CHINA: THE YEAR IN REVIEW

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00794R000201160001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 41
• Document Creation Date: December 22, 2016
• Document Release Date: July 21, 2011
• Sequence Number: 1
• Publication Date: March 28, 1986
• Content Type: MEMO

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TRANSMITTAL SLIP date 28 Mar 86
To: D/OEA
Room No.: Building
4F1b
Remarks:
THIS IS THE JOINT ECONOMIC
COMMISSION WITH CHINESE
PACKAGE THAT FORWARDED
TO TREASURY-
~OH
Hqs.
China Division
Room No. i ing Exti'nsion
4G3 2 H qs .
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
China: The Year in Review
Summary
Economic considerations dominated China's political agenda in 1985
to an unusual degree. Buoyant after the October 1984 party meeting that
endorsed urban economic reforms, Deng Xiaoping and his supporters
within the Chinese leadership sought to make 1985 the "Year of Reform,"
carrying out controversial new economic policies and seeking to improve
and consolidate their hold on the levers of power.
But economic policies did not fulfill the reformers' expectations, and
they even exacerbated a number of China's existing economic problems.
The government was rocked by soaring inflation, an overheated industrial
sector, a sharp trade deficit and diminished foreign currency reserves, a
7-percent dropoff in grain production, and a growing corruption problem,
all of which gave political critics of reform the opportunity to renew their
attacks at mid year.
This memorandum was prepared by Office of East 25X1
Asian Analysis. Information available as of 28 March 1986 was used in its preparation.
Comments and queries are welcome and may be directed to the Chief, Domestic Policy
Branch, China Division, OEA, 25X1
otivi
25X1
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Despite the increased pressure, Deng and his allies were able to
bring off a significant political victory at the September Conference of
Party Delegates. At that meeting, Deng managed to secure the retirement
of numerous members of the party's conservative Old Guard--including 10
members of the Politburo--and replaced them with younger, better
educated leaders more committed to the principles of reform. Party
conservatives nonetheless remain a formidable force. Party reformers
have recovered somewhat from the political difficulties of last year, but
the complexity of the economic problems that face China has evidently
made them more cautious, and they have set as their goal for 1986
"consolidation and digestion" of reforms already undertaken, and economic
stabilization.
Economic considerations played a major role in China's foreign
relations as well, although strategic concerns remain the central focus.
Chinese leaders expressed satisfaction with the "stable" nature of relations
with the United States, which permitted a 25-percent increase in bilateral
trade (to about $8 billion). No major trade or political issues emerged in
1985, although the usual problems of Taiwan, textiles and technology
transfer remain in dispute.
Last year saw a concerted attempt on China's part to test the new
Soviet leader's interest in rapprochement: anti-Soviet polemics were
reduced, and the level of official contact between the two governments
was raised somewhat. Gorbachev did not offer any significant
concessions on the fundamental issues dividing the two sides, however,
and, by the end of the year, the atmospherics had cooled noticeably, with
the Chinese refuting Soviet claims that relations were improving.
Economic relations between China and the Soviet Union continued their
slow trend of improvement in 1985, with bilateral trade approaching $2
billion.
Last year, the first full year in which to measure China's performance under
economic reform guidelines and policies, was a trying one for China's reform leadership.
Starting off the year full of enthusiasm for the economic reform policies approved at the
landmark Third Plenum of the 12th Central Committee (October 1984), party leaders went
from ebullient confidence to gnawing doubt and defensiveness to stiff determination as
they watched the economic, political, and social effects of their policies. Having based
their political philosophy on their ability to bring about economic improvement, party
reformers, led by Deng Xiaoping, were bruised by accusations from conservatives last
summer that they mishandled economic policies in 1985. Although the problems did not
prevent Deng from making important political gains at the Party Delegates conference
held in September, they clearly were enough to slow the momentum of political and
economic reform.
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Deng Xiaoping, 82, is still the linchpin of the political system in China, and
concerns about the state of his health emerged when Deng stopped making public
appearances for a two-month period in late 1985 and early 1986. Deng showed up for
Chinese New Year in his home province of Sichuan, but speculation about him and
possible succession changes intensified last year. Deng himself evidently helped fuel
the rumors at mid year, when, according to Hong Kong publications, he developed a
"second stage" succession package. According to the unsubstantiated account, at some
point in the next two years, the following leadership changes will take place: Deng will
resign as Chairman of the party Military Commission, and will be replaced by Hu
Yaobang; Hu Yaobang will give up his post as General Secretary of the party to
Secretariat Standing Secretary Hu Qili; President Li Xiannian will retire and his job will be
taken over by Premier Zhao Ziyang; Zhao will be succeeded as premier by one of his
younger Vice Premiers, Li Peng or Tian Jiyun.
Although the changes were not put into effect at the September Conference of
Party Delegates--as some had speculated--Deng did bring off a major political
realignment at that meeting, a rejuvenation of the party's leadership that is consistent in
intent with the "second stage" succession scenario. At the Central Committee plenum
that preceded the Delegates Conference, 65 elderly members of the Central Committee
resigned, including 10 members of the Politburo and one of six members of the crucial
Politburo Standing Committee. The full Delegates Conference then chose 91 new
Central Committee members, preparing the way for the "election" at the ensuing Central
Committee plenum of six new Politburo members and five additional members of the
Generally speaking, the leadership changes shifted the balance within all the
leading party organs in favor of those associated with reform. Almost all of the
Politburo retirees were considered "conservative" on reform issues, and seven of them
were representatives of China's armed forces, which sometimes has been viewed as
being in opposition to Deng's reforms. Most of the new leaders meet Deng's succession
criteria of younger, better educated, professionally qualified, and politically reliable (read
non leftist). Within the Politburo in particular, the addition of Hu Qili, Tian Jiyun, Wu
Xueqian, and Qiao Shi appears to significantly strengthen the reform group within the
leadership. New Politburo members Yao Yilin and Li Peng, although they publicly
support and administer reform policies, seem to lean toward Politburo Standing
Committee member Chen Yun, who emerged last year as reform's principal detractor.
Deng by no means swept away all opposition to his programs at the party
meetings. The strongest voices in the conservative cause, in fact, maintained their party
positions: Chen Yun and Li Xiannian on the Politburo Standing Committee, Peng Zhen
and Hu Qiaomu on the Politburo, and Deng Liqun on the Secretariat. It also appeared
that Deng had to compromise on some personnel issues, on the pace of implementation
of reform policies, and on the ideological tone of the party's programs. Deng's own
speech to the assembled delegates stressed some conservative themes, including the
need to improve the knowledge of Marxist theory within the party. Deng also had to sit
through a bitter diatribe from Chen Yun, who made his complaints about some aspects
of reform completely clear, and implicitly warned Deng not to try to stifle dissent within
the party.
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In the period leading up to the conference, leadership tensions had been quite
high, and we believe this was a factor in the way Beijing handled economic policy
during the middle part of the year. China's leaders were confronted with a considerable
amount of bad news during the late spring and early summer: high industrial growth
rates, a startling increase in the money supply and capital construction expenditures,
urban food price inflation, skyrocketing imports and a downward plunge in foreign
exchange reserves, a gloomy agricultural forecast, and a host of corruption scandals,
many of them involving the Special Economic Zones. Reform critics seized on these and
other issues and, in our view, forced the reformers into a defensive position. This
accounts for, among other things, Deng's statements in July that the SEZs were
"experimental," and could fail.
