Accelerating China's rural transformation

title: AcceleratingChina'sRuralTransformationauthor: Nyberg,Albert.;Rozelle,Scott.

publisher: WorldBankisbn10|asin: 0821345761printisbn13: 9780821345764ebookisbn13: 9780585232096

language: English

subject Ruraldevelopment--China,China--Ruralconditions.

publicationdate: 1999lcc: HN740.Z9C6131999ebddc: 307.1/412/0951

subject: Ruraldevelopment--China,China--Ruralconditions.

AcceleratingChina'sRuralTransformation

AlbertNybergScottRozelle

TheWorldBankWashington,D.C.

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AllrightsreservedManufacturedintheUnitedStatesofAmericaFirstprintingAugust1999

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CoverphotographbyFrederickW.Crook.SpringWheatGrowingonHighAltitudeTerraces,YuzhongCounty,Gansu,China.

ISBN0-8213-4576-1

LibraryofCongressCataloging-in-PublicationDatahasbeenappliedfor.

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CONTENTSAbstract v

Preface vi

Acknowledgments vii

AbbreviationsandAcronyms viii

ExecutiveSummary ix

PartI.TheRuralSectorChallenge 1

1.AVisionfortheRuralSector 1

PartII.AnEnablingEnvironmentforRuralDevelopment 7

2.RuralIncomeandMacroeconomicLinkages 7

A.DomesticMacroeconomicDimensions 7

B.TheInternationalMarket 14

3.RuralPublicFinance 17

4.RuralCreditandFinance 25

5.TheDevelopmentofMarkets 35

6.InternationalTradeandForeignCapitalFlows 43

A.Trade 43

B.CapitalandTechnologyFlows 51

PartIII.ManagingRuralDevelopment 59

7.CultivatedLand 59

8.WaterResources 65

9.TechnicalChangeandTechnologyTransfer 75

A.AgriculturalResearch 75

B.Extension 83

10.RuralIndustry 87

11.PovertyReduction 95

12.NaturalResourceManagementandtheRuralEnvironment

Annex:PolicyandActionMatrix 113

Bibliography 119

TABLESINTEXTTable2.1:ResourceFlowsfromAgriculturalandRuralSectorstoNonagriculturalandUrbanSectors

Table3.1:TownshipFinanceinChina,1986-93 20

Table4.1:PercentofHouseholdsEngagedinDifferentActivitiesthatFinanceActivitywithLoansandAverageLoanAmount,byActivity

Table4.2:Deposits,Loans,andAssetsofChina'sFinancialInstitutions,1996

Table5.1:CostofCarryoverStocks 38

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Table6.1:China'sAgriculturalTradeBalance,1992-97 45

Table6.2:GrainPrice,Production,andSupplyVolatility(1990-97)

Table6.3:AgriculturalSubsectorDistributionofContractedFDIInflows(1994-96)

Table6.4:FinancialIndicatorsofAgriculturallyRelatedForeign-FinancedEnterprises'95

Table6.5:DistributionofForeign-FinancedEnterprisesinAgriculturallyRelatedManufacturing,byFactorIntensity,1995

Table6.6:ODAAllocationsbySubsector 56

Table8.1:WaterBalanceandEstimatedWaterRequirements,1993,2000,and2010

Table8.2:AverageGrainOutputandRevenueperCubicMeterofIrrigationWater

Table9.1:AgriculturalResearchBudgetsandResearchIntensity,1986-96

Table9.2:AgriculturalExtensionExpendituresinChina,1986-95

Table10.1:TVEEmployment,byOwnership 87

Table12.1:IndicatorsofRuralEnvironmentandNaturalResourceConservation

Table12.2:NationalInvestmentinEnvironmentalProtection,1991-95

Table12.3:ReforestationinChina(1980-93) 109

FIGURESINTEXTFigure1.1:GrossValueofAgriculturalOutput 3

Figure1.2:RuralIncomebySource 4

Figure2.1:Rural-UrbanPerCapitaIncomeRatios 12

Figure3.1:China,NationalandSubnationalSharesofRevenuesandExpenditures

Figure3.2:Rural-UrbanPerCapitaIncomeRatios 18

Figure3.3:InvestmenttoWageSpendingRatio,Shaanxi,1983-92

Figure5.1:FreeMarketSalesIndexofAgriculturalProducts

Figure6.1:MajorCommodityGroupsasaProportionofAgriculturalTrade

Figure6.2:DomesticandInternationalGrainPriceVolatility

Figure6.3:ActualCapitalFlows 51

Figure6.4:FDIInflowasPercentofGrossFixedCapitalFormation,1991-95

Figure8.1:WaterRegionsandIrrigationZones 67

Figure8.2:ProportionofInvestmentsinWaterConservancy,byType

Figure10.1:PercentofTVEOutputValue,byOwnershipType

Figure10.2:ManagerialContractEvolutioninTVEs,SampleData,1984-93

Figure10.3:BankBorrowingasaPercentofTVEOutputValue

Figure11.1:RuralAbsolutePoor 96

Figure11.2:RealInvestmentinPoorAreasPovertyReductionProgram

BOXESINTEXTBox9.1:IndiaGrowthAccountingAnalysis 79

Box9.2:AgriculturalResearchConsiderations 81

Box10.1:TypesofTVEOwnershipandControlinRuralIndustry

Box10.2:TVECreditConstraints 90

Box11.1:MicrofinanceinYilongCounty 97

Box11.2:India:GovernmentSpending,Growth,andPoverty

ABSTRACTChina'sruraleconomicachievementsofthepasttwodecadesrapidgrowthanddecliningpovertyhavebeenremarkable.However,replicatingtheseachievementsandimprovingsustainabilityduringthenexttwodecadeswillbedifficultasmanyunderlyingconditionshavechanged.Economicreformswereinitiatedwhensupplyshortagesconstrainedgrowth,butcurrently,weakdemandismoreconstraining.Furthermore,theproductivitygainsarelargelyexhaustedfromtransitionpoliciesandinstitutions;futureproductivitygainswillcomefromefficiencies,stimulatedbymarketforces,andimprovedproductivityofscarcewaterandlandresources,throughresourceconservationandnewtechnologies.Therural-agriculturalsectorwillremaindependentonarobusturban-industrialsectortocreatejobsandabsorbsurplusruralandagriculturallabortherebypermittingtheremainingfarmersaccesstoadditionallandresources.Severalcrucialruralinstitutionsneedtobefosteredaneffectivefiscalsystem,amoreefficientfinancialsystem,aworkablelandtenurearrangementwithmarketableland-userights,andimprovedagriculturalinvestmentincentives.Continuedreformwillentailfurtherliberalizationofproduction,pricingandmarketingpoliciesandstronggovernmentpromotionofamarketenvironmentandinvestmentsinpublicservicesandinfrastructure.

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PREFACETheprimarypurposeofthisreportistoidentifyandconsolidateinformationoncrucialissuesthatimpactonruraldevelopmentinChina.Thereport,preparedwiththeassistanceofChineseandnon-Chinesescholarsandanalysts,assessesstrategicoptionsfromtheperspectiveofefficiency,equitabledevelopmentandgrowth.

Theauthorsacknowledgethatmanyreformsinthemacroeconomicenvironmentandinothersectorsareongoingandthatadditionalreformsareplanned;manyofthesegobeyondthescopeofthisreport.Werecognizethatconcurrentmacroeconomicpolicyandinstitutionalreformsacrossallkeysectorswouldbeunmanageableanddestabilizing;therefore,prioritiesconsistentwithGovernment'sgradualistreformapproachneedtobeestablished.Sucheconomy-widereformprioritiesandindividualreformsequencingaretheresponsibilityofGovernment,givingdueconsiderationtosocialstabilityissues(foodsecurity,employment,etc.)thattemporarilyoverrideeconomicefficiencycriteria,andrequire"second-best"reformsolutionsduringthetransition.

ThereportispresentedinthespiritofassistinggovernmentofficialsandWorldBankstafftoprioritizepolicyandinstitutionalreformsandpublicinvestmentdecisionsintheruralsector.Also,itishopedthereportwillsupporttheGovernmentindefiningruralreformprioritiesandprogramsfortheTenthFive-YearPlan.Asprioritiesareestablished,theWorldBankisreadytoworkwithgovernmentofficialstomovebeyondstrategyandhelpdesignandpreparethetacticalapproachestoimplementpriorityruralsubsectorreforms.

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ACKNOWLEDGMENTSThescopeofthisreportwasdeterminedindiscussionswiththeDirectorandstaffoftheInstituteofRuralDevelopment,ChineseAcademyofSocialSciencesduringavisittoBeijinginApril1998.ThereportwaswrittenbyAlbertNyberg(EastAsiaandPacificRegion,RuralDevelopmentandNaturalResourcesSectorUnit)andScottRozelle(Consultant)basedoninputsandworkingpapersfrommanyindividuals.MajorinputswereprovidedbyHuangJikun(CenterforChineseAgriculturalPolicy,ChineseAcademyofAgriculturalScience),DuZhixiongandLiZhou(InstituteofRuralDevelopment,ChineseAcademyofSocialScience),WenTiejun(ResearchCenterforRuralEconomics,MinistryofAgriculture),ChristineWongandAlbertKeidel(EastAsiaandPacificRegion,ChinaResidentMission),JohnWeatherhogg(FAO),LorenBrandt,AlbertPark,ChenChunlai,ColinCarter,AndrewWalder,GaryKutcher,andMadeleineVarkay(Consultants).InputsanddiscussionswithAbrahamBrandenburg,AlanPiazza,RichardScobey,andJuergenVoegele(EastAsiaandPacificRegion,RuralDevelopmentandNaturalResourcesSectorUnit)alsocontributedtothedevelopmentofideasandconclusions.

Thereportbenefitsfromdiscussionswithstaffofvariousinternationalorganizations(InternationalFoodPolicyResearchInstituteandAsianDevelopmentBank),internationalnongovernmentalorganizations(FordFoundation),andbilateralagencies(EconomicResearchService,UnitedStatesDepartmentofAgriculture).ThereportincludesideasgeneratedduringdiscussionsandinterviewswithnumerousChineseandinternationalscholars,particularlythoseassociatedwithChineseresearchinstitutions.Also,itcitesthefindingsandconclusionscontainedinawideselectionofliterature.

TheauthorsworkedcloselywithcounterpartsfromtheRuralDevelopmentInstitute,ChineseAcademyofSocialScience,andparticularthanksaredueProfessorsChenJi-yuan(FormerDirector),ZhangXiaoshan,(CurrentDirector),andAssociateProfessorDuZhixiongfortheirinsights,discussions,andassistance.Also,particularthanksaredueDr.HuangJikun,DirectoroftheCenterforChineseAgriculturalPolicy,ChineseAcademyofAgriculturalScience,andhiscolleagueswhoprovidedsignificantstafftimeandeffortinpreparingworkingpapersaswellasreadingandcommentingonvariousportionsofthereport.

Severalagenciesandindividualsprovidedphotographsforinclusioninthereport.TheWorldBankPhotoLibraryprovidedseveralslides;otherinstitutionalcontributorsweretheCGIARphotolibrary,theNationalHybridRiceResearchandDevelopmentCenter(YuanLongping),andtheNationalZoologicalPark(JesseCohen).Inaddition,R.Jaisaard,A.Piazza,F.Crook,A.Whitten,S.Shen,R.Zweig,G.Li,T.Tsutsumi,andF.Gillamcontributedphotographsandslidesfromtheirpersonalcollections.

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ABBREVIATIONSANDACRONYMSABC AgriculturalBankofChina

ADBCAgriculturalDevelopmentBankofChina

bcm Billioncubicmeters

CAASChineseAcademyofAgriculturalScience

CASS ChineseAcademyofSocialScience

CCAPCenterforChineseAgriculturalPolicy

DDT Dichloro-diphenyl-trichloro-ethane

EPBs EnvironmentalProtectionBureaus

FAO FoodandAgricultureOrganization

FDI ForeignDirectInvestment

FFW FoodforWork

HRS HouseholdResponsibilitySystem

GDP GrossDomesticProduct

GVAOGrossValueofAgriculturalOutput

HRS HouseholdResponsibilitySystem

IFPRI InternationalFoodPolicyResearchInstitute

IOU IOweYou

IPM IntegratedPestManagement

IPR IntellectualPropertyRight

IRD InstituteofRuralDevelopment

LGPR LeadingGroupforPovertyReduction

MFIs MicrofinanceInstitutions

MOA MinistryofAgriculture

MWR TheMinistryofWaterResources

NEPA NationalEnvironmentalProtectionAgency(nowSEPAStateEnvironmentalProtectionAgency)

NGO NongovernmentalOrganization

ODA OverseasDevelopmentAssistance

PBC People'sBankofChina

PPP PurchasingPowerParity

R&D ResearchandDevelopment

RCCs RuralCreditCooperatives

RCFs RuralCreditFoundations

RFIs RuralFinanceInstitutions

SMEs SmallandMediumEnterprises

SOE State-OwnedEnterprise

SPC StatePlanningCommission(nowSDPCStateDevelopmentPlanningCommission)

TFP TotalFactorProductivity

TVEs TownshipandVillageEnterprises

VAT Value-AddedTax

WUA WaterUserAssociation

WTO WorldTradeOrganization

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EXECUTIVESUMMARY

Initstwodecadesofreform,Chinahasachievedremarkableagriculturalandrural-industrialgrowth,impressivelyreducedpoverty,andreversedsomeoftheenvironmentalandnaturalresourcedegradation.Thepopulationgrowthratealsocontinuestodecline.Since1978aggregategrossdomesticproduct(GDP)hasgrownatanaverageannualrateof10percent;agriculturalGDP,at5.2percent;andruralindustrialoutput,at31percent.Thenumberofresidentslivinginabsolutepovertyhasdeclinedby210million,toabout6percentoftheruralpopulation.However,thesetrendshaveslowednoticeablyinrecentyearsandChina'sruralsectorstillfacesconsiderablechallengeinachievingfurtherdevelopment.

Ruralreformshavebeengradual,deliberate,andlargelyeffectiveastheruralsectorhasincreasinglymovedawayfromaplannedeconomydespiteseveralremainingremnantsoftheplanninglegacyandcontinuingmarketinterventionsbygovernment.However,theproductivitygainsfromtransitionpoliciesarelargelyexhausted.Sustainingruralincomegrowthwillrequireacarefullycraftedeffortforseveralreasons:Manyoftheconditionsthatfacilitatedearliergrowthnolongerprevail.Inaddition,China'sruralproducts,input,labor,andlandmarkets,whileimproving,arestillintheirinfancy.Finally,Chinastillneedstofosterseveralcriticalinstitutions,suchasaneffectivefiscalsystem,amoreefficientruralfinancialsystem,aworkablelandtenurearrangement,andarevampedtradeandinvestmentenvironmentforagriculture.

Increasingruralstandardsofliving,eliminatingpoverty,andreversingthedivergenceinruralandurbanincomelevelswillrequireadelicatebalanceofproductivity-enhancinginvestmentsandboldpolicymeasurestoremovetheconstraintsthatarepreventingtheemergenceofinstitutionsthatfullyincorporatemarketprinciples.Inthelongrun,thegovernmentshoulddivestitselfofindustrialandothercommercialactivitiesandfocusinvestmentsonpublicservices,researchandextension,andinfrastructure.Policyshouldfocusmoreondevelopinggovernment'sregulatoryroleandlessondirectmarketintervention.OurultimatevisionofChina'sruraleconomyisoneinwhicheconomicadministratorsfocusonpromotingpolicies,creatinginstitutions,andtargetingpublicinvestmentsthatimproveresourceallocationandcomparativeadvantage,enhanceproductivity,andfacilitatemoreefficientmarkets.Inthisvision,economicadministratorsinterveneonlywheremarketsareinefficientorhavethepotentialtopositivelyaffectnationalwelfare,suchasalleviatingpovertyandredistributingwealth,controllingenvironmentalpollution,andimprovingmanagementofnaturalresources.

