mines grew 66 percent in
1983 and another 22 percent to a total of 61,000
mines in 1984. Total small mine output in 1984 was
216 million tons (actual weight), up 27 percent, and
accounted for 28 percent of China's total coal
production.
The dramatic growth has already accomplished most
of the goals for which small mines were established,
including:
to ignore.
However, these accomplishments have not come with-
out some substantial, and probably largely unantici-
pated, costs. Small coal mines are increasingly com-
ing under fire in the Chinese press for uncontrolled
growth. Problems with the small mines include:
? Interference with state mining operations, including
encroaching on state property and ruining state
sites and equipment.
? Poor safety records, both for the inexperienced
peasant miners and for state miners operating near
them.
? Low quality of mined coal, which is usually unsuit-
able for industrial use and inequitably priced.
? Low efficiency, averaging only 20 percent recovery
rates for small mines as opposed to an average of
50 percent for state mines.
? Damage to the environment from indiscriminate
mining.
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While direct state expenditures have been relatively
small for the development of rural industries, the role
of state financing through bank loans has been
critical. Since 1983, Beijing has made several adjust-
ments to the rural banking system to enable it to
support specialized agricultural production and rural
industry. Most of the changes involved giving the
local banks more autonomy to make loans and set
interest rates on loans and deposits
Beijing has also begun turning the nation's rural
credit cooperatives' into locally managed, dividend-
paying, and profitmaking organizations. The decen-
tralization has proved to be a major boost for rural
enterprises. Loans to peasants skyrocketed, with one
Chinese press report indicating that outstanding loans
to rural enterprises increased 212 percent in 1984 to
15.2 billion yuan. The article stated that, for the first
four months of 1985, they had increased 485 percent
over the same period in 1984.5
Another major source of investment funds in the past
two years has been the reemergence of the so-called
popular forms of credit-peasant and collective funds
pooled into mutual funds and stock or bond issues.
According to a China Finance article, 30 to 40
percent of all locally raised funds for rural develop-
ment came from these forms in 1984. Peasants often
find these forms of credit more attractive than those
of the standard financial institutions because they
offer higher interest rates on deposits and are more
accommodating and less bureaucratic in their loan
procedures. In some cases, the interest rates charged
by the popular credit organizations are several times
higher than prevailing bank rates. But peasants are
still willing to sign the loans because of the high
returns from rural industrial enterprises.
Rural credit co-ops were organized in the 1950s as mutual aid
organizations with a high degree of local autonomy. But in the past
two decades the Agriculture Bank has undercut the independence
of the co-ops, increasing their bureaucracy and turnin them into
virtual subsidiaries of provincial agricultural banks.
' These figures may represent upward revisions of loan estimates or
a mistake in the presentation of the data. Earlier Chinese an-
nouncements were approximately 100 percent lower; that is, they
stated that the loans had increased to (rather than by) approximate-
ly 212 and 485 percent of the previous year's amount. In either
case, it is clear that central authorities were not expecting such a
The large pool of peasant savings provided the re-
maining 60 to 70 percent of locally raised investment
funds last year. Because of the increase in procure-
ment prices and agricultural output-as well as the
lack of consumer goods and agricultural inputs avail-
able for purchase-peasant savings deposits have
increased between 35 and 50 percent annually from
1980 through 1984. In addition to the 200 billion
yuan of peasant deposits in cooperatives in 1984,
Chinese press articles estimated that peasants hold
three-fourths of the currency in circulation, including
50 billion yuan stashed away in homes.
Were the Policies Too Successful?
The response to these policies has quickly made rural
industry a major sector of China's economy. In 1984,
rural industry accounted for 13 percent of the gross
value of social output 6 and two-fifths of the gross
output of the rural economy. Total profits reached
almost 18 billion yuan, and taxes from the sector grew
to 9.1 billion, or over 60 percent of taxes collected
from rural areas.
The number of rural enterprises also increased sharp-
ly in 1984, rising from 1.4 million to 6.1 million by
yearend. At that time, Beijing announced that rural
enterprises employed 52 million people, or roughly
16 percent of the total rural labor force. Xinhua
reports that by mid-1985 the number had risen to 60
million.
