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September 1999, No.45

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MThe "Three Reforms" in China: Progress and Outlook

Sakura Institute of Research, Inc.
Shigeo Kobayashi, Jia Baobo and Junya Sano


1. The Chinese Economy since the Start of the Reform and Open-door Policy

The reform and open-door policy of China began with the adoption of a new economic development strategy at the Third Plenary Session of the 11th Central Committee of the Chinese Communist Party (CCPCC) in late 1978. Under the leadership of Deng Xiaoping, who had returned to the political arena after his three previous defeats, the Chinese government began to pursue an open-door policy, in which it adopted a stance to achieve economic growth through the active introduction of foreign capital and technology while maintaining its commitment to socialism.

The obvious aim of this policy shift was to rebuild its economy and society that were devastated by the Cultural Revolution. The policy shift also appears to have been prompted by recognition that the incomes of ordinary Chinese were so low, in comparison with incomes in other Asian economies, that the future of the Chinese state and the communist regime would be in jeopardy unless something was done to raise living standards of its people through economic growth.

The government subsequently established a number of areas for foreign investment, including the special economic zones, open coastal cities, the economic and technology development zones, the delta open zones, the peninsula open zones, the open border citiees, and the high-tech industry development zones. The establishment of these zones provided the trigger for massive inflows of foreign investment, primarily from companies in Hong Kong and Taiwan. At the same time, China promoted its socialist market economy concept. The changes brought an entrepreneurial boom that resulted in the emergence of huge numbers of entrepreneurs and venture businesses within China.

Inflows of foreign capital, technology, and management knowhow enabled China to turn its vast labor resources and space to rapid economic growth. The shift to an open-door economic policy ushered in a period of high economic growth in the first half of the 1980s. The economy stagnated around the time of the Tiananmen Square Incident in 1989, but in the first half of the 1990s, China was again boasting high growth rates. Rapid economic growth was accompanied by a rise in per capita GDP (Fig. 1). In 1998, per capita income, though still only about US$770, was 14 times higher than in 1980. Therefore, it seems reasonable to conclude that Deng Xiaoping's first goal, which was to improve the economic status of the people, has been accomplished.

2. Emerging Conficts

The positive consequences of the reform and open-door policy have been economic development and rising national incomes. Naturally, there have also been negative effects, and these have become increasingly obvious over the years. The problems outlined below are closely linked to the living standards of people in China.

First, there is now regional disparities in income levels, and the gap between rich and poor is now extremely wide. Under the socialist controlled economy, living standards were relatively low, but there was no big gap between rich and poor. The idea, taken from the writings of Mencius, that inequality is more lamentable than poverty, has applied throughout society. With the shift to the open-door policy, however, Deng Xiaoping indicated that it was acceptable for some regions to become wealthy before others. The result was a huge wealth disparity between coastal and inland regions, and between the cities and rural areas. Fig. 2 shows the per capita annual incomes of urban households in municipalities and provinces where incomes are relatively high, and those of peasant households in relatively poor provinces. Incomes in Guangdong Province are about eight times higher than incomes in Gansu Province.

Apart from a massive influx of foreign investment, entrepreneurial activity within China was also encouraged. This led to the formation of countless foreign-owned companies, private enterprises, individual enterprises, and other types of business, in addition to the existing state-owned enterprises and township enterprises. These newly established enterprises are classified as "enterprises under other ownership structures." Many of them operate more efficiently and pay their employees more than state-owned or township enterprises (Fig. 3). This has been reflected in a growing income gap between the owners, directors, and executives of these enterprises and the employees of state-owned enterprises.

There are also clear gaps among urban office workers. At one extreme of this polarization are workers who can afford to own imported cars, while at the other are those who can afford only a bicycle. Some parents can easily afford to pay annual fees worth three million yen per child to send their children to the private boarding schools that have appeared in Beijing. Yet, on the other hand, there are aging employees of state-owned enterprises, laid off after decades of service and basically living on the street with a monthly benefit of around 3,000 yen. These are the realities of contemporary China.

The existence of this income disparity under a socialist regime is inevitably causing a variety of alarming social phenomena. Worship of money has spread among the people. Huge numbers of rural people have flooded into the cities in search of higher incomes, leaving many rural communities deserted and exposing China to the danger of future food shortages. There has been a breakdown of law and order in the cities, and corruption is rife among party officials and government bureaucrats. Government organizations are involved in tax evasion and smuggling, wwhile army, police, and court are operating businesses on the side. None of these phenomena are compatible with a socialist system, and they are indicative of inner contradiction in the political system.

China has maintained a one-party socialist dictatorship on the political level, while moving to a market system on the economic level. This conflict has exposed inadequacies in the legal system, and with each passing year, it has become increasingly apparent that there is no system of checks to prevent the arbitrary exercise of power by the Communist Party. The government has accelerated the shift to a market economic system, but it has so far failed to provide a clear definition of what is meant by a "socialist market economy." For this reason, Party and government agencies no longer function as monitors and arbiters of the market. Instead, these agencies have been given leeway to participate in business activities as direct players in the market. This situation has led them to involve in monopolistic trading and insider trading. The accepted wisdom among modern Chinese is that "those in authority (quan) will be able to acquire money (qian)."

An extreme example of this problem relates to the export rebate system for value-added taxes. Since its implementation in 1994, the rebate rates have been lowered frequently, and the range of prices covered by the tax has also been changed. The fundamental reason for this is the fact that export rebates were greater than the amount of revenue generated by the value-added tax. Behind the scenes, exporters, customs officials, tax officials, and central and regional Party officials were conspiring to obtain massive rebates by means of fraudulent export documents.

The economic development gap between coastal cities and other regions has engendered a sense of grievance on the part of regional government officials, who have misappropriated government money to create hastily planned development zones in an attempt to attract foreign investment. The resulting shortage of public money has frequently meant that residents have not received payments to which they were entitled.

According to a Chinese newspaper, 158,000 senior Communist Party officials were punished for violating the Chinese Communist Party Constitution in 1998. Public prosecutors are currently investigating 35,000 cases of corruption involving 1,820 government agency officials with ranks of section manager or above. Still, those prosecuted represent only a small minority of the total number of people engaged in corrupt activities.

China is frequently criticized for delays in updating its legal system. Despite the enactment of numerous new laws, in step with the open-door policy, China has still not established the rule of law. The collapse of the Guangdong International Trust and Investment Corporation (GITIC) in October 1998 had focused attention on the proliferation of trust and investment companies and their financial problems. At the height of the boom in the 1980s, there were almost 1,000 of these companies. Yet, China has still not established a trust and investment company law.

The declining competitiveness of the state-owned enterprises, which are the actual and ideological pillars of the socialist economy, is a problem with serious implications for China's economic and industrial structures. In essence, the state-owned enterprises were social microcosms created to feed the people and realize the ideals of socialism.

However, China began to move toward a market economic system under the reform and open-door policy. One result was an influx of foreign companies with resources that made them powerful competitors in the international marketplace. The changes also triggered an upsurge of entrepreneurial activity within China. Private and individual enterprises staked their survival on business efforts that enhanced their competitiveness. Meanwhile, the state-owned enterprises were unable to modify their corporate cultures that had evolved in China's controlled economy. In the face of this onslaught, many lost their advantage in such areas as manufacturing production, domestic sales channels, and exports.

Inextricably linked to this problem is the state of the financial system. China's main financial institutions are state-owned banks. Under the controlled economy, state-owned banks tended to see lending to state-owned enterprises as a mechanism for distributing fiscal funds. The state-owned enterprises that received these loans similarly regarded them less as loans than as allocations of public money.

When the economy was opened up, however, there was a massive inflow of foreign investment. The government was forced to establish financial policies and exercise macro-level controls, while state-owned banks were required to provide support to leading enterprises under the government's financial policies, and to improve their credit assessment capabilities. Unfortunately, credit assessment capabilities of state-owned banks have not been developed, and there was a tendency to provide continuing credit to state-owned enterprises in an environment influenced by guidance or interference from the Communist Party and the government. Now that state-owned enterprises are experiencing financial problems, state-owned banks are inevitably being left with a growing mountain of non-performing loans. Most state-owned enterprises are in need of reform, and urgent steps are needed to reform a financial system that is still based on state-owned banks.

3. The Necessity of Reform

While China has achieved economic development and improvements in the living standards of its people, there is confusion about the direction of the state and the people under a single-party dictatorship that continues to claim that the revolution is not yet complete. Bureaucratic organizations and systems are out of step with contemporary needs, while state-owned enterprises and banks have fallen far behind the world-class technology and management skills of foreign-owned and private enterprises.

The reform of organizations such as these has become an urgent priority. To become a modern state and superpower, China will need to develop a legal system that reflects contemporary needs and to establish highly efficient administrative organizations. It will also have to create a fair and objective judicial system. In other words, China must build a just society in which the existence of companies and individuals is guaranteed by law, in which administrative organizations are streamlined and orderly, in which there is no smuggling or insider trading involving the Party, the army, or government organizations, and in which both urban and rural people can experience the joy of working and dreaming of their future.

4. The Reasons for taking Up the "Three Reforms"

A wide range of reforms are needed in contemporary China. The tasks given highest priority and urgency are the reform of state-owned enterprises, the reform of the financial system, and the reform of administrative organizations. This report explores the current situation of these "Three Reforms," and considers the future outlook.

The "Three Reforms" are more important than the many other reform programs in China. This is because the state-owned enterprises, the financial system, and the administrative organizations are the three pillars of state administration; all these areas are closely interwoven; and successful reform in one of these areas brings progress in the others. Moreover, the Communist Party has been able to start work on the reform process, for it still has the power to lead the state. As China shifts further toward a market economic system, the people will inevitably adopt values that do not depend on traditional ideology, and society will begin to demand political freedom.

If the "Three Reforms" fail in this environment, China is certain to experience a major social upheaval. But the Communist Party still has the power to keep these pressures under control for a few more years. If the "Three Reforms" succeed, the result will be streamlined and efficient administrative organizations, internationally competitive state-owned enterprises with healthy financial structures, and a flexible financial system that is able to foster leading enterprises in line with financial policy. Moreover, the secondary result of this process will be an orderly society in which the people can enjoy lifestyles that let them dream.

Such a society is consistent with the ideal party-state system claimed by the Chinese Communist Party. There is concern about the declining power of the Chinese Communist Party. It is fair to say that the Party has staked its survival on the "Three Reforms."

What is certain is that, regardless of how the reforms proceed, the outcome of the "Three Reforms" will vary from the expectations of people in democratic capitalist nations. In a situation where one party has absolute power, administrative reform will inevitably lack thoroughness in such areas as enforcing discipline within the party. To quote Lord Acton, "absolute power corrupts absolutely." This is a serious issue for China. The reform of the state-owned enterprises will involve a number of difficult tasks. In March 1999, the National People's Congress (NPC) granted a degree of respectability to the private ownership economy, but socialist public ownership is still the norm in China.

The state-owned enterprises may be corporatized or privatized, but there is a danger that the process will remain incomplete if the state is the shareholder, that is, if only the mode of ownership is changed. The same applies to financial system reform. Since executives of state-owned banks are also senior Party officials, it is still not clear whether the banks will be able to totally eliminate Party interference.

If the "Three Reforms" are even marginally successful, there will be improvements in administrative efficiency and the international competitiveness of major state-owned enterprises, and China will make significant progress in its evolution into a modern superpower. However, the Communist Party will still need to establish an identity that will create China's new generation. That will depend on the extent to which it can reshape socialism and adapt it to suit contemporary needs. Unless it can makethese changes, the benefits of the "Three Reforms" will be limited.

II. Reform of State-owned Enterprises -Progress and Outlook

1. Identification of Issues and Aims of Research

In China, a state-owned enterprise is a company whose assets are owned by the state (government). The State Council, which is China's equivalent of a cabinet, can exercise ownership rights over the state-owned enterprises at anytime. For a long period after the establishment of the People's Republic of China, state-owned enterprises played a central role in economic development. However, a number of years have passed already since the first emergence of reports on the worsening financial problems that have affected many state-owned enterprises since China's transition from a planned economic system to a market economy. It is now almost a cliche to speak of the need for reform of the state-owned enterprises.

The reform of the state-owned enterprises began 21 years ago in December 1978. Unfortunately, the state-owned enterprises as a group are still in deficit. Even worse, China has not yet found the right way to solve this problem.

Chinese academics and policymakers have put forward a variety of arguments and proposals concerning the problem of deficit by the state-owned enterprises, and many measures have been tried. Particularly significant was the pledge made on March 19, 1998, by Premier Zhu Rongji, at a press conference held to mark his appointment. He said that his administration would eliminate the deficits of most large and medium-sized state-owned enterprises within three years, thereby taking the first step toward the conversion of the enterprises into modern (joint-stock) corporations by the end of this century.(1)

This statement pushed the state-owned enterprise reform back into the spotlight, in China and internationally. Structural reform policies were actually adopted, however, at the 1997 Chinese Communist Party (CCP) National Congress. Among the policies introduced were the reform of ownership structures, including the introduction of a joint-stock system, and the reform of industrial structures including the disposal of excess facilities and the restructuring of loss-making enterprises. In his political address, General Secretary Jiang Zemin set down specific targets, saying that by the turn of the century, the majority of large and medium-sized state-owned enterprises would be out of their present difficulties (deficits), and that the first steps toward the establishment of a modern corporate system would have been taken. He also indicated that the process would begin with reform of the textile industry.(2)

While the policy of restructuring state-owned enterprises through the introduction of a joint-stock system is not especially new, it is significant that the government has pledged itself to put the enterprises into the black over a three-year period. The media refer to this target as "Zhu Rongji's three-year SOE (state-owned enterprise) reform plan." The same nomenclature is used in this paper.

Why does the Zhu Rongji cabinet place such importance on the losses of state-owned enterprises? What are the targets and scope of "Zhu Rongji's three-year SOE reform plan," and what progress has been made?
In chapter II, we will examine and analyze the process of state-owned enterprise reform from the above perspectives. The main aim is to clarify the progress that has been made, and the problems that have arisen, by examining the background and objectives of "Zhu Rongji's three-year SOE reform plan" and how it is being implemented.