Since the party conference, reformers have continued to be defensive in their
speeches and articles about economic policies, but less, we believe, because they fear
conservative attacks, and more because the policies themselves have been flawed, or
incorrectly implemented. Moreover, reformers such as Tian Jiyun and Wan Li have
begun openly to rebut the criticisms leveled at reforms by conservatives last year,
particularly on such issues as grain production and rural industry, and the linkage
between reform policies and corruption. In sum, we believe the reformers have regained
the initiative as a result of the changes brought about by the Party Delegates
Conference, but will not use it to push through any controversial new reforms. Instead,
they have declared 1986 to be a year of "consolidation and digestion" of reforms already
Foreign Policy
China increasingly is tailoring its foreign policy to serve its economic
modernization drive. This is reflected in Beijing's efforts over the past year to improve
relations with both Washington and Moscow. Relations, however, continue to be closer
and smoother with the United States. Indeed, the Chinese continue to regard the United
States as an important strategic shield against Soviet military pressure as well as a key
source of investment capital and technology.
Chinese leaders repeatedly stress that Sino-US relations are "stable"--reflecting
their interest in seeing the economic relationship in particular continue to grow.
Bilateral trade jumped last year by more than 25 percent, from $6 billion to about $8
billion, according to US customs statistics. Direct US investment also increased to just
over $1 billion--most of it in offshore oil exploration and drilling. Economic ties are
likely to geta further boost as a result of recent US efforts to streamline COCOM
procedures for handling Chinese requests for licenses for Western technology. US
exports of advanced technology in fact rose to $500 million in 1985 and almost
certainlywill increase again this year.
The US-China military relationship is developing at a gradual pace but has hit
some snags along the way. The United States has taken some initial steps to assist
China with military modernization. A key component of that assistance--the sale of an
avionics package for the Chinese F-8 fighter--is now before the US Congress for
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approval. But Chinese demands that Washington give private assurances that visiting
US warships would not be carrying nuclear weapons forced the US Navy last spring to
postpone indefinitely a planned port call to Shanghai.
The differences over the port call appear to reflect an increasing reluctance on
the part of some senior Chinese leaders to have China identified strategically with the
United States--lest that complicate Chinese efforts to improve relations with Moscow
and compromise China's more independent foreign policy posture. Over the past year
or so, and especially since the accession of Soviet General Secretary Gorbachev, Beijing
has made several symbolic concessions designed in part to test the new Soviet leader's
interest in seeking a rapprochement with China. In addition to referring once more to
the USSR as "socialist," and Soviet leaders as "comrades," the Chinese have cautiously
agreed to reestablish some long-severed ties--trade union and parliamentary relations.
They have stopped short of agreeing to restore formal party-to-party ties, presumably
hoping to extract a significant Soviet political concession in exchange.
Thus far, Moscow has been unwilling to offer such a quid pro quo. At the recent
Soviet party congress, Gorbachev reiterated the standard Soviet line of offering to
improve relations with China as long as it was not at the expense of any third party--a
not very veiled reference to Soviet allies in Vietnam, Afghanistan, and Mongolia. As a
result, progress toward an expansion of political relations appears to have stalled once
more over China's demands for satisfaction on the so-called "three obstacles"--that is,
that the Soviets either withdraw their forces from Afghanistan, cease their support for
Vietnam's occupation of Cambodia, or substantially reduce Soviet forces along the
Sino-Soviet border, including those in Mongolia.
After months of muting their criticism, the Chinese in fact have increased the
volume recently of their attacks on Soviet foreign policy. They also have rebuffed
Moscow's efforts to pin down dates for the exchange of visits by Soviet and Chinese
foreign ministers, which Beijing agreed to in principle last fall. It would appear that the
Chinese are trying to exploit the Soviets' interest in the visits to induce Moscow to
adopt a somewhat more flexible approach to some of the security issues that divide
Sino-Soviet economic relations continue to improve. Over the past three years,
bilateral trade has increased substantially, approaching $2 billion. The Chinese and
Soviets are moving ahead, for example, with plans for the Soviets to help modernize
some factories they built in the 1950s, and to build several new projects. Even if
political relations remain stalemated, the Chinese probably calculate that expanding
economic ties will help to keep tension with Moscow manageable, and will give them
access to some useful Soviet technology.
China's relations with Western Europe, Japan, and much of the Third World also
are being shaped increasingly by economic considerations--that is, the desire for
markets, raw materials, technology, and investment capital. In the case of Western
Europe and countries around China's periphery, strategic considerations of course still
weigh very heavily. The Chinese continue to strongly support Pakistan and the Afghan
resistance as well as Thailand and the Cambodian insurgents as a means of keeping the
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Soviets and their allies in check. By the same token, they remain supporters of a strong
NATO as a counterweight to the USSR. In Northeast Asia, Beijing would like the United
States and Japan to make some overtures to North Korea to help China counter the
recent increase in Soviet influence in P'yongyang. Chinese leaders continue to urge
Washington in particular to agree to hold tripartite talks with North and South Korea as
a means of reducing Moscow's ability to exploit tensions on the peninsula.
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Subject: China: The Year in Review
1 - Mary Yee, Office of East-West Economic Policy, Room 4426,
Department of Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department
of State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316,
600 17th St., NW, Washington, DC
1 - Myna Stolz, Office of East Asia and the Pacific, Room 3820,
Department of Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DEV
1 - OEA/Production Officer, 4G48
1 - D/OEA, 4F18
1 - DDI, 7E44
1 - Senior Review Panel, 5G00
1 - PDB Staff, 7F30
1 - NIO/EA, 7E62
1 - C/PES, 7F24
1 - FBIS/NEAAD/China Branch, 306 Key
1 - 5E18
1 - CPAS/ILS, 7G50
5 - CPAS/IMC/CB, 7G07
1 - Author
1 - Chrono
1
~28Mar86
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
The Chinese Economy in 1985: An Overview
Summary
In 1985, Beijing confronted numerous problems arising from the
implementation of economic reforms. Poor weather and confusion
surrounding new agricultural policies caused China's grain output to fall
for the first time in five years. Industrial output, spurred by greater use of
economic incentives and relaxed central controls, grew more rapidly than
Beijing intended--worsening longstanding bottlenecks in the economy.
Inflation tripled, while the balance of trade worsened sharply and foreign
Despite these problems, China's economy registered some
significant gains--including an 11-to-12-percent increase in real GNP.
Energy output increased by over 8 percent, largely because of production
incentives, increased state investment, and technology acquisitions.
Despite inflation, workers experienced an improvement in their standard of
living. Finally, government revenues increased over 20 percent in 1985,
and Beijing claimed success in narrowing its budget deficit.
This memorandum was prepared by Office of East Asian Analysis.
Information available as of 28 March 1986 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Domestic Policy Branch, China
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Agricultural Performance in 1985--Mixed Results
After three consecutive years of record harvests, grain output fell 7 percent in
1985--a result of reduced acreage, flood damage, and confusion over new reforms that
eliminated grain quotas and replaced them with a market-oriented contract system.
Rapidly developing rural industries also pulled peasants away from less lucrative grain
production. Reform leaders maintain, however, that surpluses from previous years will
more than make up for the shortfall. The decline in grain output was offset somewhat
by increases of 10 to 30 percent in the production of meat, eggs, milk, vegetables, and
oilseeds.
Industrial Performance--Overly Rapid Growth
China's industrial output increased 18 percent last year, according to Chinese
statistics. This continued a trend of double-digit growth in industrial production that
began in 1983 and accelerated in the second half of 1984. During the first half of 1985,
industrial output expanded at a 23-percent annual rate, but efforts to cool the economy
reduced the growth rate to 10 percent by the end of the year.