RuralFiscalPolicy'sUnderminingofSectoralGrowth

Aninefficientruralfiscalsystemisoneofthemostimportantproblemshamperingruraldevelopment.Decentralizationhasledtoaself-sufficientruralfiscalstructurethat,coupledwithadevelopmentlegacyorientedtowardtheurban-industrialsector,hashardenedbudgetconstraintsanddistortedruralinvestmentstowarddevelopingpotentiallytaxablelocalindustryattheexpenseofrural-agriculturalinfrastructureanddevelopmentinvestmentsthatarelongtermandgrowthoriented.Overthetwodecadesofreform,nationaltaxrevenueshavedeclinedtoabout12percentofGDPaportionthatisamongtheworld'slowest.The1993fiscalreformandadoptionofavalue-added

taxincreasedcentralcontroloverrevenuesandstemmedthedecliningtrendincollectionsinbothrichandpoorregions.However,revenuereallocationsarestillurbanbiased,regressive,andineffectiveinredistributingresources.Thus,theequalizationoftaxation,redistribution,andexpenditureforpublicgoodshasdeclined,particularlyinthepoorestregions.Furthermore,netrural-to-urbanfiscaloutflowshaveincreasedandnowexceedY100billionannually,starvingtheruralsectorofinvestmentandoperatingresources.Themassivemovementoffundsoutoftheruraleconomyindicatesitsimportanceinthenationaleconomyandemphasizesthenecessityofkeepingithealthy.

General(untied)fiscaltransferstotownshipsandvillageshavedeclinedbytwo-thirds,inrealterms,overthepastdecade.Thusintheenvironmentofreducedsubventionsandintheabsenceoftaxingauthority,localgovernmentshaveimposedunofficial,nontaxleviesandfeesonruralproducersandconsumersandrelyonothercreativemechanismstofinancegovernance,socialobligations,andunfundedcentralgovernmentmandates.Sincethemosteasilytappedsourceofoff-budgetrevenuesarederivedfrommiscellaneousfeesassessedonruralenterprises,poorareasthatlacksuchenterprisesarefurtherdisadvantaged.Off-budgetcollectionsarenotofficiallysanctioned,arenottransparent,frequentlyareregressive,areinconsistentlylevied,distortinvestmentallocations,andhaveoccasionallycausedruraldissention.Becauseoftheurgentneedforadditionalresources,thegovernmentshouldconsiderconvertingsomeofthesefeesandleviesintotransparentcomponentsofthetaxsystem.

Inadequatebudgetsforruralsocialserviceandadvisoryinstitutions(forexample,natureandforestpreserves,agriculturalresearchandextension,schools,andruralclinics)frequentlyresultinthediversionofstaffandfinancialresourcesfromtheirprimarymissiontocommercialactivitiestosupplementbudgets.Infrastructure

investmentfundsareoftenredirectedtopotentialtax-producingenterprisesordivertedtomeetsalariesandotherrecurrentcosts.Also,togeneraterevenuesomeprotectiveagenciesresorttoexploitingtheresourcestheyarechargedwithprotecting.

FurtherfiscalreformisimperativetoenableChinatomaintainruralinfrastructureandservices,sustainlong-rungrowth,andreducepoverty.Furtherassessmentoftheconsequencesofsuchahighlydecentralizedeconomyisneeded,alongwithoptionsforadditionalrevenuesourcesandexpenditurereduction.Aradicaloptionwouldbetotransferthebasicunitoffiscalresponsibilityfromtownshipstocounties(exceptperhapsforthemostindustrializedtownswithsurplusbudgets).Thiswouldreduceadministrativestaff,amovethatwouldsignificantlyreducecosts,aswagesaretheprimaryexpenditureatthetownshiplevel.Reducingnumbersof''grassroots"staff,however,mayhinderpolicyimplementation.Localgovernmentconsolidationandreformshouldbehighonthepolicyagenda.

RuralIncomes,Off-FarmEmployment,andTownshipandVillageEnterprises

Recentincreasesinagriculturalincomehaveresulted,inpart,fromincreasedfarmgatecommodityprices.ThisoptionhasbeenfullyexploitedasdomesticpricesarenearinternationalpriceequivalentsunlessgovernmentdecidestoembarkonacostlyfarmersubsidyprogramandignorethecommitmentsmadeintheyetunfinishedWorldTradeOrganizationaccessionnegotiations.Otheroptionsforimprovingagriculturalincomegrowthinclude(a)increasingfactorproductivity;(b)diversifyingproductionintolabor-intensive,higher-valuecommodities;and(c)investingintransportandothermarketinginfrastructuretoreducemarketingcostsandenablefarmerstoincreasetheirshareofconsumerexpenditures.FactorsaffectingthesealternativesarereviewedinthisreportandinotherrecentWorldBankpublications.

ThetransformationofChinaintoamoreaffluent,modernindustrialeconomydependsonsharplyincreasingincomesandshiftingalargepartofthepopulationoutofagriculture.

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Obtainingoff-farmemploymenthasbeenthesurestroutetoimprovingincomes.Inthepast,ruralandurbaninstitutionsrestrictedthemovementoflaboroffthefarm.Therecentexplosionofoff-farmworkprovesthatmanyofthesebarriershavebeenremoved.(Nearly140millionofChina's450millionrurallaborforceworkinnonfarmjobs.)However,obstaclesstillpreventfarmfamiliesfrommovingtolocationsthatpromisethemhigherreturns,particularlyfeaturesoftheurbaneconomy,suchasstrictprohibitionstojobaccess,urbanresidentpermits,andrestrictedaccesstourbanservices.Ruralbarriersarelessrestrictive,althoughdebatecontinuesregardinghowlandtenurearrangements,quotas,andotherinstitutionsaffecthouseholddecisionstoseekemploymentorresidenceoutsideofagriculture.Chinashouldmakeeveryefforttoeliminatethebarrierstothemovementoflaboroffthefarm.

Typically,off-farmemploymentisassociatedwithrural-urbanmigration,butinChina'scasetownshipandvillageenterprise(TVE)employmentandrural-ruralmigrationalsoisanoption.Millionsofruralworkershavemigratedtourbanjobsinthepastdecade,butforthenextdecadesuchmigrationmaybecomealessviableoption,asrestructuringofstate-ownedenterprises(SOEs)andrationalizationofemploymenthasbegun.Asurplusofunemployedurban-industrialworkerswillhavepriorityfordeploymentinanynewlycreatedurbanjobs,makingagriculturallabor'ssearchfornonruralemploymentincitiesmoredifficult.Off-farmmigrationtoruralindustriescouldplayanimportantjob-creationrole.Ruralindustryprovidesthefastest-growingsubsectoroftheoff-farmlabormarket.Continuedout-migrationwouldpermitthoseremainingintheagriculturalsectortocombineadditionalland,water,andcapitalwiththeirlaborandimproveincome.Improvementintheland/laborratiowillbeacrucialelementinincreasingfutureincomewithinagriculture,particularlyifwaterdevelopmentandconservationschemesandcredit-institution

reformincreasewaterandcapitalavailability.Giventheinevitableconflictthatwillarisebetweenlaid-offurbanworkersandcity-boundruralmigrants,Chinashouldpromotepoliciesthatencouragetheefficientexpansionofruralindustries.

ConsolidatingPastGainsfromRuralEnterprises

ThecontributionofTVEstoChina'srapideconomicgrowthduringthereformperiodhasbeenextraordinary.TVEscontribute40percentofthenationalgrossindustrialoutputandemployabout130millionworkersrepresentingthemajoremployerofruralnonfarmlabor.Unfortunately,outputandemploymentgrowtharedecelerating,accesstocredithasbeencurtailed,andseveredebtproblemsareappearing.However,ownershipandmanagementareevolvingfromcollectiveandcooperativetoprivateownershipinresponsetothechangingeconomicenvironment.By1997,90percentofTVEswereprivatelyownedandaccountedformorethanhalfofTVEemployment.Also,themanagementstructureofthosefirmsthatremaincollectivelyownedisrapidlyshiftingawayfromfixed-wagemanagementcontractstomoreresponsiveprofit-sharingandfixed-leasearrangements.

Theinitialconditionsthatfavoredtherapiddevelopmentofruralindustriesnolongerprevail;productcompetitionhasincreased,productionhasbecomemoreefficient,andcompetitivepressureshaveeliminatedthelargeprofitsofearlieryears.However,theinlandprovinceshaveafewadvantagesthattendtooffsetthedisadvantageofbeingdistantfrommajor,high-incomemarketsalongthecoast,includinglower-costlaborandoftenbetteraccesstoagriculturalrawmaterials.SomecoastalTVEshavesoughttorelocateinlandtotakeadvantageofthesebenefits.However,anattemptbythelessdevelopedregionstoemulatethepoliciesandinstitutionsofanerathatnolongerexistswouldbecounterproductive.Localgovernmentsininlandandotherdisadvantagedareasshouldpromote,butnot

subsidize,small-scalefamilyenterprisesthattargetlocalnichemarketsandenterprisesthatcanexploitlocal

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comparativeadvantage,oraidfirmsthatemphasizeagricultureandrelatedsidelineproductionmorethanindustry.Officialspromotingruralindustryinlandshouldalsoseektoelicitthemanagementandcapitalinputsofthosewhohavesuccessfullydevelopedenterprisesinotherareas.

ThefinancialneedsofTVEsarenotwellmetbythefinancialmarkets,whichisaseriousconstraint.Ruralfinancialreformshavecurtailedformalcredit,andascreditbecomesrestrictive,TVEsareamongthefirsttoloseaccess.AportionofthecreditproblemisduetouncertaincreditworthinessoftheTVEs.However,thisisparadoxical,asTVEsarethemostdynamicsegmentoftheindustrialsector.Giventheirimportanceinthenationaleconomy,Chinamustfindawaytoincreasetheiraccesstocredit.Explicitfinancing(foronlendingorloanguarantees)forsmallandmediumenterpriseschanneledthroughexistingfinancialinstitutionsisanoption.However,atrainingprogramtoimprovefinancialmanagementandoperationalskillsofboththelendinginstitutionandborrowingenterpriseshouldaccompany,orbeacomponentof,afinancingprogram.

ReformingRuralCredit

Thefinancialsectorhasreformedmoreslowlythansomeothersectors,andthegovernmentmaintainsstrongcontrols.Severalfinancialinstitutionshavedevelopedtoservetheruralsector,butmostlendingistoruralenterprisesandtostateagenciestoprocuregrainandcotton(policylending).TheRuralCreditFoundationsystem,thesmallestandnewestquasi-statecreditinstitution,istheonlyinstitutionalcreditsourcethatlendsprimarilytoagriculturalhouseholds.Informalcreditamongvillagers,bothwithandwithoutinterest,isanimportantcomponentofagriculturalproductioncredit.

Adefinitiveseparationofpolicyandcommerciallendingisclearly

needed.Chinashouldfullyunderstandthatpolicylendingtostateagenciesformandatoryprocurementofgrainsparticularlythatwhichgoesintograinprocurement,strategicreservesorbufferstockswillincurlosses.Concentratingpolicylendinginasingleinstitutionwouldpermitbettermonitoringofcosts,subsidyrequirements,andimpacts.

Chinamustdecontrolinterestratesifruralcreditinstitutionsaretoadequatelyservethesector.Ruralfinancialinstitutions(RFIs)focusprimarilyonlending,buttheycouldimproveservicetotheruralcommunitybycreatingnewsavingsdepositinstrumentsthatprovideattractivecombinationsofreturnandliquidity.Suchinstruments,combinedwithimprovedruralmarkets,maypersuadefarmerstoholdincreasedsavingsintheformofdepositsandlessintheformofgrain.Regulationmustbeprudenttoensurestabilityandsafeguarddepositswhileavoidingexcessiverestrictions.

Ruralcreditisconstrained,inpart,bythelackoftechnicalandfinancialskillsofRFIstaff,whichlimitstheirabilitytoevaluatealternativeprojectsandmonitorloansappropriately.ChinashoulddevelopinstitutionsthatsupportRFIsinimprovingtheircapacitytoscreenloans,enforcerepayment,improvetheuseofloanhistoriesandcreditratings,developandstandardizeaccountingandreportingprocedures,evaluateassetsandcollateral,anddevelopresalemarketsforcollateral.Also,ChinashouldcreateadiversityofRFIstocompeteandspecializeinmeetingtheneedsofdifferentdemandcharacteristicswhichmightrangefromfull-servicebankingtospecializedbanksforruralindustrytomicrofinanceinstitutions.

Productivity-EnhancingPoliciesandInvestments

ResearchandExtension:AMeansforRaisingTotalFactorProductivity

Historically,theagriculturalsectorhasbeenwellservedbythepublicresearchsystem.Bycreatingnewtechnologiesandcropvarietiesand

improvingagronomicpractices,theresearchsystemraisedtotalfactorproductivityinagriculture,expandedproductionfrontiers,reducedlong-termproductioncosts,andimprovedruralincomes.Growthaccountinganalysesindicatethatcropgrowthoverthepastdecadewas

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overwhelminglyattributabletoresearchinvestments.Unfortunately,agriculturalresearchinvestmentshavedeclinedinrealtermsandresearchexpendituresasaproportionofagriculturalGDPhavefallenbelowtheaverageofdevelopingcountries,creatingconcernforlong-termagriculturalgrowth.Withoutaccesstonewefficientproductiontechnologies,China'sfarmerswillbedisadvantagedincompetitiveinternationalmarkets.

Governmenthasseveraloptions:(a)increasepublicinvestmentsinagriculturalresearchandtechnologytransfertodevelopacontinuingstreamofapplicablemodernagriculturaltechnologyforagriculture;(b)encouragedomesticprivatesectorinvestmentinnewagriculturaltechnology;(c)provideincentivesforforeignentrepreneurstodevelopandproducenewtechnologiesforthedomesticmarket;and(d)encouragetheimportoftechnologydevelopedelsewherethroughminimalimportconstraintsandtariffs.Themostefficientprocessislikelytobeacombinationoftheseactivities;somegovernment-financedresearchisnecessarytoensurepriorityissuesandpublicgoodsareaddressed.Thisisespeciallytruewhereresearchbenefitsarelongtermorcannotbereadilycapturedandwouldnotbeundertakenbytheprivatesector(suchasresearchonsubsistencecommoditiesforresource-poorareasandnaturalresourcemanagement).

Alargequantityoffiscalresourcescontinuetobedirectedintothegrainsubsector.Theseresourcesconsistprimarilyofstoragefacilities,stocks,andmonetarysubsidiesallofwhichabsorbfinancesbuthavenoinvestmentmultipliereffectongrowth.Redirectingsomeoftheseresourcestoagriculturalresearchwouldhaveabetterimpactonlong-termgrowth.However,pendingfiscalrestructuring,severalactionscouldimprovetheefficiencyoftheexistingresearchfunds,increaseresearchfinancing,andincreasedaccesstonongovernmentresearchresults.Toensurethemostimportantresearchissuesareaddressed,

thegovernmentshouldmakethecompetitivegrants-awardingprocessfullytransparentandwidelypublicizedandensurebroadscientificrepresentationonjudgingpanelsandaccessforyounger,recentlytrainedscientists.Toincreaseresearchfinancing,thegovernmentcouldimposecessesonagriculturalcommoditiesthatareprocessed(suchascotton,tobacco,andtea)orattransitpointswhereacesscanbeadministrativelycollected,suchasanexportport.Afterenforcingofintellectualpropertyright(IPR)protectionandlicensingbecomebetterestablished,commercialactivitiesofresearchinstitutesshouldbediscontinued.However,intheshorterterm,implementingamatchinggrantprogramtoprovidefundsequaltoaninstitute'scommercialearnings,ratherthanautomaticfundingreductions,couldstrengthentheresearchprogram.ChinacooperateswithseveraloftheInternationalAgriculturalResearchCenters.IncreasingitsinteractionwiththeseinstitutionsandwithadditionalcentersthatfocusonlivestockandcropsinaridandsemiaridzonescouldimproveChina'saccesstoagriculturaltechnologiessuitedtopovertyareas.