Chapter II will consist of an overview of the background and history of the state-owned enterprise reform in II.2; an examination of the aims of "Zhu Rongji's three-year SOE reform plan" and the state of progress in II.3; and, in II.4, an interim assessment of the state-owned enterprise reform and an examination of the future outlook based on the results of this consideration and analysis.

2. Background and History of the State-owned Enterprise Reform in China

(1) Current Status of State-owned Enterprises in China

In 1952, state-owned enterprises accounted for 41.5% of China's gross industrial production (Fig. 4). This figure may seem surprisingly high to some readers. Most of this output came from enterprises and factories in China that were previously owned by the nations defeated in the World War II, notably Japan, Germany, and Italy. These were nationalized by the Kuomintang administration after the war, and confiscated by the communist regime after the revolution.

In 1952, individual enterprises accounted for 20.6% of production, and enterprises under other ownership structures for 34.7%. The high percentage for these enterprises reflects the fact that most were owned by so-called "ethnic capitalists." While regarded as an "exploiter class," these people were tolerated as long as they contributed to the revolution. However, this situation continued only until 1957 when these businesses were singled out for "conversion to a socialist structure," which meant public ownership. Thereafter, they were progressively transformed into state-owned enterprises or collective enterprises.

The drive for conversion to public ownership also encompassed individual capitalists, who could not be classed as "exploiters." Individual capital, as well as ethnic capital, were absorbed into people's communes in the rural sector, and into state-owned enterprises or collective enterprises in the cities.

This shift to public ownership reached its peak in 1965. By then, state-owned enterprises accounted for 90.1% of gross industrial production. It appeared that the goal of public ownership of all industrial enterprises had been virtually achieved. Mao Zedong stated in his The Notes of Political Economy that this ratio was an indicator to show the "completeness" of socialism. Under the Maoist line, which went beyond the development of production capacity and called for the total reform of production relationships, industrial output stagnated and economic activity was disrupted. The leadership was forced to modify those policies, and industrial enterprises that were not suitable for the state-owned sector were denationalized.

However, denationalization simply downgraded the enterprises to collective enterprises, and conversion to individual or private enterprises was strictly prohibited. In 1978, when the shift to the reform and open-door policy began, state-owned enterprises still accounted for 77.03% of gross industrial production. By 1992-93, however, this share had fallen to less than 50%, and by 1996, it was below 30%. As of 1997, state-owned enterprises were contributing to only one-quarter (25.52%) of gross industrial production.

If we accept the view that the state-owned enterprises are the cornerstone of the socialist economy, then we can conclude that contemporary China has already lost its socialist mainstay. Juxtaposed with the state-owned enterprises are individual enterprises and enterprises under other ownership structures. In the 1950s, enterprises under other ownership structures belonged to ethnic capitalists. In the 1980s and 1990s, however, they mainly consisted of private enterprises (with eight or more employees), foreign-owned companies, and joint-stock companies.

Private enterprises have expanded their market share at an extremely rapid pace since the shift to the reform and open-door policy. Foreign-owned companies have also increased their market share, due to their strong competitiveness in the market. From just 10% in 1992, their market share has risen to almost 20% (as of 1997). Most joint-stock companies are privatized state-owned enterprises. By the end of 1996, there were reportedly 9,600 joint-stock companies.(3)

The decline of state-owned enterprises has thus been paralleled by the rise of individual enterprises and enterprises under other ownership structures. The status of the collective enterprises, however, is less clear. In 1975, before the adoption of the reform and open-door policy, these enterprises accounted for 18.90% of gross industrial production. They consisted mainly of manufacturing cooperative-owned enterprises in the rural sector, and of collective ward-owned enterprises in the cities. After the shift to the reform and open-door policy, collective enterprises has maintained over 30% of gross industrial production. The share has gradually expanded and is now the largest.

Economic reforms over the past two decades have brought a transition from a production structure dominated by a single public ownership structure in the form of state-owned enterprises and collective enterprises, to one consisting of enterprises under various ownership structures.

In 1997, there were a total of 7,922,900 enterprises in China's industrial sector. Of these, 98,600, or just 1.25%, were state-owned enterprises. The remainder included collective enterprises, individual enterprises, private enterprises, foreign-owned companies, and joint-stock companies. The state-owned enterprises, while far fewer in number than the enterprises under other ownership structures, still account for 25.52% of gross industrial production, 63.52% of the net fixed assets of all industrial enterprises, and 65.0% of all employees (Table 1).

Despite the rapid diversification of ownership structures since China's shift to the reform and open-door policy, the state-owned enterprises remain an important part of the Chinese economy in terms of their economic status, their contribution to state revenues (Fig. 5), and their role in maintaining economic and social stability. Given the extremely important role played by the state-owned enterprises, one cannot over-emphasize the crucial importance of the state-owned enterprise reform.

(2) The Problem of Losses

As stated above, the state-owned enterprises continue to occupy a crucial position in the Chinese economy. However, the state-owned enterprises lack autonomy in management, and are also required to carry out government administration functions, party political functions, and various social functions. As a result, their business efficiency is poor. This problem has been responsible for increasingly serious losses of state-owned enterprises, and it has come to the point where it can no longer be ignored.

Table 2 shows changes in the number of loss-making state-owned industrial enterprises as a percentage of the total number of state-owned industrial enterprises over the 20-year period from 1978 to 1997, together with their total losses and total surpluses (profits). In 1978, just 23.9% of state-owned industrial enterprises made a loss. By 1997, this ratio had risen to 43.9%. Similarly, total losses by state-owned industrial enterprises rose from 9.6% of total profits in 1978 to 126.6% in 1991. By 1997, the ratio had reached 205.3%.

The Chinese government recognizes the seriousness of this problem and has made its solution a priority for two reasons. First, as discussed earlier in this report, the state-owned enterprises have long been the principal source of revenue for the government. Second, the percentage of loss-making state-owned enterprises and the extent of their losses have both increased over the years, with the result that losses now exceed surpluses (profits) every year. In other words, surpluses from profitable state-owned enterprises are being offset by the deficits of loss-making enterprises.

(3) History of State-owned Enterprise Reform

Before examining the three-year SOE reform plan adopted by the Zhu Rongji cabinet, we will first trace the history of state-owned enterprise reform in China.
The reform of China's state-owned enterprises began with the adoption of the reform and open-door policy in late 1978. Table 3 summarizes the developments at each stage of the reform process.

The expansion of management autonomy during the first stage of state-owned enterprise reform (1978 - 86) was followed by the introduction of the "management subcontracting" system during the second stage (1987 - fall 1992). Unfortunately, neither of these changes solved the problem of deteriorating business performance in the state-owned sector and, in the fall of 1992, the government launched a new reform process designed to establish a modern corporate system. It is not possible to examine and analyze developments at each stage of the state-owned enterprise reform process in detail here. The following is a brief overview aimed at clarifying the significance of the present stage of the reform.

In the overall context of state-owned enterprise reform, the present phase of the reform process is characterized as the establishment of the modern corporate system. The "modern corporate system" basically means a system modeled on the joint-stock company and limited company structures that exist in the market economy nations.

After October 1992, the Chinese authorities decided to shift from a policy adjustment approach to reform, which emphasized the devolution pf authority and the transfer of profits that were characterized by the expansion of management subcontracting system, to an approach based on the establishment of a modern corporate system. In 1995, the government announced a policy calling for the thorough supervision of large and medium-sized state-owned enterprises, and for the liberalization and revitalization of small state-owned enterprises. In addition, the 1997 CCP National Congress adopted a policy calling for the reform of ownership structures of Chinese enterprises through the introduction of the joint-stock system, and the reform of industrial structure through the restructuring of loss-making enterprises. As discussed below, "Zhu Rongji's three-year SOE reform plan" (elimination of losses from state-owned enterprises) forms part of this phase of the reform process.

3. "Zhu Ronji's Three-year SON Reform Plan"and Its Progress

We will now examine the scope and specific targets of "Zhu Rongji's three-year SOE reform plan." We will also analyze the progress that has been made to date.

(1) Scope and Targets

The government has been implementing "Zhu Rongji's three-year SOE reform plan "since March 1998. Let us first look at the types of companies covered by the plan.

As of 1997, there were a cumulative total of 7,922,900 companies in China's industrial sector, including just over 98,600 state-owned industrial enterprises. Of which, 65,900 were self-accounting state-owned industrial enterprises, and among them, 14,820 were classified as large or medium-sized. Of all the state-owned industrial enterprises, 43.9% were operating at a loss. And among them, there were approximately 8,000 large of medium-sized enterprises. The
three-year SOE reform plan "does not cover all state-owned enterprises, and the main targets are those 8,000 large or medium-sized loss-making enterprises. Of these, just 2,300 are classified as high-priority targets for efforts to remedy loss-making performance (Table4).

Next, we will examine the specific aims of "Zhu Rongji's three-year SOE reform plan." The plan can best be considered in terms of "a single goal and two priorities."

The "single goal" is basically to end the loss-making performance of large and medium-sized state-owned industrial enterprises across the nation over a three-year period. Specifically, this will involve three changes (Table4).

(1) Once the majority of large and medium-sized state-owned industrial enterprises have reached the point at which losses are matched by profits, there will be a significant improvement in economic benefit and sharp rise in corporate profits. This will lead to the emergence of competitive large enterprises and corporate groups, and state-owned industrial enterprises will become considerably more influential in the economy.

(2) As far as the 2,300 high-priority state-owned industrial enterprises are concerned, the targets are to end losses by around one-quarter in 1998, by another one-third in 1999, and of the remaining enterprises in 2000.

(3) As far as the approximately 8,000 large and medium-sized state-owned industrial enterprises are concerned, the targets are to end losses by about one-third in 1998, by around another one-third in 1999, and of the remainder in 2000. Enterprises that have made losses over long periods are expected to be eliminated basically.

The "two priorities" are to end losses in the textile sector, and to implement re-employment projects.

The losses of state-owned textile enterprises have increased sharply in each of the five years since 1993. From 1.9 billion renminbi in 1993, the scale of the losses has soared to 10.6 billion in 1996 and over 9 billion in 1997. In 1996, 42% of state-owned textile enterprises were operating in the red, and this ratio was 5 points higher than the ratio of loss-making state-owned industrial enterprises in all state-owned industrial enterprises, which was at 37%. Moreover, loss-making textile enterprises account for about one-half of total employees working in the state-owned textile sector. The government's plan to take the industry out of red calls for the forced disposal of the 10 million textile machines by the end of this century. If this effort to stem the losses of the textile industry succeeds, there are likely to be positive ripple effects on the reform of the state-owned sector as a whole.

The main mechanisms that will be used in re-employment projects are separation schemes, surplus employees from the state-owned sector will gradually be separated from their present companies and absorbed by new businesses in other sectors, such as the service industry. Employees who are laid off will be sent to re-employment service centers where they will receive a variety of assistance, including living allowances, job training, and job introductions. The cost of living allowances to those laid off will be shared by the government, enterprises, and unemployment insurance funds. To increase employment opportunities and support re-employment, the government will also target accelerated growth in the non-state-owned sector and tertiary industries. The aim of the re-employment projects is to provide new jobs for 1.2 million surplus employees from the textile sector by the year 2000.

(2) Reform Targets and Results for 1998

1) Targets of the State-owned Enterprises Reform for 1998

The targets for the first year of "Zhu Rongji's three-year state-owned enterprise reform plan" were as follows.

First, the elimination of losses in the state-owned textile sector was seen as the starting point for the turnaround of the state-owned sector as a whole. The targets for 1998 were the compulsory disposal of 4.8 million old textile machines, the redeployment of 600,000 workers who were laid off to reduce surplus labor, and a 3 billion renminbi reduction in losses from the previous year's level (Table 5).

The second target was to eliminate losses in about one-third of the approximately 8,000 large and medium-sized state-owned enterprises.

The third target was to turn around the performance of about one-quarter of the 2,300 high-priority loss-making state-owned industrial enterprises.

The fourth target was to increase the profits of the state-owned industrial sector as a whole to at least 45.1 billion renminbi.

2) State-owned Enterprise Reform Measures in 1998

The Zhu Rongji cabinet applied the following measures in an effort to ensure the achievement of the 1998 reform goals. First, the government maintained its policy of supervising large state-owned enterprises closely, while liberalizing smaller enterprises and promoted mergers and bankruptcies among state-owned enterprises.

Second, special inspectors were assigned to monitor the management teams of large and medium-sized state-owned enterprises. On June 26, 1998, a graduation ceremony was held for the first group of 21 newly trained special inspectors for high-priority state-owned industrial enterprises. These people, all with ranks of vice-minister or higher, were assigned to the production facilities of state-owned enterprises.
They have two tasks. The first is to assess the management team and business situation of each state-owned enterprise by interviewing departmental managers and staff. The other task is to inspect the financial statements, accounting ledgers, and related documents in order to assess the performance of each enterprise in terms of such parameters as financial position, debt repayment capacity, earning power, profit distribution, asset management, and maintenance and expansion of state wealth effect. In some cases, the supervisors will recommend to the State Council of the central government that further inspections should be carried out by specialist accounting audit agencies.

Third, the government endeavored to find appropriate solutions for the basic problems that laid-off workers had with their livelihoods, and used every available means to implement re-employment projects. Laid-off workers were sent to re-employment service centers, which guaranteed basic expenses and medical expenses.

Fourth, the government worked to deal with the social security problems of the unemployed and laid-off workers. In 1997, the State Council issued a notification concerning the improvement of social security systems. Agencies and enterprises were instructed to establish a universal retirement insurance (pension) scheme, which is based on the social reserve system linked with individual accounts of urban workers throughout China, to create a new medical insurance scheme, and to strengthen commercial insurance and social relief scheme. In addition, the central government encouraged all cities which are directly administered by provincial governments and above to complete the establishment of basic existence guarantee systems for residents by the end of FY1998. It also encouraged counties and townships, where conditions were appropriate, to establish the systems without delay. In addition, an urban housing reserve system was established, and housing reform was accelerated to encourage home ownership.