Rural industry was the most rapidly growing sector of China's economy in 1985.
According to a Chinese press report, the output value of rural factories shot up by 35
percent and constituted almost a third of total industrial production.
In light industry, buoyant consumer demand sustained a boom in the production
of electrical home appliances. Output of building materials, heavy equipment, and
machinery generally increased more than 15 percent during the year, while production of
rolled steel increased about 9 percent.
We believe that rapid industrial growth has been caused by skyrocketing
investment spending--up by 35 percent in 1985--and a surge in wages and bonuses for
industrial workers. Successful rural reforms have increased the availability of raw
materials for industrial use, while boosting rural incomes and fueling consumer demand.
Rapid industrial growth also has been facilitated by industrial reforms, particularly those
allowing enterprises to sell overquota production at prices above the state-set levels.
To a lesser extent, rapid growth last year was due to the technical modernization of
some segments of Chinese industry.
Burgeoning Trade Deficit
Loosened central oversight of foreign trade and a surge in investment and
consumer spending led to a flood of imports--up more than 50 percent last year,
according to Chinese customs data. Because of strong domestic demand, Chinese
exports increased by only 6 percent--leaving Beijing with a 1985 trade deficit of $14.9
billion. Because of the deficit, China's foreign exchange reserves fell 25 percent
between September 1984 and September 1985, and China devalued its exchange rate
about 15 percent during the year.
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Improved Budget Outlook
Strong industrial growth, rising prices, and increased tariffs on some imports
pushed up government revenues by over 20 percent in 1985, despite media reports of
widespread tax evasion. Although statistics on government spending have not yet been
released, Chinese press reports indicate that Beijing believes the budget deficit was
eliminated last year. Chinese accounting practices, however, record Chinese foreign
borrowing and government bond sales as "revenue." As measured by Western
standards, China's 1985 budget may still have had a deficit of over $3 billion.
Problems Associated With Rapid Growth
Although Chinese leaders tout rapid growth as an indicator that industrial reforms
are working, they are concerned that a continuation of the fast-paced expansion will
exacerbate longstanding economic problems, heighten social tensions, and undermine
reform efforts.
Despite sharp increases in the production of coal, oil, and electricity last year,
energy supplies in China are strained. Additions to the transportation network have not
kept pace with the growth in industrial output, and the system remains seriously
overburdened. Chinese media report that factories still must suspend production
occasionally because of shortages of electricity and delayed shipments of raw materials.
Chinese media reports also suggest that key reform goals, such as improvements
in industrial efficiency and product quality, are being undermined by the rapid growth.
Beijing acknowledges that higher output in some cases is caused not by efficiency gains
but by the use of large amounts of inputs. Press reports also suggest that rapid growth
is wearing out equipment at excessive rates, increasing occupational hazards in
factories, and generating higher levels of environmental pollution. Moreover, according
to Premier Zhao Ziyang, recent output levels were possible only because China imported
large amounts of raw materials.
Beijing intends increased competition between state-owned enterprises to spur
improvements in product quality. The shortages caused by strong demands for
consumer goods and construction materials, however, have actually eased pressure on
firms to maintain quality standards. Press reports emphasize that low product quality
remains a serious problem throughout the economy.
Although output grew rapidly in 1985, it was not sufficient to meet the strong
demand for consumer goods, equipment, and building materials. China's retail price
index showed prices rising 8.8 percent, triple the rate in 1984. We believe Beijing is
especially concerned that rising prices will jeopardize popular support for economic
reforms. Although large increases in wages and bonuses have cushioned the impact of
higher prices for some consumers, a jump in retail food prices has caused widespread
complaints among urban residents, and the rising cost of living apparently was a factor
in student protests last fall.
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After industrial output increased at a 23-percent annual rate during the first
quarter of 1985, Beijing implemented a combination of market-oriented macroeconomic
adjustments and administrative controls. China's 1985 budget, announced last April,
called for narrowing the budget deficit by slowing the growth of government spending.
In particular, Beijing ordered a 10-percent cut in administrative expenditures. Beijing
also began pursuing a tight money policy.
? In April, Beijing raised interest rates on time deposits and on loans for working
funds. In August, Beijing boosted rates on capital construction loans and again
hiked time deposit rates.
? To soak up excess currency, Beijing set aside $2 billion in foreign exchange
reserves to be used to import scarce consumer durables, and the Ministry of
Commerce was ordered to mark down prices of overstocked domestic
commodities and increase sales to the public.
Many of the administrative controls were employed through China's banking
system.
? China's central bank was ordered to set and enforce quarterly credit limits for its
branches and the specialized banks.
? Banks were ordered to stop offering loans to inefficient enterprises and to firms
that produce poor-quality products.
? Banks were prohibited from extending credit for capital construction projects
whose spending exceeds the state quota or for projects not listed in the state
plan.
? To prevent indiscriminate increases in wages and bonuses, enterprises were
required to place wage funds in special accounts to be monitored by the banks.
Apparently, the payroll accounts of some units were frozen.
Although industrial production has slowed since July 1985, recent statements by
Chinese leaders suggest that Beijing remains very concerned with inflation, excessive
investment spending, and its large trade deficit. We believe Beijing will continue to
tighten control over credit and capital construction this year.
Readjustment and Consolidation
Deng Xiaoping and other top Chinese leaders remain committed to reform,
despite the economic dislocations in 1985. The economic problems, however, have
forced Beijing to slow the pace of reforms. In major speeches early this year, Chinese
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leaders called for a period of consolidation and adjustment in the reform program.
Premier Zhao Ziyang stated recently that no major price reforms would be implemented
in 1986, and, in his speech to the national party conference in September 1985, he
suggested that Beijing might need a two-year readjustment period to perfect
macroeconomic control techniques.
We believe Chinese leaders realize that some reforms--such as relaxing price
controls or allowing wage funds to rise with enterprise profits--might be destabilizing in
an inflationary economy, and that they must improve their ability to use indirect
economic levers, such as taxes and interest rates, to regulate the economy. In our view,
the two-year time frame mentioned by Premier Zhao probably is a guideline for the
readjustment period. We expect Beijing to move ahead with key reforms as soon as it
is confident that capital construction is under control and that it has improved its
economic regulatory mechanisms.
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Subject: The Chinese Economy in 1985: An Overview
1 - Mary Yee, office of East-West Economic Policy, Room 4450,
Department of the Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department
of State
1 - William B. Abnett, Director of China Affairs USTR, Room 316,
600 17th St., NW, Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820,
Department of Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DEV
1 - OEA/Production Officer, 4G48
1 - D/OEA, 4F18
1 - DDI, 7E44
1 - Senior Review Panel, 5G00
1 - PDB Staff, 7F30
1 - NIO/EA, 7E62
1 - C/PES, 7F24
1 - FBIS/NEAAD/China Branch, 306 Key
1 -05E18
1 - CPAS/ILS, 7G50
5 - CPAS/IMC/CB, 7G07
1 - Author
1 - Chrono
1-
1 -
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
China's Foreign Trade in 1985 and Prospects for 1986
Summary
Over the past year, Beijing has tightened its control of the foreign
trade apparatus, largely in response to declining foreign exchange reserves
and a sharply rising trade deficit. High demand in China's industrial sector,
however, will keep imports high, while increasing protectionism in the
West will continue to dampen export growth. Moreover, lower prices for
petroleum and petroleum products--which represent approximately
one-fifth of the country's export revenues---will decrease Beijing's foreign
exchange earnings. In an effort to narrow its trade deficit, we believe
Beijing will continue to exert more control over its foreign trade as a
means of reducing imports in the face of expected low export growth. We
believe, however, that the impact on US exports to China will be marginal.
