CHINA'S PROGRAM TO RENOVATE TRADITIONAL INDUSTRIES: LIMITED DIVIDENDS THUS FAR

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• Document Page Count: 18
• Document Creation Date: December 23, 2016
• Document Release Date: January 11, 2013
• Sequence Number: 2
• Publication Date: August 1, 1988
• Content Type: REPORT

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Intelligence r } ~,
China's Program To Renovate
? Traditional Industries:
Limited Dividends Thus Far
A Research Paper
se
EA 88-10037
August 1988
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China's Program To Renovate
Traditional Industries:
Limited Dividends Thus Far
This paper was prepared byl 25X1
Office of East Asian Analysis. Comments 25X1
anies are welcome and may be directed to
the Chief, China Division, OEA, 25X1
Secret
EA 88-10037
August 1988
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China's Program To Renovate
Traditional Industries:
Limited Dividends Thus Far
Summary For the past decade Beijing has carried out a program to upgrade
Information available industrial technology to remedy shortcomings in traditional industries such
as of 15 August 1988 as machine building, chemicals, and textiles-the mainstays of China's
was used in this report.
industrial production. China initially relied heavily on massive imports to
support new plant construction, but it subsequently focused on renovating
existing plants, particularly the large- and medium-sized enterprises that
account for over two-thirds of China's fixed assets and tax revenues.
Although China's state-owned enterprises have invested $170 billion in
technological renovation and capital construction in the last 10 years,
technical levels generally remain low. Only 10 percent of large- and
medium-sized enterprises have upgraded equipment, and performance has
lagged Chinese expectations in machine building, raw materials, and
energy. The technical transformation program has had selected successes,
such as in textiles and light industry, and Chinese officials generally credit
the program with increases in overall industrial capacity and output.
Budget constraints are increasingly forcing Beijing to seek more frugal
approaches to upgrading industrial technology. Enterprises are being
encouraged to fund new technology purchases by using their retained
earnings and by tapping new funding sources such as domestic loans,
foreign capital, bond sales, shareholding, and leasing. China is also
increasingly willing to import secondhand equipment and has introduced
mechanisms to recycle unused or underutilized machinery.
We believe that by focusing on the financial aspects of technical renovation
Beijing is ignoring other significant obstacles-in particular poorly coordi-
nated investment and weak indigenous technical capabilities. Measures to
improve project appraisals and monitor expenditures will not eliminate
misuse of funds. Also, China's use of microelectronics to upgrade machin-
ery is hampered by the continuing difficulties in manufacturing and using
advanced equipment.
China will continue to increase industrial output and improve quality and
productivity, but results will be uneven. Sectors such as textiles that have a
good start on introducing technology are best situated to improve perfor-
mance, including increasing exports. Similarly, machine building, petro-
leum, and some segments of the chemical industry will further progress
Secret
EA 88-10037
August 1988
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through technical upgrading, while progress in renovating the power
industry will depend partially on efforts to increase investment. Sectors
such as plastics that have had little success are likely to remain backward,
with negative implications for China's plans to improve the packaging
industry in support of its export drive.
Finally, China's inability to rapidly upgrade industry may limit reform
efforts:
? In the absence of technological upgrading, the contract system and
similar managerial innovations are likely to have limited, one-time
benefits. The contract system also could work against technological
upgrading if contract terms fail to give managers adequate incentives for
undertaking renovation.
? Under the coastal development strategy, China is counting on exports
from coastal provinces to generate foreign exchange to pay for needed
imports. But the technical levels of enterprises in coastal areas-though-
generally better than elsewhere-are still low, and in many cases will
limit export-led growth.
? The slow pace of renovating traditional industries hampers overall
economic development, as shortages of raw materials and energy limit
industrial output, and state subsidies to technically backward enterprises
drain the budget.