Fifth, the government identified the state-owned textile sector as the starting point for the "three-year SOE reform plan," and it aggressively promoted reform in this area. As early as 1991, a major directive had been issued calling for the disposal of textile machines. However, only 210,000 machines were disposed of between 1992 and 1996, in part because preference was given to regional interests. While this measure actually reduced the total number of textile machines in operation in the eastern coastal region, most of the machines removed from the plants in that region were relocated to plants in the western inland region. As a result, targets for the disposal of textile machines were mostly unfulfilled.

The government was determined not to repeat this experience during the present reform process for state-owned textile enterprises. It opted for the forced disposal of textile machines through a combination of administrative and economic means, to avoid relocation or sale of the machines. Six major cities were designated for pilot schemes for the disposal and restructuring of textile machines. The cities named Shanghai, which has traditionally been a major textile production center, and Qingdao, Tianjin, Wuhan, Jinan, and Dailian (4).

To ensure the competition of its scheme to dispose of 10 million textile machines, the Zhu Rongji cabinet adopted the following reform measures.

First, a government subsidy of 3 million renminbi would be paid for every 10,000 machines disposed. Central and regional governments would each provide half of the funding for this measure.

Second, a 2 million renminbi interest subsidy, funded by regional governments, would be provided.

Third, banks would use bad debt reserves amounting to 10 billion renminbi to dispose of non-performing loans relating to major cases of restructuring projects in the textile industry.

Fourth, support would be provided for the expansion of exports of textile products. In 1998, the export rebate rate for value-added taxes on textile products was increased from 9% to 11%, and over 15% of the quotas for textile products exported to the United States and Europe would be allocated directly to textile companies with autonomous export rights.

Fifth, the production permit and purchase permit systems for textile machinery sold within China would be rigorously enforced, and stringent limits would be imposed on the installation of new additional textile processing capacity. At the same time, exports of textile machinery would be encouraged through the provision of export credit and full refunds of value-added taxes.

Sixth, the supply system for raw cotton would be improved, and prices would be allowed to fluctuate over a 6% range. In addition, companies that exported products made from Xinjiang cotton instead of imported cotton would be exempted from value-added tax and receive a 90 renminbi reduction in the purchase price per 50 kilograms of raw cotton.(5)

3) Results of Reform Efforts in 1998

This survey has clarified the following information about the results of the efforts on the state-owned enterprise reform during 1998, which is the first year of the "three-year SOE reform plan."

First, of the approximately 8,000 large and medium-sized state-owned industrial enterprises, approximately one-third had basically shifted out of a deficit situation in 1998.(6) Second, of the 2,300 state-owned enterprises that were targeted for high-priority measures to turn around loss-making performance, just over one-quarter had basically moved out of the red.(7) Third, the textile industry was seen as the starting point for the state-owned enterprise reform process. The results of reform efforts in this sector during 1998 were as follows.

(1) A total of 5.12 million textile machines were disposed. This is higher than the initial target of 4.8 million machines.

(2) The initial personnel redeployment target (600,000) was also exceeded.
A total of 660,000 surplus employees were restructured and later redeployed.

(3) The losses of state-owned textile enterprises were reduced from 9.0 billion renminbi in 1997 to 6.48 billion in 1998. (8) The 2.5 billionrenminbi reduction was just 500 million renminbi short of the initial target (3 billion renminbi).

These figures indicate that efforts to end the loss-making performance of enterprises targeted for reform brought reasonable progress in 1998, and that the goals were mostly achieved. As discussed below, however, many problems still remain.
(3) Reform Targets and Measures for 1999

In March 1999, the Zhu Rongji cabinet issued new reform targets based on its review of progress in 1998.(9) The first target is to turn around the performance of another one-third of the approximately 8,000 loss-making large and medium-sized state-owned industrial enterprises.
The schedule basically calls for the solution of the problems of the remaining enterprises in the year 2000, and the government aims to reduce the percentage of loss-making enterprises to a normal level (around 15% or lower).

The second target is to turn around the performance of another one-third of the 2,300 high-priority loss-making state-owned industrial enterprises in 1999. The problems of the remaining enterprises will basically be solved in the year 2000.

The third target relates to state-owned textile enterprises. The government is aiming to reduce the losses by 6.0 billion renminbi by disposing of 10 million textile machines and restructuring and redeploying 1.2 million surplus workers. All three target figures are set at double the previous year's target.(10)

At a national textile industry conference on January 26, 1999, Du Yuzhou, the head of the State Textile Industry Bureau, said that since the total losses of (state-owned) textile enterprises amounted to 6.48 billion renminbi in 1998, the problem could be almost entirely eliminated by reducing the losses by a further 6.0 billion renminbi in 1999.

The Zhu Rongji cabinet has adopted the following reform measures to achieve
the targets set down for 1999.

First, it has placed a limit on new industrial projects.

Second, the government will maintain its policy of closely supervising large state-owned enterprises while liberalizing and revitalizing smaller state-owned enterprises. It will also promote further mergers and bankruptcies among state-owned enterprises.

Third, the government would continue to appoint special inspectors to monitor the management teams of large or medium-sized state-owned enterprises. On January 8, 1999, the second group of 38 special inspectors had graduated from training and were assigned to state-owned enterprises. Apart from this, another 60 special inspectors have been assigned to state-owned enterprises since January to oversee priority projects.(11)

Fourth, efforts to improve economic performance through work force restructuring are continuing. Appropriate steps are being taken to overcome the livelihood problems of unemployed and laid-off workers, and all possible means are being used to put re-employment projects in practice and to establish social security systems. The Chinese authorities regard the reduction of surplus workers as an important step toward the improvement of economic performance of state-owned enterprises. Since 1998, the government has worked to increase the economic benefits of employee reductions in state-owned enterprises by promoting the establishment of re-employment centers.

In the "Report on the Work of Government" to the March 1999 National People's Congress, Premier Zhu Rongji announced a policy based on "three assurance lines" to assist laid-off workers. Under this policy, laid-off workers who are re-employed must sever their employment contracts with the state-owned enterprise that originally employed them. Laid-off workers who remain out of work after three years will be transferred to social insurance agencies, which will provide unemployment benefits. These workers will also have to sever their employment contracts with the state-owned enterprises they originally worked for. If any workers remain unemployed after receiving unemployment benefits for two years, they will be transferred to the public welfare administration, which will provide the minimal living allowance available to urban residents.(12)

4. Interim Assessment of and Future Outlook for the State-owned Enterprise Reform

As stated in the previous section, in March 1999, the Zhu Rongji cabinet announced new 1999 reform targets based on the achievements of 1998. It has taken a series of measures to achieve those targets. To what extent is "Zhu Rongji's three-year SOE reform plan" achievable? The final assessment must wait until the end of the year 2000, which is the final deadline set by the Zhu Rongji cabinet for the reform process. The following is an interim assessment based on progress to date under the "three-year SOE reform plan," together with a review of key factors that have become apparent so far. This will be followed by an attempt to forecast the outlook for the reform process.

(1) Interim Assessment of the State-owned Enterprise Reform

First, judging from such indicators as numbers of textile machines disposed, laid-off workers re-employed, and loss reductions in 1998, which was the first year of "Zhu Rongji's three-year SOE reform plan," it appears to have been a resounding success, with most initial targets achieved. Despite the effects of Asian financial crisis since the second half of 1997 and the massive flooding that hit northeast and southern China in the summer of 1998, the state-owned enterprise reform is apparently on track, especially with regard to the reduction of losses in state-owned enterprises. This should be highly evaluated.

Second, though the state-owned enterprises were the main source of state revenues for a long period of time, the percentage of loss-making state-owned enterprises and the size of their losses have risen steadily over the years, to the extent that the losses made by loss-making enterprises have surpassed and negated the profits raised by profitable state-owned enterprises almost constantly over the past few years. This is why "Zhu Rongji's three-year SOE reform plan," aimed at eliminating losses run by state-owned enterprises, is seen as being highly significant. If the plan succeeds in turning around the loss-making performance of state-owned enterprises, the state will be able to secure its revenue flows, and there is also likely to be an improvement in the competitiveness of Chinese industry.

Third, as stated above, the "three-year SOE reform plan" does not target all state-owned enterprises, but rather focuses mainly on large and medium-sized industrial enterprises. In particular, a transition away from loss-making performance in the textile industry is identified as the starting point for reform. As such, the state-owned enterprise reform focusing on a single industrial sector at first is expected to produce ripple effects in other sectors.

Fourth, as part of its efforts to overcome the problem of losses in state-owned enterprises, the Zhu Rongji cabinet has adopted the "three assurance lines" policy. The announcement of this policy to all the people of China is highly significant. This is because the reform of state-owned enterprises will involve the restructuring of large numbers of surplus workers, and unless the plan is understood and supported by the people, there could be serious implications not only for the implementation of the reform process, but also for social stability.

Fifth, the Chinese authorities have assigned special inspectors to large and medium-sized state-owned enterprises in an attempt to monitor management teams of the enterprises and improve management efficiency. To some extent, the reform measures themselves can be expected to contribute to the improvement of efficiency in state-owned enterprises.

(2) Future Outlook

Though successful so far, the process of China's state-owned enterprise reform is not without its problems. "Zhu Rongji's three-year SOE reform plan" has focused solely on the limited area (textile industry) and certain large and medium-sized loss-making state-owned industrial enterprises. Though the reform have yielded some benefits, the losses of the state-owned sector as a whole are still a serious problem.

For example, according to China's State Statistical Bureau, the total losses of state-owned enterprises and state-owned holding companies increased by 21.9% from the previous year's level to 102.3 billion renminbi in 1998.(13) In an economic report presented in December 1998, Premier Zhu Rongji said, "Though I stated early in 1998 that the performance of the majority of large and medium-sized loss-making state-owned enterprises would be turned around over the next three years, in fact, 1998 has brought increases in both the percentage of enterprises making a loss and the amount of those losses."(14) Though his speech did not include specific figures about the losses of state-owned enterprises, he revealed that both the amount of the losses and the percentage of loss-making enterprises had risen when compared with the previous year's figures.

The official view in China has been that the losses of state-owned enterprises were attributable to excess capacity.(15) In fact, partial disposal of textile machinery has been one of the key measures employed by the Zhu Rongji cabinet in its efforts to reduce the losses. This reflects the view that the elimination of surplus capacity held by state-owned enterprises will restore and enhance the competitiveness of the textile industry, thereby solving the problem concerning profitability.

While excess capacity is one of the factors responsible for the losses by state-owned enterprises, however, it is not the fundamental problem. The writer would like to emphasize that the basic reason for the loss-making performance of state-owned enterprises is the inefficiency of China's state-owned enterprise system. Characteristics of that system include: bureaucratic control, which has resulted in the establishment of state-owned enterprises in uncompetitive as well as competitive sectors, and in the continuing existence of monopolies in many industrial sectors; the lack of a clear demarcation between ownership rights and management rights, which are both held by the government; the lack of demarcation between the administrative functions of the government and the economic functions of enterprises; the overlap between the political functions of the Party and the economic functions of enterprise; and the lack of separation between various social functions and the economic functions of enterprises.(16)

As stated earlier in this report, the Zhu Rongji cabinet has achieved most of the targets that it set for the reduction of the losses of large and medium-sized state-owned enterprises in 1998. However, a fundamental solution to the loss-making performance of state-owned enterprises has not yet been found. The key factor appears to be in the state-owned enterprise system itself. Real solutions will come only when the inefficiency problem of the state-owned enterprise system has been thoroughly resolved.

The Chinese government first began to work on reforms designed to turn state-owned enterprises into modern companies in October 1992. The main methods used have been (1) the conversion of large and medium-sized state-owned enterprises into join-stock companies, (2) the reform of small state-owned enterprises under joint-stock cooperative system, and (3) merger and acquisitions of state-owned enterprises by foreign capital. The CCP National Congress formally adopted a resolution calling for the full-scale implementation of a program to turn state-owned enterprises into joint-stock companies.

In the past, the government held both ownership and management rights in state-owned enterprises. Once an enterprise has been changed into a joint-stock company, however, individuals or corporations can own the stocks, and the enterprise shifts out of state ownership. This is what happened when Japan's National Railway system was privatized. The original state-owned enterprises is turned into a joint-stock companies. By 1998, over 10,000 joint-stock companies had been created or restructured from state-owned companies.

In China, the normal practice when converting a state-owned enterprises into joint-stock companies. However, the traditional concept of official ownership was redefined at the 1997 CCP National Congress, and it appears certain that the privatization process will become significantly easier. The conversion of state-owned enterprises into joint-stock companies is expected to lead to the discovery of solutions to remedy the inefficiency and loss-making performance of state-owned enterprises.

Due to the limitations of space, the discussion and analyses in chapter II have focused mainly on the "three-year SOE reform plan" and progress with its implementation. The inefficiency of the state-owned enterprise system and the reforms needed to remedy this problem will be examined elsewhere.

III. Financial System Reform -Progress and Outlook

1. Identification of Issues and Aims of Research

The onset of the Asian financial and currency crisis in the second half of 1997 exposed the fragility of financial systems in Asian economies. In contrast, China's financial systems remained basically untouched by the crisis, due to strict foreign exchange controls and the fact that capital accounts had not yet been liberalized. However, the Chinese financial system is not without its problems. Signs of instability include problems with non-performing loans and the bankruptcies of non-bank companies. The Chinese authorities need to deal with some urgent issues, including ways in which to prevent the effects of the Asian financial crisis from spreading into China, and measures to keep similar latent problems existing in the Chinese economy from turning into a real crisis.

It was under these circumstances that the Chinese government held a national financial conference during November 17-19, 1997. At this conference, the government adopted, as a financial reform goal, the creation of a financial system suitable for the development of market economy, over a period of approximately three years. Then, as a vice premier, Zhu Rongji was effectively the most senior official in the area of economy and finance. In his inaugural speech after his appointment as premier in March 1998, he attracted considerable interest at home and abroad by identifying financial system reform as one of "three programs for execution," and by promising that the problems would be fundamentally solved within three years. It was from this time that the media began to refer to the financial system reform as "Zhu Rongji's three-year financial reform plan." The same nomenclature is used in this paper.