I
This memorandum was prepared by I I Office of East Asian Analysis.
Information available as of 28 March 1986 was used in its preparation. Comments and
queries are and may be directed to the Chief, China Division, OEA,
25X1
LOA I
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After more than five years of progressive liberalization of many foreign trade
practices, over the last year Beijing has begun to reimpose selected central controls
over foreign trade. The reassertion of control by the Ministry of Foreign Economic
Relations and Trade (MFERT) is apparently in response to a 25-percent decline in foreign
exchange reserves between September 1984 and September 1985, and to the
leadership's concern about a growing trade deficit. Although Beijing's current level of
foreign exchange reserves is sufficient to cover three months' imports, Chinese officials
prefer to maintain a five-month foreign exchange reserve cushion.
One Step Back for Decentralization
Recentralization began with MFERT regaining control over the establishment of
new trading organizations. China's open-door policy had given rise to a proliferation of
import-export companies, many of which lacked the necessary skills for conducting
trade. As a result, foreign and domestic traders encountered considerable confusion.
Moreover, the competition among the many Chinese entities--both national and
provincial--authorized to trade had initiated a price war, driving down the prices of
China's exports and dampening foreign exchange earnings. Under the new guidelines, a
new organization may be approved only if its business scope does not overlap existing
companies and the new firm has qualified personnel.
In another move to strengthen management over foreign trade, last spring MFERT
implemented a system of licensing imports and exports. Initially export licenses were
required for 30 products; later the list was trimmed to 15 key export products. Last fall,
however, Beijing broadened its export license requirement to 151 items, covering almost
every major product the country exports. Import licenses were also imposed to dampen
the flow of incoming goods--many of which China could 'produce domestically--and to
conserve foreign exchange. In addition, in the past year Beijing announced changes in
its customs regulations--increasing some tariffs to protect infant industries from
imports, reducing import duties on some goods including raw materials and
high-technology items, and abolishing nearly all export duties. These measures will help
reduce the variation in local assessments of duties and licenses, which had caused
confusion among foreign traders.
Despite these measures, China posted a record $14.9 billion trade deficit last
year, according to Chinese customs statistics. Imports soared more than 50 percent in
1985 as rapid industrial growth and high consumer demand--sparked by an increased
money supply--led to sharply higher purchases of raw industrial materials and
consumer durables. Although petroleum export revenues increased, earnings by other
major exports--such as textiles and apparel--were sharply lower and, according to
Chinese data, overall export earnings rose by only 6 percent.
The Search for New Export Markets
Developing New Partners. While Beijing recorded only a marginal increase in
exports to its major trading partners (Hong Kong, Japan, and the United States), its
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exports to the Soviet Union, Latin America, and Eastern Europe showed substantial
increases. We estimate that exports to the Soviet Union increased more than 35
percent over 1984, along with an additional 22-percent increase in goods to Eastern
Europe. Exports to Mexico and Chile more than tripled in 1985, reflecting Beijing's
strong interest in developing ties to Latin America.
Hong Kong continues to be China's largest export market, accounting for more
than one-fifth of China's total trade. Beijing has actively pursued closer economic links
to promote the territory's stability and prosperity. Moreover, China is particularly in
need of a host of services that Hong Kong can provide--financial, trade, and shipping.
Earlier this year, Hong Kong opened an office in Beijing to further promote trade--its
first official representation in China--with a second office scheduled to open in
Shanghai before yearend.
Moving Into New Commodities. Although grain output fell 7 percent, China
became a net exporter of grain last year, almost tripling grain export levels to over 9
million metric tons. Imports--15 percent of which were from the United States--totaled
about 5.4 million metric tons. Corn constitutes nearly half of China's grain exports with
the balance in soybeans and rice. Sales to Hong Kong, the Soviet Union, West Germany,
the Philippines, and Singapore account for more than half of China's grain sales.
Although revenues from exports of petroleum and petroleum products jumped 25
percent in 1985, Beijing's search for new export markets will intensify this year as China
feels the effects of lower oil prices. For the past six years, petroleum and petroleum
product exports have accounted for roughly one-fifth of total export earnings,
amounting to nearly $6.4 billion in 1985. If Beijing carries out its promise to hold oil
export volume at the 1985 level in support of OPEC's attempts to shore up oil prices,
China could lose at least $1.6 billion in foreign exchange earnings this year.'
For the next few years, we expect manufactured goods to provide the largest
source of export growth as the Chinese substitute sales of processed goods for raw
materials wherever possible. In addition to the higher value-added earnings that
processed goods command, this strategy is also directed toward compensating for the
increase in volume quotas developed nations impose on imports from China. The
Chinese are also attempting to increase their gains from trade by moving into exports
that reflect their comparative advantage in labor-intensive manufactured goods. For
example, earlier this year, Beijing announced its plan to export $1.5 billion worth of
carpets in the next five years and established the China Carpet Import and Export
Association to coordinate international sales.
' This assumes that oil prices will average $18 per barrel in 1986 and that petroleum
products--nearly 20 percent of China's oil-related export volume--will earn
approximately 25 percent more per barrel than crude.
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Implications for the United States
China has little chance of turning to alternative commodities to compensate for
the expected drop in oil export revenues--attempts over the past several years to
diversify exports have met with limited success. Hence, Beijing will probably focus on
slowing runaway imports. We believe much of the slowdown in import growth will be
effected through stricter foreign exchange controls, including an additional curtailment
of the purchase authority previously granted to local traders under decentralization.
Beijing will also continue other restrictive measures such as import licensing and
selective tariff increases. According to Hong Kong press reports, Beijing's attempts to
conserve foreign exchange are driving some small, marginal Chinese import-export
companies out of business. These same sources caution that, because of foreign
exchange shortages, China may also renege on negotiated contracts--similiar to the
cancellations of grain and synthetic fiber contracts that occurred in 1983.
We believe that tightening import restraints will change the composition of
China's purchases over the next year. Restrictions are already in place on commodities
that China can produce domestically, including such consumer durables as color
televisions, refrigerators, radios, and motor vehicles. But Beijing will also need to cut
deeper into its import shopping list. We believe these cuts will begin with capital
equipment purchases for postponed or cancelled government projects.
We believe, however, Beijing will continue to encounter problems slowing
economic growth and therefore will achieve only moderate success in reducing
industrial and capital equipment purchases. Consequently, the effect on US exports to
China, more than one-third of which are machinery and transport equipment, will be
marginal. Moreover, demand for raw materials and chemicals--which represent an
additional 25 percent of US exports to China--probably will also be sustained.