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Contents
Summary
iii
Modernizing Traditional Industries: Shifting Strategies
1
The High-Tech Approach
1
Mixed Results to Date
3
Looking for Solutions
4
Unresolved Problems Dim Prospects
6
Longer Term Costs of Neglecting Industrial Renovation
9
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China's Technological Transformation Program
What Is Technological Transformation? Upgrading
technology and equipment in enterprises to improve
efficiency, output, products, and profits. China has
increasingly tried to focus on expansion and recon-
struction of existingfacilities, although new construc-
tion continues as well. Although the terms techno-
logical renovation and transformation are used
interchangeably, the broader concept of technological
transformation also includes quality control, stan-
dardization, patents, and information exchange.
Where Is the Technology From? From both advanced
foreign and domestic innovations. China has import-
ed over $13 billion worth of technology to support
industrial transformation (see figure 2). Indigenous
technology is being promoted by reforms encouraging
greater cooperation between research institutes and
factories, between universities and industry, and be-
tween military and civilian research and production
units.
How Is It Funded? State budget allotments, state
loans, and funds raised by enterprises-including
bank loans, foreign capital, and other measures.
Although total investment in technical renovation has
risen, state allotments have decreased from 18
percent of technical renovation funds in 1980 to only
3 percent in 1986, with state loans and enterprises
making up the difference.
Who's Involved? Central government commissions
and ministries provide policy planning, oversight, and
funding; provincial and local authorities, together
with factory management, fund and plan projects and
oversee implementation. Foreign firms provide capi-
tal and technology. Domestic research institutes also
contribute management and technical expertise, as do
various information clearinghouses. Beijing sponsors
annual national conferences for enterprises to discuss
experiences with technological transformation.
What Sectors Are Being Upgraded? All sectors.
Priorities are currently shifting from light industry
and textiles to:
? Heavy industry-including machinery, raw and
semiprocessed metals, chemicals, building materi-
als, power, petroleum, and coal.
? Manufacturing-machine building, metals, cement,
chemical fertilizers, and pesticides. .
? Infrastructure-transport and telecommunications.
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China's Program To Renovate
Traditional Industries:
Limited Dividends Thus Far
power, and building materials (see figure 1).
Modernizing Traditional Industries:
Shifting Strategies
For 10 years, industrial modernization has been a key
to China's development strategy. In addition to estab-
lishing or expanding capabilities in new technical
areas such as computers and electronics, China has
sought to upgrade traditional industries that serve as
the mainstay of its economy. These include machine
building, textiles, food processing, chemicals, metals,
sumption, and increase exports
In the late 1970s and early 1980s, imports played the
central role in Beijing's industrial modernization
strategy, and the open-door policy allowed an unprec-
edented burst of foreign equipment purchases to
support plant construction and renovation. The diffi-
culties and costs of importing a modern industrial
base became obvious quickly, and China began recon-
sidering its priorities. Beijing increasingly emphasized.
the need to more effectively use its machinery and
technology. The Sixth Five-Year Plan (1981-85),
adopted in 1982, increased investment in technical
transformation, with the machine-building industry
designated a high priority. The Seventh Five-Year
Plan (1986-90) further called for cutting back on plant
construction and funneling investment into techno-
logical renovation of established enterprises, particu-
larly the large- and medium-sized enterprises that are
vital to the economy. China's leaders argued that
technological renovation of existing plants uses less
money and produces quicker returns than new capital
construction; they especially criticized the long lead-
times and slow returns on investment from large new
showcase projects such as the Baoshan Steel Complex.
To emphasize the shift in focus to technical transfor-
mation, in 1986 the State Planning Commission
adopted measures calling for:
? Reduced tax rates to encourage technical transfor-
mation projects.
? Strict oversight by banks to ensure the proper use of
technological transformation funds.
? Emphasis on projects that improve quality control,
conserve energy resources, reduce materials con-
Figure 1
China: Gross Industrial Output
Value by Industry, 1986
Miscellaneous
Power and coal
Petroleum
Building materials
Source: Statistical Yearbook of China.