About one year has passed since the launch of "Zhu Rongji's three-year financial reform plan." Since then, how has the financial reform process progressed in that period, what achievements have been obtained, and what problems exist?

In chapter III, we will approach the question of financial reform from these perspectives. The main aim is to analyze the background, policies, and realities of the "three-year financial reform plan," in order to clarify the current state and characteristics of the reform process and identify any problems.

Chapter III consists of the following sections. III.2 contains background information about the financial reforms, in the form of an overview of the current state of the Chinese financial system and the problems that exist in it. III.3 examines "Zhu Rongji's three-year financial reform plan" and the progress made to date. III.4 presents the results and conclusions of these studies and analyses. Finally, the writer will attempt to forecast the outlook for the financial system reform.

2. Background of Financial System Reform

China's shift to a reform and open-door policy began at the end of 1978. The start of the financial reforms was relatively late, and the reform process did not begin in earnest until the second half of 1993. However, numerous measures had been implemented before that time. While the discussion here will focus primarily on "Zhu Rongji's three-year financial reform plan" rather than the whole trend of financial system reforms, we will look first at the background of the present reform, including the actual situation of the Chinese financial system and the problems that affect it.

(1) Current State of the Financial System

1) The Financial System before the Shift to the Reform and Open-door Policy

Before analyzing the current state of China's financial system, we will provide a brief overview of the state of the financial system before the shift to the reform and open-door policy.

For many years, the only bank in China was the People's Bank of China. Until 1979, the People's Bank sign hung in front of all banks in major cities. The only activities of the bank were the absorption of savings, lending, and the provision of remittance services. There was no wide-area clearance system for bills, checks, and other instruments. The banking sector existed as an adjunct to the government sector. Banks simply implemented the financial plans of the central government, and they had no independence. It was assumed that profits gained were paid to the government, and losses were offset by subsidies from the government.

The Chinese financial system that existed under the old planned economy was basically not affected by the types of problems that are occurring today, such as non-performing loans and bankruptcies among non-bank financial institutions.

2) The Financial System after the Shift to the Reform and Open-door Policy

Fig. 6 provides a simple overview of the current Chinese financial system. Under the People's Bank of China, which is China's central bank, there are three policy banks, four state-owned commercial banks, and the private sector commercial banks. There are also the Urban Cooperative Bank, the Rural Cooperative Bank, and various types of non-bank financial institutions.

The transition from the situation prior to the adoption of the reform and open-door policy, when the People's Bank of China was China's only bank, to the present system began in 1979. Initially, four major state-owned professional banks, namely, the Industrial and Commercial Bank of China, the Agricultural Bank of China, the China Construction Bank, and the Bank of China, were separated or restructured out of the People's Bank of China and the Ministry of Finance. The aim was to expand banking services, improve the financial system, and introduce the principle of competition. In 1984, private sector commercial banks were established at the regional and national levels. Since then, the number of financial institutions has increased rapidly. The number peaked in the early 1990s, when there were over 60,000 banks and non-bank financial institutions.

Gradual improvements were made to the financial system. The commercial banking functions of the People's Bank of China were transferred to the four major state-owned professional banks after their establishment in 1979. At the same time, the People's Bank of China, as China's central bank, was placed under the direct jurisdiction of the State Council. However, it did not begin to function as a proper central bank until 1984. It was not until the enforcement of the People's Bank of China Law in March 1995, that its status as a central bank, the monetary policy, and its areas of responsibility including supervision of financial institutions were fully specified (Table 6).

In 1994, the State Development Bank, the Export and Import Bank of China, and the Agricultural Development Bank of China were established as institutions to carry out policy finance. The four major state-owned professional banks were restructured into state-owned commercial banks with autonomous management rights. The purpose of these changes was to separate policy finance from commercial finance. In July 1995, the long-awaited Commercial Bank Law took effect. The basic framework of China's modern financial system now in place was thus developed.

The state-owned commercial banks continued in their role as suppliers of funds to the state-owned enterprises, which were the main economic entities under the old planned economic system. The financial needs of the emerging non-state-owned business sector became the niche market for non-bank financial institutions and credit association, which were small and medium-sized financial institutions serving the urban and rural sectors.

With household savings expanding steadily, the supply of funds to support investment in economic development appears to have occurred relatively efficiently in China, when compared with Eastern Europe and Russia, although the oversupply of credit sometimes led to inflation.

(2) Problems in the Chinese Financial System

Why does China need a financial system reform when its financial system has already won considerable praise as stated above? In fact, there are still many problems in China's current financial system, which is still yet unable to cope adequately with the diversified financial needs and risks that have emerged from the rapid economic growth that has resulted from the evolution of the Chinese domestic economy into a market economic system in the 20 years under the reform and open-door policy. The following discussion of the Chinese financial system focuses primarily on the non-performing loan problems of the commercial banks, and on the problem of bankruptcies among non-bank financial institutions.

1) Non-performing Loan Problem of Commercial Banks

It is known that all four major state-owned commercial banks are burdened with non-performing loans, but opinions vary on the scale of the loans. According to one theory, their non-performing loans amount to as much as 2 trillion renminbi, which is equivalent to twice as much as China's state budget for FY1998, or 20% of total lending by the four banks.

However, at a press conference held in Beijing on March 11, 1999,(17) People's Bank Governor Dai Xianglong stated that in China, the concept of "non-performing loans" was defined in terms of three categories: loans in arrears, loans in arrears by two years or more, and unrecoverable loans. This means that "non-performing loans" are not necessarily loans that cannot be recovered. According to this broad definition, the non-performing loans (aggregate of the old three categories above) of state-owned commercial banks amount to approximately 25% of their total loans, while loans to bankrupt borrowers, which will need to be written off, are equivalent to 2.9% of total loans. In addition, about 5% of loans in arrears, as defined under the old loan classifications, will need to be written off as unrecoverable. On this basis, the actual ratio of non-performing loans is about 7.9%.

At the end of 1998, total loans made by all financial institutions amounted to 8,652.4 billion renminbi. This total includes 6,844.2 billion renminbi in loans made by state-owned commercial banks.(18) If the ratio of "non-performing loans" is 25%, state-owned commercial banks have "non-performing loans" amounting to approximately 1,700 billion renminbi, of which an estimated 7.9%, or about 540.7 billion renminbi, will need to be written off as genuine non-performing loans (that is, unrecoverable in the new loan classification).

Financial institutions appear to have accumulated those non-performing loans during the transition to a market economic system. The majority of the non-performing loans resulted either from the collapse of the real estate bubble of the early 1990s, or from problems with long-standing accumulations of loans to state-owned enterprises. Since loans to state-owned enterprises account for about 90% of total lending by the four state-owned commercial banks, difficulties with these loans are likely to have more serious implications than problems with loans relating to the real estate bubble.

China's problems with non-performing loans in the wake of its real estate bubble are similar to the problems experienced in other Asian economies. What is unique to China is the problem of massive non-performing loans to state-owned enterprises, which have been the recipients of massive lending. The high level of the non-performing loans can be explained by a number of factors. First, there is pressure from regional governments to continue lending to state-owned enterprises. Second, state-owned enterprises have loss loans. Third, state-owned enterprises have shown poor moral discipline in relation to loans and credit. Fourth, state-owned enterprises lack awareness of the importance of repayments.

Whatever the reasons for the problem, the disposal of non-performing loans will be a vital issue of the Chinese government's efforts to reform the financial system.

2) Bankruptcies among Non-bank Financial Institutions

The inadequacies of the Chinese financial system suddenly became apparent with the announcement, in October 1998, that Guangdong International Trust and Investment Corporation (GITIC) was to be liquidated. This incident has damaged the confidence of foreign financial institutions in China.

Under the reform and open-door line that China has followed since 1978, trust banking was advocated as a way of absorbing funds. The government began to consider the establishment of trust and investment companies since then, and in October 1979, the Bank of China set up a trust and inquiry division. This led to the establishment of China International Trust and Investment Corporation (CITIC).

Other banks subsequently set up trust banking operations, and regional trust and investment companies were also established. The number of such companies reached a peak of 745 in 1988. Apart from CITIC, which is under the direct control of the central government, most of these companies are either owned by or structured as divisions of banks and regional governments. The investment and trust companies derive about one-half of their funds from "trust deposits," which normally have maturities of one year or longer. Apart from the procurement of funds, the companies are also involved in lending and investment. Most also underwrite securities and engage in a wide range of other activities, such as trusts, guarantees, and project management.

The establishment of so many trust and investment companies is explained by a number of factors. First, the devolution of authority under the reform and open-door policy led to an increase in the amount of funds used outside of budgets controlled by the central and regional governments. This has generated the need for investment in projects resulting from regional initiatives, and the demand for fund-operating opportunities that would provide better results than interest rates on bank deposits. Second, the shift to the reform and open-door policy led to the emergence of new financial needs. Banks established trust banking divisions or trust and investment companies as vehicles for an involvement in areas that were not approved as normal banking activities. Third, China wanted to experiment with the use of foreign bond issues and other mechanisms to obtain foreign currency funds.

The circumstances that led to the creation of these trust and investment companies are reflected in the fact that they now play dual roles. One is positive, the other negative.
On the positive side, the trust and investment companies bridged a gap caused by inadequacies in China's existing financial system, which was unable to cope with the transition to a market economy under the reform and open-door policy. Because of their access to local information, the non-bank financial institutions have been more successful than the state-owned commercial banks in monitoring borrowers and enforcing sanctions to ensure the repayment of loans. The system, whereby state-owned commercial banks attracted savings, which were then invested in the investment and trust companies in the form of loans, has worked effectively in the regions.

However, the investment and trust companies have also played a negative role as financial institutions that could be used to avoid regulations. During the transition to a market economic system, commercial banks and regional governments established numerous trust and investment companies to engage in subsidiary activities beyond the reach of regulation by the central government and the central bank.

During the financial upheavals that occurred in 1987-89 and 1993-94, there was active investment in property, stocks, and other assets via a variety of trust and investment companies. The government limited bank lending, but the trust and investment companies were beyond the scope of these restrictions and had continued to lend. This aggravated the turmoil that swept through the financial sector.

Table 7 shows the scale of assets and liabilities of trust and investment companies across the nation at the end of 1997. As is apparent from this data, the companies had renminbi liabilities of 269.27 billion renminbi and foreign currency liabilities amounting to US$14.59 billion. The liability ratios for both renminbi and foreign currency accounts were both around 85%.

There have been a number of problems relating to the management of these trust and investment companies. First, their practice of borrowing and lending at high interest rates has disrupted China's financial order. Second, huge amounts of investment and lending have become non-performing assets. Third, many trust and investment companies are exposed to serious liquidity risk because of cash flow problems resulting from the investment of short-term funds in speculative ventures and medium- and long-term deals.

The results of an inspection conducted by the People's Bank of China in 1996 showed that there were problems of inadequate equity ratios, high percentages of non-performing assets, and illegal operation among trust and investment companies. The People's Bank of China reported that large numbers of non-bank financial institutions were operating at a loss, and were in danger of becoming insolvent. In short, many trust and investment companies were on the verge of bankruptcy.

For the Chinese government, the liquidation and restructuring of these trust and investment companies will be a crucial aspect of financial system reform.

3. "Zhu Rongji's Three-year Financial Reform Plan" and Its Progress

(1) The Main Targets

As described above, the aim of "Zhu Rongji's three-year financial reform plan" is to build, over a period of approximately three years, a financial system which is adequate to the development of a market economic system. To achieve this important goal, the Zhu Rongji cabinet has announced a number of specific targets, which are summarized below (Table 8).

1) Management System Reform of the People's Bank of China

The first target is to reform the management system of the People's Bank of China, which is China's central bank. According to the People's Bank of China Law, which was promulgated and took effect in March 1995, the People's Bank must not allow interference by regional governments or government agencies at any level in the performance of its duties and responsibilities (Article 7), and it must apply uniform guidance and management to all of its subsidiary organizations (Article 12). In practice, however, regional organizations of the People's Bank of China were subject to constant interference and intervention by regional governments. The result was a dual system in which control was exercised both by People's Bank headquarters and regional governments. This situation has severely limited the ability of the central bank to implement uniform financial policies, which were determined by the central government, at the regional level.

Collusion between the government and business played a role in the financial crisis that hit South Korea. Recognizing that similar relationships exist between regional governments and state-owned enterprises, the Chinese government has realized the urgent need for financial system reform.

The People's Bank of China had branches at province, city, and county levels. It decided to close the provincial branches and to create "larger-region branches" based on economic blocks spanning several provinces. This concept was implemented after the central financial conference in November 1997.

2) Management System Reform of State-owned Commercial Banks

The second target is the reform of the management system of state-owned commercial banks. The four state-owned commercial banks account for about 70% of total commercial lending in China. Their non-performing loans, based on the new loan classification criteria, amount to 540.7 billion renminbi, or about 7.9% of their total loans.(19) The improvement of their management foundation will be an urgent priority in relation to China's economic development, and the reform of management system of state-owned commercial banks has been identified as the key priority in the financial system reform process. As outlined below, there are four specific goals.

(i) Organizational reform of state-owned commercial banks

The reform of management systems of the People's Bank of China will obviously have a major influence on the organizational management of state-owned commercial banks. Organizational reform of state-owned commercial banks, therefore, is also inevitable.

(ii) Abolition of loan ceilings

In the past, the People's Bank of China used its supervisory powers to set upper limits for lending by commercial banks, to exercise direct control over financial markets. However, the diversification of banking structures since the mid-1980s is reflected in the growing contribution of financial institutions other than the state-owned commercial banks to new lending. From just 22% in 1990, their share of total new lending had increased to 49% by 1996. In addition, the development of the capital markets has brought an increase in the percentage of direct financing, as well as inflows of foreign capital. Changes such as these have rendered the ceiling on the loans made by state-owned commercial banks meaningless.

(iii) Reform of legal reserve system

Because of changes in the financial situation, it has also become necessary to reform the legal reserve system. After the People's Bank of China assumed the role of a central bank in 1984, the legal reserve ratio for liquid deposits was raised to 12% in 1987, and then to 13% in 1988. These increases in the legal reserve ratio had helped to curb economic overheating. Subsequently, however, they were used not to adjust the money supply, but rather to supply the funds needed for buying up agricultural products and financing priority projects. Moreover, since the state-owned commercial banks could deposit funds with the People's Bank of China at higher interest rates than the normal deposit rate, they tended to leave funds (cash reserves) in the People's Bank in excess of the legal reserve ratio set to cover their liquid deposits.