Extensionservicessufferfromsubstantialfinancialproblems,staffingshortages,andstaffskilldeficiency.Fundingshortageshavedrivenawaymanyfieldstaff.Thoseremainingin-postrequireincreasedtrainingtoupgradetheirexistingskillsandacquirenewskillsrelatedtoproductionofnontraditionalcommodities,andnewmethodsofunderstandingandaddressingmarketingissues.Giventhesmallscaleofitsfarms,Chinamustrevitalizeitspublicextensionsystem.Someactivitiesofthepublicextensionservicecouldbeassumedbytheprivatesectorifcommercialcompanieswerepermittedgreaterparticipationindomesticmarketing.Suchactivitieswouldincludeintroducingnewseedvarieties,managingpests,applyingagrochemicals(includingfertilizer),andcontrollingthequalityofcommodities.

ForeignDirectInvestmentinAgriculture

Chinahasbeenenormouslysuccessfulinattractingforeigndirectinvestment(FDI)primarilyinlabor-intensivemanufacturingwhich

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hasbeenanimportantsourceofnewjobcreation.However,onlyabout4percentofactualFDIinflowsduringthe1990swasforagriculturalandagriculturallyrelatedmanufacturinginvestments.FDIintechnology-intensiveagroindustries(seed,agrochemicals,veterinarypharmaceuticals,andagriculturalmachinery)haveimportantmodernizationpotentialandcouldsupplementorsubstituteforresearchthatiscurrentlybeingcarriedoutbyChina'sown,already-stressedresearchsystem.Giventhepotentialcontributiontosectoralgrowth,thegovernmentmightactivelyseekforeigninvestmentintechnology-intensiveindustriesaswellascapital-intensiveindustries,suchasfertilizer,whichisinshortsupplydomestically.

AlthoughthegovernmenthasenactedIPRlegislation,legalprotectionisperceivedtobepoorandChina'slargepotentialmarketfornewinputtechnologyhasnotattractedsignificantprivateinvestments.Consequently,technologydevelopedbytransnationalcorporationsandmadeavailableforChinesefarmersprimarilycomprisesinputsthatareverydifficulttoreplicate,thusthepropertyrightsaretechnicallyprotected.Iftransnationalcorporationsaretoprovideandpromoteproprietarytechnology,ChinamustshowthatitwillresolutelyenforceitsrecentlyenactedIPRlegislation.Inaddition,officialsoftransnationalcorporationshaveindicatedthattheweakregulatoryenvironment,opaqueforeigninvestmentpolicy,andfragmentedwholesalingandretailingnetworksinhibitsinvestmentintechnologyandcapital-intensiveindustries.Incentivesneedtobecraftedtostimulateinvestmentandresolvethevariousmarketinganddistributionconstraints.

ResourceDevelopmentandProductionInputs

Water:TheMajorConstrainttoFutureAgriculturalProductivity

Chinahasabundantlaborbutotherresourceinputsareinshortsupply.Waterisagriculture'smostlimitingagriculturalresource,particularlyinnorthernChinaandthegovernmenthasidentifiedseveralhundredwaterdevelopmentprojectstoassistinalleviatingthisconstraint.Despitemassiveinvestmentsinwaterdevelopmentandconservationoverthereformperiod,wateravailableforirrigationin1993wasmarginallylessthanthatof1980.Giventheunmetwaterrequirementsinsomesectorsandthehigherproductivityofwaterinothersectors,largeinvestmentsindevelopingnewresourcesandinimprovingdistributionanduseefficiencyareneededifsuppliestoagriculturearetobemaintained.Themostprobablesourceofnewsuppliesarewatertransfersfromthemorewater-abundantsouth,asbothsurfaceandgroundwaterresourcesarefullyoroverexploitedinmostnorthernlocations.Chinashouldinitiateworkononeormoreofthesouth-northtransferroutesasearlyaspossible,ascompletionwillbecostlyandtimeconsuming.

Whilewatertransfersfromthesouthwillhelpshortagesinthenorthinthenearterm,theywillnotincreaselong-termwatersuppliesinthenorth,asthetransfervolumeswilllikelybelessthancurrentoverabstractionofgroundwaterintheNorthChinaplain.Investinginprojectsforimprovingirrigationefficiencyisequallyimportant.Thesewouldincludeimprovingdeliveryefficiencythroughrehabilitatingsystemsandliningcanals(orbuildingpipelines),andimprovingon-farmefficiencythroughimplementingadvancedapplicationtechniquesandnewwater-savingtechnologies.Achievingthetargeteddeliveryefficiencyof78percentwoulddeliveranadditional100billioncubicmetersofwatertofarmers'fieldsincreasingproductionandfarmers'incomeenormously.

Applyingfinancialresourceconstraintsmeansthatfarmerswillberequiredtoshoulderthecostsofmanaging,operating,andmaintaininglateralcanals.Somesuccessfulpilotprogramsintransformingirrigationmanagementagenciesintoself-financing

entitieshavedevelopedandshouldbereplicatedasrapidlyasinstitutionalmanagerscanbetrained.However,farmershavelittleincentivetoconservewaterandaltertheircroppingpatternsifwater

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costsareloworunrelatedtotheamountused.Therefore,toensurewaterconservationandefficienton-farmwateruse,weencouragerapidimplementationoffull-costvolumetricwatercharges.Chinamustbegintoaddresswaystobegintoimplementwaterpricingschemes.

InsouthernChina,controllingtheflowofabundantwateristhegreaterissue.Floodcontrolisanintegralcomponentofaninvestmentprogram,andChinashouldclearlydirectadditionalattentiontowatershedmanagement.

LandResourcesandLandUseRights

NearlyeveryfarmhouseholdinChinaisendowedwithland.Bylaw,landownershiprestswiththevillage(orcollective),whichcontractsorotherwiseallocatestheuseofthelandtohouseholds.Thecentralgovernmentrecentlyextendedlegaltenuresecurityoncontractedlandfrom15to30years,butvillageleadersfrequentlydonotfollowthesepolicydirectives.Thedynamicsofhouseholdandvillagedemographicsandotherpolicypressuresofteninducelocalauthoritiestoreallocatelandbeforecontractexpiration.Althoughsignificantlong-termgainstoproductivitywouldlikelybeassociatedwithbettertenure,severalanalyseshavedemonstratedthatChina'slandtenuresystemhasonlyamarginalimpactonagriculturalproduction.However,theabsenceofsecuretenurerightsdoespreventfarmersfromusinglandascollateralandlimitstheiraccesstoformalcreditmarkets.

Formalland-rentalmarketsareinfrequentlyfoundinChina.Informalarrangementsallowhouseholdstotransfershort-termuserightstoothersforafeeincludingtaxandquotaliabilitiesalthoughtheproportionoflandrentedisverysmall.Farmersfindrentingouttheirlandincreasinglydifficultasincreasingnumbersofruralresidentsmigrateorotherwiseobtainnonagriculturalemployment,leadingto

inefficienciesinlandutilization.Findingamechanismtopermittheremainingfull-timefarmerstoaccessadditionalfarmland,andthusimproveincomesbyraisingtheland/laborratio,isimperative.

Despitethebenefitsthatfarmerswouldreceiveiflandwereprivatizedoriflandrightsweremoresecure,anumberofhouseholdsurveyshavedeterminedthatmostfarmersprefercollectiveownershipandperiodiclandadjustmentsbasedondemographicdynamics.Therefore,anabruptchangeinlandpropertyrights,suchasprivatization,wouldhavesignificantsocialcostsandbeilladvised.GiventheimportanceoflandinChina'sruralsociety,continuingexperimentsinthelandmarketandtenuretocarefullyassessimpactsonsecurity,income,equality,investmentsandefficiencyarecrucial.

ImprovingResourceUseandAllocationEfficiency

ExternalAgriculturalTrade

Agriculturaltradeincreasedabout50percentoverthepastdecadesomewhatlessthanoveralltradeandtheagriculturaltradebalancehasbeenpositiveinallbutoneofthoseyears.Althoughthetradedataseriesareshort,theyimplythatthecompositionofagriculturalexportsincreasinglyreflectsaproductionandtradepatternconsistentwithcomparativeadvantageexportsoflabor-intensivehorticultureproductsandimportsofland-intensivecerealshavebothrisen.

Intheinterestofstabilization,statetradingcompaniescontinuetomonopolizemuchofChina'sagriculturaltrade.Butseveralfactorscombinetodenyachievingthestabilizationgoal.Statetradingcompaniesrespondslowlytochangingtradeconditions,implementtradequotasplannedfarinadvanceofharvest(bythetimethetradeoccursitmaybeunrelatedtoprevailingsupplyconditions),andintheabsenceofcompetitiveefficienciesdestabilize,ratherthanstabilize,suppliesandprices.PricesinsomeofChina'sgrainmarketshavebeen

morevolatilethaninternationalpricesandgrainimports/exportshaveexacerbateddomesticsupplyfluctuationsoverthepastdecade.

Aliberal,open,andcompetitivegrainmarketincludingstateandnonstateenterprisesoperatingunderthesameconstraints,incen-

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tives,andcommercialstandardswouldfacilitatemorerapidtraderesponsestograinsurpluses(includingsurplusstocks)andshortages,andbemorestabilizingthanthecurrentmarket.Moreopentradewouldrequireremovingtradequotasandreplacingthetwo-tiergraintariffregime(1to3percentforwithinquotaandmorethan100percentforabovequota)withasingletariffratethatwouldprovidefarmerswithdownsidepriceprotectionandprotectconsumersfromexorbitantpriceincreases.

IfChinamaintainedtariffsatthebindingratesthatithasofferedinitsWorldTradeOrganization(WTO)negotiations,grainandoilseedpricesfordomesticproducersandconsumerscouldbemaintainedatabout60percentaboveworldprices.Whilesuchbindingsarelowbyinternationalstandards,theywouldpreventChinafromadoptingtheextremeprotectionistpolicyofitsEastAsianneighbors,andpricescouldbekeptatalevelthatwouldsignificantlybenefitgrainandoilseedproducers.IfChina'sobjectivesfocusedmoreonconsumerwelfare,itwouldlowerthetariffrate,makingproductionofthesecropslessattractiveanddirectingproductiveresourcesintoalternativehigh-valuecrops.Thiswouldimprovethelong-runwelfareofbothproducersandconsumers.Totheextentthatruralpovertygroupsarenotself-sufficientinfoodstaples,ahighimport-tariffregimewouldincreasetheirfoodcosts,butliberalizedtradingruleswouldhurtthosewhospecializeingrainproduction,apartoftheruralpopulationthatisstillrelativelypoor.

ReevaluatingFoodSecurity

Somenationalobjectiveswillrequirecompromiseifotherobjectivesaretobeeffectivelyaddressed.Thisparticularlyappliesto95percentcerealself-sufficiencyandmaintaininglargebufferstocks,whichcompromisepovertyreductionandefficiencyobjectivesandexertasubstantialdrainonthenationalandprovincialtreasuries.Evaluating

nationalfoodsecurityfromafinancialperspectiveandplacinggreaterrelianceondomesticandinternationalmarketswouldaddressbothefficiencyandfood-securityobjectives.Savingsresultingfromdecreasinggrainstoragecouldberedirectedtoassistthosegroupsmostaffectedbytradeliberalization.Growthandincomealsomightbeincreasedbydiscontinuinggrainquotasandpermittingfarmerstoselecttheirownproductioncombinationonthebasisoftheirresourceavailabilityandprices.

Fromafinancialperspective,Chinaisfoodsecurebecauseitsforeignexchangereservesandbalanceoftradearehighlyfavorable.Internationalgrainpricesareexpectedtocontinuetheirlong-termdecline,althoughshort-termvolatilityislikely.Internationalgrainreservesexceed100milliontons,andthemajorgrain-exportingcountriescouldrapidlyproduceandexportmuchlargervolumesifasteadygrowthinexportdemandwereanticipated.Chinaalsohastheinfrastructureandbureaucraticexpertisetorunaneffectivebuffer-stocksystemaspartofitsdomesticmarketingstrategy.Thissystemcouldalsobeusedinconjunctionwithimportstobufferdomesticprices.Liberalizinginternationalcerealandoilseedtradingwouldbeanefficientoptionformanagingtradeandsupportingtheobjectiveof95-percentgrainself-sufficiency.

DomesticMarketing:RoomforMoreImprovement

Marketingandpricingpolicyreformshaveledtounprecedentedmarketdevelopmentoverthepastdecade.Mostfoodcommoditiesarenowsoldatmarketprices,andstatisticalanalysesindicatedomesticgrainmarketsarewellintegratedandincreasinglycompetitiveandefficient.Theriseofaprivatetradingclasshasresultedin25to35percentofChina'sgrainprocurementgoingthroughprivatechannels.

DespitetherapidemergenceofChina'smarkets,problemareasremain,includingcontinuedinterventionbygovernmentgrainagencies,incompleteseparationofpolicyandmarketfunctions,the

continuanceofproducerquotas,andthehighexpenseinvolvedwithalargeandcostlygrainreserve.Themarketingchannelsofthegrainbureaucontinuetoincurlosses,ex-

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tendoverdueloans,andrequirelargesubsidiesinefficienciesthatresultinpartfromtheconflictoftheiroperatingcommerciallywhileimplementingpolicydirectives.Grainstockshavecontinuedtoriseandrequireexpensivemaintenancefromthefiscalandfinancialsystem.Anappropriatelybudgetedgovernmentagencyshouldberesponsibleformaintaininggrainreservesorbufferstocks,knowingthatitwillincurlossesdirectlyrelatedtotheirsize.Therefore,Chinashouldcarefullyevaluatetheneedforreservestocksfromtheperspectiveofminimizingrequirements.IndiaandIndonesiaemploybufferstockstostabilizegrainprices,albeitatsignificantcost,butprocureonly20to25percentofthemarketedgrain.

Iftheproposedgrainreformsof1998hadbeensuccessfullyimplemented,thegovernmentwouldhavemetitscomplexsetofpolicyobjectivesofimprovedefficiency,protectionoffarmerincome,andreductioningovernment'sfiscalburden.However,policyimplementationdepartedfromthedesignandwilllikelyfallshortofmeetingthecoreobjectives.Recentmeasuresadoptedinmid-1998arereminiscentofthoseofthe1980s,whichwerecostlyandrelativelyunsuccessful.Thesemeasuresincluderemonopolizingfarmgateprocurementatgovernment-determinedprices,prohibitingthegrainbureauenterprisesfromsellinggrainatpricesbelowthegovernment-determinedprocurementprices,andclearlyseparatingcommercialandpolicyfunctionsandcentralandlocalgovernmentresponsibilitiesinpricestabilizationandbufferstockmanagement.Implementationofthenewpolicieswilllikelyleadtosubstantialgrainoverprocurementstressingfinancialandphysicalstoragecapacity.

Althoughthemarketingoffruit,vegetable,andlivestockproductswasliberalizedmorethanadecadeagoandhasgrownrapidly,severalpolicyandinstitutionalconstraintsimpedemarketingefficiency.Standardizingnationalquarantineandphytosanitaryinspectionproceduresandshippingdocumentsapplicabletoallinterprovincial

commoditytransportwouldimprovemarketingefficiencyandfarmers'incomes.Commoditytransportersmeetingnationalstandardsshouldbeabletotransitallprovincesunhindereduponpresentationofcertifieddocumentsatprovincialbordercheckpointsandpaymentofofficiallysanctionedtransitfees(basedonweight,numberofaxles,orotherobjectivecriteria).

Producermarketingassociationsareinstitutionsdesignedtoimprovefarmers'bargainingpowerwithrespecttodownstreampurchasers.AfewfarmerorganizationshavedevelopedinruralChina,butthesefocusprimarilyonproductionratherthanmarketing.Thegovernmentcouldassisttheirdevelopmentbyestablishingapositivelegalandregulatoryframeworkfortheirexistenceandobligations.Thelackofprohibitinglegislationisinsufficienttoencouragethemtodevelop.Also,farmersneedtechnical,managerial,andtrainingassistancetodeveloptheexpertiserequiredtoestablishsuchanorganizationandtodevelopassociatedmarketintelligenceunits.Withoutmarketingorganizations,farmersareunlikelytobeabletoexploitmarketnichesandmeetsupplydeficitsthatmayexistinscatteredmarkets.

Thegovernmentcouldassistmarketdevelopmentbymakingmarketinformationcomprehensiveandbyconsolidatingtheinformationsystemundertheauspicesofasingleagency.Toensureadequateinformationwasprovidedtothecentralmarketinformationagency,Chinacouldmakelicensingofwholesalemarketsconditionalontimelysubmissionofmarketinformation.