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CHINA: EXPORTS, F.O.B., BY AREA
-----------------------------------------------------------------------------------------------------------------------------------------------------
III IV 1 II III IV 1 II III IV 1 II III IV II III
1981 1982 1983 1984 1985
Legend
DEVELOPED COUNTRIES
LESS DEVELOPED
COUNTRIES
COMMUNIST COUNTRIES
TOTAL
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 Exi
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CHINA: IMPORTS, F.O.B., BY AREA
Legend
DEVELOPED COUNTRIES
LESS DEVELOPED
COUNTRIES
COMMUNIST COUNT,
TOTAL
II 111 IV 1 11 III IV I II Ill IV I II III IV 1 II III
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UNITED STATES-CHINA TRADE
------------------------------------------------------------------------------------------------------------------,/--'-----------------------
0
1979 1980 - 1981 1982 1983 1984 1985
BILLION US $
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China's Foreign Trade in 1985 and Prospects for 1986
1 - Mary Yee, Office of East-West Economic Policy, Room 4450, Department of the
Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department of State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316, 600 17th St., NW,
Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820, Department of
Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DOM
1 - C/OEA/CH/DEV
1 - OEA/Production Officer, 4G-48
1 - D/OEA, 4F-18
1 - DDI, 7E-44
1 - Senior Review Panel, 5G-00
1 - PDB Staff, 7F-30
1 - NIO/EA, 7E-62
1 - C/PES, 7F-24
1 - FBIS/NEAAD/China Branch, 306 Key
1 -5E-18
1 - CPAS/ILS, 7G-50
5 - CPAS/IMC/CB, 7G-07
1 - Author
1 - Chrono
1-
1 -
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I I
Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
Foreign Investment in China: Impact of New Regulations
Summary
Since 1979 more than 5,000 joint ventures, cooperative enterprises,
and businesses wholly owned by foreign firms have been established in
China. By the end of 1985, we estimate that total paid-in foreign
investment in these enterprises reached $5.4 billion. We believe that
through the Seventh Five-Year Plan (1986-90) Beijing will continue to seek
higher levels of foreign investment, although changes in Chinese
regulations may work against small investors. In addition, the drop in oil
prices will probably delay further investment in China's oil industry.
How Much Foreign and US Investment Now?
Foreign investment in China has been growing rapidly over the past five years.
According to China's Ministry of Foreign Economic Relations and Trade (MFERT),
between 1979 and 1985 Chinese authorities granted approval for nearly 2,300 joint
ventures and over 3,700 cooperative enterprises. In addition, there were 30 offshore oil
This memorandum was prepared by Office of East Asian Analysis.
Information available as of 28 March 1986 was used in its preparation. Comments and
queries are and may be directed to the Chief, China Division, OEA,
25X1
25X1
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exploration and exploitation projects' as well as 120 wholly owned foreign enterprises.
According to MFERT, by September 1985 paid-in foreign investment totalled $5.4 billion.
total US investment in China as of last
December was about $1 billion, $600 million of that in oil exploration. US firms also are
involved in some 100 joint equity ventures with investments of about $150 million. The
balance of US investment is probably in cooperative enterprises.
Driving Forces Behind Foreign Investment in China
Hong Kong is responsible for roughly two-thirds of all foreign investment in
China and as much as 80 percent of all joint equity venture projects. Hong Kong
businessmen find China, especially neighboring Guangdong Province, an attractive place
to invest partly because of family ties and other personal linkages. In addition, China
has designed some of its investment incentives--such as establishing the Shenzhen
special economic zone adjacent to the Hong Kong border--specifically to attract Hong
Kong investment. Potential investors, faced with a 3.4-percent unemployment rate that
makes enterprise expansion difficult within Hong Kong itself, find China's labor
costs--one-third lower than Hong Kong's--especially attractive.
China has also improved its investment environment by developing its legal
infrastructure. In 1983, Beijing began to enact scores of laws to attract or protect the
foreign investor. In September of that year, China issued regulations to clarify its 1979
law governing joint ventures. The new rules offered longer tax holidays, increased
opportunities to sell the output of the venture in the domestic Chinese market, and gave
more decisionmaking autonomy to the venture. In early 1984, China exempted joint
ventures from import duties and abolished selected taxes on ventures that import
advanced machinery and technology. In April 1984, the National People's Congress
formally ratified the leadership's decision to open 14 additional port cities and Hainan
Island to foreign investment, giving entrepreneurs many of the advantages available in
the Special Economic Zones. However, the central government has since withdrawn
plans to invest heavily in infrastructure in these areas.
In May 1984, Beijing extended the maximum limit of the term of joint ventures
from 30 to 50 years, giving the foreign investor more time to recoup its investment and
make a profit. In December of that year, China also joined the Paris Convention for the
protection of industrial property rights thereby easing concerns of investors about
pirating protected technologies.
1 We count only 25 offshore contracts total. MFERT may also count areas where bids
have closed but no firm contracts have been signed.
25X1
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Last year, Beijing revamped its tariff regulations, lowering duties on raw materials
and high-technology items and gave special tax reductions and exemptions to joint
ventures and projects in Special Economic Zones. The State Council also eased
regulations for high-technology joint ventures giving them more discretion over the
level of their reserves and greater access to domestic markets.
Investment in the Seventh Five-Year Plan
China will continue to try to attract foreign investment throughout the Seventh
Five-Year Plan but with a few modifications. Priority will be given to the development
of natural resources, transport, upgrading existing enterprises, and tourism. Because of
foreign exchange difficulties, however, China has revoked some of the autonomy allowed
local planners. Beijing also is instituting regulations to prevent foreign exchange loss in
certain types of investment. For example, wholly foreign-owned ventures will be
required to export part or all of their product; officials stress that this rule is not
intended to limit foreign investment but to stem foreign exchange loss.
Beijing is also implementing internal regulations designed to limit the share of
borrowed funds that can be used to finance small investments. The rule permits no
debt for any investment less than $3 million; Beijing believes low levels of equity have
been a major cause of bankruptcies. The limitations could undermine plans of small
investors who lacked sufficient financial resources to cover the cost of their venture but
hoped to profit from China's growth in the late 1980s.
Of special interest to the United States over the past few years, investment in oil
exploration probably will slow as long as oil prices remain low. This will adversely
affect the total share of future US investment in China inasmuch as oil represents
two-thirds of all US investment in China and has been the one area where US firms
have been dominant. This, too, is more likely to affect small, independent firms that
have insufficient financial resources to survive until oil prices rise again.
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Typescript "Foreign Investment in China: Import of New Regulations
1 - Mary Yee, Office of East-West Economic Policy, Room 4450, Department of the
Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department of State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316, 600 17th St., NW,
Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820, Department of
Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DOM
1 - C/OEA/CH/DEV
1 - OEA/Production Officer, 4G-48
1 - D/OEA, 4F-18
1 - DDI, 7E-44
1 - Senior Review Panel, 5G-00
1 - PDB Staff, 7F-30
1 - NIO/EA, 7E-62
1 - C/PES, 7F-24
1 - FBIS/NEAAD/China Branch, 306 Key
1 -5E-18
1 - CPAS/ILS, 7G-50
5 - CPAS/IMC/CB, 7G-07
1 - Author
1 - Chrono
1-
1 -
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I I
Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
China's Energy Picture in 1985: Good
Performance, Uncertain Prospects
Summary
China's energy sector turned in a strong performance in 1985, with
record production of coal, oil, and electric power. Energy growth of 8
percent, supplemented by improved efficiency and conservation, helped
sustain China's double-digit industrial growth last year. Nonetheless,
chronic problems with power shortages and coal transport continued to
disrupt the economy, and offshore oil exploration showed little promise of
providing a new long-run source of supply.
This memorandum was prepared by Office of East Asian
Analysis. Information available as of 28 March 1986 was used in its preparation.
Comments and queries are welcome and may be directed to the Chief, China Division,
25X1
25X1
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China's future energy prospects are further clouded by budget and
foreign exchange problems that may reduce funds needed for expansion.