(iv)Issuance of special government bonds

The equity ratios of the state-owned commercial banks are low. To avoid financial risk, they need to improve their equity ratios through special government bond issues.

The main aims of these changes to the management systems of state-owned commercial banks are to prevent financial crises and to strengthen the management foundation of the four major state-owned commercial banks.

3) Reform of Separate Management Systems for Banking, Securities, and Insurance Sectors

The third target is the establishment of separate management systems for banking, securities, and insurance sectors. In the past, there were no clear dividing lines between these areas of business. To avoid financial risks, industry boundaries need to be defined more clearly, and separate management systems must be established to define areas of activity for each sector and ensure that financial institutions do not stray beyond their scope of activities.

4) Disposal of Non-performing Loans

The fourth target is the disposal of non-performing loans held by financial institutions. The two main approaches in this area are the introduction of a five-tier loan classification criteria and the establishment of financial asset management companies.

Until the introduction of the five-tier loan classification criteria, Chinese financial institutions had classified their loans into just two categories: normal and non-performing. Non-performing loans were then subdivided into three categories: in arrears, in arrears by two years or longer, and unrecoverable. These classification criteria did not match international standards, and were used primarily for afterward recognition of non-performing loans. In practice, normal loans also included loans that were at risk of becoming non-performing loans. Some financial institutions may also have used this criteria as a way of preventing non-performing loans from coming to light.

The People's Bank of China decided, therefore, to change the loan classification criteria to match international standards. The aims of this move were to strengthen risk management and self-responsibility of each financial institution, to prevent the generation of non-performing loans, and to grasp accurately the present extent of non-performing loans (The five-tier loan classification criteria is discussed later in this report).

The establishment of financial asset management companies was another response to the massive amounts of non-performing loans held by China's state-owned commercial banks. It became necessary to establish these companies to avoid financial risk and provide a mechanism for the disposal of non-performing loans.

5) Liquidation and Restructuring of Financial Institutions

The fifth target is to liquidate or restructure financial institutions. Some financial institutions had become insolvent and were unable to meet loan repayment obligations. Urgent action is needed to liquidate or restructure these institutions. The financial collapse of non-bank financial institutions has gradually emerged as a serious problem since the economic overheating that occurred in 1993. Particularly after the onset of the Asian financial crisis in the second half of 1997, improvements in financial order and the liquidation or restructuring of financial institutions became particularly urgent priority, because of the need to prevent the contagion of the financial crisis from spreading into China.

(2) Progress under "Zhu Rongji's Three-year Financial Reform Plan"

1) Progress toward the Management System Reform of the People's Bank of China

In August 1998, the People's Bank of China restructured its head office organization. It then began to reorganize its 148 regional branches. Starting with the Shanghai Branch, it closed its province-level branches in November and December, and instead, established nine "larger-region branches," each of which covers several provinces. The new management system was put into practice from January 1999 (Table 9). The structure now consists of one headquarter, nine larger-region branches, two business administration divisions (in Beijing and Chongqing), 333 central branches, and 1,827 county-level branches. Under this system, monetary policy decisions are centralized at headquarter level, while branches focus on the policy implementation and supervisory operations.(20)

2) Progress toward the Management System Reform of State-owned Commercial Banks

With the reform of management system of the People's Bank of China, management system reform of state-owned commercial banks has also begun in earnest.

As far as organizational restructuring is concerned, the state-owned commercial banks are currently consolidating their provincial branches and branches in provincial capitals. This process is scheduled for completion during 1999. They are also streamlining their peripheral organizations.

With regard to the loan ceilings, the People's Bank of China abolished, in January 1999, the lending ceilings that previously limited the amount state-owned commercial banks could lend in each quarter and each financial year. It also created a new management structure based on asset management responsibility and risk management.

Third, the reform of the legal reserve system began in March 1998, when the reserve ratio for liquid deposits was cut from 13% to 8%. In addition, deposit rates were lowered three times in June and December 1998, and in June 1999.

Fourth, in August 1998, the Ministry of Finance implemented a special government bond issue amounting to 270 billion renminbi. The issue was required because of a decision to inject public funds into the four major state-owned commercial banks, in order to strengthen their equity weakened by non-performing loans. The proposal to implement a special government bond issue was approved by the Standing Committee of the National People's Congress in February 1998. Maturity was set at 30 years and the interest rate at 7.2%. The bonds were issued to the four major state-owned commercial banks in August. The banks purchased the bonds using funds released by the 5% reduction in the legal reserve ratio for liquid deposits, as mentioned above. The Chinese government is investing the 270 billion renminbi raised in this way into the state-owned commercial banks in the form of capital funds.

3) Progress on Reform of Separate Management Systems for Banking, Securities, and Insurance Sectors

In October 1992, the Securities Committee was established within the State Council of the central government, together with the China Securities Regulatory Commission (CSRC) as an implementation agency. In July 1997, the Shanghai and Shenzhen Stock Exchanges, both of which had previously been supervised jointly by the CSRC and the regional governments, were placed under the direct jurisdiction of the CSRC. The CSRC took over responsibility for the appointment and dismissal of exchange presidents and vice-presidents.

The administrative reforms of 1998 resulted in the abolition of the State Council's Securities Committee, leaving the CSRC as the sole agency responsible for the supervision of the securities sector. On December 29, 1998, the Securities Law was passed by the Sixth Session of the Standing Committee of the 9th National People's Congress, five years after the start of deliberations. The new law took effect from July 1, 1999. The Securities Law, which consists of 214 articles in 12 chapters, will ensure the sound development of China's securities markets.

In the insurance sector, the China Insurance Supervision and Management Commission was established in November 1998 as an independent agency, separated from the People's Bank of China. This move is expected to result in the gradual normalization of the regulation and supervision of the insurance industry in China. The creation of the Commision completed the establishment of separate management systems for banking, securities, and insurance sectors in China.

4) Progress toward Disposal of Non-performing Loans

Efforts to deal with the non-performing loans of financial institutions began to make progress with the introduction of the "five-tier loan classification criteria." In February 1998, the People's Bank of China selected Guangdong Province as a pilot area for the application of these criteria, which are the international standards. The loan portfolios of banks, depending on their degrees of risk, were classified with reference to five ranks: "pass," "other assets especially mentioned," "substandard," " doubtful," and "loss." Loans in the bottom three ranks are defined as "non-performing loans" (Table 10). The task of classifying all bank loan portfolios under the five-tier system will be completed in June 1999.

In addition, the Chinese authorities have been considering ways to dispose of the non-performing loans of the four major state-owned commercial banks, taking into account the experiences of other countries, including the role of the Resolution Trust Corporation (RTC) in the United States and developments in Japan. In January 1999, a People's Bank of China conference adopted a policy calling for the establishment of financial asset management companies.

On April 20, 1999, the Xinda Asset Management Company of China was established.(21) Affiliated to the China Construction Bank, the company is capitalized at 10 billion renminbi and is wholly owned by the Ministry of Finance. It will dispose of all non-performing loans of the China Construction Bank up to 1996, which amount to 200 billion renminbi (US$24 billion). Preparations are now being made for the establishment of similar companies for the Bank of China, the Industrial and Commercial Bank of China, and the Agricultural Bank of China.

As part of their efforts to strengthen control systems for asset-liability ratios, the Chinese authorities have directed the state-owned commercial banks to reduce their non-performing loan ratios, which stood at 7.9% (25% under the old classification system) at the end of 1997, by 2-3% each year.

The non-performing loans of rural credit associations have also become a serious problem. To avoid risk, these organizations will also be required to reduce their non-performing loan ratios by 2-3% annually.(22)

At present, the task of non-performing loan disposal is being approached through reductions of the debts of state-owned enterprises, on the grounds that this will facilitate state-owned enterprise reform. Table 11 shows targets for the reduction of non-performing loans, together with progress to date. The amounts written off refer to loans from commercial banks to designated state-owned enterprises in 111 cities designated for capital structure rationalization, which is a part of the state-owned enterprise reform process. Under the regulations for financial institutions, losses on loans to bankrupt borrowers in other regions and by other financial institutions are being disposed of.

5) Liquidation and Restructuring of Financial Institutions

In China, the financial position of non-bank financial institutions had become a problem as early as the economic overheating phase of 1993. In the second half of that year, the procurement of funds from the interbank market was prohibited, and in 1995, the central government had ceased providing guarantees when regional trust and investment companies raised funds offshore. In its "decision concerning financial system reform" at the end of 1993, the government adopted a regulatory policy designed to guide non-bank financial institutions in a sound development direction.Thereafter, closures and liquidations reduced the number of non-bank financial institutions to 239 by the end of 1998, from 745 at the end of 1988.

In December 1998, the Chinese government announced that it would formulate and implement a restructuring plan to separate and transfer operations of companies owned and managed by the army, the police, the Party, and government agencies.(23) Among the 239 non-bank financial institutions concerned, the plan called for the continuing existence of the China International Trust and Investment Corporation (CITIC) and Guangda Trust and Investment Company as central-level organizations. In principle, one institution would be retained in each province and municipality, and all others would be restructured through closures, amalgamations, transfers, and other methods into approximately 40 companies.

As early as 1997, the China Rural Trust and Investment Company and several other companies had already been shut down after becoming unable to repay their debts through insolvency. The period since 1998 has seen a series of liquidation or restructuring of several financial institutions, including the Hainan Development Bank, the Guangdong International Trust and Investment Corporation, and the China Investment Bank (Table 12).

4. Interim Assessment of and Future Outlook for the Financial System Reform

As is apparent from the preceding discussion and analysis, the main aims of "Zhu Rongji's three-year financial reform plan" were to dispose of non-performing loans and improve the financial order in order to prevent financial risk. To what extent will the financial system reform help to achieve these goals, and how achievable are they? Obviously, the final verdict must await the conclusion of the three-year period covered by the plan, at the end of the year 2000. Our main aim in this section is to provide an interim assessment at the current point in time, based on the progress made under the plan. We will also attempt to predict the outlook for financial system reform.

(1) Interim Assessment of the Financial System Reform

First, reforms affecting the administrative structures of the People's Bank of China have essentially boosted the bank's authority. The reform process was a way of keeping the bank independent from regional governments so that it could manage and supervise the financial system as a whole. Interference and intervention by regional governments were eliminated from all aspects of the bank's operations, personnel management, and financial activities in the areas under its jurisdiction. Its management and supervisory powers were thus strengthened, enabling it to centralize macro-level adjustments at its headquarters.

Second, reforms affecting the management systems of state-owned commercial banks resulted in a shift from direct control, based primarily on the quantitative limitation of lending, to reliance primarily on indirect controls. This was achieved through such measures as organizational reform of state-owned commercial banks and the abolition of lending ceilings. The People's Bank of China issues quarterly and annual (fiscal year) guidelines to state-owned commercial banks as macro-control indicators. The commercial banks simply take these into account in their fund procurement planning and are able to invest the funds, of which they have raised, on the basis of their own judgment. These changes will facilitate the conversion of state-owned banks into commercial banks, and are expected to make a major contribution to the qualitative improvement of finance and the prevention of increases in the amount of non-performing loans.

The commercial banks will benefit from the reform of the legal reserve system. Since they will aggressively work to tap potential demand for funds and stimulate the economy, the deteriorating trend in their earnings will be mitigated. Unlike measures designed simply to promote financial easing, this change can be seen as a mechanism to encourage a more autonomous and aggressive lending stance on the part of the commercial banks.

The issue of special government bonds worth 270 billion renminbi to state-owned commercial banks is a valuable move that will raise the banks' equity ratios above the 8% international benchmark.

Third, the reform of separate management systems for banking, securities, and insurance sectors will make an important contribution in terms of avoiding financial risks.

Fourth, the introduction of the "five-tier loan classification criteria" has resulted in the reclassification of banks' non-performing loans according to international standards. This will enhance the ability of the People's Bank of China to supervise and regulate financial institutions. It will also ensure that loans are managed in accordance with international standards, thereby making an important contribution to the facilitation of lending-risk control. The establishment of financial asset management companies to handle the disposal of non-performing loans reflects the determination of the Zhu Rongji cabinet to overcome this problem.

Fifth, the liquidation and restructuring of financial institutions have centered primarily on the closure and amalgamation of non-bank institutions. This process is now occurring widely. Particularly important from the viewpoint of avoiding financial risk are the liquidation and restructuring of major financial institutions, such as GITIC and the China Investment Bank. These moves are indicative of the Zhu Rongji cabinet's determination to commit to financial system reform in its true sense.

It would be reasonable to conclude that, in most cases, the financial system reform has prevented financial risk and stabilized the financial system.

(2) Future Outlook

As discussed below, however, there are still a number of issues relating to financial system reform in China. These issues could hinder the reform process.

First, as indicated in the preceding discussion, the reform of the management system of the People's Bank of China is clearly playing a positive role. However, it is possible that the adjustment process will bog down when it comes to establishing the larger-region branch structure.(24)

Second, there is concern that slower economic growth will cause a further increase in the non-performing loans of state-owned commercial banks. While the government is expanding public investment in infrastructure and other areas under an aggressive fiscal policy, other demand items for the Chinese economy, such as business sector equipment investment, personal consumption, and exports, are all sluggish. Under these circumstances, it is inevitable that the reform of state-owned enterprises, which results in unemployment, will decelerate. In the medium- to long-term perspective, this could cause an increase in non-performing loans.

Third, the disposal of non-performing loans is most crucial to the reform of the state-owned commercial banks. Since 1998, the Chinese authorities have aggressively responded to this problem by introducing the "five-tier loan classification criteria," which are international standards, and establishing financial asset management companies. However, the non-performing loans that exist today date from the transition to a market economy, and because of the vast amounts of money needed to dispose of the loans, ultimately the only solution will be an injection of public funds. This is because the government has been forcing financial institutions to shoulder the responsibility for poor performance (in the form of non-performing loans) by state-owned enterprises, which have been a breeding ground for non-performing loans, when really it should have taken this management responsibility upon itself, through fiscal expenditure.