PovertyAlleviation

Intheearlyyearsofreform,rapidgrowthwasassociatedwithrapidreductionsinpovertywhichwasachieved,inpart,bylabormigrationtothecoastalareas,wheregrowthandjobcreationwereoccurringmostrapidly.The50millionresidentsstilllivingbelowthenationalpovertylinearebelievedtoliveinareasthatareremote,lessaccessible,andveryresourcepoorlimitingpotentialforincreasing

agriculturalproduction.Thelargewage-ratedifferentialsbetweenpoorruralareasandpros-

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perousurban(andrural)areasprovidepowerfulmigrationincentivesandmeanstoovercomepoverty.Toalleviatepoverty,theseareaswillneednonagriculturalemploymentandimprovedlinkageswiththerestoftheeconomy.Education,whichmakesindividualsmoremarketableinthelaborforce,alsocontributestopovertyalleviation.

Effectivepovertyalleviationrequiresgettingwell-designedprogramstothosewhoneedit.Properlytargetingpoorhouseholdsratherthanjustpoorcountiesiscrucialsubcountyadministrativeunitsneedtotheconsidered.Targetinginsomeprovinceshasimprovedinrecentyears,buttargetinginsomeotherprovinceshasbeenlesseffective.Designingandimplementingpovertyreductionprogramsonthebasisofdetailedconsultationswithlocalleadersandplannedparticipantsisparticularlyimportant.CommunityparticipationhasbeenanintegralelementindesigningtheWorldBank-supportedpovertyreductionprojects,whichalsoinvolveconcentratedresourcesandintensivemonitoring.Food-for-workprojectsapparentlyhavebeenquitesuccessful,inpartbecausethefundsbypassthefiscalsystemandinpartbecausetheprojectsarenarrowlydefined,easilymonitored,andfocusonhigh-returninvestments.Investmentsinagriculture,ruralenterprises,roads,andotherruralinfrastructurehaveincreasedtheproductivityandincomeofthepoor.However,resourceconstraintsinmanypoorareaslimitefficientinfrastructureinvestments.Investmentsthatdonothavereasonablyfavorableratesofreturnshouldbereconsideredunlesspovertyalleviationconsiderationsarecompelling.

Whileeconomicgrowthisclearlyassociatedwithpovertyreduction,programsforreducingpovertyhavehadmixedsuccessinincreasinggrowth.Ifpovertyprogramsaretocontributetolong-termgrowth,theymustbebasedonefficiencycriteriaandaddtoinvestmentstock.Thesubsidizedcreditprogramforpovertyalleviationgenerallyhasnotreachedthepoor,achieveslowrepaymentrates,andshouldbe

replacedwithprogramsthatplacefundsintothehandsofruralhouseholds.Insomeareas,"grassroots"microfinanceprogramsthatareabletoreducethetransactioncostsinvolvedinevaluatingprojects,issuingloans,andmonitoringrepaymentbyusingpeermonitoringandgrouplendinghavesucceededinalleviatingpoverty.Suchprogramsmustbecarefullydesigned,staffed,andimplemented,andtheirimpactsmustbecarefullyevaluated.Also,itisimportantthatcreditpoliciesbesufficientlyflexible,particularlyregardinginterestrates,thattheprogramscanbesustained.

NaturalResourcesandtheRuralEnvironment

Naturalresourcedegradationandpollutionoftheruralenvironmentareaseriousconcern.Anecdotes,quantitativeassessmentsofsmallcircumscribedareas,glaringvisualimpactsoferosionandpollution,andthe1998YangtzeRiverfloodcreateanimpressionofveryseveredegradation.However,littlenationwidequantitativeassessmentoftheextentandseverityofnaturalresourceandenvironmentalproblemshasbeenconducted.Thenaturalresourcebasesufferedfromwidespreaddeforestationandpastureconversiontocultivatedland,leadingtoseriouserosionproblemsduringthe1950sand1960ssituationsthatwerereversedinthe1980sand1990s.Theevidenceonenvironmentaldegradationisambiguous;statisticaldataindicatethatforestcoverisincreasingandsedimenttrapsalongtheYellowRiverhavereducedsedimentconcentrationsby25percentinthelowerreaches.However,manyriversarepollutedalonglengthystretches,coastalwetlandscontinuetobedrained,anddesertificationissaidtobeincreasing.

Also,interpretationsoftheimpactofenvironmentaldegradationongrowthconflict.Variousestimatesofthecostofenvironmentaldegradationrangefromzeroto15percentofGDP,butthehighestestimatesarebasedongrossassumptionsthatarenotcredible.Oneofthemorecomprehensivestudiesontheimpactofenvironmental

pollutionandecologicaldegradationestimatedthecostat7percentof

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GDP.However,thecostofdegradationreductionandpreventionhasnotbeenanalyzed.Betterinformationisneededtodeterminewhatpreventionandreductionmeasureswouldbeeconomicallyefficient.Also,minimalefforthasbeenmadetodeterminetheproportionofdegradationthatisoccurringnaturally.Athoroughquantitativeassessmentoftheimpactongrowthofnaturalresourcedegradationandenvironmentalpollutionandthecostsandbenefitsofpreventiveandremedialactionsisessentialtosupportaneffectivenaturalresourcepolicy.

Severalfactorscontributeorleadtoenvironmentaldegradation.Thelegalframeworktoconservenaturalresourcesandprotecttheenvironmentexists;however,thefiscalsystemoftenprovidesinsufficientfinancialresourcesforenvironmentalprotectionservicestoproperlyperformtheirjobs.Consequently,agenciesresponsibleforconservationandprotectionareoftenencouragedtousenaturalresourceassetstogeneraterevenueforwagesandotherrecurrentexpenses.Suchincome-generatingactivitiesmayexploittheresourceandcontributetofurtherdegradation.Thefiscalresourcesforenvironmentalprotection,maintainingbiodiversity,andsustainablemanagementoflong-termnaturalresourcesmustcomefromthepublictreasury.

Povertyisanimportantcontributortoenvironmentaldegradation.Thepresent,ratherthanthefuture,istheconcernoftheverypoor.Consequently,denudinghillsidestocultivatesubsistencecropsanddeforestationtomeetimmediatefuelwoodneedshaveledtoerosionandnaturalresourcedegradation.Variousprojectshavefoundthatimprovingerosioncontrolthroughincreasingvegetativecoverandimprovingcultivationtechniquesareeconomicallyefficientandshouldbereplicated.Similarly,expandingtheforestresourcestosupportcontinuedgrowthinconstructionandagroprocessinghasbeenaneconomicallyefficientinvestment.

PARTITHERURALSECTORCHALLENGE

1.AVisionfortheRuralSectorSincethefoundingofthePeople'sRepublic,theleadersofChinahavebeenpreoccupiedwithoneoverarchinggoal;themodernizationofthenation.Ourvisionfortheearlypartofthe21stcenturyperceivestheruraleconomyasanintegralpartofthismodernizationeffort,withequitableincreasesinincome,andtheeliminationofpoverty,achievedinlargepartbytransferringrurallabortotheurban-industrialeconomyallaccomplishedinanenvironmentallysustainablemanner.Weenvisionanenormousgovernmenteffortintransformingitsroleintoaninvestorforpublicservicesandgoodsandfosteringamarketenvironmentenablingindividualfarmandnonfarmproducers,consumers,andtraderstomakemoreefficientdecisionsandimprovetheirwelfare.

Inpursuitofthisvision,twoissuesremaincentraltothegovernment'sruraldevelopmentobjectives:foodsecurityandpovertyalleviation.Chinahasmaderemarkableprogressinmeetingthesegoals;theeconomy,includingtheruralsector,hasgrownatphenomenalratesduringthereformperiod.ThegrowthoffoodsupplieshasexceededthegrowthofdomesticdemandandChinaexportshorticultural,livestock,otheragricultural,andaquaculturalproducts.Thegrowthof

ruralindustryhasbeenanimportantelementofrecentgrowthastheruraleconomycontinuestodiversify.Increasedproductivityandincomegrowthhavereducedthemassivepre-reformpovertyproblem,improvedthestandardoflivingofmostresidents,andlaunchedthestructuraltransformationofChinafromatraditionalruraltoamodernsociety.

However,growthwillbedifficulttosustain

andmanychallengesfacethoseresponsibleforChina'smodernization.Theeconomicbaseisconsiderablygreaterthanitwastwodecadesago,theeasysourcesofgrowthhavebeentapped,andseveralunderlyingconditionshavechanged.FurtherexpansionandintensificationofChina'scultivatedlandbasewillbedifficultandinputlevelsforagriculturearealreadyhigh.Developmentofadditionalwaterresourceswillrequiremassiveinvestments.Futuregrowthwillincreasinglyrelyontechnology,capital,increasedcroppingintensity,andproductionshiftstohigher-valuecommodities.Theearlyrapidgrowthoftownshipandvillageenterprises(TVEs)andtheexpansionofjobstheycreatedwerepossiblebecauseoflarge,unfulfilleddomesticdemandasituationthatexistsmuchlesstoday.Pastgrowthalsoreliedpartiallyonnewexportmarketsandforeigndirectinvestmentinflows.Increasedglobalcompetitionwillmakefurtherexpansionofexportmarketsmoredifficult.

ObjectivesandStructureofthisReport

Theobjectiveofthisreportistoidentifyanddevelopstrategyoptionsthatwillassistpolicymakersanddonorstoprioritizeinvestmentdecisions,policyandinstitutionalreformefforts,andcontinuetoguideChina'sprogresstowardmodernization.ThisvolumepresentsourvisionofthegrowthanddevelopmentofruralChinainthe21stcentury.Tothisend,wesystematicallyreviewtheinstitutions,stateofChina'sresourcebase,andthepoliciesthattransformedtheruraleconomyinthefollowingchapters.Weexplorethemacrolinkageswiththeruralsectorandimpactsofindustrialandexternalsectorinteractionsonruralincomes(Chapter2).WeexaminethestateofChina'sruralfiscalandfinancialservicesystems,andtrytoassesshowfurtherreformandperformancecanbeenhanced(Chapters3and4).Wesearchforoptionsinwhichgovernmentcanassistproducersmanagetheirresourcesmoreefficientlybyimprovingdomestic

marketsandinternationaltrade(Chapters5and6);andencouragingnewproductivity-enhancinginvestmentsinland,water,andnewagriculturaltechnology(Chapters7to9).Furtherattentionisfocusedoneffortsrequiredtorevitalizetownshipandvillageenterprises(Chapter10),povertyalleviation(Chapter11)andenvironmentalandnaturalresourceprotection(Chapter12).

Webrieflyreviewrecentruraleconomicandincomegrowthandachievements,examinethesourcesofgrowth,delineateanumberofchallengesstillfacingChina'sruralsectorleaders,andrecountsomeofthebasicstrategiesthatleadershaveattheirdisposaltoaddressthem.WediscussestheState'srolesandoptionsinestablishinganenablingenvironmenttomaintainthegrowthmomentumintothenextcentury,includinggovernance,regulatoryframeworkandmarketinterventions,investmentsinruralinfrastructureandpublicservices.Someweaknessesintheruralfiscalandfinancialpoliciesandinstitutionsareexposedthat,unlessresolved,couldseriouslyunderminefuturegrowth.Publicinterventionsindomesticmarketingandinternationaltradearethendiscussed,followedbyareviewofinvestmentsinruralinfrastructureandpublicservices.Finally,thenecessitytoreducepovertywhilemaintaininggrowthisemphasized,asistheimportanceofsustainablegrowththroughnaturalresourceandenvironmentalprotectionandpollutioncontrol.

Althoughthisvisionstatementaddressesproblemsacrosstheruraleconomicspectrum,severalimportanttopicshavebeenexcluded.Theproblemsofvillagegovernance,barrierstotheemergenceofruralproducerandmarketingorganizations,thedevelopmentofagriculturalinputmarkets(suchasseeds,fertilizer,pesticides,andcustomservices),andruralinfrastructurearenotexaminedTheirexclusiondoesnotmeantheyareunimportantbutthattimeandbudgetconstraintsprecludedamorecomprehensiveassessmentofthesector.SomerecentlycompletedandimpendingWorldBankstudiesaddresssomeoftheseissues.

Post-ReformGrowthandAchievements

Historically,agriculturehasbeentheprimarycontributortoruralgrowth,buttheexceptionalgrowthoftheoutputvalueofTVEs(averaged24percent,1985-95)hasmadethemamajorfactorsince1987.By1995theoutputvalueofTVEswasmorethanthatofagriculture.Totalagriculturaloutputgrewatanannualrateof4.2percentbetween1985and1997.GrowthinthemajoragriculturalcomponentsisillustratedinFigure1.1.Cropscontinuetocontributewelloverhalfoftheoutputvaluedespiterapidgrowthinlivestockandfisheries.Livestockcontributesabout30percentoftheoutputvalue;fisheries,lessthan10percent;andforestry,about3percent.RecentanalysesbyZhong(1998)concludedthatChina'sagriculturaldatabasestendtooverstateproduction,particularlylivestockstatistics;thusthesegrowthratesmaywellbeupwardlybiased.Notwithstandingadjustmentsthatwillfollowtheevaluationoftherecentagriculturalcensusdata,thestatisticswilllikelyconfirmexceptionallyhighagriculturalgrowth.

Rapideconomicgrowthandactivepovertyalleviationactivitiesliftedmorethan210millionfrompovertyandreducedthenumbertoaround50millionin1997about6percentoftheruralpopulation.TheexplosionofruralindustrialgrowthandofffarmemploymenthasbeenanimportantelementofChina'soverallrapideconomicgrowth,rapidincreaseinruralincomes,andpovertyreduction.TVEsexpandedrapidlyduringthereformera,contributingmorethan40percentofChina'sindustrialoutput.Ruralenterprisesalsowereanimportantsourceofjobcreation.Morethan135millionpeoplefoundoff-farmjobsbythemid-1990scontributingtothe63percentincreaseinrealpercapitaincomesbetweenthemid-1980andmid-1990s.

RuralreformshavebeengradualandmethodicalandoftenbasedonpolicyexperimentsTheseexperimentaloptionsarelimitedtospecific

geographicallocationstoensurethatactualandtheoreticalresultsaresufficientlyconsistenttoproceedwithwiderimplementation.Iftheexperimentisjudgedunsuccessful,itisdiscontinued;however,ifitmeetsadeclaredobjective,thepolicyispromotednationwide.Thisformatisperceivedtohavebeensuccessfulandwilllikelyremainthenormforfutureruralreforms.Thusreformsinareasofmajorimportance(e.g.,land)willproceedslowlyuntilsufficientexperimentsindicatetheselectedpolicywillmeetacomplexofobjectives.Experimentalapproachestopolicyreformmaybecostlyinefficiencytermsandshouldbediscouragedinthelongerterm;but''BigBang"reformspracticedinsomeothertransitioneconomies,areunlikelytobepracticedinthenearterminChina.

SourcesofPastGrowth

Asignificantpartofoutputandproductivityhascomefromimprovedincentivesforhouse-

Figure1.1GrossValueofAgriculturalOutput(1985=100)

holds,TVEownersandmanagers,andlocalgovernmentofficials.Replacingcommunalresponsibilitywiththehouseholdresponsibilitysystem(HRS)contributed30to60percentofthegrowthofagriculturaloutputduringtheearlyreformyears.ImprovedincentivesformanagersofruralindustryandtheriseofprivateruralfirmsmadethesectoroneofthemostdynamicelementsofChina'seconomy.However,institutionalreformsprovideone-time,incentives.

Investmentsinagriculturaltechnology,ruralinfrastructure,andsocialwelfarealsohaveincreasedproductivityintheruraleconomy.OvertheentirereformperiodincreasedproductivityfrominvestmentsinagriculturalresearchandextensionsystemexceededproductivityincreasesgeneratedbyHRS.Improvementsinirrigationandwatercontrolalsocontinuedtohelpexpandyieldfrontiers,especiallyinNorthChina.Thesearethetypesofinvestmentsthatwillincreaseresourceallocationefficiencyinthelongrun.