The High-Tech Approach
Beijing is particularly emphasizing adding microelec-
tronics technology to enhance productivity in tradi-
tional industries. For example, at a national confer-
ence in 1986, Li Peng, then Vice Premier and now
Premier, stated that the improvement of industrial
machinery through incorporation of electronics-es-
pecially microcomputers-would largely determine
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Figure 2
China's Technology Imports, 1979-87
Textile and
light industry
38.5
Machinery and
electronics
36.5
Hardware
82
Coastal
provinces
48
Interior cities
and provinces
40
the progress of modernization for all other sectors of
the economy. The machine-building industry heads
the list for computerization because Beijing believes
the provision of electronic-controlled machinery will
set the pace for the technological upgrading of other
sectors such as energy and building materials. Using
electronic technology to transform old machine tools,
for example, can greatly improve precision and effi-
ciency.
At the conference, State Economic Commission
Chairman Lu Dong announced that:
? All enterprises in machine building and electronics
will be required to experiment with computer-assist-
ed production and management before 1990. The
machine-building industry is to introduce micro-
computers into management at 1,000 enterprises
and complete a computer-aided design (CAD) sys-
tem for 24 major electrical machinery products.
? All technological upgrading projects-as well as all
major construction-must include funds for com-
puter facilities. Lu suggested that 3 to 5 percent of
technical transformation funds be set aside for
computer applications and called for preferential
arrangements to reduce costs and tax payments for
enterprises experimenting with computerization.
Chinese universities, research institutes, and enter-
prises are working on both CAD and computer-aided
manufacturing (CAM)-which many Western spe-
cialists view as the two most important industrial
applications of computers and an important measure
of a nation's industrial skill level. CAD applications
are more numerous than CAM in China, although
computers have been applied to manufacturing-
mostly in the form of process-control systems in the
chemical, petroleum, metallurgy, and cement indus-
tries, or in the use of a single microcomputer or
microprocessor to control a piece of equipment. Other
applications include development of computer systems
for choosing placement of cartons in loading cargo
ships, and computerized financial models for machine
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China values robots for a variety of civilian and
military applications and sees them as an important
means of improving quality and safety and of reduc-
ing waste. Chinese press articles in mid-1987 said
China has developed over 100 models of robots, but
only a few have been installed in production facilities.
Plans call for the application of 100 robots in indus-
try per year by 1990.
labor force is controversial.
The use of industrial robots and other labor-saving
machinery in a country with a large, underutilized
the government has yet to make a long-
stitutes and universities are working on robotics, and
three centrally sponsored test projects are evaluating
their use in manufacturing-primarily spot and arc
welding, and spray painting applications for automo-
tive and manufactured products. An announcement as
to whether China will continue to press applications
of robotics in manufacturing was due in mid-1988.
term commitment on robotics. Selected research in-
performance in raw materials, energy, and machine
building (see inset on page 5), and outmoded technol-
ogy in larger enterprises. For example, largely
through technology transformation, the chemical in-
dustry rapidly expanded capabilities to become one of
the world's largest producers of chemical fertilizers,
but expansion has not been rapid enough to prevent
China from remaining one of the largest importers. At
the same time, the quality of Chinese industrial
plastics remains very poor. As for energy, the electric
power industry's inability to meet demands despite 25X1
continuing increases in production is exacerbated by
inefficient transmission equipment and outdated fac-
tory equipment that wastes energy. Although only
8,800-or less than 2 percent of China's 499,000 25X1
enterprises-count as large- or medium-sized, they
account for over two-thirds of fixed assets and tax
revenues, and half of output value. According to the
Chinese press, most of these enterprises were built in
the 1950s and 1960s, but only 10 percent have
upgraded equipment. In 1986 such enterprises actual-
ly decreased the number of technical renovation pro-
jects and the amount of investment, according to one
press report . 25X1
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metalworking industries will
China's State Science and Technology Commission is
also promoting computer-integrated manufacturing
(CIM). In November 1987, Chinese officials said they
plan to establish a state-of-the-art CIM plant within
the next five years and are seeking a US consultant to
help with project design and implementation. Depend-
ing on the success of this project, Beijing will decide
on further funding for CIM technology in 1992-93.
be the exclusive focus of CIM for the next, five years.
