A joint CEPR conference with the Centre d'études prospectives et d'informations internationales (CEPII, Paris) and the OECD Development Centre on `Different Approaches to Market Reforms: A Comparison Between China and the Central and East European countries (CEECs)' was held in Budapest on 6/7 October at the Institute for World Economics of the Hungarian Academy of Sciences. The conference formed part of a joint research project between CEPR and the Institute of Developing Economies (IDE), Tokyo, on `Economic Reform in Central and Eastern Europe and its Implication for China and Vietnam', funded by a grant from the European Commission under its PHARE and ACE programmes. It was organized by András Inotai (Institute for World Economics), Jean Pisani-Ferry (CEPII) and Richard Portes (CEPR and London Business School).
Fan Gang (Institute of Economics, Beijing) presented `China's Incremental Reform: Progress, Problems and the "Turning Point"', noting that China has no well- designed strategy for economic reform. Instead, pragmatic responses to fiscal and other problems are characteristic. This `incremental' approach means that the new market system is first developed outside of the old state sector, the concept of the `dual track'. As the former starts to function, it changes the environment for the latter. While initially there was high state sector resistance to reform, 1993 was a turning point. This was when the issue of ownership reform for the state-owned enterprises was first officially raised.
László Csaba (Institute for Economic Market Research and Informatics, Budapest) presented `Initial Conditions and the Political Economy of the Reform Strategy: A Central European Perspective'. He examined contextual, environmental, social and developmental differences between China and the CEECs; and what the CEECs can learn from the Chinese experience. He emphasized the role of foreign direct investment (FDI) in overall modernization, the limitations of spontaneity and of `social engineering' in systemic change, the relevance of a strategy based on specific national endowments, and the importance of export orientation and the open door policy in growing out of debt. An unpopular lesson is that reform policy can be internationally successful only if wages are kept at the right level and the regulatory framework is competitive.
Georges de Ménil (DELTA, Paris) questioned the `dual track' concept, asking whether a market economy can really survive simultaneously with the planned economy. Moreover, he saw a tight relationship between political and economic reform in China. He concurred that no economic reform is possible without some political reform.
Gérard Roland (ECARE, Université Libre de Bruxelles and CEPR) presented `Economic Efficiency and Political Constraints in Privatization and Restructuring', comparing different types of privatization in the CEECs from the perspective of the efficiency of restructuring. He analysed how the techniques affect managerial behaviour, taking into account the differences in initial country conditions and in the political constraints on privatization and restructuring. His most striking conclusion was that restructuring behaviour was roughly similar across the more advanced CEECs, despite the different privatization techniques applied.
Oliver Bouin (OECD Development Centre) presented `Hard Budget Constraints and State Enterprise Reform in China: Towards a Credible and Long-lasting Commitment?'. He first demonstrated the presence of the soft budget constraint in China's state sector. Then he listed the most important elements of the CEECs' experience in hardening the budget constraint: the establishment of an institutional environment for financial discipline, the importance of an appropriate monetary policy, and the implementation of bankruptcies, initially for their psychological impact. Lastly, he used these lessons as a framework for analysing the steps China needs to take towards hardening the budget constraint, with supporting enterprise level data.
Rumen Dobrinsky (21 Century Foundation, Sofia) noted the emergence of new types of soft budget constraints in the CEECs, related not to direct government intervention but to the weak institutional environment and the existence of exit barriers. Such constraints may be emerging in China. Moreover, he questioned the role of bankruptcies when, in the CEECs, they are applied more to small and medium-sized companies than to large ones. This also has implications, he claimed, for Roland's paper, which seems to assume that firms are viable. Dobrinsky pointed out that the largest firms, the so-called `socialist dinosaurs', are too big to fail: they enjoy considerable economic and political power.
According to Janusz Dabrowsky (Gdansk Institute for Market Economics), privatization methods are not as clear cut in the CEECs as Roland suggested. Almost all use a different mix of techniques, and so it is hard to compare their effect on restructuring across countries. Moreover, he saw no direct link between the quality of management and the success of restructuring in an enterprise; companies' external conditions exercise a more important effect on performance. For Bouin's paper, he emphasized that the soft budget constraint can be replaced by inter-enterprise arrears, and that the role of bankruptcies is limited in the CEECs.