Increaseddomesticmarketintegrationandlinkageshavefurtherimprovedefficiencyintheruraleconomy.Theriseofmarketshasincreasedspecializationandresourceallocationefficiency.Domesticresourceusepatternsareincreasinglymoreconsistentwithregionalcomparativeadvantage.Marketsformostagriculturalcommodities,farminputs,andlaborhaveincreasedincomeearningopportunitiesformanyruralhouseholdsandhavecontributedtothedeclineinpoverty.

PersistentChallenges

Whilepastgrowthanddevelopmentachievementshavebeenimpressive,futuregrowthwillbemorechallengingasmuchofthepotentialgainsfromtransitionhavebeenachieved.Anunnecessarilylargecomponentoftheagriculturaleconomyremainsfocusedoncultivatingrelativelylow-valuedcereals,dueinlargeparttothe

policyenvironment.Food-securitygoalsremainanimportantelementinpolicy-making.Grainfundamentalism,theprovisionofrelativelyinexpensiveandstablesuppliesofgrainfortheurbanpopulation,stillprevailsintheformofquotas,marketingregulations,directandindirectsubsidies(albeitreducedfrompreviouslevels),andbysocialpressurefromlocalofficials.Suchpoliciesobligatefarmerstoignoremarketdevelopmentsandcultivatelowerprofitabilitycropssuchasgrainandcotton.Theemphasisongrainproductionalsohasresultedintheconversionofsomefragileecosystemswetlands,forests,andpasturesintocultivatedlands,contributingtobiodiversitylossesandsoilerosion.

Thestructureofruralincomeearningshasevolvedslowly.Wagelaborasaproportionofnetincomehasincreasedtoonly25percentdespitetheextraordinarygrowthinTVEs(Figure1.2).Householdincomefromnonagriculturalactivities,suchastrading,construction,andtransport,alsoincreasedbutisoftennotanoptionformanyhouseholdsandindividuals,particularlyininlandprovinces.Althoughtheimportanceofagriculturecontinuestodecline,itstillprovided58percentofruralhouseholdincomein1997.Butincomeinequalityhasincreasedrapidlyandincomegapsbetweenrichandpoor,urbanandrural,andcoastalandinlandaregrowing.Relativelyequitableincomedistributionsprevailedinthelate1970s,but

Figure1.2

RuralIncomebySource(constant1995)

bythemid-1990sincomedistributioninChinawasamongtheworld'smostinequitable.Incomegrowthratesinruralareasarelessthanhalfthelevelofurbanresidents.

Decentralizationgenerallyhasbeenagrowthstimulus,butithasalsocreatedfiscalproblemsandretardedpotentialgrowthastheruraltaxbaseisexceptionallylimited.Thefiscalcrisisisanoverridingproblemfacingtheruralsector.Theruraleconomyhasneitherviablefiscalnorfinancialinstitutions.Decliningrealinvestmentforvirtuallyallagriculturalandruralinfrastructure,anddecliningrecurrentexpendituresforservicesandactivities,bodesillforfuturegrowth.Mandatedexpendituresabsorbalargeandincreasingportionofthebudget,leavinglittleforactivitiessuchastechnologydevelopmentandtransfer.Manypublic-serviceinstitutionsandstaffareencouragedtoundertakecommercialactivitiestosupplementbudgetaryresources

Increasedsupportofagriculturalresearch,watercontrolandmanagement,ruralinfrastructureandsocialservicesisneeded.Buttheagriculturalresearchandextensionsystemisweakanddeteriorating,andrestrictionsonimportinghightechnologyfrominternationalsourcesforagricultureinhibitfarmers'accesstobetteragriculturalpractices.Newproductiontechnologiesandmanyservicescouldbedevelopedandprovidedbytheprivatesectordomesticandinternationalbutweakenforcementofexistingintellectualpropertyrightsandpoorwholesaleandretailchannelsdiscourageinterestandinvestmentbysuchfirms.

Povertyandenvironmentaldegradationremainseriousproblems.Millionsofpeopleremaininpovertypocketsinresource-poorruralareasparticularlyinthesouthwestandnorthwestmountainousuplands.Poorregions,characterizedbypoorphysicalandhumancapital,receivelowerlevelsofinvestmentinbasicservicesandinfrastructure.Povertydisproportionatelyaffectsminoritygroupsand

isanimportantcauseofnatural-resourcedegradation.

FutureVision:MeetingtheChallengesandModernizingRuralChina

China'smiraclegrowthisaptlytitledandwithgoodgovernanceChinashouldcontinueonasustainedgrowthpath.Thispositivevisionoftheruraleconomywillrequirenumerouspolicyinitiativesandinstitutionalreforms,accompaniedbyanenablingmacroeconomicenvironmentthattreatsrural-urban,agriculture-industry-service,andgovernment-privatesectorsasequallyimportantandmutuallysupportingpartners.Chinawillapproachmodernitywhenthesesectorsareintegrated,self-reinforcingpartners.Eachsectorwouldhaveequalaccesstoefficiency-pricedresources,ensuringnocross-sectorsubsidizationexceptfortargetedsubsidiestopovertygroups.

Aspartofthepolicyandinstitutionalreform,thegovernmentwouldnotonlybalanceagricultural-ruralwithothersectorsbutidentifyandseparatetherolesandactivitiesthatitwillretainaspublicgoodsandservicesandthoseitwillpermitnongovernmententitiestoundertakewithoutintervention.Governmentalsowouldembracetheprivatesectorasanintegralcomponentofthedevelopmentprocessandencourageittobecomethenewengineofgrowth.Newjobsforproductivelyabsorbingtheunderemployed,redundantlaborfromgovernmentdownsizing,state-ownedenterprise(SOE)restructuring,andnewlabor-forceentrantsmustcomefromnonagriculturalandnongovernmentsectors.

Governmentreconsiderationandreexaminationofseveralpoliciesincludingthoserelatedtodomesticproductionandmarketing,externaltrade,and95-percentgrainself-sufficiencywiththeobjectiveofconsistencyandefficiencywouldlikelyalterpoliciesenablingfarmerstoproduce,andmerchantstotrade,morelabor-intensiveandhigher-valuecommodities.Reformingthedomestic-marketandinternational-tradestructurestomakethemmoremarketresponsivewouldhavemixedimpacts,andtheimpactsofspecificreformsshould

becarefullyassessedbeforebeingimplemented.A

reconsiderationofnationalfiscalpolicieswouldincludeidentifyingmethodsandprocedurestogeneratemoretaxrevenuefromtheruralsectorandtoallocatemoreresourcestopovertyareasandtosubprovincialjurisdictions,andtoeitherdiscontinueoff-budgetrevenuesandexpendituresorincorporatethemintothebudget.Financialpolicieswouldbereexaminedtoensurethatfinancialflowsweredrivenbyfinancialincentivesnotbyadministrativedecisionstosupportorsubsidizestate-ownedindustryandassistinlevelingtheplayingfield.Therural-agriculturalsectorwouldhaveequalaccesstocredit,althoughconditionsoflendingmaywelldiffertocovervariousrisksandhigheradministrativecostsofsmallerruralloans.

Agriculturalincomewouldbeincreasedbyensuringfarmershadaccesstomorenonlaborresources(landandwater,credit,capital,andtechnology)topermitthemtomovetowardmoreoptimuminputandoutputcombinations,includinghigher-valuelivestock,aquatic,andhorticulturalproducts.However,landisauniqueproductioninputthatperformsanexceptionallyimportantsocial-securityroleinChina;thuslegalchangesintenureformswouldbeimplementedonlyaftercarefulassessment.Nevertheless,aland-usemarketwouldbedevelopedtoprovideamechanismforfull-timefarmerstoaccessadditionallandresourcesandoptimize(ormovetowardoptimum)inputsandimproveincome.

PARTIIANENABLINGENVIRONMENTFORRURALDEVELOPMENT

2.RuralIncomeandMacroeconomicLinkages

Theruralandurbansectorsaredualisticandpoorlyintegrated.China'sruralsectorhascontinuouslytransferredresourcestotheurban-industrialsector,includingcapital,wagegoods(food),industrialinputs,andtoalesserextent,labor.However,constrainedlaborflowshavecontributedtothelargedifferentialinruralandurbanlaborproductivityandincome.Theruralsectorhasalsoservedtobuffertheimpactofmacroeconomicshocksontheurbaneconomy.Thespreadofmarketforcesandincreasedrelianceoncompetitivepriceshastendedtoincreasetheflowoflaborandotherresourcesandimproveintegrationinrecentyears.Unlesslabormovementconstraintsareliftedthedualisticnaturewillremain.

A.DomesticMacroeconomicDimensions

AsChinahasmovedfromaplannedtoamoremarket-orientedeconomy,balancedsectoralgrowthandintegrationhavebecomemoreimportant.Theurban-industrialsectorprovidesthedemandfortheruralsector'smarketedsurplus,andastheagriculturaleconomybecomesanincreasinglysmallercomponentofthenationaleconomy,

changesingrowthratesoftheindustrialandservicesectorsstronglyaffecttheagriculturalandruraleconomy.

DomesticTermsofTrade

Inmostcountriesgrowthinthetotalproductivityofallproductionfactors(land,labor

andcapital)totalfactorproductivity,orTFPhasledtodecliningruraltermsoftradedespitevariouspricesupportandsubsidyprograms.InChina,however,risingdomesticdemand,thephasingoutofadministeredpricing,andtheadoptionofmarketpricesimprovedfarmertermsoftradeover1990-97,asreflectedintheratioofpricesreceivedbyfarmerstopricespaidbyfarmers.Domesticcommoditypricesarenowsimilartointernationalborder-priceequivalents;thusChina'stradeandpricepolicydecisionswillinfluencefuturetrendsintermsoftrade.IfChinaliberalizesitstrade,domestictermsoftradeshoulddeclineovertheneartermconsistentwithinternationalexpectations.Ifnot,demandwilllikelyrisefasterthansupplyinthenearterm,meaningpriceswillriseunlessimportsareexpanded.Othernationalpoliciesandeventsnoteffectivelycapturedintermsoftradecalculations,suchasoutputplanningandquotaprocurement,enforcebothimplicitandexplicittransfersfromruraltourbansectors.Inaddition,nationalcreditpoliciesgenerallyfavorurbaninvestorsanddiscriminateagainstruralborrowers.Ruralresidents,ontheotherhand,havebenefitedfromlowerincreasesinconsumerpricesrelativetourbanresidentsoverthepastdecadeandrisingopportunitiestoremitwages.

ResourceFlows

Overthereformperioddirectbudgetaryexpenditurestoagriculturalactivitieshaveexceededagriculturaltaxreceipts,butthenetfiscalflowtoagriculturedeclinedduringtheearlyandmid-1990s.Fiscalexpendituresincludeallocationsforinvestmentsinirrigation,landimprovement,specialtycropproductionbases,etc.However,anetoutflowfromtheruraleconomyhasoccurredastaxesfromrural-basedindustrieswereconsiderablygreaterthanthenetflowtoagriculture.Thenetannualrural-to-urbanflowaveragedaboutY113billion(constant1995)overthe1994-96period(Table2.1);buttheofficialresourceflowmayhavereversedin1998asabove-marketpricesforgrainsdirectedsignificantresourcesintotheagriculturalsector.

Table2.1:ResourceFlowsfromAgriculturalandRuralSectorstoNonagriculturalandUrbanSectors

(Ybillion,constant1995)FiscalSystem FinancialSystem Grain TotalResourceFlow

Agriculturaltonon-

agricultural

Ruralto

Agriculturaltonon-

agricultural

Ruralto

UrbanMarketing(implicit

Agriculturaltonon-

agricultural

Ruralto

1980 -38.5 -30.0 13.2 3.7 46.0 20.8 19.7

1985 -18.4 11.8 23.5 7.4 15.6 20.7 34.8

1990 -31.1 16.1 68.9 47.8 43.0 80.8 106.9

1991 -35.6 20.0 59.4 28.3 27.9 51.6 76.2

1992 -35.8 38.5 536.9 17.3 20.8 41.8 76.5

1993 -28.5 103.8 49.1 8.6 24.9 45.5 137.4

1994 -26.4 105.2 53.4 38.3 59.5 86.4 203.1

1995 -21.3 122.5 51.1 27.8 50.2 80.0 200.6

1996 -22.1 113.2 44.0 27.6 32.9 54.7 173.7

Source:DerivedfromChinaFinanceYearbooksandChinaStatisticalYearbooks,variousyears

Regardlessofthedirectionofofficialfiscalandfinancialresourceflows,itisimprobablethatthe"farmer'sburden"hasbeenlifted.Largeamountsofoff-budgetfunds(notincludedinTable2.1)aregeneratedintheruralsectorthroughunofficialtaxes(leviedparticularlyonTVEs),variousfees,andcorvéelaborleviedonruralhouseholds.Farmersarelegallysubjecttoamaximumtotalpayment(townshipfee,villagefee,andlaborormonetaryequivalent)of5percentofthepreviousyear'snetincome.However,severalcounty-levelsurveyshaveconcludedthataplethoraofadditionalfeesandchargesareleviedbyprovincialandsubprovincialjurisdictionsthatincreaseactualtaxand"tax-like"paymentsofruralhouseholdsto20percentormoreoftheirincome(Wen1998).Totheextentthattheseresourcesarespentonsalariesoftownshiporvillageofficials(andsurveysindicatethatmanyfarmersperceivetheirvillageisoverstaffedwithofficials),insteadofruralinfrastructureandservices,suchfeesareapuretax.Furthermore,iftheresourcesarenotspentinruralareas,additionaloutflowofruralresourcesmayoccurthroughunofficialchannelsthatarenotcapturedintheconsolidatedfiscalstatements.

Investmentsinlandandwaterresourcesareobviouslynecessaryforcontinuedsectorgrowth,butinvestmentsinenergy(electricity),transport(road,rail,waterwayandport),andotherinfrastructurethatreducesmarketingcostsareequallyimportantforpromotingrural-sectorgrowth.AnalysisbyWorldBankstaffindicatesthattheinfrastructureinvestmentelasticityinEastAsiais1.0,implyingthatforevery1percentofpercapitagrowth,infrastructurestockneedstoincreaseby1percentofgrossdomesticproduct(GDP).Therefore,ifapplicabletoChina,infrastructureinvestmentwillneedtobe6to7percentofGDPifGDPgrowthgoalsaretobeachieved(WorldBank,undated).

Tostimulatedomesticdemandanddevelopinfrastructure,the

governmenthasembarkedonathree-year$1.2trillioninfrastructureinvestmentprogram.ArecentcomponentwasaY100billionbondissuetofinanceinvestmentscommencinginthefourthquarterof1998.Muchoftheinvestmentwillfocusonruralinfrastructurethatemploysrurallaborforirrigation,road,andrailconstructionandonrehabilitationoftheruralelectricalgrid.

Theinvestmentprogramdescribedabovemaybehavinganimpactfixed-assetinvestmentrose28percentinthethirdquarter(year-on-yearbasis).However,thecompositionoftheinvestmenteffortremainsaconcernasinvestmentsduringthefirstninemonthsof1998roseby20and19percent,respectively,forSOEsandpropertydevelopment.ThusarealriskremainsthatinvestmentsmaybedivertedfromfinancingpublicgoodstoSOEs,whereovercapacityisalreadyseriousandreturnsarelow.

China'sfinancialsector,likethoseinotherAsianeconomies,hasnotevolvedinparallelwithrealsectorperformance,remainsstructurallyweakandpotentiallyputsruralgrowthanddevelopmentatrisk.Governmentintervention,intheformofpolicylending,pervadesthebankingsystem;andgovernmentremainsinvolvedwithSOEinvestmentinnonpublicgoods.Lardy(forthcoming)reportsthat,ifproperlyaccountedfor,thebankingsystem'snonperformingloanswouldbe30to40percentofGDP.Stockandcommodityfuturesmarketsremainunderdevelopedandunderregulated,andmanyhavebeenclosedorconsolidated.