Although the continued shortcomings often overshad-
ow gains, we believe the technological transformation
effort nonetheless is contributing to greater availabil-
ity, variety, and quality of products from many
traditional industrial sectors. The program's greatest
successes have come in textiles-now one of the
nation's major foreign exchange earners-and light
industry. The machine-building industry has im-
proved indigenous production of certain equipment
sufficiently to limit imports in these categories, and is
slowly expanding exports of machine parts and ma-
chinery.
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Mixed Results to Date
Despite a decade of effort, and over $84 billion
invested in technological renovation and equipment
and $86 billion in industrial capital construction by
state-owned enterprises (see figure 3
(technical levels
remain low and too few factories have been upgraded.
Of particular concern for Beijing has been the lagging
in general, technologi-
cal upgrading combined with managerial improve-
ment accounted for 60 percent of the nation's
increased output value between 1981 and 1985.
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Figure 3
China: Investment in Industry
by State-Owned Enterprises, 1979-88
Technological
transformation
Looking for Solutions
As budget constraints have forced a more realistic
appraisal of the state's ability to fund the technologi-
cal transformation program, Beijing has sought more
frugal approaches to renovation: shifting the burden
from the state by getting enterprises to fund renova-
tion themselves; using investment and technology
more effectively; and providing incentives for both
factories and research units to engage in industrial
renovation.
? Between 1979 and 1987 technological transforma-
tion projects created fixed assets worth $57.3 bil-
lion,' more than one-third of the fixed assets of
government-owned enterprises in 1980. For exam-
ple, technological renovation has created an addi-
tional 12 million tons of capacity in the steel
industry.
? Instead of only 10 percent a few years ago, nearly
30 percent of China's machinery and electrical
products now meet world standards of the late
1970s and early 1980s.
Beijing, for example, is encouraging enterprises to
invest their retained earnings in new technology and
to tap new sources of funding, including:
? Domestic loans. The Industrial and Commercial
Bank of China, for example, extended nearly $3
billion for technical renovation in 1987.
? Foreign capital, through joint ventures and bank
loans. Li Peng told the Seventh National People's
Congress in spring 1987 that enterprises should
cooperate more with foreign investors to accelerate
technological upgrading. China has received techni-
cal transformation loans from international organi-
zations such as the World Bank, the Asian Develop-
ment Bank, and the UN.
? Bond sales. Enterprises in Shenyang began the
practice of issuing bonds to raise funds for techno-
logical upgrading in 1986 and reportedly collected
more than $94.6 million by the end of the year.
China's High-Tech Venture Company issued the
first nationwide financial bonds in April 1988 to
raise money for key projects such as construction of
energy plants, transportation systems, and technical
improvements, according to press reports.
? Shareholding. China introduced shareholding-al-
lowing employees to own shares in a company to
boost productivity-in 6,000 factories, and press
reports call the experiments an effective way to raise
money for technological upgrading.
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Beijing has given priority to the machine-building
industry because of its importance to the development
of other industrial sectors. The industry encompasses
over 100,000 plants and accounts for one-fourth of all
industry's workers, output value, fixed assets, profits,
and taxes. It produces machine tools, power machin-
ery, and equipment for transportation, metallurgy,
construction, mining, petroleum, and agriculture.
Structural reforms to improve the performance of the
sector have mirrored trends throughout the economy:
decentralization of management from central minis-
tries to provincial or local authorities, grouping
enterprises into corporations to take advantage of
complementarities and reduce redundancies, greater
involvement of defense industries in civil production,
and, more recently, cooperation with the electronics
industry to upgrade capabilities and products.