Zhaohui Chen (LSE) presented a historical review of China's exchange rate policy. He concluded that exchange rate policy reform in China is part of the gradual overall reform, and thus determined by other policy elements. Second, the smoothness of transition from the coexistence of the official and market rates to the gradual phasing-out of the official rate, was due to the gradual economic policy approach. Third, the applicability of standard Western models in China has increased as the system becomes more international and market oriented. Fourth, while the present system is highly stable, it is achieved in a market with limited scale and scope. In future, the stability of the system will face the test of large scale international capital flows.
In `Transformation and the Exchange Rate Regime', Charles Wyplosz (INSEAD and CEPR) presented the advantages and disadvantages of choosing a fixed or flexible exchange rate regime, particularly in transition. He then evaluated the experience of transition economies, placing them in two groups: fixers and floaters. Comparing their macroeconomic performance, fixers performed better on inflation, though there was little difference in the longer run. In addition, fixers experienced a smoother but larger real appreciation, they had a persistent but moderate current account deficit, and they suffered deeper unemployment. Weaker monetary discipline was characteristic among floaters, and they had bigger and persistent budget deficits.
Jean Pisani-Ferry thought that while on paper China had a floating rate regime, considering the actual degree of control, it is closer to a fixed system. He stressed the importance of analysing the effects of exchange rate policy other than those on foreign trade. He also raised methodological problems that limit the relevance of Wyplosz's results: first, the problem of characterizing regimes, where actual rather than declared exchange rate policy must be assessed; second, the smallness of the sample; and third, whether the analysis should control for differences in other elements, such as initial conditions and political economy priorities. The most important question is whether the real exchange rate appreciation is an equilibrium phenomenon or not.
Daniel Daianu (National Bank of Romania) raised other methodological problems: the diversity of the environment in the countries in transition; the exchange rate policy reversals, which could put a country into a different group during the period analysed; and the differing effects of policy reversals on credibility. In connection with differences in initial conditions and environment, he criticized Wyplosz's implicit preference for fixed rates to reduce inflation. He indicated that in another environment, other preferences may be more relevant. Moreover, the vulnerability of the environment in transition economies makes commitment to the exchange rate an unreliable anchor.
Kiichiro Fukasaku and Henri-Bernard Solignac Lecomte (OECD Development Centre) presented `Economic Transition and Trade Policy Reform: Lessons from China'. They concluded that while China has gradually established markets for goods and services and pursues an export-oriented policy, and despite efforts to liberalize and decentralize trade activities, the country's import regime is still highly distorted, hampering integration into the world trading system. It is characterized by high average nominal tariff rates, a wide dispersion of tariffs and an extensive use of non-tariff measures, making China one of the most protected economies in Asia. The gradual approach to trade liberalization has been an obstacle to China resuming its status as a GATT contracting party and becoming a founding member of the WTO.
Françoise Lemoine (CEPII) presented `Trade Policy and Trade Patterns During Transition: A Comparison Between China and the CEECs', noting that while there are important differences, one common feature of reforms in the CEECs and China is the aim to be (re)integrated into the world economy. China and the CEECs follow different trade policies, constrained by their different initial domestic conditions and international environment. Their export policies also differ: in China, export promotion is the core strategy, selective incentives are applied, and FDI policy's main aim is to promote exports; in the CEECs, selective export promotion is not applied, and industrial policy is absent. On the whole, however, their trade performance is similar, with a rapid rise in trade with OECD countries. But China's trade has remained closely in line with an inter-sectoral division of labour and could realize the country's comparative advantage in labour intensive industries. The most advanced CEECs' trade is dominated by intra-industry specialization: they could successfully strengthen their export capacities not only in labour intensive and heavy industries, but also in mechanical industries. FDI plays an important role in both cases in changing trade patterns.
Richard Pomfret (University of Adelaide) pointed out the different purposes and settings of foreign trade opening in China and the CEECs. With China, the main aim was to promote growth and create trade patterns where comparative advantages were easy to identify. With the CEECs, however, the growth impact of opening was much smaller. Trade liberalization was more important as a cornerstone of the overall reform of the economy: world prices were needed to reach the appropriate set of relative prices. This difference explains different speeds of liberalization. While trade liberalization is beneficial in all transition economies, its purposes may be different.