Due to the present economic environment, however, it would be unrealistic to expect the government to take on the fiscal burden of disposing of such huge amounts of non-performing loans, since it is already working to stimulate the economy through large-scale bond issues. It also faces other costs, including the need to provide for a rapidly growing unemployed population and to bring the social security system in for a soft landing. The disposal of non-performing loans will inevitably be a lengthy process.

Fourth, in relation to the establishment and operation of financial asset management companies, the government will need to avoid moral hazard and a hasty approach to the disposal of non-performing loans.

Fifth, insolvent banks and non-bank financial institutions are being liquidated and restructured as part of the financial reform process. The collapse of GITIC has heightened the concerns that foreign financial institutions and investors have about Chinese businesses. The Chinese authorities must learn from the GITIC case and recognize the effects an inadequate bankruptcy processing can cause. Hereafter, they must take account of the international implications of policy measures.

Sixth, financial system reform is gradually bringing improvements in the Chinese financial system, and progress is also being made toward the disposal of non-performing loans. Yet, financial institutions have been made to bear the cost of internal inconsistencies in the state-owned enterprises. For this reason, the process of financial system reform must be steered toward the elimination of government interference in the management of state-owned enterprises and financial institutions, and toward the development of a framework that will allow financial institutions to have management autonomy, take responsibility for their own activities, and select sound borrowers.

China is starting to search for such a framework. The question is whether or not the state-owned enterprises can become healthy recipients of finance. It is the state-owned enterprises that are jeopardizing the health of the financial system. The successful reform of state-owned enterprises is an essential prerequisite for genuinely successful financial system reform. Because of space limitations, we will leave this topic for a future article.

IV. Reform of Administrative Organizations -Progress and Outlook

1. Identification of Issues and Aims of Research

In this chapter, we will analyze the current state of reform in China's administrative organizations and the problems affecting the reform process. We will also attempt to predict the short-term outlook from the results of this analysis. Such an analysis is important in terms of assessing whether administrative organizations are helping to promote the current structural economic reforms.(25)

Even if state-owned enterprises or financial institutions rationalize their operations by reducing their work forces or facilities and thus become able to compete with foreign companies and financial institutions, they will be unable to take advantage of their new strength if administrative organizations continue to interfere excessively in their activities. This would negate any benefits from state-owned enterprise reform and financial system reform. Conversely, if the government can reduce interference in the management of individual enterprises and financial institutions, and successfully strengthen the sector in charge of implementing fiscal and financial policies that reduce economic overheating or stagnation, conditions will be right for accelerated economic reform.

As Zhu Rongji made clear in his inaugural press conference as premier, administrative reform is regarded not simply as a way of facilitating structural economic reform, but as one of the government's most important priority. If the reform fail, Zhu Rongji's political base will be weakened, and there could even be a decline in the prestige of the leadership as a whole, which is led by President and General Secretary Jiang Zemin. It is from this perspective that we will examine the reform of administrative organizations, which has again come into the spotlight since the organizational reform of the State Council (cabinet) in March 1988.

Our research goals in chapter IV are threefold. First, we hope to deepen our understanding of the current state of, and future outlook for, state-owned enterprise reform and financial system reform discussed in chapters II and III, through clarifying the current state of administrative organization reform and the problems involved. At least, since administrative organization reform will have a major influence on economic activities, an evaluation of the progress made should contribute to the task of accurately assessing the current structural economic reforms.

The second research goal is to list major measures already implemented or scheduled for the future, and to analyze the content of those measures. Because of the short period of time that has passed since the reform began in 1998, papers and media reports on the topic of administrative organization reform have tended to provide little more than explanations of individual measures and reports on the current situation. Such sources usually focus on just one aspect, and they tend to be complicated.

It is surprisingly difficult to ascertain goals for the three-year period from the start of the reform (following Zhu Rongji's statement at his inaugural press conference as premier), and the extent to which those goals have been achieved to date. We have used official Chinese sources, including "Explanation on the Plan for the Restructuring of the State Council" and the "Report on the Work of Government," to overview the progress made since the start of the reform just over one year ago, and to identify key measures to be implemented in the future.

The third research goal is to clarify the structural problems affecting China's administrative organizations, and to show the uniqueness of the administrative reform that is now being implemented under the leadership of Premier Zhu. Our analysis will include a comparison with past debate about "reforms of political regime," which was especially evident in the second half of the 1980s.

In section IV.2 and subsequent sections, we will endeavor to achieve these three research goals through specific analyses. We will begin by identifying the main problems affecting administrative organization of Chinese government and summarizing the process that led to the present administrative reform program, through examination of existing research and speeches by Chinese leaders.

2. Background and History of Administrative Organization Reform

(1) Principal Problems Affecting Administrative Organizations

We will first identify the issues that Chinese leaders regard as major problems affecting government organizations. The following discussion is based primarily on two major speeches.

The first speech was made by then Vice Premier Deng Xiaoping at an extended meeting of the Political Bureau of the Chinese Communist Party in August 1980. The speech was entitled "Reforming Leadership Systems in the Party and the State" [Deng (1980)].

In his speech, Deng Xiaoping listed abuses relating to the leadership structures of the Party and the state, and called for remedial action. He placed particular emphasis on the following three points.

The first problem was the tendency toward bureaucratic rule. Specific examples listed by Deng Xiaoping included not only issues of personal morality, such as bribery, abuse of authority, and scolding away people needlessly, but also the problem of bloated organizations, in which the number of people increased but the amount of work did not, and a lack of clearly defined areas of authority within organizations.

The second problem was the excessive centralization of authority. Though the Cultural Revolution practically ended with the death of Chairman Mao Zedong in 1976, its effects on government organization still remained. In the name of unitary leadership by the Communist Party, powers that should have resided in the government or economic organizations (such as the state-owned enterprises of that period) had been concentrated in the hands of the Party committees and, ultimately, the Party Chairman (or Party committee secretaries in the regions). Deng Xiaoping asserted that this system, in which all matters were decided on the basis of "the voice of the Authority" by leaders, was the main cause of policy errors like the Cultural Revolution. He called for changes to remedy the excessive centralization of power.

Before listing problems relating to the leadership system, Deng Xiaoping referred to the criteria for selecting the next generation of State Council leaders. He took issue with a situation in which the blurring of boundaries between Party business and government business allowed the Communist Party to take over the role of government. He also said that leaders should not hold both Party and government posts. This point is highly significant, both as part of the program to correct the excessive centralization of power, and also as a point of debate in relation to subsequent political and administrative reforms.

The third problem was the lack of proper systems relating to terms of office and retirement for senior officials. When Deng Xiaoping raised this issue, there were no "clear and appropriate rules" concerning these matters. A small number of senior officials, notably the "Gang of Four," had been dismissed for crimes against the revolution and other reasons. However, others were able to remain in office until they died. Moreover, many people whose careers had been interrupted during the Cultural Revolution had returned to public life, necessitating the creation of more second-tier and nominal posts and the establishment of new organizations. As a result, the number of organizations under the control of the State Council had soon risen to 100. Clearly, it would not be possible to control the growth of this already bloated structure without proper systems to govern terms of office and retirement.

The second speech was a report presented by then General Secretary Zhao Ziyang to the 13th CCP National Congress in 1987. His theme was "Toward the Socialism with Chinese Characteristics" [Zhao (1987)].

This comprehensive report covered foreign policy, the economy, and social issues, and was not a document only pointing out problems within administrative organizations. In it, Zhao Ziyang acknowledged the aforementioned speech by Deng Xiaoping as a "guiding document" and basically followed the same line. The report was highly significant, however. Since 1986, the progress of economic reforms had prompted growing debate over the need for parallel "reforms of political regime." And against the backdrop of this situation, the report contains a proposal, from the Communist Party leadership itself, for the reform of the entire political system.(26)

In relation to administrative organization, General Secretary Zhao Ziyang acknowledged the lack of a clear demarcation between Party affairs and government affairs, and the fact that efficiency was adversely affected by a system in which the Party carried out all political functions by proxy. While affirming that leadership by a strengthened Communist Party was essential, he called for the separation of Party functions and government functions. In the sense that it contained an explicit call for the separation of the Party and the government, the report was more radical than the Deng's speech. The report is also highly significant in discussing the history and problems of administrative reform because it expressed concern about bloated administrative organizations and called for the simplification of organizations and reduction of officials.

(2) History of Administrative Organization Reform

To what extent have these problems been overcome? The following discussion re-examines reforms relating to government administration in the period between the 1980s, and the start of the administrative organization reform process led by Premier Zhu Rongji in 1998.

There has been considerable improvement in the area of terms of office and retirement rules for senior officials. The 1982 Constitution specified terms of office for key state leaders, including the President of the Republic (Head of State), the Premier and Vice Premier of the State Council, and the Chairman of the Standing Committee of the National People's Congress (equivalent to the speaker in a parliament). It also prohibited re-election to a third term of office. (The constitution did not include a rule prohibiting a third-time election to the chairmanship of the Central Military Commission, which was the post then held by Deng Xiaoping.) This rule is still observed today.

In 1982, the Central Advisory Commission of the Communist Party was established to facilitate the changing of the guard by softening resistance to change among the older generation of leaders. The commission, which was made up of people who had retired from senior posts, continued to exercise a certain amount of influence on Chinese politics. It was abolished in 1992, however, in part because several of its members had died, and also because of the need to curb interference by Party elders in order to strengthen the power base of the Jiang Zemin leadership. The dissolution of the Central Advisory Commission made it virtually impossible for anyone to retain senior posts in the Communist Party or the government for life.

Efforts to correct the tendency toward bureaucratic rule have produced varying results. China's leaders have frequently implemented programs of political and ideological education to correct the situation of senior officials breaking the rules. At times, they have also imposed severe sanctions, including expulsion from the Party and dismissal. That these measures have not been entirely effective is evident from the fact that one of the causes of the Tiananmen Square Incident in 1989 was anger against the abuse of power for illegal personal gain by individual bureaucrats or groups of bureaucrats, and from the fact that cases of official corruption and abuse of power have continued even after the Tiananmen Square Incident.

Administrative reforms have also sought to reduce the number of ministries and commissions. The number of organizations within the State Council, which had swollen to 100 by 1981, was reduced to 61 as a result of these measures. However, new organizations were subsequently created, or re-established, on the grounds that they were needed to "build the economy," and by the end of 1986, the number had climbed back to 72. Administrative reforms implemented in 1988 and 1993 failed to produce significant changes. This view is based on the fact that, while the number of standing organizations was reduced, the effectiveness of the measures was negated in other ways, such as through the establishment of non-standing organizations.

Nor was there any real progress toward the solution of other problems, such as vague demarcations of authority between government agencies and excessive interference in the management of enterprises. In relation to numbers of personnel, China's leaders themselves have admitted, albeit indirectly, that they have been unable to find an effective solution to the vicious circle in which organizations are simplified only to become bloated again, leading to further simplification measures followed by further bloating [Jiang (1997)].

Efforts to correct the excessive centralization of power had brought some improvement, due to measures that included the abolition of the post of Communist Party Chairman. However, priority has been given to political stability since the 1989 Tiananmen Square Incident and the resignation of Deng Xiaoping as Chairman of both the Communist Party's and the People's Republic of China's Central Military Commissions. This is reflected in efforts to return power to the center. This tendency is typified in the fact that General Secretary Jiang Zemin is holding both positions as President (Head of State) and the chairmanships of the Party's and the state's Central Military Commissions.

Under the policy of separating the Party and the government, which was adopted at the 13th CCP National Congress in 1987, steps were taken to abolish the "Party groups" that had previously played a leadership role within administrative organizations (they were established within any leadership organization outside of the Communist Party), and to confine the leadership role of the Communist Party in administrative organization to major policy decisions and the allocation of key posts only. Efforts in this direction have faltered since Tiananmen Square Incident, however, and the Party group system has been restored.

3. The Aims of Administrative Organization Reform and Its Progress to Date

(1) The Aims of Zhu Rongji's Administrative Organization Reform Program

Two aspects will be analyzed in this section. First, we will identify the principal aims of administrative organization reform, which was positioned as a major priority for the government led by Premier Zhu Rongji. Second, we will discuss the measures that had been implemented already, or had been adopted for future implementation at the time of writing this report (June 1999).

We will begin by ascertaining what problems were identified and what goals were set for the administrative organization reform initiative led by Premier Zhu Rongji, using sources including the official documents introduced in IV.1, records from Premier Zhu Rongji's inaugural press conference, and other information. We will also consider whether there has been any shift away from the perceptions mentioned in IV.2. The sources also include General Secretary Jiang Zemin's political report to the 15 th CCP National Congress in 1997. This predates Zhu Rongji's emergence as leader of the administrative organization reform in 1998. However, it cannot be excluded from the scope of the analysis, since it is at the CCP National Congress that the basic political and economic line is determined for the next five years.(27)

The first goal of the administrative organization reform led by Premier Zhu Rongji is to achieve a functional transition that will result in the creation of a government and organizations capable of fulfilling the role needed under a socialist market economic system. Even in the second half of the 1980s, when there was vigorous debate about the need for "reforms of political regime," there were calls for the government to shift from direct to indirect methods of controlling enterprises in response to the "demands imposed by economic reform" [Zhao (1987)]. At that time, however, priority was given to the separation of the Party and the government, and this functional transition was treated as a secondary issue.

Subsequently, the concept of a socialist market economy, the aim of which is to essentially create a market economy (in which, for example, resources are allocated through market functions) was approved as basic policy for both the Communist Party and the state. And the government began to announce specific measures for the achievement of this functional transition. It would strengthen the macro-control, social management, and public service sectors, while it would restructure and downsize those sectors responsible for the control of production and business activities, and transfer authority for these areas to the enterprises themselves. Because the separation of the Party and the government was no longer a goal, this functional transition assumed greater prominence as a goal for administrative organization reform.