Both the quantity and quality of Chinese machinery
have increased significantly in recent years-largely
as a result of foreign technology acquisitions, in our
view. For example, China has 20 large-scale compre-
hensive production plants producing 100 complete
sets of coal-mining equipment annually. China in
recent years has restricted imports of over 100 types
of machinery that authorities believe can be supplied
domestically, and has even begun to export some
types of machinery
Nonetheless, domestic production generally is unable
to meet demand, in terms either of the quantity or the
type of goods needed. Only a small fraction of plants
are capable of using modern manufacturing methods
for large-series production; of 155,000 machine tools
produced in 1985, only 1 percent were manufactured
using numerical-control technology that allows great-
er quality control and efficiency. Similarly, by the
end of June 1987, China had managed to reequip only
13,000 machine tools and apply microcomputers to
renovate less than 1 percent of the 360,000 industrial
furnaces and boilers in the machine-building and
metallurgical industries. Product quality remains
generally inadequate, with only a low-grade-precision
machining capability. In 1985, in fact, Chinese offi-
cials announced that imports of machinery and elec- 25X1
trical products were $18 billion, almost equal to the
total output value of the domestic industry.
To improve performance, industry officials in May
1987 announced they were revising their plan for the
Seventh Five-Year period to improve coordination
between departments. Technology imports will con-
tinue, but at a slightly lower rate and on a more
selective basis, focusing on energy, transportation,
raw materials, textiles, and agriculture. Production
will also be more selective, such as the call in
January 1988 for enterprises to cease production of
outmoded textile machinery. Reorganizations-cre-
ating a State Machine-Building Commission in 1985,
and in 1988 merging the Commission and the Minis-
try of Electronics into the Ministry of Machine
Building and Electronics Industries-may eventually
eliminate some redundant personnel and improve
manufacturing and marketing skills
Other steps to spur development of the machine-
building sector include the following:
? In August 1987, the State Machine-Building Com-
mission established an office to coordinate produc-
tion of internal-combustion engines, previously
scattered among 14 ministries.
? Beijing is concentrating efforts to develop numeri-
cal-control systems by combining the research pro-
grams of several enterprises.
? Under a March 1988 agreement, the Communica-
tions Bank of China will issue loans to help com-
mercialize research achievements related to ma-
chine building, provide credits to expand exports,
issue bonds or stocks on behalf of enterprises, and
help run businesses that lease Chinese and foreign
machinery.
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? Defense industry cooperation with civilian industry.
For example, defense industries in Jiangxi Province
have raised more than 70 million yuan over five
years for investment in technology in civil
enterprises.
? Leasing. Enterprises are also turning to leasing as a
mechanism for financing equipment needs. Since
1981, more than 40 leasing companies have been set
up-including 13 Sino-foreign joint ventures-and
1,100 leasing contracts have been signed involving
production lines for food, equipment, shoes, and
industrial materials. Leasing is particularly useful
for smaller plants with enough retained foreign
exchange to lease machinery, but not enough to
purchase it all at once.
To get the most out of money spent on foreign and
domestic equipment, China is trying to recycle unused
or underutilized machinery-often a lingering re-
minder of poor planning that resulted in machinery
inappropriate for the intended use, or idled by a lack
of servicing, supplementary equipment, or production
inputs.' The Chinese press reports that up to 10
percent of the country's 400 billion yuan ($107 billion)
worth of machinery is idle. One commentary estimat-
ed that, if the more than 900 pieces of idle equipment
in Wuhan City were put into production, the output
value would climb by $32 million and the profit tax
remitted to the State by $8 million. Efforts to improve
use of machinery include:
? The machine-building industry holds a national fair
annually to promote domestic secondhand equip-
ment sales.
? New companies have sprung up in at least six cities
to help redistribute idle machinery. The Over-
stocked Products and Information and Redistribu-
tion Center in Beijing, for example, provides infor-
mation on idle equipment at enterprises throughout
China to prospective buyers.
' Beijing is also increasingly willing to import secondhand equip-
ment. Since 1983, China has spent more than $250 million on used
foreign machinery, instead of spending over $1.2 billion on new
? In February 1988, the State Economic Commission
announced that, under a new program to improve
the use of imported technology, 300 products manu-
factured with imported technology would have pri-
ority access to foreign exchange, bank loans, materi-
als, and tax reductions or exemptions.