Planners are taking a hard look at planned "big ticket" items like the
civilian nuclear program and the Three Gorges dam, and have already
cancelled a major coal venture with Japan. In the short run, US exports to
China of energy technology and equipment may be hurt by these cutbacks,
but the United States is likely to remain China's principle foreign investor
in the energy sector and a key source of energy technology crucial to its
Last year's energy growth of 8 percent (down slightly from 9 percent in 1984)
was enough to sustain an 18.4-percent increase in China's gross industrial output (see
table 1). Even so, the Chinese claim that one-fifth of their industrial capacity is idled by
chronic power outages. Industry is using energy more efficiently, but these advances
are more the result of better resource management than of technological improvements.
Because these are largely one-time gains, China's ability to maintain double-digit
industrial growth with single-digit energy growth remains highly doubtful.
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Table 1. China's Energy Production in 1985
Growth
Share of
China's Energy
1985
1984
(%)
(%)
Total energy*
840
780
7.8
100.0
Coal (million
metric tons)
850
789
7.7
72
Oil (million
barrels per day)
2.496
2.286
9.2
21
Natural gas
(billion cubic meters)
12.86
12.43
3.5
2
Electric power (billion
kilowatt hours)
Of which:
407.3
377.0
8.0
**
Hydropower (bkwh)
91.0
86.8
4.8
5
* In million tons of coal equivalent, or standard coal; it is equivalent to 1.4 tons of coal,
.014 b/d of oil, 752 cubic meters of natural gas, or 2,421 kwh of electricity.
**Electric power's share of China's energy is included under primary sources--coal, oil,
and hydropower.
Last year's runaway industrial growth--which taxed domestic resources and
contributed to a drain in China's foreign exchange holdings--threatens Beijing's ability to
expand energy supplies. Indeed, despite the high priority the Chinese have given the
energy sector over the past few years, proposed energy investments face stiff
competition from other rapidly growing sectors of the economy for scarce state funding,
foreign exchange, and building materials.' With less money likely to be available, China
will be forced to weigh carefully decisions on expensive, long-term projects such as
nuclear plants and the massive Three Gorges hydroproject against the construction of
cheaper, coal-fired power plants that are faster to build. China may also have to cut
imports of Western technology that are critical to its efforts to expand oil and coal
production. Transport improvements--essential to moving energy to consumers--could
also be hit by the budget and foreign exchange crunch. The net effect of lower
' The funding shortage will be exacerbated by the drop in world oil prices, which could
cost Beijing $1.6 billion in earnings in 1986.
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investments in energy and related transport projects over the longer run would be to
impose further constraints on economic growth; similar cuts in 1981 dampened later
energy output and economic growth and are still being felt.
The United States--which to date is China's largest foreign investor in the energy
sector and a key supplier of energy-related technology--is likely, in turn, to be affected
by any cutbacks.2 In fact, the United States already appears to be out of the running in
supplying China with nuclear power plants, despite passage of the nuclear cooperation
agreement. We still expect US firms to account for a major share of China's
energy-related imports for some time. Just as China presses Japan to meet US levels
of direct foreign investment, however, it will continue to prod the United States to
match Japan's lower-cost project and equipment financing.
We believe that reforms in mine ownership, wages, and prices have been the
primary reasons for the strong growth in China's coal output. Beijing's decision in 1983
to allow individuals and collectives to mine coal did much to encourage peasants, eager
to profit from small-scale industries, to increase production. Last year, 62,500 such
small mines produced about one-fourth of China's coal; another quarter came from
medium-sized mines owned by provinces or localities, and China's large state-owned
mines produced the remaining half. According to preliminary figures issued by Beijing,
production last year at small- and medium-scale mines grew two and a half times
faster than at the state mines, largely because of the opening of 12,500 new small
At all levels, the use of piece wages and special bonuses continued to improve
productivity. Beijing has also raised the average price of coal to encourage production.
While the official price of coal remains low, prices are negotiable for above- uota
production from large-scale state mines and for all coal from smaller mines.
The United States is the largest foreign investor in China's energy sector. China's
two biggest joint ventures--the Pingshuo open-pit coal mine and the offshore natural
gas field near Hainan -- both involve US firms. The United States also has provided
key energy technologies that helped China to find more oil and accelerate oil
production, to upgrade hydro and thermal power plant construction and operation,
and to develop safety procedures for new nuclear plants.
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Last June, China signed a $650 million joint venture with the US firm Occidental
Petroleum to jointly develop the world's largest open-pit coal mine--Pingshuo--located
in Shanxi Province. The project, which will produce 15 million tons a year beginning in
1988, would have been signed several years ago, but the declining international price of
coal made financing difficult. Falling prices also recently contributed to Royal Dutch
Shell's cancellation of an open-pit mine project in Shandong Province, and to Japan's
indefinite postponement of another large open-pit mine planned for Inner Mongolia. If
international prices stay low, China may find it difficult to market its coal abroad, and
could be forced to dip into its foreign exchange reserves to pay off foreign investors.
Oil--Offshore Exploration
Foreign oil companies exploring China's offshore basins began trial production of
oil from offshore wells in 1985, with commercial production and export scheduled for
later this year. Even so, offshore efforts continue to be a major disappointment for
China's long-run energy planning. The Chinese originally hoped to find a 1 to 2
million-barrels per day (b/d) supply offshore, both to meet growing consumption and
export needs and to offset expected eventual declines at mature onshore fields.
Production this year will reach only 20,000 b/d, from sites developed by the Japanese in
the Bohai and by the French in the Beibu Gulf. In the absence of a now-unlikely major
find, we believe China will be lucky to eventually produce one-tenth the amount it
anticipated offshore.
The big financial losers in the offshore effort, of course, are the foreign oil
companies who bore all survey and exploration costs, spending almost $2 billion. Three
US firms found oil, but all will carry out more drilling before committing themselves to
commercial production. Most firms fared much more poorly; China had to give some
unsuccessful participants additional acreage to keep them from quitting.
China in 1985 offered for bid a second set of exploration blocks, before foreign
interest had waned any further. Of the 19 blocks available, contracts have been signed
for six of the more promising areas. Declining world oil prices and continued poor
showings from first round drilling are, however, likely to dampen Western enthusiasm
and leave most of the remaining blocks unsigned.
China's 9-percent increase in crude oil production during the past year came as a
result of new finds, improved recovery techniques, and greater productivity at existing
onshore fields. The Shengli oilfield, located in Shandong Province, has made particularly
impressive production gains and provided almost 40 percent of last year's total growth.
The Chinese predict that Shengli's major new finds will double the field's production by
1990 to 1 million b/d. Over 50 Western technicians are working at Shengli to find and
develop new wells.
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Recent discoveries on the periphery of several existing fields led Beijing to
predict that China's oil output will grow by 5 percent per annum through the current
Seventh Five-Year Plan, reaching 3 million b/d in 1990. We believe China can reach this
goal, but sustaining it will require additional new finds to replace declining production at
China's ambitious oil production goals hinge on maintaining output at China's
largest field, Daqing, a mature field in Heilongjiang Province. Almost half of China's
current oil supply is produced at Daqing. We believe production at Daqing could start
declining in the next few years, despite recent Chinese claims that they can sustain
Daqing's current production for another 10 years.
In March 1985, China opened 1.83 million square kilometers in 10 southern
provinces to oil exploration by foreign firms, in the wake of the offshore program's
disappointing results. The areas Beijing opened have few existing fields and are largely
unexplored. An Australian consortium signed the first--and to date only--onshore oil
exploration contract in May 1985 for an area on Hainan Island. In July China opened its
first onshore basin to international bids--the Subei Basin in Jiangsu Province.
