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January 18, 1985

China: A Visitor's Report
During the last four years, I twice visited China.
The first time was in the Summer of 1980, and the
second, last Fall. Between the two visits, China
undertook some dramatic basic economic reforms.
In this Letter, I present my impressions ofthe
changes I witnessed and discuss the problems still
confronting China's economy.

Modernization, 1980
The 1980 visit took place shortly after China
launched its "Modernization" program. As
reported in the Letter of October 24, 1980, China
completely transformed itself from a private enterprise to a socialist-planned economy after the
1949 Revolution. By 1958, private enterprise had
been completely eliminated in the industrial and
commercial sectors, and agriculture was either
nationalized or collectivized. The twenty years
that followed were marked by turmoi I and calamity as the nation suffered through the "Great
Leap Forward" in the late 1950s and, afterfour
years of recovery, the Cultural Revolution of
1966-76. China emerged from the late 1970swith
outdated technology, low worker morale, a stagnant economy insu lated from the rest of the world,
and a greatly swollen population.

The task was gargantuan and the obstacles to
reform were numerous. History is not replete with
cases of huge, clumsy bureaucracies rejuvenating
themselves by relinquishing tight controls on a
national economy. China's case was made even
more difficult by a decade of self-destruction
during the Cultural Revolution, when all schools
were shut down and a whole generation lost the
opportunity for education. Ideology superseded
technical expertise, and slogans substituted for
knowledge. Although impressed by the reformers'
obvious determination and fervor, I nevertheless
felt that the prospects for the reform's success
were bleak.

Observations, 1984

After Chairman Mao's death in 1976, the new
leadership made a landmark decision in December
1978 to begin a shift from the completely collectivized, egalitarian, Soviet-type command economy
toward an economy in which the market mechanism would be allowed to playa large role in
allocating resources within a socialist framework.

It was thus with considerable surprise that I found
on the 1984 return trip a new dynamism and
confidence in the country's future. There was pervasive evidence, absent four years ago, of a nation
onthevergeof"economictake-off." In Beijing, in
particular, many modern highrises had altered the
city's skyline. People were better dressed in a
wider variety of colors and styles. Where there had
been sparsely stocked stores in 1980, there was
now an abundance of meats, vegetables, fruits,
and consumer goods. Streets still crowded with
bicycles were now also clogged during peak r~sh
hours with automoiles and trucks, many imported.
Moreover, the quality of city living as represented
by its cleanliness and attractiveness seemed greatly
improved. In Beijing, many trees, shrubs and lawns
now front apartment houses where four years ago
there was only bare ground.

From the start, the reformers real ized the enorm ity
of their task. Instead of following a preconceived
blueprint, they adopted a pragmatic, experimental
approach toward reaching the ultimate goals of
economic reform. Nevertheless, the general direction of the reform was clear. First, they resolutely
turned away from a preoccupation with capital
investment towards a greater emphasis on meeting
consumer needs. Second, the reformers decided
to remove stifling, direct bureaucratic control over
economic activities to give enterprises greater
autonomy. Third, they emphasized opening the
economy to foreign trade and foreign investment.

Even more impressive were the improvements in
the rural areas, where eighty percent of the population reside. On visits to the countryside, one
could not help noticing the handsome two-story
houses that the farmers had themselves bu iIt
during the last two or three years. There were
clearly more consumer goods available in the
rural area as well, as evidenced by the large
number of bicycles, radios, and even television
sets in farm households. Particularly interesting
were the many small tractors driven by farmers on
rural roads; these tractors plowed the fields but
also served as a means of rural transportation.

Government officials invariably attributed this
dramatic improvement in rural living conditions
to the recently introduced "household responsibi Iity" pol icy. Th is pol icy distributed land to farmers through long-term leases according to the
number of persons in each farm household. In
return, a household must turn a fixed amount of
produce (set by a negotiated contract between the
farmer and the authorities) over to the state, but
can keep any surplus for its own consumption or
for sale in the open market. In effect, this policy
represents a dramatic land reform that has largely
reversed the earlier collectivist policy. It has replaced the nationwide agricultural communes
and collectives with a land-tenure system similar
to sharecropping -except that the farmers are
obligated to turn in a fixed amount, rather than a
fixed percentage, of their annual produce. The
fixed amount provides a great incentive for a
farmer to increase production to earn the surplus.
The new land-tenure system plus the high official
purchase prices of farm products have combined
to fuel a su rge of productive effort and creativity in
the farm sector. In many regions, the authorities
had stopped buying grains from farmers because
they had run short of storage space. I was repeatedly told that there are now many "10,000-yuan
households," meaning that there were now many
households with annual incomes exceeding
10,000 yuan (about $4,000) in rural areas all over
the country. This income compares well to the
annual income of about 4,000 yuan for a cabinet
minister, 1,000 yuan for a school teacher, and 700
yuan for a factory laborer. These 10,000-yuan
households have made their fortunes not only
through agriculture but also by raising pigs, chickens and ducks, by stocking fish ponds, and by
selling handicrafts.
The authorities are making a showcase of all those
who have become wealthy through innovative
individual entrepreneurship, although there is evidence that the agricultural reforms had other purposes as well. For example, they also seem aimed
at reducing the pressures on urban development.
The historical imbalance between farm incomes
and those of urban occupations has encouraged a
strong trend of migration from farms to cities.
The apparent success of rural economic reform
has led Chinese officials to extend the principles of
the household responsibility policy to urban industrial and commercial enterprises. In October

1984, the Party's Central Committee adopted a
plan intended to subject city enterprises to the
discipline of the market, letting them prosper or
fail according to their success in meeting market
demand. To many, the decision means the start of
Phase Two of the "Second Socialist Revolution"
launched six years ago.