Information for the first half of 1985 indicates that
the output of rural industries continued to grow at a
rate more than one-and-a-half times the growth in the
same period of 1984. At the beginning of 1985, the
sector was producing more than one-fourth of the
nation's coal, two-fifths of its garments, and three-
fourths of the output of building materials. Although
rural enterprises were originally envisioned as devel-
oping the nation's food-processing industry, higher
profits in other operations have led to the production
of a wider variety of goods.
`Gross value of social output is the measure of growth for China's
economy as a whole, including industry, agriculture, capital con-
struction, transportation, business, and commerce.
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Figure 3
China: Composition of Rural Enterprise
Output, 1984
Much of the recent growth has occurred in private
business enterprises owned and run by one or more
peasant families. At the end of June 1985, Chinese
press reports indicate that 10.6 million private busi-
nesses (both rural and urban) with over 15 million
employees had registered with the state. This repre-
sents a 14.5-percent increase since 1984 and nearly 15
times the number of private businesses in 1980. These
figures probably understate the real growth because
of those engaging in business without a license.
Registered private businesses include:
? 5.8 million commercial establishments.
? 1 million food stalls and restaurants.
? 800,000 transport firms.
? 750,000 repair shops.
? 650,000 service shops and stalls.
? 40,000 house-repair businesses.
Coal Metallurgical
5 3
Food
9rocessing
The Positive Results
The expanding rural industrial sector has raised the
quality of life for many of the 800 million inhabitants
of rural areas. One 1984 Chinese survey showed that
income of families engaged in rural enterprises aver-
aged 24 percent higher than those specializing in
agricultural production. Chinese press reports state
that the peasant saying "no economic stability with-
out agricultural development" has been replaced by
"no prosperity without engaging in industry." And,
perhaps just as important, rural industry is beginning
to provide a greater variety of consumer goods and
services for peasants to dispose of their rising incomes.
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The Accuracy of Chinese Rural Statistics
Rural industries have also helped draw enterprises
into the sectors that have been bottlenecks for the
economy, particularly energy and transportation.
Over the first half of 1985, the number of people
engaged in private transport businesses grew by over
40 percent, and these businesses now account for more
than 40 percent of the total goods transported in
China on a ton/kilometer basis. This phenomenal
growth has occurred despite China's poor transport
infrastructure and persistent press reports that some
state transportation officials hinder private operators.
The vast majority of private transport enterprises
engage primarily in local hauling, and benefited from
the state's decision earlier this year to increase short-
statistical skills.
We believe that the statistics announced by the
Chinese Government are usually the best it has, and
their accuracy is improving as China develops its
constant prices.
It is unlikely, however, that Beijing has current and
reliable statistics on the vast number of changes
occurring in the countryside. Indeed, the US Embas-
sy reports that both State Statistical Bureau officials
and State Council economic advisers have comment-
ed unofficially that information on the rural economy
is especially poor. State Statistical Bureau officials
cautioned that rural enterprise statistics are unreli-
able, overstated, and in current prices, while statistics
on state-run enterprises are relatively reliable and in
activity.
It is also apparent that definitions of new organiza-
tions and accounting methods are not uniform
throughout the country. At the local level, cadre
reporting is probably being influenced by ideology as
well as the lack of statistical skills. For example,
cadre eager to follow the new central directives on
rural industry may overestimate growth and success
under their administration. Likewise, Chinese press
reports indicate that cadre in some areas are opposed
to implementing the new reforms, which could lead
them to distort their reports on rural industrial
The Chinese-source statistics cited in this report were
taken from the most authoritative sources and the
most recent publication dates available. In some
cases, conflicting data are given when a clear choice
as to accuracy could not be made. In a few cases, our
comments on the accuracy of the data are also given.
haul rail freight rates.
China has reported that energy produced by rural
industries in 1984 was equivalent to 164 million tons
of standard coal or 20 percent of the nation's total
energy output. During the same period, those indus-
tries reportedly consumed less than the equivalent of
100 million tons of standard coal.
Finally, a Chinese survey revealed that changes in the
management of the firms had resulted in better
service, higher profits, and greater satisfaction among
both employees and customers. In addition to unleash-
ing initiative by linking personal income to produc-
tion, rural enterprises have other advantages over
state enterprises in their ample supply of cheap labor,
flexibility, and full decisionmaking power. One town-
ship enterprise official described his attitude toward
competition with other businesses:
We have what others have not; what we have is
better than others; others may have good quality
but ours is cheaper; and when theirs becomes
cheaper, we will shift to some new products.