Fabrizio Coricelli (Università di Siena and CEPR) presented `Fiscal Issues of the Transition to a Market Economy', focusing on the CEECs' worsening fiscal balances. He noted a close connection between the speed of reforms, cuts in subsidies and the imposition of harder budget constraints, and the increase in social expenditures. First, the correlation between output behaviour and the state budget is weak, partly because worsening balances did not occur in the initial years of transformation, when output decline was steepest. Second, the increase in social expenditures was the main force behind worsening budget deficits. Third, the need for initial transfers to losers to create support and foster reforms should have been recognized, and appropriate schemes designed. This has important implications for unemployment benefit policy and the design and reform of pension schemes.
Bert Hofman (World Bank) presented `Fiscal Decline and Quasi-fiscal Response: China's Fiscal Policy and Fiscal Systems 1978–94', reviewing the broad trends in China's fiscal system: the steep decline in revenues and expenditures, the complexity of the tax system, and the growing share of revenue for local government, all of which led to the 1994 reforms. The aims of the reforms are to make the tax system more viable, to rationalize the tax administration and to increase central government's share of revenue relative to local government. The decline in government revenues did not lead to fiscal distress, because the budgetary resources were increasingly supplemented by extra-budgetary funds, and by quasi-fiscal activities of the central bank and the banking system. But to sustain stability in the longer run, the generous recourse of China's government to the banking system for fiscal reasons must be restricted, and the consolidated government deficit must be reduced.
Roumen Avramov (Centre for Liberal Strategies, Sofia) thought that subsidies have not disappeared in the CEECs, but still appear in a more subtle form. He did not consider unemployment to be the main indicator of restructuring. Neither China nor the CEECs are behaving the way market economies behave, so more economic history should be used for understanding their economic processes.
Francesca Cornelli (London Business School) and Richard Portes presented `The Capital Structure of Firms in Central and Eastern Europe', giving two possible explanations for the fact that the debt to total assets ratio is much lower in the CEECs than in Western economies, and even lower if insolvent firms are included. First, banks are working well: they try to solve the problems of bad debts, and they are financing firms that need more funds and are less able to self- finance. In these circumstances, firms are able to achieve their optimal capital structure. Second, banks are not working well: they have no experience or ability to monitor firms and assess their ability to borrow. The consequence is credit rationing: either banks finance only those firms which have already revealed their qualities and will be profitable in the future; or, facing incomplete information, they raise interest rates. Hence, firms that are able (the most profitable ones) will use internal financing, while others will be credit constrained. In these circumstances, companies cannot achieve their optimal capital structure. Preliminary data on companies of the most advanced CEECs support the hypothesis of credit rationing.
Wing Thye Woo (University of California, Davis) presented `Financial Intermediation in China', surveying the development of the system of financial intermediation and of modes of financing fixed investment in China. The most important economic consequences of the distorted Chinese financial system are: first, a persistent inflationary bias that comes from the incentives for state-owned banks to expand credit; second, an anti-inflationary bias that comes from an increasing demand for money; and third, a significant misallocation of capital. Woo listed the most important and necessary elements of future reform of the financial system.
According to Eric Girardin (OECD Development Centre), the historical task of German-Italian-type banks was to mobilize outside finance when inside financing was insufficient. But this is not necessarily the case for the transformation period. The major link between China and the CEECs is conflict over the roles of banks. He underlined the role of the missing agents, non-bank intermediaries. In China, two more issues are important: more independence for the central bank and separate policy banks and commercial banks.
Jérôme Sgard (CEPII, Paris) drew attention to the slower speed of reform in China, and the allied dangers of further liberalization. In order to avoid these, strict monetary control is required. As for the role of banks in the CEECs, he emphasized the different macroeconomic environments in the most advanced economies. For example, Czech firms are characterized by high liquidity but low productivity in contrast to Polish and Hungarian ones. The role of banks can differ in these countries, and their activities can have a different impact not only comparing China and the CEECs, but even among the CEECs.