Remaining challenges
The 1984 visit left Iittle doubt thatthe great majority of the people, especially those in the countryside, are living much better today than they did a
mere four years ago. The removal of rigid controls
over economic activities has led to a veritable
explosion of creative energy. The subsequent improvement in living conditions and adroit management of resources have been impressive and
even startling in view of the short time that has
Yet, to applaud the progress is not to say that
China's Modernization is no longer fraught with
difficult unresolved problems. Perhaps the biggest
problem today is reform of the domestic price
structure which is seriously out of line with the
relative costs of production and world prices.
Without a reasonable pricing system, it makes
little sense to talk about letting market incentives
help directthe allocation of resources. The problem was obvious to Chinese policymakers four
years ago, but the price structure remains rigid.
Thus far, no major price adjustments have been
made although officials are acutely aware of the
obvious under-pricing of coal, staple foods, public
transportation, and housing. Reportedly, subsidies
on these goods and services account for more than
one-half of the central government's budget
expenditures. Such long inaction testifies to the
enormous political risk involved in making basic
changes in the price structure.
The problem of a rigid domestic price structure
has also exacerbated China's difficulty in formulating a sensible exchange rate policy. Since 1981,
China has had what is generally regarded as a dual
exchange rate system. Under this system, tourist
expenditures, inward remittances, and foreign
diplomatic spending have all been conducted at
the official rate -which up to about nine months
ago, was stable at around 2 yuans per U.S. dollar
-while all import and export transactions between the state trading corporations and domestic
residents have been at a fixed "internal settlement
rate" of 2.8 yuans per dollar.

This dual exchange rate system has caused much
confusion and misunderstanding. U.S. industries,
for example, have demanded countervailing duties against textile imports from China, alleging
that the differential between the Chinese internal
settlement rate and the officialrate constitutes an
export subsidy. The system also has been responsible for extensive black market activities that
have caused the government to lose foreign
exchange receipts. Partly in response to these concerns, the authorities have allowed the official
exchange rate to float gradually upward during the
past nine months; it reached a high of 2.62 yuans
during the author's visit.
Another major problem facing China's Modernization program is the country's ponderous bureaucracy. Despite the reforms that have been
implemented, the bureaucracy continues to make
all major economic decisions and to dominate all
large enterprises. Government industrial bureaus
have been renamed corporations with new plaques
decorating their front doors and former bureau
heads are now called presidents. However, with
no real system of internal responsibility or external
discipline imposed by market competition, the
newly formed corporations still operate like the
old bureaucracies.
Combined with the effects of unchanged prices,
which place essential inputs (such as raw
materials, fuel, transportation, and finance) in
perpetually short supply, a large part of Chinese
entrepreneurship consists of acquiring and using
the political clout needed to secure scarce but
essential supplies. For instance, because of the
acute shortage of transportation equipment, a
license to import a truck was said to be worth at
least as much as its import price. Without an open

bidding system, the import licensing authorities
obviously hold a great deal of economic power.
A similar situation exists in the labor market.
Because wages too are frozen, managers, techniciansand skilled workers who are highly valued in
their places of employment are rarely granted the
perm ission to leave in search of higher wages. The
reduced labor mobility limits productivity. In short,
bureaucracy continues to hold sway over a large
part of China's economic life despite the progress
wrought by very significant economic reforms.

No visitor to China today can help but be impressed
by the prevailing spirit of enterprise and confidence. Surprisingly large progress has been made
in living conditions in the last four years. While the
progress has bolstered hope for continued improvements, there is reason to believe that serious
obstacles still lie ahead. Basically, the reformers
have yetto decide on the extent to wh ich they wi II
yield direct administrative control to the workings
of the market system. In other words, they have yet
to settle on an appropriate mix of market principles
within a socialist economy.
The Chinese economic reform is undoubtedly the
world's largest controlled economic experiment
of this century, involving one-quarter of the human
race. It is like turning a gigantic ship around, with
one bi II ion passengers aboard, in largely uncharted
waters. The world holds its breath in watching the
maneuver. Although the direction of reform has
been spelled out in the October 1984 declaration
of the Party's Central Committee, the true test still
lies ahead -in its implementation.

Hang-Sheng Cheng

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (415) 974-2246.

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(Dollar amounts in millions)

Selected Assets and liabilities
Large Commercial Banks
Loans, Leases and Investments1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
U.S. Treasury and Agency Securities 2
Other Secu rities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances 4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts '---Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Net free reserves (+)/Net borrowed( - )





Change from 12/28/83


- 250
- 67


- 1,309



Period ended


Period ended









Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borroWing via FRB, IT&L notes, Fed Funds, RPs and other sources
Includes items not shown separately
Annualized percent change