Meanwhile, Beijing continues to contract with foreign firms, including ones from the
United States, to provide seismic survey crews and equipment to search for oil in
Almost all of China's increased oil production last year was exported as either
crude oil or petroleum products. We estimate that China exported 580,000 b/d of crude
oil and 120,000 b/d of petroleum products in 1985, worth $6.4 billion, almost 25 percent
of China's exports. Beijing has nearly doubled the volume of its crude oil exports in the
last two years by undercutting OPEC prices, marketing aggressively, and conserving
domestic supplies. But in February, China announced that it will freeze the volume of its
oil exports at the 1985 level to help support the falling international price of oil. If
China sustains a freeze and crude oil prices average $18 per barrel, we believe China's
foreign exchange earnings from oil could decline by $1.6 billion this year.
Electric Power: Shortages Force Equipment Imports
Faster power growth in 1985 stemmed from improved coal shipments to power
plants, good rainfall in hydropower areas, and accelerated power plant completions.
Nevertheless, chronic shortages remained serious as the economic policies encouraging
industrial growth collided with inadequate power capacity--fallout from ill-conceived
investment cutbacks in the early 1980s that slowed power plant construction through
China added 6,100 megawatts of new capacity in 1985, the most in one year
since the late 1970s and the direct result of power budget increases of 25 percent in
1983 and 35 percent in 1984. About 90 percent of the new plant capacity came from
thermal plants in the power-starved east and northeast, many brought to completion
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Hydroplant construction problems--only one major generator became operational
in 1985--have forced Beijing to emphasize construction of coal-fired plants that are
cheaper and faster to build, even though they are more expensive to operate. China's
ability to supply power generation equipment is still not up to the task, however.
China's three major power equipment factories have all imported US technology but are
still unable to meet demand. Meanwhile, China has said it will import 10,000 MW of
thermal generators over the next five years, over half of its planned capacity additions.
Reportedly, China will buy up to 6,000 MW of these imports from the USSR and Eastern
Europe as part of its efforts to expand trade with the Soviet Bloc.
Beijing already recognizes that even these additions will not solve the power
crises in its eastern cities. In 1985, China established the Huaneng Energy Corporation
to negotiate imports of complete power plants outside of the state plan. On 26
February, a consortium led by the US firm General Electric signed contracts in Beijing to
provide Huaneng's first two whole-plant imports for Nantong in Jiangsu Province, and
for Shijiazhuang, the capital of Hebei. The Chinese are unlikely to award all Huaneng
contracts to a single source--and Tokyo is considering new low-cost financing so
Japanese firms can improve their competitiveness--but prospects for additional US
China's Nuclear Power Program
Progress has been slow in China's efforts to begin commercial nuclear power
production. In March, China signed letters of intent with France to supply reactors for
its planned 1,800-megawatt nuclear plant at Daya Bay in Guangdong Province, but final
contracts have not yet been signed. Work continues on a small (300 MW), domestically
built reactor at Qinshan that relies substantially on components and technology
imported from Japan and West Germany. Meanwhile, China has postponed or cancelled
plans for additional nuclear plants at Sunan (Jiangsu Province), and in Liaoning and
Fujian; China will probably scale back its plans to have 10,000 MW of nuclear power
operational by the year 2000.
Natural gas production had its best year since 1980; the discovery of a massive
offshore natural gas reserve by the US firm Arco bolstered China's interest in gas as a
source of energy. The Chinese in 1985 signed a $500 million agreement with
Arco--China's second-largest joint venture after Pingshuo--to develop the field off
Hainan Island and bring the gas ashore. China expects the project to yield 3.25 billion
cubic meters of gas per year--equal to one-fourth their current output--for about 20
years, beginning in 1992. Beijing also plans to accelerate growth of onshore gas
exploration and production while awaiting development of the Arco find. China
announced recently that it will double production by 1990 at gasfields in Sichuan
Province, the source of half of China's natural gas.
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China has also stepped up efforts to collect oil-associated gas at oilfields like
Huabei and Liaohe and is adding to pipelines that transport the gas to eastern cities.
China hopes to expand its use of natural gas at smaller power plants and in urban
households for heating and cooking, to reduce coal consumption and urban pollution.
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China's Energy Picture in 1985: Good Performance, Uncertain Prospects
1 - Mary Yee, Office of East-West Economic Policy, Room 4450, Department of the
Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department of State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316, 600 17th St., NW,
Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820, Department of
Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DOM
1 - OEA/Production Officer, 4G-48
1 - D/OEA, 4F-18
1 - DDI, 7E-44
1 - Senior Review Panel, 5G-00
1 - PDB Staff, 7F-30
1 - NIO/EA, 7E-62
1 - C/PES, 7F-24
1 - FBIS/NEAAD/China Branch, 306 Key
1 - 5E-18
1 - CPAS/ILS, 7G-50
5 - CPAS/IMC/CB, 7G-07
1 - Author
1 - Chrono
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Central Intelligence Agency
DIRECTORATE OF INTELLIGENCE
28 March 1986
China: Policy Response to Economic Instability
Summary
Economic developments in 1985 highlighted the fundamental
problem of managing an economy that is being transformed from a
centrally planned system to one that mixes planning and market elements.
We believe Beijing's response to the problems, particularly the absence of
a reflexive clamp down on reforms, provides insight into the leadership's
approach to economic policymaking, and reform prospects in general.
As Premier Zhao Ziyang stated in a recent interview, one of the key problems
Beijing's reform program faces is how to maintain economic stability while reducing
direct government control over state enterprises. Reforms implemented in the past two
years have significantly diminished administrative control over production, investment,
and pricing decisions. Enterprises now retain a much larger share of earnings--which
they can use for investment or worker remuneration--and are permitted to sell
This memorandum was prepared by Office of East Asian Analysis.
Information available as of 28 March 1986 was used in its preparation. Comments and
queries are welcome and may be directed to the Chief, Domestic Policy Branch, China
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overquota production of industrial goods at prices above state-set levels. Price controls
have been relaxed for some products, and more retail goods are marketed outside
government-run commercial channels.
Although mandatory planning still plays an important role in China's economy, in
our view, Beijing has given up an element of direct control over aggregate demand by
allowing increased enterprise autonomy. Reformers hope to control aggregate demand,
and maintain economic stability, by employing indirect economic levers such as interest
rates, credit levels, and taxes.
We believe Beijing's ability to implement comprehensive economic reform*
depends on its success in using indirect economic levers in place of administrative
directives. When reforms were launched in 1979, opponents warned that Beijing could
lose control of the economy if the central planning mechanism was weakened--and
argued that strict limits should therefore be placed on economic decentralization.
Reforms proceeded, in part, because Chinese leaders became convinced that
macroeconomic levers could be used to regulate economic activity occurring outside of
the plan.
We believe economic developments in 1985 highlighted the fact that Beijing has
not yet perfected a new macroeconomic control mechanism. A surge in investment,
wages and bonuses, and credit that began in the middle of 1984 caused industrial
output to shoot up at a 23-percent annual rate during the first half of last year. Efforts
to cool the overheated economy gradually reduced the industrial growth rate, but
inflation tripled and Chinese imports soared. At the beginning of 1986, Beijing was still
concerned with overly rapid growth in credit, capital construction, and wage levels.