Following the pattern of reporting occurring in 1979-
81 when the peasant responsibility system was rapid-
ly being implemented, it is likely that the quality of
Chinese statistics on rural industry will improve as
uniform definitions and statistical collection mecha-
Trying To Control Growth
We believe, however, that the decentralization of
authority over the rural financial system set the stage
for dangerously high levels of investment in rural
industry. Because of the high profits available in the
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enterprises, peasants flocked to banks and coopera-
tives to sign loans for investment funds. In 1984, for
example, the Agricultural Bank increased rural enter-
prise loans by 120 percent to 48 billion yuan ($16
billion), when its goal was for only a 20-percent
increase, and loans to rural enterprises during the first
quarter of 1985 rose 420 percent over the same period
of 1984. Chinese officials recently told visiting US
officials that the level of investment and industrial
growth had taken them completely by surprise.
Moreover, the resurgence of popular credit forms,
outlawed since 1949, has not come without some
ideological opposition. The state is losing its monopoly
over rural credit, and interest rates have also climbed
dramatically as mutual fund and bond issues bid for
money. Several Chinese press articles have attacked
the credit forms for returning usury to the country-
side.
Beijing Clamps Down. Alarmed at the expansion, by
April of last year Beijing began announcing economic
and administrative controls to slow growth and cool
down the economy. The State Council transmitted
orders to all banks to limit loans and the issuance of
currency by:
? Limiting the credit quotas and balances of all
specialized banks (such as the Agricultural Bank).
? Having the specialized banks set credit balance
limits for all provinces and instruct the provincial
banks on handling their loans and deposits.
? Setting guidelines on making loans only to profit-
able, efficient businesses producing desired goods.
? Subjecting the specialized banks to Peoples Bank
regulations on deposits, credits, and interest rates.
? Requiring rural cooperatives to place at least 30
percent of their deposits in the Agricultural Bank,
thus decreasing their funds available for loans.
? Requiring agricultural procurement funds to be
treated as a special item and not to be lent.
The impact of the regulations was dramatic in Si-
chuan, according to the Chinese publication Econom-
ic Information. Officials there suddenly found them-
selves without any funds in the midst of an
foundry near Beijing.
unprecedented economic expansion. The revised tar-
get for Sichuan's bank loans to rural industries was
dropped to 95 million yuan, down from 1.4 billion for
all of 1984. But, during the first quarter of 1985,
Sichuan's banks had already lent 160 million yuan to
rural enterprises. All new loans were frozen, bank
officials ordered rural enterprises to return 70 million
yuan, and banks began to obtain working capital by
making withdrawals from the accounts of some enter-
prises that had already invested their loans.
Growth Continues. By the end of August, Beijing
announced that the growth in state loans had been
slowed, but loans were still 20 billion yuan more than
during the same period of 1984. Banks apparently had
difficulty recalling loans and controlling credit, as
evidenced by the inability of some banks to pay
peasants for the procurement of their crops at mid-
year. Some banks were criticized for not aggressively
calling in their loans because bank personnel, or their
friends and relatives, had interests in the enterprises.
Peasants were also reluctant to repay the loans, and
one county in Guangxi even increased its loans by
having the local party officials threaten the bankers
with the loss of their party membership if they
insisted on recall.
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Moreover, even after state credit tightened in most
areas, rural enterprises were continuing their expan-
sion by using popular credit, over which the state had
no direct control. Boosted by rural enterprises, nation-
wide expenditures on capital construction through
July were up by 43 percent and industrial production
had increased by 23 percent, and this trend continued
to place severe constraints on prices and supplies of
many goods. During that time, investment in rural
enterprises had risen 87 percent nationwide, and had
more than doubled in eight provinces. Bank officials
were encouraged to withdraw funds from the current
operations accounts of rural enterprises. No loans for
new construction projects were to be made, and local
banks lost the authority to make such loans.
Turning to Administrative Controls. Beijing evidently
was not confident that simply limiting state funds was
adequate, and so it turned to administrative controls.
In October, the State Council ordered local govern-
ments to run a credit check on popular credit institu-
tions and to temporarily suspend their activities.
Tianjin subsequently announced the closure of a
county trust and investment company, with its capital
to be turned over to the state banking system immedi-
ately. The new controls and the closing of an appar-
ently healthy investment company are probably only
the first steps to control "unofficial" rural financial
activity.