China is also instituting financial incentives to en-
courage all sectors to more rapidly upgrade technol-
ogy. In April 1987, China announced tax concessions
on imports of equipment for technical renovation. To
accelerate the renewal of equipment, a new method of
calculating depreciation of fixed assets has also been
adopted. China's old depreciation rate for equipment
and buildings was replaced by a system with catego-
ries of rates for different machines and buildings.
China's average depreciation rate is expected to rise
1 percent, to 5.3 percent, but still lower than the
average for the United States (6.4 percent) and Japan
(5.9 percent)
In addition, Beijing is encouraging enterprises to
upgrade production by developing a national quality-
control system-that rewards product improvements
by improved access to raw materials, manager bonus-
es, and quality certificates to aid in marketing prod-
ucts. The patent system is reportedly being strength-
ened to protect such industrial innovations. To
overcome the lack of technical expertise within indus-
try, Beijing is providing salary incentives to urge
technical personnel to transfer to industry, is cutting
state research funding to force research institutes to
seek industrial projects, and has announced that
research institutes will be required to merge with
businesses by 1990. One press account suggested that
over 42,000 cooperative ventures between enterprises
and research institutes or universities were established
by November 1987.
Unresolved Problems Dim Prospects
We believe that, by focusing on the financial aspects
of technical renovation, China is ignoring significant
obstacles. Beijing thus risks repeating the mistakes of
the late 1970s, when it tried to "buy modernization"
without recognizing general economic conditions and
infrastructural constraints.
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output for China's food a
Figure 4. Imported equipment
has contributed to increased
been neglected
Problems Controlling Investment. Even though Beij-
ing renewed its emphasis on industrial renovation
after 1985, local authorities and factory directors
have been slow to follow suit; much of the investment
labeled technological transformation has actually con-
tinued to go into capital construction. In December
1986, for example, China's State Statistical Bureau
estimated that the share of funds labeled technologi-
cal renovation but actually used to construct new
capacity had grown from 32 percent to 46 percent in
two years. Critics also claim that there has been too
much investment in low-priority sectors and in up-
grading equipment for processing lower grade goods,
while basic industries and the infrastructure have
Beijing has taken steps to improve the utilization of
funds. For example, in 1987 the China International
Engineering Consultancy Corporation was empow-
ered to appraise feasibility studies on all major con-
struction and technical transformation projects. Like-
wise, in January 1987, China's Investment
Consultancy Company-set up in 1986 to appraise
projects applying for Bank of China loans-estab-
lished an expert committee to evaluate investment in
the state's key projects and technological transforma-
tion efforts. But Chinese economists believe control of
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investment may dissipate if more corporations are set
up to manage investment in fields such as energy,
transportation, raw materials, agriculture, forestry
and manufactured goods-including machinery, elec-
tronics, textiles, and light industries-as reforms call
for in 1988. Such corporations may be too specialized
to compare the merits of projects in different fields. In
addition, they will implement projects approved by
the State Planning Commission, and thus probably
lack independence for approving or rejecting projects.
Beijing will be particularly hard pressed to control
locally financed investments, which have expanded
greatly over the past four years. China announced
recently that tax rates for locally financed investment
for new capital construction and technological trans-
formation will be raised to between 10 and 20 percent
of value, even within the State plan. Out-of-plan
projects will be taxed at 20 percent of value, except
for nonproductive projects, which will be taxed at 30
percent. With the booming domestic economy and low
tax payment rates, however, these indirect measures
We believe that technical upgrading of China's large-
and medium-sized enterprises will be particularly
slow:
? Ninety percent of larger enterprises have no invest-
ment in laboratories and testing equipment; trial
manufacturing is carried out on production lines,
and quality checks are left to the consumer. One
Chinese journal reported that, of the more than
1,270 major enterprises in the machinery industry,
only 130 had research departments.
? Only 20 percent of the engineers and technicians
working in state enterprises work on technology
development, compared with 60 percent in foreign
countries.