Party conservatives, who oppose some aspects of the pragmatic reform program,
criticized reformers for the economic problems last year. The sharpest attack came at a
party conference in September 1985, when Chen Yun, a Politburo Standing Committee
member and the doyen of China's economic bureaucrats, warned that market forces
were unreliable economic levers. According to Chen, "market regulation involves no
planning, blindly allowing supply and demand to determine production... planning is the
essence of macroeconomic control." We believe, that in a broader sense, Chen's
argument carried the clear implication that economic reform was progressing too
quickly and that there are limits on how far economic decentralization can go without
threatening social disorder. In our view, reformers themselves recognized the need to
improve economic controls and have therefore decided that major economic reforms
will be put on hold until after 1986.
In one sense, the potential for economic dislocations is endemic to the reform
process. In the transition from a centrally planned economy to a more market-oriented
system, Beijing must loosen some types of central controls before testing the economic
levers slated to replace them. In our view, enterprises have been quick to respond to
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enhanced decisionmaking authority--such as the right to sell overquota production at
market prices--but have not been as responsive to macroeconomic levers as Beijing
expected. For instance, higher interest rates on loans do not effectively curtail
borrowing by some enterprises that rely on the state budget for their operating
expenses. Other enterprises have proved adept at evading taxes or raising funds for
capital construction outside of the banking system. To increase the responsiveness of
enterprises to economic levers, we believe Beijing must press ahead with industrial
reforms--but further decentralization may temporarily increase economic instability. In
our view, the conflict between enhancing enterprise autonomy and maintaining
macroeconomic control will impart a pattern of rapid growth followed by
government-induced retrenchment to China's economic performance.
Sources of Instability
We believe that policy errors, a one-sided grant of enterprise autonomy, and
strong local pressures for rapid growth contributed to economic problems last year.
Policy Errors
A major source of economic instability was the 50-percent increases in currency
in circulation and loans to industrial enterprises that occurred in 1984. In our view, the
money supply surge was caused by errors in the implementation of new banking
reforms. In 1984, Beijing granted increased autonomy to local banks and urged them to
adjust their loan policies to support economic reform. Intense demand for funds by
enterprises and local officials, and lax oversight and muddled accounting by the central
bank, however, allowed credit to increase much more than Beijing intended.
One-Sided Enterprise Autonomy
Chinese press reports indicate that many managers have taken advantage of
increased autonomy by excessively increasing capital construction and rapidly expanding
wages and bonuses. In our view, this growth in investment spending and worker
remuneration was another source of economic problems. Chinese reformers recognize
that the grant of autonomy is onesided--managers have more flexibility in using
enterprise revenues, but their decisionmaking is not yet disciplined by market forces.
Because Beijing still subsidizes state enterprises that lose money, managers increase
wages--or take more loans--without worrying about bankruptcy. We believe reformers
recognize that bankruptcy is a necessary lever for restraining autonomous enterprises,
but experiments with bankruptcy laws have been limited: a working group was formed
only recently to draft bankruptcy laws. A major impediment to enforcing bankruptcy, in
our view, is China's irrational price system, which makes it difficult to determine whether
enterprises are losing money because of inefficiency, or because of low state-set prices.
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We believe the implementation of bankruptcy laws also will meet strong resistance from
local officials who fear they will have to bear the-economic--and political--costs of
workers who lose their jobs when enterprises close.
We believe Beijing faces enormous pressure from workers, managers, and local
officials for rapid growth. Promotion of "10,000 yuan households" by the media in 1984
and exhortations to get rich through hard work generated rising expectations among
workers for an improvement in their standard of living. Rising food prices have
intensified worker demands for raises, while the relaxation of state controls over some
enterprises has weakened the ability of managers to resist them.
Given years of emphasis on meeting quantitative targets, many managers still
believe that they must prove their competence by rapidly expanding enterprise
production. To boost local revenues, low-level officials pressure enterprise managers to
increase output and speed completion of local construction plans. Although
downplaying the extent of the problem, recent editorials have warned that, if officials set
unreasonable output targets, enterprise managers may resort to falsifying production
data--making it more difficult for Beijing to judge how well control measures are
working. We believe Chinese leaders are also worried that rapid growth of enterprises
operated by rural towns has caused a proliferation of small, inefficient, and redundant
firms that compete with state enterprises for funds and raw materials.
Beijing's Response to the Economic Problems
We believe that the political strength of the reform coalition and the increased
economic sophistication of its leaders was evident in Beijing's reaction to the economic
problems in 1985. Instead of halting the reforms and quickly damping the overheated
economy by reimposing strict administrative controls--as they might have in the
past--Chinese leaders implemented a combination of market-oriented macroeconomic
adjustments and state directives that were designed to slow the economy gradually.
We believe Beijing's willingness to use economic levers to stabilize the economy
was particularly significant. China's 1985 budget, announced last April, called for a
reduction in the rate of growth of government spending and a 10-percent cut in
administrative expenditures. Beijing also clamped down on credit and twice raised the
general level of interest rates. Administrative directives were issued that required
enterprises to place wage funds in special accounts to be monitored by the banks, and
that prohibited banks from extending credit for construction projects not listed in the
state plan.
During the year, Beijing began to recentralize some aspects of its foreign trade,
and it ordered a halt in construction of some projects, but it did not backtrack on
fundamental reforms. Despite surging consumer and investment demands, Beijing
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implemented planned hikes in urban food prices, and introduced--after a lengthy
delay--new wage scales for teachers and government workers. At the national
conference last September, the Chinese Communist Party formally made reform its
primary economic goal for the five-year period beginning in 1986. Although Beijing
recently announced that major economic reforms will not be implemented this year, we
believe that some types of reforms, such as the removal of central government units
from the direct management of enterprises, will proceed.
Improving the Mechanisms of Macroeconomic Control
To improve its ability to maintain economic stability with indirect economic
levers, Beijing is increasing the powers of China's central bank and making greater use
of taxes as regulatory tools. We believe Beijing has given the central bank expanded
authority to administer China's specialized banks (such as the Agricultural Bank and the
Industrial and Commercial Bank). For instance, the central bank's credit plan now
includes the funds of all of the specialized banks, and the specialized banks no longer
have overdraft rights with the central bank. Beijing recently announced a new tax
scheme for individual entrepreneurs, and Chinese press reports suggest that in 1986
Beijing will increase enforcement of taxes on capital construction. Media reports also
suggest that Beijing will boost taxes on rural industries, in part to slow their rapid
growth. Beijing also is improving its ability to collect taxes from enterprises. We
believe these changes in the banking and taxation systems will eventually provide
Beijing with better economic levers.
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Subject: China: Policy Response to Economic Instability
1 - Mary Yee, Office of East-West Economic Policy, Room 4426,
Depatment of Treasury
1 - Joan Plaisted, Office of Chinese Affairs, Room 4318, Department of
State
1 - William B. Abnett, Director of China Affairs, USTR, Room 316,
600 17th St., NW, Washington, DC
1 - Myna Stoltz, Office of East Asia and the Pacific, Room 3820,
Department of Commerce
Central Intelligence Agency
2 - C/OEA/CH
1 - C/OEA/CH/FOR
1 - C/OEA/CH/DEF
1 - C/OEA/CH/DEV
1 - OEA/Production Officer, 4G48
1 - D/OEA, 4F18
1 - DDI, 7E44
1 - Senior Review Panel, 5G00
1 - PDB Staff, 7F30
1 - NIO/EA, 7E62
1 - C/PES, 7F24
1 - FBIS/NEAAD/China Branch, 306
1 -0 5E18
1 - CPAS/ILS, 7G50
5 - CPAS/IMC/CB, 7G07
1 - Author
1 - Chrono
1-
i-
Key
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