The second goal of administrative organization reform was to simplify organizations. As discussed above, the bloated structures of the government had repeatedly been identified as a negative factor, and many attempts had been made to remedy this problem. However, it was not possible to eliminate all of the abuses associated with bloated organizational structures, and many problems, including a lack of clearly defined areas of authority, remained unresolved. For this reason, the simplification of organizational structures has been an issue ever since the 1980s.

However, there is a new reason, one that was not apparently recognized in the past, why simplification is essential. This was summed up by Luo Gan, who previously served simultaneously as a State Councillor and the Secretary-General of the State Council (equivalent to the Chief Cabinet Secretary in Japan) but is now only a State Councillor. He stated in his "Explanation on the Plan for the Restructuring of the State Council" speech that "there are many administrative agencies, and many places producing policies" [Luo (1998)].

As a specific example, let us consider the situation surrounding petrochemical plants. Before the current administrative orgatnization reform program, petrochemical plants were under the jurisdiction of the Ministry of Chemical Industry, the State Economic and Trade Commission, and the State Planning Commission. When a single area of activity is under the control of multiple government agencies, there will inevitably be problems, including duplication of tasks and confusion over policies. That appears to be why simplification has emerged once again as a key goal for administrative organization reform.

The third goal is to decrease the number of personnel and skill up the staff. As stated earlier in this paper, personnel numbers have been reduced many times since the 1980s, leading to temporary declines in the numbers of people employed in administrative organizations. But because these cuts fell short of the size of the reductions that were really needed, agencies continue to employ more people than is required to carry out their tasks. In fact, an analysis of trends in the numbers of employed persons in government agencies, the Party agencies, and social organizations suggests that numbers may actually have increased due to the such measures as the establishment of non-standing organizations (Fig. 7).(28)

Consequently, it has not been possible to curb rises in expenditure for government administration, especially the cost of labor. This situation has led to chronic deficits in the state budget, as well as shortages of funds to invest in education and other areas (Fig. 8). What is different about the present situation from the past is that Chinese leaders now clearly recognize and indicate the need for organizational reform and the reduction of personnel from a fiscal point of view. This is a key feature of the present administrative organization reform process.

The harmful consequences of over-staffing in administrative organizations do not remain in the area of state budget. To cover the costs, each sector of the government levies payments (known as "unreasonably collected fees") on the ground of various reasons. This practice imposes an extra burden on the people and on foreign enterprises.

To sum up, there is a sense of crisis in China that rising administrative expenses are creating a situation that could bankrupt the state and discourage foreign direct investment. That is why the government is working to reduce the administrative work force and create a smaller team of highly skilled people. It also explains why the reductions sought are larger than in early reform attempts.

The creation of an elite administrative work force is important for another reason. This change will not only curb widespread corruption, including bribery and abuse of authority, but also help to instill in employees the idea that public service workers have a duty to behave ethically and to carry out their tasks efficiently and in accordance with the law.

(2) State of Progress at Start of Second Year

The administrative organization reform process led by Premier Zhu Rongji has entered its second year. The program has begun to produce tangible results. The steps the government will take to ensure that pledged goals are achieved within the period of three years are also becoming clearer. In this section, we will examine three major benefits produced by the reform to date, together with specific measures planned for the future.

One key achievement is the reduction of personnel numbers. Before the administrative organization reform began, there were six Vice Premiers and eight State Councillors who are one rank below the Vice Premier. As a result of the government's efforts to create an elite administrative team, there are now four Vice Premiers and five State Councillors. From these levels, the reductions are now being extended to the entire State Council organization. The weekly journal Liaowang reported in its issue of December 7, 1998 that the number of jobs had been reduced by 47.5%.(29)

A variety of measures are being implemented to assist those made redundant by the cutbacks. For example, under a new system, senior officials at vice minister rank and above in the State Council are assigned, after a period of training, as special inspectors. Their new task is to supervise the management of high-priority large state-owned enterprises. Another system helps laid-off staff to find new careers by sending them to university to obtain bachelor's or master's degrees. In addition to jobs relating to business, finance, accounting and taxation, and legal affairs, these people are also being employed in "social intermediation organizations," which appear to be involved in consulting activities [Li Peng (1998)].

A second major achievement is the organizational restructuring of the State Council. A start has been made on a restructuring process in line with the "Explanation on the Plan for the Restructuring of the State Council" approved by the National People's Congress in March 1998. Under this program, State Council organizations have been consolidated and streamlined after being classified into the following four sectors: (1) macro-control (responsible for financial and fiscal policies, etc.), (2) industrial and economic control, (3) education, science and technology, culture, social security, and resource control, and (4) state political affairs (Table 13).

Of special significance, in industrial and economic control sector, is the integration of six ministries, which were previously deeply involved in the control and management of individual enterprises or specific industries, into the State Economic and Trade Commission (equivalent to Japan's Ministry of International Trade and Industry). Among the six ministries were the Ministry of Machine-Building Industry and the Ministry of Chemical. Some of powers previously held by the ministries, in such areas as the notification of production and allocation planning, were not inherited under the new system.

Another aim of the program is to place under the same sector those activities that are the same or similar. In line with this policy, functions have been integrated from multiple ministries. Examples of significant achievements include that functions relating to social security policy, which were previously shared among ministries including the Ministry of Civil Affairs (responsible for social insurance in the rural sector) and the Ministry of Personnel (responsible for social insurance in individual organizations and institutions under its control), have been integrated under the Ministry of Labor and Social Security, which were previously split primarily between the Ministry of Posts and Telecommunications and the Ministry of Electronics Industry, have been brought together under the new Ministry of Information Industry.

This restructuring has reduced the number of ministries and commissions (equivalent to Japan's ministries and agencies) from a pre-reform total of 40 to just 29 today. The number of organizations and institutions under direct control of the State Council has increased from 43 to 51, but this is because several ministries and commissions were restructured into directly-controlled organizations. The overall number of organizations in the State Council has been reduced compared with the pre-reform total. A decision has been made to eliminate all but a few non-standing organizations.

As far as the macro-control sector is concerned, the powers of the State Planning Commission, which played a leading role in China's planned economy, have been dramatically curtailed of its authority. For example, its role in formulating and implementing industrial policies has been transferred to the State Economic and Trade Commission. It has also been renamed and is now called the State Development Planning Commission [JETRO(1999)]. As stated earlier, however, the powers of the State Economic and Trade Commission have been expanded.

With regard to the People's Bank of China, regional government interference in the bank's management has been eliminated, and in 1998, it restructured its branches to enhance its independence as a central bank. The Premier has been given responsibility to chair the State Commission for Restructuring Economy, which has been upgraded into a deliberation unit made up of the relevant ministers (It is not included in the total number of organizations). The restructuring has strengthened the functions of the macro-control sector as a whole.

In addition, over 200 bureau-level organizations have been reduced. This was achieved in part through the relinquishment of some functions, such as the inspections of projects which are carried out by enterprises using their own funds or loans from commercial banks, and the transfer of some functions, such as responsibility for coal mines, to regional governments [JETRO(1999)].

A third major achievement is the separation of the corporate sector from state agencies and the Communist Party organization. Until now, state agencies, including the army and judicial organizations, established enterprises and engaged in commercial activities for profit. In some ways, this practice was inevitable, given the traditional expectation, dating from the war against Japan, that agencies would meet their own expenses. This might be acceptable if the agencies limited their involvement to normal commercial activities.

However, there has been a succession of cases involving behavior that has triggered public anger. For example, some of them have directly engaged in smuggling and have hampered state revenues or harmed the productive activities of enterprises. The Jiang Zemin administration must have concluded that this problem could not be left unremedied.

Since the second half of 1998, a consensus has been established within the Chinese leadership that state agencies and the Party should withdraw from profit-making commercial activities. As part of efforts to combat corruption, priority has been given to the separation of profit-making enterprises from the army, the armed police force, the courts, and the public prosecution agencies. These enterprises were either closed down or transferred to regional governments, and this task was completed by December 15, 1998. Judging from the 1999 "Report on the Work of government," it appears that other Communist Party agencies at the central level are "steadily severing" their links with profit-making enterprises [Zhu(1999)].

The current administrative organization reform, which has been positioned as one of the "Three Reforms," is not limited to the State Council. The plan calls for similar changes to be made right down to the peripheral regional governments within the three-year time-frame. There will also be political education programs for senior officials of the Party and state agencies at the county level, aimed at curbing dishonesty, abuse of power, and other forms of corruption. The following analysis of the reform schedule will focus primarily on these two areas of regional administrative reform and political education.

The specific timetable for regional administrative reform is set down in the 1999 "Report on the Work of Government," [Zhu(1999)]. The report divides the regions into provinces and peripheral units, and sets out action programs for each. In the actual measures, "peripheral units" are further subdivided into cities, counties, townships, and districts.

Organizations at provincial level will be required to formulate their own reform plans and submit these to the central government. The targets for the plans will include the restructuring of departments modeled basically on the ministerial structure of the State Council, and a halving, in principle, of personnel numbers.

Once the plans have been checked and approved by the central government, the regional
organization will be required to phase in the reforms. Judging from the reforms implemented in 1998, it appears that the requirement to model organization basically the structure of the State Council and economic control sector. For reasons discussed later in this report, the sequential flow of newspaper reports gests that these plans are either being formulated or are already at the implementation stage.

The approach used for peripheral units is similar to that used at the provincial level in the sense that organizations will be required to formulate and implement reform plans in accordance with the central government line. There is, however, a major difference: that is, provincial governments, instead of governments of peripheral units, are required to report to the central government about the size of personnel reductions after "due consideration of the circumstances." Organizations at the county, township, and district level are also proposed to delay the start of the administrative reforms "until next year to play safe". (It is possible to surmise from this expression that reforms at the provincial level and the city level, among the peripheral units, will be implemented before that.)

The political education programs are intended to strengthen discipline through education in the "three priorities." The programs will be implemented according to the following timetable using the method described below [Kojima (1999)].(30)

Class materials will include the Chinese Communist Party Constitution, the political report to the 15th CCP National Congress, and the works of Chinese leaders including Mao Zedong, Deng Xiaoping and Jiang Zemin. The Central Committee of the Communist Party and governments at provincial level or above are required to complete their education programs, of which study period will be around two months, by mid-1999, and Party and administrative agencies at lower levels by the end of 1999. The Central Committee of the Communist Party will provide personnel to supervise and inspect the education programs, and organizations at each level will be mandated to submit written reports to the next highest level (to city governments in the case of counties and to the central government in the case of provinces).

By providing thorough political education through these programs, the Jiang Zemin administration aims to produce senior officials with certain characteristics, quickly and in large numbers. The desired characteristics are loyalty to central directives and self-control (the ability to avoid becoming involved in corruption).

4. Interim Assessment and Future Outlook for the Administrative Organization Reform

(1) Interim Assessment of Administrative Organization Reform

Premier Zhu Rongji has made administrative organization reform one of his government's top priorities. Judging from progress to date, to what extent can we expect the major aims of the reform to be achieved? Zhu Rongji stipulated a three-year deadline for the completion of the program, and final a evaluation must await the conclusion of that period in the year 2000. The following is an interim assessment.

It appears that targets relating to the functional transformation of government organizations have been largely achieved. Most of the ministries that previously exercised direct control over corporate management have been singled out for restructuring. In most cases, their powers, including the authority to issue production and allocation planning directives to enterprise, were either relinquished or curtailed when the organizations were absorbed in the State Economic and Trade Commission. Since these measures have expanded the areas in which enterprises(especially state-owned enterprises) and financial institutions can make autonomous management decisions, it would be reasonable to conclude that they have also helped to facilitate structural economic reform.

The process of removing enterprises from direct management by the Party and government agencies, including the army and judicial organizations, has also yielded tangible benefits. These changes have accelerated the functional transformation by forcing the agencies concerned to focus on their core activities.

Apart from the State Planning Commission, which wielded enormous power under the planned economic system, the ministries responsible for fiscal and financial policies have strengthened in terms of their authority and independence. As a result, the government's functional transition, from direct control over the management of companies and other organizations, to macro-control of the economy has become more apparent.

However, the preceding assessment refers only to the central level, especially the State Council. At the regional level, many organizations are still preparing their reform plans, and it would be inappropriate to assess the functional transformation at this stage. The only observation that might be made is that if the principles of the functional transformation achieved at the central level had been applied consistently at the regional level, the functional transformation goals for Party and state agencies would have been mostly achieved.

The special inspector system is a new way for administrative agencies to exercise control over enterprises. In some senses, it runs counter to the principle of separating the government from enterprise. However, the government has given priority to the establishment of conditions that will facilitate the reduction of job numbers, by creating new jobs, such as this senior officials at vice minister level and above. For this and other reasons, the government appears to have had no other choice at this stage.

There has also been further progress toward the simplification of organizations, at least as far as the State Council is concerned. By giving single government agencies responsibility for particular areas, such as special inspector system, for redundant petrochemical plants, information policy, and social security, the government appears to have alleviated the harmful effects of a situation in which "there are many administrative agencies, and many places producing policies."

Even so, there are still some areas within the State Council that require simplification. For example, the Ministry of Foreign Trade and Economic Co-operation should be merged with the State Economic and Trade Commission, and the Ministry of Railways with the Ministry of Communications. The various research institutes administered by the State Council should also be consolidated and streamlined. Simplification at regional level will not begin in earnest until the second half of 1999. Any assessment of achievements of the targets for simplification of administrative organizations must be discounted, therefore, to reflect these factors.

As far as the turning of personnel into highly skilled elites is concerned, the State Council has achieved a 47.5% reduction in the job numbers. Since the numerical target was to halve the work force, it seems that this goal has been achieved in respect of the State Council. Unless the various steps taken to assist those made redundant prove to be ineffective, leading to situation in which redundant employees are taken back into non-standing organizations established for that purpose, it seems increasingly likely that the target will be achieved within the allotted period. However, considerable difficulties are anticipated with regard to the qualitative dimension in the formation of a team of elites and the reduction of employee numbers at the regional level.