Analysisofdatafromthebankingsystemindicatesanettransferoffinancialresourcesfromagriculturetoindustrythroughoutthereformperiod,althoughsuchfindingsneedtobeinterpretedwithcautionbecauseofconcernsonthecoverageoftheavailablestatistics.ConsolidateddataonruralsavingsandloansexcludetransactionsofRuralCreditFoundations(RCFs),thesmallestoftheruralcreditinstitutions,andresultsinamodestunderstatementofthefinancial

flows.ConverselytheinclusionofAgriculturalDevelopmentBankofChina(ADBC)datacontributestooverstatingfinancialflows,asitslendingisalmostexclusivelyforagriculturalprocurementbygovernmentmarketingagencies.ManydepositsintheAgriculturalBankofChina(ABC)arebyurbanresi-

dents.Aftermakingallowancesfortheseshortcomings,itisclearthatalthoughruralindustries(TVEs)absorbaportionofthesetransfersofagriculturetoindustry,asignificantrural-to-urbanfinancialflow(Y30billionperyearin

1995realterms)remainedduringthe1994-96period.Whetherthefinancialflowsreflecttheresponseofrationalinvestorsmovingfundsfromlow-returntohigh-returnsectorsorwhethertheyresultfromdistortionsinthefinancialandfiscalsystemisundetermined,butthemassivemovementoffundsoutofagricultureandtheruraleconomyhighlightstheimportanceofthesectorandemphasizestheimportanceofkeepingithealthy.

About40percentoftheSOEsincurlossesandsurviveonsubsidiesandbankoverdraftswhichthenbecomenonperformingloansofthebankingsystem.AgovernmentpriorityisSOErestructuring,ofwhichamajorelementisemploymentrationalization.This,combinedwithdownsizingthecivilandmilitaryservices,willmovelargenumbersofworkerstotheranksoftheunemployed.LaborreductionsshouldimproveSOEperformance,butthereducedlaborincomewillcertainlyerodedemandandemphasizestheneedforrapidgrowthtocreatenewjobsforredundantlabor.Thisoverhangofunemployedurban-industrialworkerswillhavepriorityforemploymentinnewlycreatedjobsandmakeitdifficultforruralworkerstostayandworkinurbanenterprises.Tomitigatetheimpactofincomelosses,governmenthasbudgetedY1.5billionforanewwelfareprogramtoassistlaid-off,retired,anddisabledworkers.

Tightcreditthathashamperedgrowthandexpansionofsmallandmediumenterprises(SMEs)whichaccountfor60percentofindustrialoutputhasbeenrelaxed.Lendingbystate-ownedcommercialbankstoSMEs,includingTVEs,hasbeenincreasedbyseveralbillionyuan.Thisshouldbodewellforexpansionandemployment,butitisas

importanttoensureborrowingproposalsandloansmeetappropriatefinancialandeconomicefficiencycriteria.

Ingeneral,therurallaborforceactsasabufferstockfortheurbaneconomy,providinglaborunderboomingeconomicconditionsandabsorbinglaborbackfromthecitywhenjobgrowthslows(Zhangetal.,1999).Thebufferingcapacityprovidesastabilizinginfluencefortheoveralldevelopmentoftheeconomy,butcontinuedaccessofruralworkerstourbanjobsisacrucialelementofChina'smodernization,providingincome-earningopportunitiesforpoorruralresidentsandincreasingtheefficiencyofurbanenterprises.RecentreformsinSOEshaveresultedinlayoffsforlargenumbersofurbanworkersand,asaconsequence,manycitieshaveenactedregulationsrestrictingemploymentforruralmigrantstolow-quality,low-payingjobcategories.Suchregulationsandgeneralurbaninvestmentslowdownsaffectstheruralmigrantlaborforceanditsfamilies.Theadverseconsequencesoflayoffsandurbanrecessioncouldbemitigatedbyplacingtheunemployedinretrainingprograms,insteadofgrantingthemprivilegedaccesstojobswithoutregardfortheirskilllevel.

Rural-UrbanMigrationandEmployment

NaturalpopulationgrowthisslowerinurbanthaninruralareasbutoverthepasttwodecadesChina'surbanpopulationincreasedfrom18to30percent(in1997)oftotalpopulationduepartiallytoexpandingurbanboundariesandpartiallytorural-urbanmigration,whichhasbeencontinuousdespiterestrictionsonpopulationmovement.Achangingcomplexofincentivesanddisincentivesinfluencesboththedecisionofruralresidentstomigrateandthecharacteristicsofmigrants.Therural-urbanincomedifferentialhasbeenapowerfulstimulustomigrate(officiallyorunofficially)butthehouseholdregistrationsystemmadeitdifficultforruralresidentstoobtainaccesstourbansocialservicesandobtainwell-paidjobs;also,village"useit

orloseit"landpoliciesmayinhibitfamilymigration.Jobsavailabletomi-

grantswereprimarilyintraditionalmale-dominatedconstructionortransportationsectorsasindustrialSOEsarestillobligedtohireurbanresidents.Thus,urban-boundmigrantsaretypicallyyoungmaleswhosefamiliesremainedinthevillagestotillfamilyplots.

Marketdevelopment,relaxationoflabormovementandurbanemploymentrestrictions,anddiscontinuanceofthegraincouponsystemintheearly1990sremovedsomeofthemigrationdisincentives.Meanwhile,thecontinuingrural-urbanincomegaphasmaintainedthemigrationincentive.Duringthe1990surbanjobcreationandemploymentincreasedatfivetimestherateofruralemploymentandupto100millionrurallaborersandself-employedtradershavemigratedtocitiesandcoastalregions(Chan1996,HuangandCai1998).

Barrierstomigrationappeartobeprimarilyontheurbanside,implyingrural-urbanmigrationwillincreaseastheconstraintsandbarriersareremoved.Whethersuchmigrationwillresultinthecreationofmegacitiesorwhethernewmedium-sizetownswillbedevelopedasjobcentersremainsunderdebate.Regardless,however,increasingpressurewillbeplacedonurbaninfrastructureandservicesandadditionalurbaninvestmentswillberequired.Astrong,andopen,urbansectorisimportantfortheruraleconomyasmigrationreducestheagriculturallaborforceandimprovestheratioofnonlabor/laborresourcesandincomepotential.

Agriculturalemploymentreachedanabsolutepeakofabout350millionin1991andthendeclinedby19millionby1997butagriculturalemploymentasaproportionoftotalemploymentdeclinedcontinuouslyoverthereformperiodandnowaccountsforlessthan50percentoftotalemployment.However,Chinaisuniqueasalargeshareofindustrialoutputisproducedbyruralindustriesthatemployabout25percentoftherurallaborforce.Thus,duringthesameperiod

theruralindustrialsectorcreatedabout38millionadditionaloff-farmjobs.AlthoughTVEemploymentsufferedadeclinein1997,itistooearlytodetermineiftheemploymenttrendhasreversedastemporarydeclineshavepreviouslyoccurred.

TVEgrowthandexpansionhasbeenimpressiveovertheentirereformperiodexceptduring1989-90.Despiterapidgrowthinruralindustrialemployment,output,andwages(TVEwageshavegrownat18percentannually),andthesubstantialdirectandindirectcontributiontotheruraleconomy,rural-urbanincomedisparitieshaveworsenedsince1985.Doubtlessly,rapidTVEexpansionpreventedtheincomeratiofrombeingevenmoreadverse,butitwasunabletoreversetheworseningtrend.JinandQian(1998)foundthatTVEsdidnotincreaseaveragepercapitaruralincomegiventhelevelsofnonfarmemploymentand/orlocalpublicgoodsprovision.Furthermore,thelocalnatureofruralindustryalsohascontributedtorisingintraruralinequality(Rozelle,1994).

TVEsnotonlyhavesuccessfullygeneratedoff-farmworkopportunitiesforthelocalrurallaborforce,butforworkersfromothervillagesaswell,creatingrural-to-ruralmigration.Rural-to-ruralmigrationinChinaisaparadoxinternationallyithaspreviouslynotbeenobservedonsuchalargescale,andyetinChinaitisthefastestgrowingsubsectoroftherurallaborforce.Theriseofprivatesectorownershipcan,inpart,accountfortheshiftinhiringnonvillageresidents,sincetheirownersareunconcernedwithnoneconomiccriteria,suchasemploymentpriorityforlocalworkers.Fromthemigrant'sviewpoint,commonbackgroundspermitruralin-migrantstobetterintegrateintotheworkenvironment.Thesefactors,inadditiontothefactthatmostTVEsengageinlabor-intensivelightindustry,meanthatin-migrantsaremorelikelytobewomen,older,andlesseducated;rural-to-ruralmigrationisoneofthemostimportantnewwindowsofopportunitiesforruralresidentsintothewageeconomy.

Ananalysisoffactorsinfluencingmigrationfoundfewvillageinstitutionsthatconstrainedmigration(Lohmar,Zhao,andRozelle1999).Village"useitorloseit"landpoliciesmayinhibitfamilymigration,butlandtenureandgraindeliveryquotas,perse,donotinfluencemigration.However,theabilitytorentoutlandwhile

maintainingnominaluserightsappeartofacilitateout-migrationasdoestheexistenceofinformalcreditmarkets.

Thereare,however,severalfactorsthatfacilitateout-migration.Theoverwhelminglyimportantmigrationdeterminantwasa"villagenetwork."Pastmigrationleadstofuturemigrationfellowvillagerswhocanberelieduponforinformation(andpossiblefinancialassistance),includingpotentialjobprospects,provideachaintoattractadditionalvillagersintothemigrantlaborforce.AsimilarlinkagehasbeenfoundforMexicanlaborersworkinginU.S.agriculturewhereitiscommonforcontractorstosolicitadditionallaborfromthesamevillageaspreviouslyrecruitedlabor.Educationgenerallyimprovesthechancesofobtainingoff-farmemploymentalthoughthatfactorismoreimportantforworkerswholiveandworkathomethanthosewhoengageinrural-to-ruralmigration.Urbanin-migrationcontinuestobeseverelyinhibitedbythehouseholdregistrationsystemandlimitedaccesstourbansocialservices.

Rural-UrbanIncomeDichotomy

Inequality,amongotherthings,isabarometeroftheefficiencyofaneconomyaswellasitspoliticalstability,andthefactthatduringthereformeraChinahasexperiencedanexceptionalincreaseininequalityiscauseforconcern.Giniratioshavebeenabove0.40sincetheearly1990sandhavecontinuedtorise.China'srural-urbanincomegapislargebyinternationalstandardsparticularlywhentherecent1998revisionstourbanpercapitain-

Figure2.1Rural-UrbanPerCapitaIncomeRatios

comedataareapplied.Innominalterms,therural/urbanpercapitaincomeratiodeclinedfrom0.54in1985to0.35in1994,thenrecoveredbyfivepercentagepointsbetween1994and1997(Figure2.1).TheseratioscomparepoorlywithVietnamwherethe1997/98ruralpercapitaincomelevelwas67percentofthatofurbanincomes(Bales).Evenwhenadjustingofficialruralandurbanincomedataforhousingcostsandotherpoorlymeasuredorexcludedcomponentsofincome,rural/urbanincomeratiosdonotimprove.Further,YangandZhou's(1996)analysisofrural-urbanincomeratios,for36countriesoverthe1985-95decade,demonstratedthaturbanincomesarerarelymorethantwiceruralincomes.Theurban/ruralincomeratioofonlyonecountry(outof22forwhich1995datawereavailable)exceededthatofChina.Usingconsumptionasanincomeproxy,ChinacomparesunfavorablywithIndiaintermsofitsrural/urbaninequality.In1993-94thepercapitarural/urbanconsumptionratioswere0.28and0.61,respectively,forChinaandIndia.

Therural/urbanincomeratiousingconstant1985prices,reflectsthedifferentialincreasesinthecostoflivingbetweenruralandurbanareas,andillustratesasimilarbutslightlymoremodestdeclineinrelativeincomes.However,thesedataunderestimatebothruralandurbanin-kindincome.Pricedeflatorsadjustfordifferentialpricechangesbutnotpricelevels.Adjustingforthisdifferential(15percent),imputingrenttoruralincomesandadjustingurbanincomestoincludein-kindincomeforhousing,education,healthcare,pensionsandothersubsidizedservicesprovidesmoreaccurateincomeestimates.Theseadjustmentsloweredruralincomesto31percentofurbanincomesin1990substantiallylessthanthe45percentsuggestedbyofficialdata(WorldBank,1997c).

Thelargerural-urbanincomegappointstoalargedifferentialinlabor

productivityandtoconstrainedfactormobility,especiallylaborandcapital;italsoreflectsthearbitrarynatureinwhichcompensationlevelsareset.Although

onlyexaminingdatathrough1992,YangandZhou(1999)determinedthatthemarginalproductivityoflaborinagriculture,TVEs,andSOEswasY601,Y1,211,andY9,346respectively,in1992.Suchlargeproductivitygapsindicatebarrierstolabormobilitypreventanarrowingofthedifferentialdespitelargenumbersofsanctionedmigrationandlargernumbersof''floating"population.Thegovernmentattemptstocontrolthepaceofmigrationtoensureurbanservicesarenotoverwhelmed,andinparttoassureurbangrainsufficiency.Otherfactorsalsoconstrainmigration,including;lackofjobinformation,housing,medical,educationandothersocialserviceswhichareunavailabletoruralmigrants.Governmentpoliciescontinuetosupportandsubsidizeurbanstandardsofliving,includingtheabsenceofhardbudgetconstraintsforSOEs(protectingurbanjobs),andlow-costcapitalforurbanenterprisesalthoughhousingandenterprisereformsandfiscalconstraintsaremitigatingthesebenefitsasurbanworkersnowpayhigherrentsandcontributemoretotheirpensionandmedicalbenefits.

Intraruralinequalityhasalsorisenrapidlyduringthe1980sandearly1990s,atypeofinequalitythatmaybemoresociallysensitivesinceruralresidentsmaybemoreawareofthedifferencesinstandardoflivingbetweenthemselvesandotherruralcounterparts(Rozelle,1996).TheWorldBank(1997a)hasshownthatoneofthelargestgapsexistsbetweencoastalandinlandprovinces.Someofthegapmaybeduetofactorsrestrictingtheflowoflaborandotherresourcesbetweenrichandpoorruralareas.Withrisingmarketintegration,thebarriersmaybedeclining,butlargeinitialdiscrepanciesinresource,humancapital,andlocationalendowmentsmayrequiregenerationstoequalizewealthlevels.

Itwillbeverydifficulttoimprovethetrendsinrural/urbanincomeratioswithoutimprovinglaborefficiencyandproductivitythroughincreasedcapital/laborandland/laborratiosinagriculture.Whiletheformerratiocanbeincreasedbymakingcapitalmoreaccessible,significantincreasesintheland/laborratiocanbeachievedonlybytransferringlaboroutofagriculture.Duringtheearlyandmid-1990sincreasingagriculturalpricescontributedto

increasingruralincomes,preventingfurtherdeteriorationintherural/urbanincomeratiobutadditionalrelianceonagriculturalpricepolicyislimitedsincethepricesofmanycommoditiesarenowaboveinternationalprices.Shiftingproductiontohigher-valuecommoditiesandcontinuedimprovementsinTFPwillpermitmodestincomegrowthinagriculture,butwithoutadditionallandandcapitalperagriculturallaborer,futurepercapitaincomegrowthinwillbeslowinagriculture.

Theproductionoflabor-intensive,high-valuecommoditiessuchasfruitsandvegetables(particularly

greenhousevegetables),useslandresourcesmoreefficientlythandoestheproductionofgraincropsbutmoreimportantly,provideshigherincomes.

B.TheInternationalMarket

Internationally,exchangeratepolicies,graintradequotas,andmonopolystatetradinginfluencetheperformanceofChina'sruraleconomyandtrendsinruralincomesandconsumption.AlsotheongoingAsianfinancialcrisisandthecontinuinglackofeconomicgrowthandreduceddemandforimportsinJapanandKoreahavethepotentialtohinderruralgrowthanddevelopment.

