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Monetary Policy

China is home to the world’s second-largest economy (in terms of purchasing-power parity). China’s economy has been growing by leaps and bounds ever since the state decided to initiate reforms to the old Soviet-style centrally planned economy 20 years ago. Government officials began the reforms due to the growing economic gap between China and the industrialized countries of the world. In some respects the planned economy model worked well because it assisted with the stable growth of the languishing economy although it also prevented the economy from reaching its full potential.

The new system that was adopted is referred to by the Chinese as a socialist market economy...

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.... The reforms have proven successful with average annual economic growth rates of 10.2% and 9.7% during the respective periods of 1980-1989 and 1990-2002. These staggering growth rates were among the highest in the world for these periods. As a result of the economic development that occurred in the last couple of decades, China’s GDP has quadrupled since the reforms began in 1978.

Although the reforms have benefited the country greatly, there have been some drawbacks. For instance, economic prosperity hasn’t been enjoyed equally by all of China’s people resulting in further widening of income gaps (the largest discrepancies occurring between urban and rural peoples). Due to strict migration policies, unemployment has been on the rise. In addition, the rapid unbalanced expansion has caused inflation and difficulties for China’s economic planners.

Labor

As of 2002, China had the largest labor force in the world, roughly 769 million strong. A vast majority of this force, nearly 64%, is located in rural areas. The distribution of the workforce among industry groups hasn’t changed much over the last decade. According to 2001 estimates, 50% of the labor force was in agriculture, forestry and fishing. Manufacturing, mining and construction, which make up the industrial sector, employed 22%. The remaining 28% worked in banking, government, transportation, tourism, and retail trade that are grouped within the service sector.

In spite of sustained growth rates, unemployment and underemployment have become serious problems for the PRC. Towards the latter half of the 1990’s, the official urban unemployment rate lingered around 3.1%; although, the figure is considered to be unreliable due to the difficulties associated with conducting censuses in China and the large population of rural refugees who float from city to city picking up employment anywhere they can find it. The following graph illustrates a comparative analysis of unemployment for China against 9 other nations.

Unemployment and underemployment problems have been exacerbated by new trends that have occurred as a result of the reforms. For example, now that state-owned enterprises have been given more independence, they have been laying off superfluous workers to improve their efficiencies. Additionally, by moving away from the inefficient cooperative farming practices, there’s now a large collection of unemployed and underemployed rural citizens. Therefore, the true unemployment rate is estimated to be anywhere from 2 to 4 times the officially published figure.

The economic reforms have brought many changes to the workplace as well. In the past people were assigned to a work unit, where they often remained for a lifetime. Today the employment conditions are becoming more flexible with the introduction of labor contracts. Through labor contracts, enterprises are permitted the freedom to hire and fire new employees for a fixed-term period on a contractual basis as opposed to bringing on a lifelong worker. The state is also encouraging new compensation systems. These systems are based on the idea of paying for performance through merit raises and promotions. Although these freedoms now exist, many are reluctant to adopt them due to the insecurity that goes along with change.

On the surface, women are encouraged to enter the workforce and are treated as equals to their male counterparts. In actuality, this differs somewhat. Traditionally China has been a patriarchal society, which is evident by the unbalanced number of women that are still concentrated in lower paying positions. Some progress has been made through legislation aimed at protecting women’s rights. Specifically, legislation that was passed in 1992 known as the Law on the Protection of Rights and Interests of Women sought to restrict gender discrimination by outlawing the consideration of pregnancy, maternity leave, or child-care issues in hiring or firing decisions.

Trade unions are present in virtually every industry sector in China. Primarily they operate in the interests of the union members: settling labor disputes, protecting jobs, and looking out for employee’s welfare. The All China Federation of Trade Unions (ACFTU) is closely tied to the CCP and acts as the central hub from which all other unions are an extension. In contrast to the industry specific unions, the ACFTU doesn’t play a role in the protection or promotion of worker’s interests. Instead, the ACFTU focuses its attention and efforts on ways to improve production. Primarily this is accomplished through the education of new entrants and the retraining of existing employees in the workforce.

Banking System & Monetary Policy

Along with other significant economic reforms, China’s banking system has also been radically upgraded over the last two decades to more closely emulate those of free markets. Previously the banking system was entirely controlled by the State. Today, more autonomy has been granted to the country’s financial institutions although the government still plays a significant role in their operations.

The People’s Bank of China (PBOC), established by the CCP in 1948, is China’s central financial institution. Under the planned economy model, the PBOC essentially acted as cashier, simply doling out funds to state enterprises for use as working capital. Instead of receiving interest payments, all revenue that was collected was handed over to the government as part of the state ownership system. Thus, no loans were ever paid off or removed from the books.

Beginning in the 1980’s, a series of new legislation has been passed aimed at changing the PBOC’s role in the economy and its relation to the government. As a result, the PBOC shifted away from its previous role as direct lender. In relinquishing many of its micro-level operations to lower level financial institutions, the PBOC has taken on many macro-level operational and policy matters: formulating and implementing monetary policies; issuing renminbi or yuan (China’s currency) and managing its circulation; supervising the establishment of financial institutions and regulating them; regulating the financial market; issuing rules and regulations concerning the operation of the financial industry; holding, managing and operating state foreign exchange reserves and gold reserves; operating the state treasury; safeguarding the normal operation of payment and clearing systems; compiling financial statistics, conducting financial investigations and making forecasts; engaging in domestic and international financial operations.

Thus the PBOC is playing a crucial role in the modernization efforts by transforming China’s financial system to a more market driven sector; although, the State Council still maintains the final say with regard to economic policies. The Commercial Bank Law that was promulgated in 1995 standardized the operations of China’s commercial banking institutions. There are 4 major state-owned commercial banks: the Bank of China, which handles foreign exchange reserves and China’s international accounts; the China Construction Bank, which handles the moneys for basic construction; the Agricultural Bank of China, which deals with loans in rural sectors; and the Industrial and Commercial Bank of China that works with commercial and industrial credits for international business.

Taken together, they control China’s commercial banking system handling in excess of 50% of all the deposits and loans in the PRC banks. Due to the monetary policies that were in place prior to the reforms, there are a significant amount of non-performing loans in these 4 major commercial banks. These monetary policies allowed the state-owned enterprises to become heavily indebted without repercussion. This lack of action now weighs down the state in the form of non-performing loans, which is estimated to account for at least 30% of the loans in the portfolios of the state banks. The following chart details a breakdown of savings deposits and loans for all of China’s financial institutions in 2003.

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