(2) Future Outlook

The administrative organization reform initiative led by Premier Zhu Rongji differs from previous attempts in a number of ways. For example, the government has explicitly acknowledged that the bloated administrative organizations have become a heavy burden on government finances. In addition, the program included, from the outset, specific measures to restructure ministries that had previously exercised direct control over enterprises and financial institutions. Because of these and other differences, there were significant achievements in the first year of the reform, and the level of achievement is expected to rise still further. Even so, it would be overly optimistic to predict that all targets will be fully achieved in the time that remains. This is because the reform process will be more difficult at the regional level, and the outcome could affect the overall progress of administrative organization reform.

For example, the State Council had 33,000 employees at the start of the reform period, so it needs to find new jobs for one-half of that number, or 16,500. However, to halve the number of employees at the regional level, which counts eight million people, it will be necessary to find new jobs for four million people.(31) It may not be possible for the current re-employment measures being implemented to deal with the number of people who will be affected by the restructuring. People restructured out of the State Council have ability and connections with many important persons. A high value is placed on these qualities, and reports indicate that there has been a flood of job offers. On the other hand, the consensus is that those restructured out of regional administrative organizations are generally lacking in both skills and connections. The task of finding new jobs for these people is likely to be difficult.

Of course, it is possible that the size of job cuts at the regional level will be eased to reflect regional conditions, such as a lack of employers other than state organizations capable of providing large numbers of jobs [Zhu (1999)]. Yet, if the goal of reducing the overall number of personnel in regional organizations by about 50% cannot be achieved, it will be seen as a failure of the administrative organization reform promoted by Premier Zhu Rongji. Such an outcome would probably damage the prestige of Zhu Rongji and the entire Jiang Zemin leadership. Events at regional level do not always proceed in accordance with the wishes of the central government, since "for every policy at the top, there is a countermeasure at the bottom." Therefore, theprogress of administrative organization reform in the regions will need to be monitored closely, especially from the perspective that the outcome can be an indicator of the influence the central government has over the regions.

A major difference, in comparison with the second half of 1980s when there was widespread debate about "reforms of political regime," is that the administrative organization reform program led by Premier Zhu Rongji does not aim to change the relationship between the government and the Party, or to separate the Party from the government. The leadership under Jiang Zemin has made political stability its first priority, and the administration is apparently trying to avoid any measure that has even the slightest potential to trigger political upheaval by eroding the leadership of the Communist Party, which is a fundamental element of governance in China.

As is clear from the analysis in IV.2, however, some issues are still unresolved. The restored Party groups could lead to such problems as the mingling of Party and government affairs, and to reduced efficiency when the Party handles government affairs by proxy. The administration has made significant progress toward the clarification of areas of authority between the ministries and commissions of the State Council, but not between the Party groups and administrative organizations.

If the government targets simplification in this environment, it is possible that the Party's superfluous control structures within administrative organizations will quickly emerge as targets for restructuring. Moreover, the simplification of administrative organizations was identified as an essential measure in terms of "strengthening the energy of the Party" in the "Report on the Work of Government" presented to the 15th CCP National Congress [Jiang (1997)].

There may be a division of opinions within the leadership between those who think that simplification should be taken further in order to maintain the leadership of the Communist Party, and those who want the present systems maintained. If that happens, the reform process will stall until a consensus can be reached.

It is possible too, that the relationship between the Party and the government may need to be changed fundamentally in order to realize the goal of turning the bureaucracy into a highly skilled elite.

If the current "three priorities" program is effective in the short term and leads to a decrease in the incidence of corruption cases, it may not be necessary to confront this difficult situation. However, the rot is extremely widespread, and numerous cases of bribery have been discovered even among the prosecution authorities, whose task is to enforce the rules against corruption. Education alone is unlikely to bring a rapid improvement in this situation.

Of course, the government is improving the legal system and strengthening the judicial system. While the Communist Party is required to "act within the law and the constitution," its role also includes to "guide the people and determine the constitution and law" [Jiang (1997)]. In other words, the Communist Party is able to act above the law. The Communist Party also continues to influence the courts and the prosecution authorities. There is no outside organization that can adequately supervise or check the behavior of the Communist Party.

As a result, unless the Communist Party can regulate its own behavior, it will not be possible to bring corruption under control. Moreover, since government administration is integrated with the Communist Party, this situation will also limit the extent to which the bureaucracy can be turned into a highly skilled elite. If public opinion starts to adopt this viewpoint, the people will conclude that the administrative organization reform has failed. This could lead to an eruption of mass demonstrations throughout China, calling for the resignation of the Jiang Zemin leadership and an end to the Communist Party's single-party dictatorship.

This is a worst-case scenario. However, the Jiang Zemin leadership wants to avoid such an outcome, and it is possible that they will resort to the Party-government separation line of the late 1980s again, in an effort to create a structure in which "the Party supervises itself" [Zhu (1987)].

The achievement of a consensus on such an approach within the leadership would take a considerable period of time, and there is a risk that the reform process would bog down.

For those who need to base decisions about investment in China, or assessments of structural economic reform on the outlook for the administrative organization reform, it will be necessary to take into account the ways in which the leadership of the Communist Party and the relationship between the Party and the government could be altered by the simplification of organizations and by the creation of highly skilled elites, which are the principal goals of administrative organization reform.

End Notes

  1. People's Daily, March 20, 1998.
  2. People's Daily, September 13, 1997.
  3. People's Daily, October 13, 1997.
  4. Liaowang magazine, July 13, 1998; and People's Daily, March 19, 1999.
  5. China Textile Industry Association, China Textile News, June 19, 1998.
  6. Speech by Mr. Zheng Silin, Vice Minister of the State Economic and Trade Commission, reported in People's Daily, March 2, 1999.
  7. Ibid.
  8. People's Daily, March 19, 1999.
  9. People's Daily, March 2 and 19, 1999.
  10. Zeng Peiyan, "Report on the Implementation of the National Economic and Social Development Plan for FY1998 and the Draft of National Economic and Social Development Plan for FY1999" (March 6, 1999, at the 2nd session of the 9th National People's Congress).
  11. People's Daily, December 29, 1998 and January 9, 1999.
  12. For details of Premier Zhu Rongji's "Report on the Work of Government," see People's Daily, March 18, 1999.
  13. State Statistical Bureau, Statistical Communique of the People's Republic of China on the 1998 National Economic and Social Development, 1999.
  14. For information about Premier Zhu Rongji's statement, refer to JETRO (1999), p.72.
  15. Refer to speeches by Wu Bangguo (Vice Premier) and Shi Wanpeng (Director of China Textile Industry Association) made at a national textile industry restructuring conference; and Du Yuzhou (1994).
  16. For a discussion of the inefficiency of Chinese state-owned enterprises, see Jia (1997), (1998), and (1999).
  17. People's Daily, March 12, 1999.
  18. People's Daily, January 13, 1999.
  19. Under the old loan classifications, total non-performing loans amounted to 1.7 trillion renminbi, or about 25% of total lending.
  20. People's Daily, January 28, 1999.
  21. China Communication, May 14, 1999.
  22. People's Bank of China, China's Financial Outlook in 1998, p. 30.
  23. People's Daily, January 1, 1999.
  24. For example, the concept of including Shanghai, Jiangsu, and Zhejiang in the Shanghai Branch was initially favored. However, Nanjing Branch was established in Jiangsu Province (to cover Jiangsu and Anhui).
  25. The government and the Communist Party have become fused together on various levels, including the members who make up their organizations. Accordingly, the term "administrative organization reform" as used in this paper encompasses not only administrative agencies and the people involved in their activities, but also the state organizations and personnel, namely, the courts, the public prosecution system, the army, and the Chinese Communist Party.
  26. There was lively debate about "reforms of political regime" in the second half of the 1980s. Some people called for political reform, not just as an adjunct to economic reform, but as a wider process that would also include the separation of the three arms of government and the abolition of the Communist Party's single-party dictatorship. It is assumed that open discussion of such issues ended with the 1989 Tiananmen Square Incident. For that reason, the "reforms of political regime" period is defined in this paper as ending at that time.
  27. Strictly speaking, the 1998 "Report on the Work of Government" was presented by then Premier Li Peng. However, the content of the report appears to have been influenced considerably by the views of then Vice Premier Zhu Rongji, who had already been selected as the next premier. That is why it has been included in this analysis.
  28. Only totals are shown in the China Statistical Yearbook.
  29. Liaowang is a weekly magazine with general content, including analyses and commentary about current events. It has a reputation for frequently carrying contributions and comments from the Communist Party, state leaders, and their advisors.
  30. The "three priorities" are learning, politics, and ethical behavior. General Secretary Jiang Zemin proposed this approach in 1998, and it is now being implemented on a trial basis.
  31. This figure also includes people employed by Communist Party agencies. It was decided to use this figure, however, because the expensesof Communist Party agencies are met from the state budget [Tang (1997), p.57], and because no other suitable data could be found.
  1. State Statistical Bureau, China Statistical Yearbook, China Statistical
    Publishing House, 1998.
  2. State Statistical Bureau, A Statistical Survey of China, China Statistical Publishing House, 1998 and 1999.
  3. State Statistical Bureau, Statistical Communique of the People's Republic of China on the 1998 National Economic and Social Development, February 26, 1999.
  4. Editing Committee of Finance Year Book, China Ministry of Finance, Financial Year Book of China, 1998.
  5. Speech by Zheng Silin, Vice Minister of the State Economic and Trade Commission (in People's Daily, March 2, 1999).
  6. Zeng Peiyan, "Report on the Implementation of the National Economic and Social Development Plan for FY1998 and the Draft of National Economic and Social Development Plan for FY1999" [in Chugoku Tsushin (China Daily News), Chugoku Tsushinsha, March 23, 1999].
  7. Speech by Wu Bangguo, Vice Premier, at a national textile industry restructuring conference (in China Textile Industry Association, China Textile News, December 30, 1997).
  8. Speech by Shi Wanpeng, Director of the China Textile Industry Association, at a national textile industry restructuring conference (in China Textile Industry Association, China Textile News, December 30, 1997).
  9. Du Yuzhou, "How to Reform - The Thought of Textile Industry Escapes from Distress," in Economic Management, 4th quarter, 1994.
  10. JETRO, Chugoku Keizai (Chinese Economy), April 1999.
  11. Jia Baobo, "Chugoku Kokuyu Kigyo Minei-ka no Mosaku," in World Economy Research Association, Sekai Keizai Hyoron (World Economic Review), December 1997.
  12. Jia Baobo, "The Factors of Inefficiency in Chinese State-owned Enterprises and the Policies for Improvement," in Dong Ying Qusuo (Japan Studies), No. 9. 1998.
  13. Jia Baobo, "M&A of State-owned Enterprises by Foreign Capital," in Dong Ying Qusuo (Japan Studies), No. 10, 1999.
  14. People's Bank of China, Loan Risk Classification Principle, 1998.
  15. People's Bank of China, China's Financial Outlook for 1998, 1998.
  16. Deng Xiaoping, "Reforming Leadership Systems in the Party and the State" (speech), 1980. [Japanese translation by Katsuhiro Ota, eds., Chugoku Kyosanto Saishin Shiryo-shu (CCP Latest Materials II), Keiso Shobo, 1986.]
  17. Hama, Katsuhiko, "Chugoku Gyosei Kiko Kaikaku no Seika to Kongo no Tenkai" (Progress and Outlook of China's Administrative Organization Reform), in Japan-China Association, Nicchu Keikyo Journal (JCA Journal), May 1999.
  18. JETRO, "Shu Yoki Seifu no Mittsu no Kansei no 98nen no Shinten (2)" (Progress in 1998 of the Three Reforms by Zhu Rongji Government (2)), in JETRO, Chugoku Keizai (Chinese Economy), May 1999.
  19. Li Peng, "Report on the Work of Government," 1998. [Japanese translation in JETRO, Chugoku Keizai (Chinese Economy), June 1998.]
  20. Li Yongchun, eds., Moves of Reforms of Regime after the Third Plenary Session of the 11th CCP Central Committee, Chungu Press, 1987.
  21. Luo Gan, "Explanation on the Plan for the Restructuring of the State Council" (speech), 1998. [Japanese translation in Chugoku Tsushin (China Daily News), March 12, 1998.]
  22. Jiang Zemin, "Let's Promote the Construction of Socialism with Chinese Characteristics toward the 21st Century under the Great Slogan of Deng Xiaoping Theory" (the political report to the 15th CCP National Congress), 1997. [Japanese translation in Chugoku Tsushin (China Daily News), September 25, 26, 1997.]
  23. Radio Press, Junkan Chugoku Naigai Doko (China Quarterly), April 10, 1998; May 31, 1998; and April 30, 1999.
  24. Kojima, Tomoyuki, Kiro ni Tatsu Chugoku (China Standing at the Crossroads), Ashi Shobo, 1990.
  25. Kojima, Tomoyuki, "Arata na Seifu Kosaku ga Hajimaru?" (Will a New Rectification Movement Start?), in Toua (East Asia), Kazankai, May 1999.
  26. Kokubun, Ryosei, Chugoku Seiji to Minshu-ka (Politics and Democratization in China), Simul Press, 1992.
  27. Pekin Shuho (Beijing Review), Pekin Shuhosha, April 7, 1998; and May 26, 1998.
  28. Liaowang (OUTLOOK), Outlook Weekly, March 12, 1998; December 7, 1998;
    and December 28, 1998.
  29. Shen Caibin, Tsushi to Theme de Yomitoku Chugoku Keizai Tokuhon (Understanding Chinese Economy from Its History and Themes), Aki Shobo, 1999.
  30. Takahara, Akio, "Chugoku Shu Yoki Kaikaku 2-nenme no Kadai" (Second Year Issues for Zhu Rongji's Reforms), in Toua (East Asia), Kazankai, June 1999.
  31. Tang Liang, Gendai Chugoku no Tosei Kankei (The Party-Government Relationship in Contemporary China), Keio University Press, 1997.
  32. Zhao Ziyang, "Let's Proceed along the Line of Socialism with Chinese Characteristics" (the political report to the 13th CCP National Congress), 1987. [Japanese translation in Chugoku Soran 1988nen-ban (China Survey 1988), Kazankai, 1988.]
  33. Zhu Rongji, "Report on the Work of Government," 1999. [Japanese translation in Pekin Shuho (Beijing Review), Pekin Shuhosha, April 6, 1999.]

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