Although data for the second half of 1985 have not
been announced, Zhang Yi, head of the Agriculture
Ministry's Rural Enterprises Bureau, estimated in
November that the rate of growth in rural enterprise
output would decline. Zhang conceded, however, that
the growth rate for 1985 will still exceed the record
growth in 1984 output. He projected that 1986 would
bring slower growth rates in both the sector's output
and its borrowing.
Problems in Production and Consumption
This loss of control has affected other sectors of the
economy as well. In agriculture, for example, the
higher profits available in rural industry and industri-
al crop production led to a decline in the funds,
acreage, and labor expended on the 1985 grain crops.
China Daily reported in August that 1.3 million
tractors, or more than one-fourth of the nation's total,
had been diverted to transport goods full time. Grain
stored from previous bumper harvests has thus far
kept the problem from affecting food supplies, but
Beijing is clearly worried. Some areas are reinstating
grain output and acreage quotas, and Jiangsu has
even required rural factories to invest in farmland
improvement and to give other forms of aid to grain
producers.
Rural industries, particularly energy inefficient be-
cause of their small scale and obsolete equipment, are
also draining China's limited energy resources. Much
of their equipment was transferred to them, or even
previously scrapped, because of its energy inefficien-
cy. Although rural enterprises mined more coal in
1984 than the equivalent energy they consumed, the
coal was of poor quality and not distributed nation-
wide, leaving areas away from coal deposits even more
strapped for energy. The planned expansion of blast
furnaces in one province, moreover, has led to con-
flicts with larger state-owned plants for raw materials,
as well as cutthroat competition with other small
plants.
Worsening Income Distribution
Rural enterprises are also worsening China's income
distribution, which is already causing concern among
conservative senior cadre, who are afraid that the
growing income gaps will lead to a new class polariza-
tion in rural areas. The issue arose during the summer
of 1985, and particularly during the September Con-
ference of Party Delegates, when Politburo Standing
Committee member Chen Yun castigated the party
propaganda apparatus for giving too much publicity
to "10,000-yuan households." The reformers moved
quickly to defend rural industrialization policies, in-
sisting that certain peasant families were bound to get
rich first, before they aided other families in doing so.
The concern of conservatives will become harder to
dispel, however, as income disparities remain and in
fact widen under the reform policies. Although more
wealthy provinces would probably have developed
faster in any case, that fact was assured when state
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Figure 4
Growth of Rural Industry, 1980 to 1984
0 500 Kilometers
i I I11, 1 T
0 500 Miles
Boundary representation is
not necessarily authoritative.
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funds were cut off in April and Beijing announced
that rural enterprises were to be developed with
private and collective funds. In fact, the most rapid
growth has occurred in the richer, coastal provinces;
poorer, inland provinces still lack the funds, technol-
ogy, and market access to capitalize on enterprise
development.
Beijing is undertaking several measures to improve
income distribution. Supply and marketing coopera-
tives are being established nationwide to provide
better marketing opportunities and supplies of inputs
in less developed areas. The Agricultural Bank has
also adopted a program to provide 300 million yuan to
the poorest 200 counties in China annually through
1990, and an additional 300 million yuan was sched-
uled to be lent to these areas in 1985. Articles in the
Chinese press have even discussed the possibility of a
personal income tax, motivated, we believe, by the
desire to redistribute rural income.
Several of Beijing's other long-term economic goals
will be adversely affected by the development of rural
enterprises. Efforts to control personal consumption
expenditures may be more difficult because of the rise
in disposable income and the increase in the number
of consumer goods and services. In addition, rural
areas probably will grow even less obedient to the
state's one-child population control measures as farm
labor becomes more scarce and the size of family
farms increases.
Parallel Concern Over Social Control
The problems with unplanned and unbalanced eco-
nomic production are perhaps symptomatic of an
equally dangerous problem for Beijing-that of a
growing, or at least more visible, unwillingness among
peasants to subordinate personal interests. From early
1984 to mid-1985 the Ministry of Justice established
more than 20,000 township law offices to handle the
growing number of state and civil disputes. A steady
stream of Chinese press articles is attacking economic
crime, warning peasants of the punishment for crimi-
nal activity, and citing the necessity of following party
discipline and state law.