? Most major enterprises spend less than 1 percent of
total sales on technology, compared with up to 5
percent in Japanese enterprises. For example, one
survey showed that only 12 of 75 major enterprises
in Guangzhou have established technology develop-
ment funds.
are likely to have only a limited effect
Technical Limitations. Weak indigenous technical
capabilities, particularly in electronics, and continu-
ing shortages of skilled personnel to operate more
advanced equipment will slow future gains from
industrial renovation. China's reliance on microelec-
tronics to upgrade machinery is hampered by the
domestic electronics industry's slowness in learning to
effectively use sensitive equipment, its inability to
turn out commercial quantities of advanced integrat-
ed circuits and continuing difficulties-such as export
controls and foreign exchange shortages-importing
advanced equipment and technology. Redundant re-
search and waste of personnel and materials are
slowing China's CAD/CAM efforts, as is the lack of
computing power.
Chinese research activities lag the West by five to 10
years in the use of modal analysis techniques-critical
for producing accurate and reliable machine tools.
Efforts to introduce computer-assisted or -controlled
manufacturing will also be slow, often requiring reor-
ganization of the shop floor layout and production
? Low depreciation rates of fixed assets inhibit enter-
prise managers from upgrading technology and
equipment.
Competing Priorities. Probably the most significant
obstacle for the technological renovation effort, how-
ever, is the leadership's preoccupation with other
economic priorities. Despite the rhetoric for empha-
sizing technological transformation in 1988 (see inset),
such admonitions have become, in the words of Chi-
nese economist Ma Hong, "a platitude." Beijing's
economic agenda for 1988 instead focuses on manage-
ment reforms, such as the contract system to link a
manager's income to the factory's performance,' poli-
cies such as bankruptcy, the use of monetary and
fiscal policies, trade reform, and experimenting with
crucial, but politically sensitive, price reforms
processes.
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Rhetoric on the Importance of Technological
Transformation in 1988
and equipment should begin immediately.
In statements to the press in early 1988, Ma Hong,
Director General of the Economic, Technological,
and Social Development Research Center, said the
leadership is working on a formal industrial policy to
be announced in 1988 to focus attention on technol-
ogy levels in industry. For the past year, Ma has
argued that the policy on reforming the industrial
structure should be combined with the technological
transformation policy. China's most important enter-
prises, especially in the eastern coastal areas and the
northeast, are too old to serve as the foundation for a
modern economy and are deteriorating rapidly, he
argues. Therefore, massive infusions of capital for
heavy industry and the supporting new technology
tries and infrastructure.
Premier Li Peng appears to have been echoing these
priorities during his work report to the Seventh
National People's Congress this spring when he
called for speeding the development of basic indus-
eign technical developments to enterprises.
In late 1987, Zhu Rongji, then Vice Minister of the
State Economic Commission, said outmoded equip-
ment and inefficient management are the major ob-
stacles to developing industry, and that upgrading
enterprise technology will be a priority in 1988. Zhu
called on all departments to draw up plans, policies,
and regulations to improve management of technical
work and provide information on domestic and for-
.Elected in the technical progress of enterprises.
Chinese commentaries subsequently called 1988 a
crucial year for ensuring success in upgrading indus-
trial enterprises. An article in People's Daily ac-
knowledged that, compared with economic structural
reforms, the momentum and progress of technical
advance in enterprises has obviously lagged. The
commentary said now is the time to attach great
importance to technical renovation and to stress that
the achievements of economic reform should be re-
The visibility of technical transformation at the na-
tional level is further reduced by the decentralization
of enterprise management and industrial renovation
projects, which leaves the search for workable solu-
tions to lower-level officials. Beijing's unbalanced
approach to its economic needs could further slow
technical renovation efforts:
? The implementation of the contract system-which
allows the use of bank loans and retained profits to
upgrade industrial technology--could work against
technological upgrading if contract terms fail to
give managers adequate incentives for investing in
new equipment and technology. Chinese officials
have issued guidelines that call for contracts to
stipulate the targets for industrial renovation, evalu-
ate appreciation of fixed assets, set standards for
grading enterprise managers, and provide guidelines
for an evaluation of managers' efforts in plant 25X1
modernization, but enforcement of these guidelines
remains a question.