China'sagriculturalexportvalue(foodandtobacco,butexcludingnaturalfibers)isonly7percentoftotalexportvalueconsiderablylessthanmostofitsneighbors;alsoagriculturalexportsareonly7percentofagriculturalGDP.Thuswhile$11billionofannualagriculturalexportsisobviouslyimportant,itisrelativelyunimportantinrelationtototalproductionandtotheshareoftotalexports.Theimpactonagriculturalimportslikelywillbeminimalgiventherelativelyhighquotaandtariffprotectionforagriculturalcommodities.Severalmodels(e.g.,IIEmodeldescribedinNolandetal.1998andtheG-CubedmodeldescribedinStoeckeletal.1998)

1havebeendevelopedtomeasurethedevaluationimpactofAsian-crisiscountriesontradepatterns.TheIIEmodelindicatesChina'stradebalancecoulddeclineby$12billionprimarilythroughreducedexports,with50percentofthatreductionaccruingtoJapaneseandKoreanmarkets.Thebalanceofthereducedexportswouldbederivedthroughthird-countrymarketslosttocompetitionfromthedevaluingAsiancountries.TheG-CubedmodelindicatesthatChina'simportadjustmentswouldberelativelyrapidandwouldreturntotheirbaselinetrendby2000.However,threefactorswillmitigateagainstincreasedimports:(a)quotaandtariffprotectionofagriculturalcommoditiesarerelativelyhigh;(b)withtheexceptionofpalmoil,themajoragriculturalimportsaretemperatecommoditiesthatarenotproducedinthedevaluingcountries;and(c)internationallytraded

commoditiesareinternationallypricedandwillbelargelyunaffectedbydevaluations.

Japan,Korea,andHongKongareChina'sprincipalexportdestinationsabsorbingabout70percentofitsagriculturalexports.Totalexportstothesedestinationshavedeclinedoverthepastyear,buttheshareofagriculturalcommoditieshasremainedrelativelyconstant.Thus,therecoveryoftheJapaneseandKoreaneconomiesiscrucialtomaintainingandexpandingChina'sagriculturalexports.

Asthemanufacturingsectorislessregulatedandmoreimportantintheexternalmarketthanagriculture,itwilllikelyabsorbmostofthemarketchangesbroughtaboutbytheAsiancrisis.TVEexportdestinationsareunspecified,butTVEsexportabout40percentoftheiroutput.Thus,TVEexportdemandwilllikelybereduced,whichinturnwillreduceTVEemploymentandruralincomesbuttheimpactonagricultureshouldbemarginal.

ExchangeRatePolicies

Sinceconsolidatingthetwo-tierexchangerateinlate1993thenominalexchangeratehasappreciatedabout5percentagainsttheU.S.dollar(through1997).Therealeffectiveexchangerate(tradeweighted),however,appreciatedby30percent(InternationalMonetaryFund).Totheextentthatinternationalpricesinfluence,orestablishanupperbound,fordomesticprices,theimpactofexchangerateappreciationhasbeentolimitthedomesticpriceincreases.Thus,hadtherealeffectiveexchangeratenotappreciated,farmgatepricesforgrain,cotton,oilseeds,andothertradedcommoditiescouldhavebeen30percenthigher.Instead,theappreciationbenefitedurbanconsumers.

Althoughprospectsseemincreasinglyunlikely,theinternationalcommunityremainsconcernedaboutacurrencydevaluationbyChinaanditsimpactbothinternallyandexternally.Adevaluationwould

erodedomesticandinternationalpublicconfidence,reduceforeigndirectinvestment(FDI)inflows,andincreasedomesticdebtbutwouldyieldrelativelysmallgains.WhileChinacouldtheoreticallybenefitbyregainingsomecomparativeadvantageinlabor-intensivemanufacturingpreviouslylosttodevaluingcountries,actualgainswouldbe

limitedparticularlyifitprecipitatedafurtherroundofdevaluations.Actualgainswouldaccrueincompetingthirdmarkets,asbilateraltradebetweenChinaandtheAsian-crisiscountriesisrelativelysmall.Thesefactors,plusthelargepositivetradebalance,appeartosubstantiallymitigatethisrisk.

Adevaluationwouldhavedifferentimpactsondifferentcomponentsoftheruralandagriculturalsector.Producersoftradablecommodities,bothfarmersandindustrialTVEs,wouldexperienceincreasingcostsbecausefertilizers,agrochemicals,andvariousotherrawmaterialsareimported.However,outputvalueswouldincreasemoretherebyincreasingincomesforthatcomponentoftheruralsector.Producersofnontradedgoods,subsistencefarmers,povertygroups,andurbanwageearnerswouldexperienceanincomedecline,andthenumberofresidentslivinginpovertywouldincrease.Theimpactmodelssuggestthataverymodestdevaluationwouldreturntherealeffectiveexchangeratetothepre-crisislevel.

IncontrasttomanyotherAsianeconomies,Chinahasacontinentalmarketmostdomesticallyproducedgoodsaredomesticallyconsumed,withmodestrelianceonexternalmarkets.Althoughexportsandworldwidedemandareimportanttodomesticgrowth,contributingabout3percenttorecenteconomicgrowth,thehealthofthedomesticeconomyisoffargreaterconsequence.TotaltradeasapercentofGDP,ortradeintensity,demonstratestherelativeimportanceofexternalmarkets.IntheAsian-crisiscountries,tradeintensityrangesfromabout50percent(Philippines)toalmost200percent(Malaysia).China'stradeintensityis35percent,withexportscomposing20percentofGDP.However,usingpurchasingpowerparity(PPP)-adjustedestimatesofGDPreducesthetradeintensityratiotoabout10percent.

ImportRestrictions

China'sscarcityoflandandabundanceofrurallaborimplythatmarketforceswillultimatelymakeland-intensiveproductsexpensiveifimportsarerestricted.Normalweatherfluctuationsimplythat,periodically,inflationwillemanatefromacombinationofdiminishedproductionandrestrictionsonimports.Economiclogicsuggeststhatlow-value,land-intensive,andnonperishableproducts(suchasgrain)shouldbeproducedlessandimportedmore,sothathigher-value,labor-intensivecommodities,likefreshvegetablesandanimalproducts,couldbeproducedmoreefficiently,abundantly,andcompetitively.Nevertheless,grainimportsarerestricted.Possibleexplanationsincludeconcernsfor:(a)famine,whichoccurredasrecentlyas1958-60;(b)overrelianceandhighcostofimportinglargequantitiesofgrain(i.e.,Chinaistoolargetorelyonsubstantialimportsofgrain,asitwouldincreaseworldpricesanddepriveotherimportingcountriesofsupplies);and(c)managingrural-urbantermsoftrade(i.e.,transferinvestableandconsumableresourcesfromruraltourbanareas).Nevertheless,theimpactofthisrestrictionissuppressionofthevalueofoverallruraloutputandruralhouseholdincomes.

StateTrading

Grainexportsandimportstraditionallyfunctionasbalancingmechanismstodisposeofdomesticsurplusesortoacquirestockstomakeupproductiondeficits.However,China'sexternalgraintradealsoservespoliticalinterestsasgraintradetargetsareplanned,butunpublicized,inadvanceofthecropyear.Tradeisintendedtobestabilizing,butunfortunately,China'sexecutionoftradeplanshastendedtoexacerbatefluctuationsindomesticcerealsupplies(rice,wheat,andcorn),andprices(Carteretal.1997;WorldBank1997b).

ConclusionsandRecommendations

Theruralandurbansectorsarestronglylinked,butfullintegrationisimpededbyvariouspoliciesandinstitutionsthatfostersorhinders

resourceflows.Thepolicyframeworktransfersfiscalresourcesfromtheruralsector;thenetflowoffinancialresourcestotheurbansectormaybepolicydirectedormayrepresentefficientmarketsthattransferresourcesto

higherreturnuses.Regardless,theruralsectorprovidesalargenetcapitalflowtotheurbansectorandillustratestheimportanceofmaintainingavibrantruraleconomy.Conversely,rural-urbanlaborflowsarepolicy-inhibited,leadingtoadverserural/urbanpercapitaincomeratios.Itisimprobablethatlong-termsustainableincreasesinagriculturalincomecanbeachievedwithoutremovinglargenumbersofagriculturallaborersfromthesectorandincreasingtheaverageland/laborratio.

Thefollowingmediumtermstepstoprogressivelytransferlaborfromtheagriculturalsectorandreversethedivergingtrendinrural/urbanincomeratiosarerecommended:

·Removemigrationconstraints.Thiswouldincludedisassemblingadministrativeandinstitutionalbarrierstorurallaborersseekingurbanemployment.However,forthispolicymeasuretobeeffectivelyimplemented,thecurrentriseinunemploymentinurbanlabormarketsmustbereversed.AstheStatecompletesitslaboradjustmentoverthemediumterm,itisexpectedthaturbanunemploymentwilldeclineandcreateamorefavorableenvironmentforremovingtheserestrictionswithoutsocialdisruption.

·Supportpoliciesandsocialservicesthatfacilitatesmigration.Thiswouldincludesupportofalandusemarketthatwouldpermitmigrantstoleasetheirlandtoothersyetprovideaminimalamountofsecurityifurbanemploymentwasterminated.Additionalsupporttoruraleducationtoimprovevocationalskillswouldincreasethemarketabilityoftherurallaborforceandencouragemigration.Removaloftheconstraintsonurbannonresidents'accesstourbansocialservices,sucheducationfortheirdependents,wouldalsopromotemigration.

·Encouragethecreationoflabor-intensiveoff-farmjobs.TomodernizeitseconomyChinamustsupporttechnology-intensive

industries,whicharetypicallycapital-intensiveaswell.However,someindustrieshavetheoptionofoperatingineithercapital-orlabor-intensivemodes;wherethisoptionexiststhelabor-intensivemodeshouldbepursuedgiventhelargenumberofjobsthatmustbecreatedtoabsorbagriculturallabor,improveagriculturalland/laborratiosandincomes.

1.AlthoughCGEmodelshavebeendevelopedtoanalyzetheimpactsoftheAsiancrisis,onlytheresultsfromtwoofthemorecomprehensivemodelsarementionedinthisreport.Theyare(a)themodeldevelopedbyNolandLiu,Robinson,andWang(describedinNolandetal.1998),hereaftercalledtheIIEmodel,and(b)theAsiaPacificG-Cubedmodel(describedinStoeckeletal.1998).

3.RuralPublicFinance

Chinaneedsahealthypublicfinancesystemtoenablegovernmenttoprovidebasicinfrastructureandsocialservicesandanenablingenvironmentforequitableandsustainableincomegrowth.Fortheruralsector,thisincludesprovidingorfacilitatinginvestmentsinfarmlandimprovements,agriculturalresearchanddevelopment,extensionservices,infrastructuresuchasroadsandcommunications,andsocialservices(suchaseducation,health,andsocialsecurity).Thefiscalsystemalsosetsincentivesthatguidetheallocationofresourcesandinfluencedevelopment.

Chinahasoneoftheworld'smostdecentralizedsystemsforprovidinggovernmentservices.Inmanycountriessubnationalgovernmentsprovideday-to-dayadministrativeandsocialservices,butfinancingtypicallycomesfromthenationaltreasury.LocalgovernmentsinChina,however,arelargelyself-financing,atrendthathasincreasedduringthereformperiod.China'sprovincialcountyandtownshipgovernmentsinruralareasfinanced48percentofbudgetaryexpendituresfromlocalsourcesin1990,butcollected66percentoftherevenues(Figure3.1),alevelmuchhigherthaninmostcountries.

TheConductofRuralPublicFinance

Atypicalcountybudgetisdividedintothreemainparts,withroughly40to45percentofthetotalspentonsocialservices,25to30percent

onadministration,and10to15percentoncapitalexpenditures.Theexpendituresharesarechangingasanincreasingshareofthebudgetisspenttomeetsocialservicesmandatedbythecentralgovernmentandpaynationallysetsalarylevels.AdistinguishingfeatureofChina'sfiscalsystemisthatruralgovernmentfunctionsoverlapandareperformedjointlybythecountyandthetownshiportown,withsomehelpfromvillageresidents'committees.Attheendof1997Chinahadnationwidesome2,100countiesandcounty-levelcities,44,700townshipsandtowns,and740,000villageresidents'committees.Thislargegovernmentalapparatusisstaffedbyalargeandrapidlygrowingnumberofofficials,whosesalariesandbenefits

Figure3.1China,NationalandSubnationalSharesofRevenuesandExpenditures

havecommandedanincreasingshareofthebudget.Incontrast,whileagriculturalinvestmentsabsorbsanimportantshareofbothcapitalandadministrativeexpenditures,itssharehasdeclinedovertime.

Theexpenditureresponsibilitiesoftownshipgovernmentshavetwoprimaryfoci:socialservices,principallyeducation,healthandwelfare;andadministrationoflawandorderandofdisasterrelief.Providinginfrastructuralsupporttotheeconomyagriculturalextension,waterconservancy,farmmechanization,andothercapitalinvestmentsintheruralsectoristheresponsibilityofthecountygovernment.

Althoughvillagesarenotaformalpartofthegovernmentanddonothaveindependentfiscalpower,theystillplayanimportantroleinChina'sfiscalsystem.Whenpeople'scommunesweredisbandedintheearly1980s,productionbrigadesandteamsrevertedtotheirtraditionalnameof"village."However,theyinheritedaframeworkofgovernancefromthecollectivesandexercisesignificantexpenditureduties,suchassalaryorsubsidypaymentstovillageofficials,socialwelfarefortheagedandinfirm,andsometimessupplementaryeducationalorhealthprovision.Duringthecollectiveera,theseobligationswerefinancedfromlocalproceeds.Totheextentthatmanyvillagescontinuetocarryonthesefunctions,theyhavehadtofindoff-budgetmechanismsforfinancingthem,usuallythroughnontaxleviesonruralincomesandproduction.

Alegacyoftheplannedeconomyisthetreatmentoftheagriculturalsectorasmarginaltothefiscalsystemitisneitherasignificantsourceofrevenuesnoramajorrecipientoffiscaltransfers.Intheplannedeconomy,therealfiscaltransferstookplacethroughthepricemechanism("thepricescissors")thatextractedsurplusesfromtheagriculturalsectorbysettinglowpricesforagriculturalrawmaterialsandhighpricesformanufacturedconsumergoods(Huangand

Rozelle).Supporttoagricultureincludedsubsidiesthatwereexternaltothefiscalsystem;theywereprovidedthroughgovernmentcontrolledlowpricesforagriculturalinputs(fertilizers,fuel,andelectricpower)andinvestmentinindustriesthatproducedagriculturalinputs.Astheseprice-basedtaxesandsubsidieshavedisappeared,thetaxcontributionbyagricultureandallocationstotheruraleconomyhavefallen.

ThesechangestoruralpublicfinancehaveoccurredinthecontextofoverallfiscalreformthathaslaggedbehindChina'stransitiontoamarketeconomythroughoutthepasttwodecades.Therevenue-generatingcapacityoftheoldsystemhasbeenerodedwithdismantlingofplanningmechanisms,andthenationwidebudget(alljurisdictions)hasdeclinedfrommorethan30percentofGDPinthelate1970stothecurrent10to12percentofGDP(Figure3.2).Incontrast,treasuriesinotherEastAsiananddevelopedcountriescommand20to30percentofGDP(somehighlysocialistnationssuchasDenmarkandIsraelapproach50percent).

1Thisfiscaldeclinehasreducedthecapacityandwillingnessofhigher-levelgovernmenttotransferresourcestotheruralsector.

TaxReforminthe1990s

Concernwithcentralrevenuedeclineledtoacomprehensivereformofthefiscalsystemin1993,aspartoftheefforttomodernizemacroeconomicpolicy.Themainissuesweredefiningamorestableandrisingrevenuebase;makingthetaxstructuremoretransparentandlessdistortionary;andmodifyingnational-

Figure3.2Rural-UrbanperCapitaIncomeRatios

subnationalrevenuesharing.Keyprovisionsincludedtheadoptionofavalue-addedtax(VAT)andrevenue-sharingarrangements.Thenewtaxpolicyappearstohavemetsomeofitsgoals.IthasstemmedtherapidfalloftaxrevenuesasashareofGDP(Figure3.2),andcentralgovernmentcontrolofrevenuesandexpenditureshasreversed(Figure3.1).