This task has been more difficult because of the
rapidly changing definition of economic crime. Many
activities that were previously forbidden, such as
nearly all rural enterprises, are encouraged. And
sometimes the distinction between legal and illegal
activities-allowing peasants to transport goods but
not to make profits on sales at another location-
remains rather nebulous.
But many rural enterprises have clearly overstepped
state regulations, committing a number of crimes and
producing a myriad of counterfeit goods. Provincial
reports are presenting an increasingly lengthy list of
fake wines, fertilizers, watches, aluminum ingots, and
other goods produced by rural enterprises. The State
Economic Commission has responded to the illegal
activity by drafting regulations such as those for
quality control of pharmaceuticals, food hygiene, the
standardization of boiler pressure, and the licensing of
permits for industrial production.
Another problem for local and provincial officials has
been the proliferation of state loans to nonexistent
companies. Such companies are referred to in the
Chinese press as "briefcase" companies. The Sichuan
party committee described in June how some brief-
case companies had wangled loans of tens of thou-
sands of yuan by posing as specialized households.
Having secured loans from local banks, the borrowers
disappeared, leaving local governments to absorb the
loss.
Rural industrial development also is exacerbating
already poor relations between peasants and cadre.
Some officials have obstructed rural enterprises be-
cause of resentment, ideology, or simply to protect the
state operations under their administration. In some
cases, state-operated enterprises are unable to com-
pete with the tax-exempt and flexible operations of
rural industries and seek local government help to
close them down. Policies or prices have been changed
to protect state enterprises, angering peasants who
believe the rules have been changed after they have
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made their investment. In other cases, enterprises
have had their licenses revoked or have had lengthy
interruptions of production pending state inspections.
The problems of state and private competition proba-
bly will increase as private and collective enterprises
expand and as officials become more responsible for
the profits of the state operations under their control.
tionally dominated by the state.
According to Red Flag, administrators in many areas
have begun to impose charges against wealthy peas-
ants to solve the problem of insufficient departmental
funds. In one county in Guangdong, peasants wishing
to own a tractor were required to pay 29 separate fees
to 11 departments, including maintenance fees equal
to one-third the tractor's price. Peasants in the area
were evidently using the tractors mainly to engage in
transport, reaping high profits in an enterprise tradi-
difficult and slow.
Rural enterprises have gotten into trouble with the
State Council on the question of tax payments. In a
recent investigation of Hubei's 600,000 individual
industrial and commercial operators who should have
been paying taxes, only 370,000 had even registered
to do so. Hunan estimated that 78 percent of the units
and individuals in the province evaded some taxes, led
by 92 percent of collective enterprises and an even
higher percentage of individual traders. The Ministry
of Finance began a nationwide inspection on taxation
and financial affairs in August, but improvements in
collections from rural enterprises probably will be
of grain production, the resources, including th
ants themselves, might be difficult to put back.
Reduced Political Control
The detrimental effects of the rapid growth of rural
industry have given ammunition to opponents of
reform. The most visible attack was made by Chen
Yun in his speech before the closing session of the
National Party Conference in September. Chen em-
phasized grain production, implying that the successes
achieved there by reform are being jeopardized by the
rapid transfer of resources to rural industry. Once out
A state department store in Wuxi, Jiangsu, with
brisker business occurring at a competing private
Chen's view is typical of that held by conservative
economists in China who believe that central planning
is the only way to avoid the excesses of unbalanced
growth. In midsummer the conservatives launched a
press attack on popular forms of credit for rural
industrial development. Proponents of reform argued
that all enterprises and individuals have a right to
take deposits to run businesses, and that the bank's
restriction on credit was blocking the free circulation
of capital in the countryside. Fiscal conservatives
countered with ideological opposition to unplanned
growth, usury, and economic crime and warned that
growth was still occurring at too rapid a pace.
The state's divestiture of its small businesses is also
being criticized by conservative leaders, who see
socialist enterprises being transformed into capitalist-
style semiprivate operations. The new organizations
have been attacked for paying out too much in profits
at the expense of public welfare and for changing
their operations without permission merely to obtain
higher profits. The central government is therefore
belatedly drawing up regulations to govern the taxing,
finance, pricing, and labor management of the
state/ collective contracted enterprises. We believe it
likely that the regulations will limit the flexibility, and
therefore the success, of the contracted enterprises.
