Chinese iron and steel industry in transition : toward market mechanisms and economic efficiency

Abstract

Economic reforms in the Chinese industrial sector during 1979-88 have followed two lines: decentralization of the authority of the central government bureaucracy to the provincial and local level and movement within enterprises towards greater reliance on the market mechanism and away from government planning. The latter movement has led to the development of market mechanisms in Chinese industry, but the bureaucratic decentralization has restricted the development of a national market and encouraged local fragmentation with a consequent lack of scale economies. Local governments continued to have strong incentives to retain the collection of revenue from enterprises in their region even after the reforms. Decentralized fiscal and financial systems, particularly, the confusion between tax and industrial financing in the current taxation system, enabled local governments to do this. Distorted factor and goods markets also encouraged protection of local markets. The initiatives of enterprises in seeking profit maximization were reflected in decreasing production costs. The expansion of enterprises, however, was not decided solely or mainly by relative costs, but by the extent of local government control. Many (generally smaller) enterprises with high production costs were in a favourable position to take advantage of market distortions created by the partial introduction of market mechanisms. Market imperfections led to a pattern of iron and steel industry expansion which saw enterprises with high production costs expanding more rapidly than those with low production costs. This expansion pattern distorted resource allocation so that many enterprises operated at less than minimum efficient scales, and potentially more efficient large-scale enterprises were disadvantaged. Empirical analysis supports the following hypotheses. From the point of view of the industry as a whole, overall industrial performance would have been affected by two competing driving forces: improved rates of technical progress due to the increasing market orientation of profit maximizing enterprises, and decreasing scale efficiency due to distortions in mechanism controlling expansion in the iron and steel industry. From the point of view of the enterprises, their technical efficiency might have been improved by efforts to udlize their production factors more effectively; the allocative efficiency of factors over which they have control might have been also improved. The allocadon of factors which remain subject to distortions in factor markets, however, has remained inefficient. The scale efficiency of enterprises might not have been improved and may even have deteriorated as a result of the segmentation of local markets due to local authority involvement in industrial investment and protection. Further reforms require the establishment of an equitable taxation system, a financial market and a labour market. The profitablity of enterprises would then be directly linked to their economic efficiency. The two-tier price policy and the policy of low nominal interest rates (usually negative while inflation rates were high) has to be changed to minimize the distortions in goods and factor markets. Show more