? Thereexport-led coastal development strategy, an-
nounced by Party Secretary Zhao Ziyang in early
1988, may draw attention away from technical 25X1
renovation, making industrial upgrading even more
difficult in interior and western regions. For exam-
ple, the export-led strategy stresses the acquisition
of raw materials through imports, rather than
through upgrading domestic industry and infra-
structure. The export-led strategy also increases
competition for capital and skilled people, possibly
pulling them away from industries in the interior.
Longer Term Costs of Neglecting Industrial
Renovation
China's inability to solve these fundamental develop-
ment problems could have a great economic and
political cost for China, because it limits the progress
of the leadership's priority reform efforts at a time
when the reform program is stalled and searching for
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an avenue to show progress in the urban industrial
economy. In general, we think the costs of a sluggish
industrial renovation program are these:
For Managerial Reform and the Contract System. In
the absence of technological upgrading, the contract
system and similar managerial innovations are more
likely to have limited, one-time benefits. Numerous
accounts in the Chinese press suggest that without
technological innovation, factories adopting manage-
ment reforms show only temporary growth, while
firms that combine management reforms with tech-
nology renovation programs are far more successful in
sustaining good performance. For example, a paper
mill received its first new equipment in 26 years after
its new manager, operating under contract, used
retained profits to fund 71 upgrading projects; the
percentage of quality products meeting national stan-
dards subsequently rose from less than 7 to over 75.
Similar success was reported when metallurgy firms
under the contract system used 60 percent of retained
profits for technical upgrading and new product de-
velopment.
For the Export-Led Coastal Development Strategy.
The technical levels of coastal areas-even though
generally better than elsewhere-are still low, and in
many cases will obstruct export-led growth. China is
counting on exports from coastal provinces to gener-
ate foreign exchange to pay for imports of needed
agricultural goods, raw materials, and capital goods
but more industrial renovation is needed to support
these goals. Although officials originally stressed
making full use of China's abundant manpower by
developing labor-intensive export-processing indus-
tries in coastal areas, officials are increasingly ac-
knowledging the importance of upgrading technology
and including knowledge-intensive industries in the
coastal development strategy.
For China's International Trade. Continued technical
renovation will be needed for China's traditional
industries to satisfy domestic needs and meet goals for
expanding exports. Textile industry officials, for ex-
ample, say more flexible manufacturing systems are
needed to increase exports of finished textile products.
The machine-building, metallurgy, and chemical in-
dustries also are counting on new technology for
improvements in quality and capacity needed to ex-
port more products, particularly those with a higher
value added. Although China is limiting imports of
selected categories of machinery, purchases of foreign
equipment will remain an important means of upgrad-
ing the traditional industries
For Economic Development. Slow progress in renovat-
ing traditional industries makes it likely that this
large component of industry will continue to be a drag
on overall economic performance and modernization.
The rate of increase in Chinese industrial output-
though impressive-has been outpaced by demand,
and shortages of raw materials are slowing industrial
development. A national industrial survey released in
February 1988 said the energy and raw materials
industries remain weak links in economic development
while processing industries are developing too rapidly.
Heavy and light industrial growth is straining domes-
tic supplies of raw materials. For example, in 1987
processing industries grew 17.3 percent, while the raw
materials industry increased only 13.1 percent. And
despite energy production gains in recent years, ener-
gy shortages continued to idle about 30 percent of
China's industrial production capacity, according to
August 1988 Chinese press reports
Finally, technologically backward enterprises will
continue to drain the state's budget, undermining the
progress of the economic reform program and limiting
overall economic growth. Reducing the number of
deficit state enterprises is even more important with
price reforms moving slowly. With no way to pass the
higher cost of wages, bonuses, and raw materials on to
the consumer, technical improvements are one of the
few options for increasing productivity and profit.
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