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measures multiply and begin taking effect.
Beijing's Next Moves
Despite the problems, we believe China's reformers
have little choice but to continue their program for
developing rural industry because of the great invest-
ment of political capital. Rural industrial growth,
therefore, is likely to continue to lead other sectors of
the economy, at least through China's current five-
year plan (1986-90). Rather than stimulate the sector
any more, however, we believe Beijing will try to slow
the growth of rural enterprises without retreating on
the policies of administrative independence and price
incentives. As a result, we believe that the growth rate
of rural enterprises will slow in 1986 as administrative
trying to circumvent the controls of both.
Over the next few years, we also expect that rural
enterprises will probably be the most fluid sector of
the Chinese economy, rapidly changing its product
mix and rate of growth. Of all sectors of the economy,
rural enterprises have shown the greatest response to
market incentives. Therefore, the sector probably will
continue to be swayed as price, wage, and financial
reforms are instituted for the rest of the economy.
Beijing probably will feel its way along, trying to
guide the sector by using a combination of financial
and administrative controls. The delicate balance
between the two controls will bring continuing clashes
between the market-oriented reformers and the con-
servative proponents of a planned economy, with
undecided bureaucrats and businessmen at all levels
(GATT).
Bejing hopes to export an increasing share of the
output of rural enterprises to earn foreign exchange
and fuel the expansion of the sector. The products will
compete directly with the light industrial goods of
many of China's neighbors, vying for a share of the
US market. China's realization that it must increas-
ingly engage in world markets to develop its light
industry may be contributing to Beijing's efforts to
join international financial and trade organizations,
such as the General Agreement on Tariffs and Trade
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Appendix
Continuing Economic
Constraints
The past two years have shown that the reform
policies will encourage growth in rural industry, but
Beijing has yet to prove that it can control the growth
and make the sector efficient. Several economic bot-
tlenecks remain to be dealt with in this area, including
energy, technology, trade, service industries, and the
lack of market information in China.
Energy prices remain relatively low, and, until China
takes the painful step of raising them, energy use will
remain poorly distributed and inefficient. A Septem-
ber article in People's Daily estimated that the energy
consumed by rural industries in the year 2000 will
reach 200 million tons of standard coal. But if the
1984 increase in energy consumption by rural enter-
prises continues, the estimate will be reached in
roughly five years.
Technology transformation in rural industries is an
important issue to the leadership, and 1985 was the
beginning of a two-year "sparking plan" to develop
technology in areas of the economy where quick
results can be expected with a minimum of invest-
ment, such as the processing of agricultural and
sideline products. More liberal financial rules have
been made for enterprise investments in technology,
and cadre leaving the military have been cited as
contributing to the technical and management skills
of rural industries. In reality, however, it is likely that
technology is merely being used to get rural industries
to hire the roughly I million soldiers who are to be
demobilized. Far more technology is likely to be
absorbed from heavy industry, where a small but
growing number of urban technicians are being lured
away by the high salaries and bonuses offered by
rural industries.
Trade, both domestic and international, must also be
developed for the continued economic success of rural
industries. To encourage domestic trade, regional
trade centers for rural and industrial goods, which are
basically wholesale centers, are being set up. The
value of exports from rural businesses rose to more
than 4.7 billion yuan in 1984, but virtually all of the
products came from the wealthier coastal provinces.
Import taxes established in mid-1985 suggest that
China is becoming more serious about protecting
some of its fledgling industries from foreign competi-
tion. At some point in the future, China will have to
shake itself free from its own bureaucracy and wean
these industries from state protection if it intends to
avoid the problems other developing countries have
experienced in adopting import substitution policies.
Service trades and businesses are developing rapidly
despite strong ideological opposition in many local-
ities. Continued expansion of the labor service indus-
try will be necessary both to absorb labor and to
support the development of other industries.
industrial society.
Information and current, reliable statistics will be
needed if Beijing intends to use economic levers to
control the economy. The government is taking steps
to improve its statistical collection system, and is
undertaking surveys to assess the number and state of
rural enterprises currently in operation. More finan-
cial information is also being disseminated to local
enterprises to allow more rational production and
marketing decisions. The fact that possibly one-fourth
of China's peasants are illiterate, however, empha-
sizes the difficulties that China will have in dissemi-
nating market information, gathering equitable taxes
from business records, and pressing toward a modern
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