Thetaxsystemremainscenteredonindustry.(TheVATisassessedprimarilyonindustrialproducts.)RuralgovernmentshavebecomeincreasinglydependentonVATrevenuesgeneratedbyTVEs,andtheincreasedremittancesofVATtothenationalgovernmenthasalmostcertainlyincreasedruralbudgetdeficitsaslittleprogresshasbeenmadeinrevenueredistribution.Thereformsdidnotaddressregressiveintergovernmentaltaxsharingandredistributionissues,andthuscreatedseriousshortfallsinmanyruralcountiesandtownships.Taxsharingisbasedoncollection,sothatrichprovincesreceivemorecentraltransfersandrebatesthanpoorprovinces(Rozelle,Zhang,andHuang1998a).Thus,overallintergovernmentaltransfersarestronglydisequalizing.Forexample,Guizhou,Shaanxi,andSichuanProvinceshadbudgetdeficitsexceeding20percentinthemid-1990s,afterincludingcentralgovernmenttransfers.

Thegrainquotatax(duringtimeswhenthemarketpriceisabovethestate-setprocurementprice)isnolongertargetedatsupportingurban

Figure3.3InvestmenttoWageSpendingRatio,

Shaanxi,1983-'92

grainsubsidies;rightstothesequotataxes(thedifferencebetweenmarketandquotaprices)areunclear.TheMinistryofAgricultureisexperimentingwithchangingallfarmertaxburdensintoagraintax,whichhasmetwithsomesuccessandsomeproblems.

GovernmentTransfers

Subventionsfromnationalandprovincialgovernmentsstillareanimportantcomponentofthebudgetsofcountiesandtownships.However,theuntiedtransfersthatformerlyprovidedresourcestocountiesandtownshipsforgeneralexpendituresareincreasinglyreplacedbyspecific,earmarkedtransfersforagriculturalinfrastructureinvestment,educationandhealthcaresupport,welfare,anddisasterrelief.A1988nationalpolicyfixedgeneraltransfersinnominalterms,irrespectiveofrequirements;inrealterms,inflationhassinceerodedmorethantwo-thirdsoftheirvalue.Theimpactismostseriousinpoorcounties.

Targetedtransfersareerodinglessrapidly,butthereformshaveimposedmorefiscaldemandsonlocalities,astransfersareinadequatetomeetmandatedexpenditures.Unfundedpublic-servicemandatesabound;forexample,thecentralgovernmentoftenannouncestargets,suchasspecificreductionsinschooldropoutratesorimprovementsininfantmortality,butthefundstoachievethegoalsarenotprovided.Tomeetthesemandatescountyandtownshipgovernmentsmustraisethefinancialresources.

ImpactonInvestmentandProvisionofRuralSocialServices

Persistentfiscalgaps,orshortfallsbetweenrequiredexpendituresandfiscalcapacity,haveseveraladverseeffects.Oneisthatmanyruralgovernmentsareunabletoprovidethelevelandqualityofsocialservicesmandatedbynationalpolicy.

Investments

Deferredinvestmentisanimmediatevictimoffiscalshortfall.Asofficialsstruggletomeet

wagesandotherimmediateneedsfromdiminishingrevenues,theseneedsaredisplacingdevelopment-orientedinvestments(Figure3.3).Evenifbudgetaryofficialsaredirectedtoallocatefundstofixedinvestment,thefundsareoftendivertedorborrowed,andifnotreturned,theinvestmentisnotjustdelayedbutpermanentlydeferred.

RuralEducation

Callsfromthenationalgovernmenttobolsterruraleducationarenotmatchedbyearmarkedallocations.Nationalofficialshavesetaneducationexpendituretargetof4percentofGDPby2000,upfrom2.66percentin1994.Imploringlocalgovernmentstoincreaseeducationfundingmorerapidlythanthegrowthinfinancialrevenuehasgonelargelyunheeded,andmeetingthistargetappearsimprobable.Insufficientfiscalrevenueshaveunderminedthequalityofeducationasmeasuredbyanumberofhumancapitalindicators.Forexample,aStateStatisticalBureausurveyshowsthat30millionChinesestudentshaveneverbeentoschoolorhavedroppedout,4milliondropoutofschooleachyearbecausetheycannotaffordthecost,andonly64percentofruralstudentscompleteprimaryeducationwithoutrepeatingayear.

RuralHealth

MinistryofPublicHealthgoalscallfor8percentofruralbudgetstobespentonhealthcare.Nationalofficialshavemandatedimprovedfacilities,expandedcoverage,andminimumtrainingfordoctors.Rulesdescribewhatisexpectedofcountyandtownshipleadersforestablishingidealruralhealthsystems.However,likeeducation,theactualresourcesallocatedtoachievenationalobjectivesfallfarshortofneeds.Thenationalgovernmentallocatesonly2.4percentofitsrecurrentbudgetforhealthcareservices,andonly1.2percentofthecapitalconstructionfund.Thesituationismoresevereinpoorareas.

Schoolfeesandhealthchargeshavesoaredinrecentyears.West(1998)reportsinmanyareastherearebothrisingdropoutsduetodifficultyinmeetingthesenewschoolingcosts,andfallingmaternalandinfanthealthcarevisitsbecauseofrisingcosts.Inareaswherefundscannotberaised,educationandhealthserviceshavedisappearedordeclinedinquality,resultinginthelarge-scaleout-migrationofteachers,doctors,andotherprofessionals.

ExtrabudgetaryRevenueSources

Asecondadverseeffectoffiscalpressureisthegrowingrelianceonoff-budgetfinance.The

Table3.1TownshipFinanceinChina,1986-93(Percent)

1986 1987 1988 1989 1990 1991 1992 1993

Totalrevenue 100.0100.0100.0100.0100.0100.0100.0100.0

Budgetaryrevenue 83.3 82.7 80.0 75.9 74.6 72.0 71.5 73.8

Extrabudgetaryrevenue 5.0 4.7 5.6 6.0 6.4 6.9 7.1 6.5

Self-raisedfunds 11.7 12.6 14.4 18.1 19.0 21.1 21.5 19.8

Totalexpenditure 100.0100.0100.0100.0100.0100.0100.0100.0

Budgetaryexpenditure 77.4 76.6 74.3 69.4 69.0 66.4 65.9 67.6

Extrabudgetaryexpenditure

6.4 6.1 7.0 7.2 7.4 7.7 7.6 7.0

Self-raisedfunds 16.2 17.3 18.7 23.4 23.6 25.9 26.5 25.4

Source:MinistryofFinance,1994.

abilityoflocalgovernmentstoraiserevenuesvariesgreatlyanddeterminesthequantityandqualityoflocalpublicservices.Countyandtownshipofficialsareevaluatedontheirfulfillmentofmandates.Thisisanimportantreasonfortheincreasingoflocalfeeassessmentsandrisingburdens(Wen1998).

Tomeettherevenuerequirementsoftheseexpendituredemands,countyandtownshipgovernmentsattempttoincreaserevenuefromoff-budgetsources.Withoutlegaltaxingauthorityorabilitytoborrow,countiesandtownshipshavedevelopedoff-budgetsources,primarilyextrabudgetaryfunds(EBFs)andself-raisedfunds(SRFs).Fromthelate1980sthroughtheearly1990s,theproportionoftotalfundsfromthesesourcesrosecontinuously,reaching28.6percentin1992(Table3.1).Atthetownshiplevel,EBFsarefewer(comparedtocities),andconsistmostlyofruraleducationandagriculturaltaxsurcharges.Themajorityofoff-budgetrevenuescomefromSRFs,whichincludemiscellaneousfees(assessedonlocalenterprises),rentalincome(fromleasedcollectiveassets),andremittancesfromTVEs.TheMinistryofFinancehasreportedthat,onanationalbasis,off-budgetrevenuesbringtotalrevenuecollectiontoabout30percentofGDP(AgencyFrancePresse,Beijing,Sept.22,1998).

Thegrowthofoff-budgetrevenueshaseasedfiscalpressuresformanylocalities,butithasalsoproducedadverseconsequences.Ithashastenedthedeclineoftheformalfiscalsystembyprovidinganalternativetaxsourcethatis100percentretained.Ithascreatedataxsystembeyondthereachoftheformalfiscalsystemthatisadhoc,nontransparent,andregressive;thelackoflegitimacymaybemoreofasourceofruraldiscontentthanthetotalburden.Also,localofficialsrelyalmostexclusivelyonenterprisesforSRFs,thusthemostruralandpoorestjurisdictionshavetheweakestpotentialforsupplementingbudgetsfromthesesources.

Perhapsthemostegregiousconsequenceofoff-budgetfinancingisthetendencyofcountyandtownshipgovernmentstogivepolicyandregulatoryagenciescontrolovertheassetstheyregulateoroperate(ortheresourcestheyarechargedwithprotecting).Officialsthenencourageagencyofficialstousetheseassetstogenerateincomeforstaffsalariesandotherexpenses.Thisisapervasiveissueandwillresurfaceinsubsequentdiscussionsofnatural-resourcemanagementandagriculturalextension.

EqualizationIssues

Previousstudieshavenotedunusuallylargedifferencesinpercapitabudgetaryrevenuesamongprovinces(WorldBank1992a;Wong,Heady,andWoo1995).However,revenueandexpendituredifferencesarealsolargeatsubprovinciallevels;andwithdecreasingtransfers,percapitarevenueandexpenditurehavebecomeincreasingcorrelated.WhiletheVATwasdesignedtopermitthecentralgovernmenttocontrolmorefiscalresources,negotiationshaveenabledprovincestokeepalargeproportionofthetaxestheygenerate.Thisretentionoftaxes,combinedwiththeregressiverebate,mitigatedthemoreprogressivenontaxtransfersandintendedredistributionimpact.

FiscalCrisesinPoorCounties

Inrecentyearsdeficitshavebecomepersistentinpoorcounties.In1994,halfofChina'scountieshaddifficultiesmeetingevenbasicexpenditures,suchaswagedisbursements(Parketal.1996).Countiescangenerateextrarevenuesbysellingurbanpermits,borrowingfundsearmarkedforotheruses(suchasfamilyplanningorschoolconstruction),orborrowingfromlocalSOEsorbanksafrequent,althoughlegallyprohibited,practice.Poorercountiesarerevenuestarvedevenmorethanisreflectedinacknowledgednetdeficits;hiddendeficitsarerepresentedbybudgetaryfundsdivertedfromprescribedusestopaysalariesandwages.Salaryandwagepayments

areoftendeferred,andsomecountyandtownshipgovernmentshavedeclinedtopayforemployeebenefits,suchashealthreimbursements.(Countiescanappealtoupper-levelgovernmentsforspecialsubsi-

diesorincreasesinfixedsubsidies,buttheseadjustmentsareonlymadeinspecialcases,suchasnaturaldisasters.)Thesehiddendeficitsindicatethatfinancialstatisticssystematicallyunderestimatetruefiscaldeficits.

EffectofBudgetPressuresonPublicExpenditurePatterns

Thepressuretoeliminatedeficitsmayresultinunderinvestmentinpublicgoods,especiallyinpoorerareas(whereneedsaregreatest)andincreaseincentivesforlocalgovernmentstomaximizerevenuesratherthansocialwelfare(Wu1994).Localgovernments'placingpriorityonmeetingtheirwagebillshasledtodeferredmaintenanceanddeterioratingcapitalstockinmanyofthepoorercountiesandconsequentlytodecliningefficiencyofresourceuse(GallagherandOgbu1989).

Theimpactoffiscalreformsontheabilityofcountyandtownshipgovernmentstomakeproductiveinvestmentsininfrastructureandsocialserviceshasimportantimplicationsforeconomicdevelopmentinpoorregions.Someofthefallininvestmentinpoorcountiesmightbeexpectedtobecompensatedbyincreasedspendingthroughotherchannels,especiallyChina'spovertyprogram.RecentresearchinSichuan,showsthatlocalinvestmentsineducation,health,andagricultureleadtogrowth,butpovertyprograminvestmentstypicallyreplace,ratherthansupplement,budgetaryinvestments(Rozelle,Zhang,andHuang1998a);andon-budgetinvestmentsandsocialserviceshavedeclinedfromthemid-1980stothe1990s.

Deficitcountieshavebeguntoreducetheirwageobligationsthroughwagesuspension,stafftermination,andreorganizationsthatreassign,butdonotterminate,localgovernmentpersonnel.Somecountyandtownshipgovernmentbureaushavebeenredesignatedascompanies,withworkerpaylinkedtoprofits.Otherbureausandagenciesare

urgedtodesignandpursuerevenue-generatingactivities;andmanystaff(boththosereassignedandstillingovernment)pursueentrepreneurialactivities,suchasopeningrestaurantsandhotelsorengageintrade.

Theconductofruralpublicfinanceaffectstheentirenation'sstabilityandlong-rungrowthprospects.However,theruralfiscalsystemgeneratesinadequaterevenuesandpoorlyredistributescollectedrevenues,which,unlessimproved,willconstrainlong-termdevelopment.

Fiscaldecentralizationhastransferredcontrolovermostresourcesandresidualrightsovermostincrementalrevenuestosubnationaljurisdictions.Nationaldirectivesandtax-collectionproblemshavealsoreducedresourceredistribution(Wong1997).Fiscalreformshavehardenedbudgetconstraintsforallsubnationaljurisdictions;andfiscalsharingruleshaveincreasedtaxcollectionsinbothrichandpoorregions(Parketal.1996;Wong1997).Somescholarshaveidentifiedgrowth-inducingeffectsinChina'sfiscalreform,supportedbyempiricalevidence(Lin,LiuandZhong1997).However,thereformsareincomplete,aswidespreadfiscalcrisessufferedbysomanyruralgovernmentshasreducedpotentialeconomicgrowth,welfare,andequity,andhasledtoinvestmentstarvation.Some70percentofthecountiesandtownshipshavenetdeficitbudgets,andtheirpolicyobligationscontinuetorise.

China'staxsystemischaracterizedbydeficientrevenuegenerationandpublicservicespendingatalllevels.Thetaxsystemisheavilyindustry-dependentandhasneithermadetaxassignmentsclear,norgivenruralcommunitiesarevenuebaseonwhichtobuildrationalfiscalplans.The1994taxreformincreasedthetaxcollectionpowerofthecentralgovernment,whichwouldallowmoreequitableredistribution.Whilemorerevenueshaveflowedintocentralcoffers

(reducinglocalrevenues),littlehasbeenshiftedtopoorerareas,andthenewtaxpolicycontinuestofavorrelativelyaffluentareas,exacerbatingratherthanalleviatingtheruralfiscalcrisis.

Fiscalresourcesinpoordeficitareasareinsufficienttomeettheruralsector'sdevelopmentinvestmentrequirements.Increasedpressureatcountyandtownshiplevelstogeneraterevenuesleadstobiaseddevelopmentpolicies

andmaybecomedistortionaryandinimicaltoeconomicdevelopment.Forexample,investmentsinrevenuedeficitregionsmaytendtobeindustrybiased,becauseoftherelativeeaseoftaxandfeeextraction,evenifinvestmentsinagriculturemightbetterservegrowthanddistributionalgoals.

Werecommendthefollowingstepstoimprovepublicfinancingoftheruralsector:

·Continuefinancialreformtorectifyapotentiallyseriousconstrainttolong-runsustainablegrowthandpovertyalleviation.Mechanismstobroadenlocaltaxbasesandgeneratemoreon-budgetrevenuefromallsectors,includingagriculture,andimproverevenueredistributiontoreallocaterevenuesmoreequitablyaresorelyneeded.Chinamustreconsidertheregressivecomponentsoftheoverallfiscalsystem,especiallythenewVATandrebatepolicies,toimprovefiscalflowstopoorerareas.Giventhemagnitudeandsensitivityoftheproblem,itmustbesolvedinternally;outsideagenciescanassistonlymarginallybyprovidingassistanceinidentifyingthestrengthsandweaknessesofthecurrentsystem,designingandassistingwithexperimentalprograms,andassistinginpublicfiscalpolicytraining.

·Continueevaluatingtheconsequencesofmanagingsuchahighlydecentralizedeconomy,includingbothbenefitsandcostsofdecentralization.Alternativefiscalstructurestobeconsideredincludereturningbasicfiscalresponsibilitytothecounty,fromthetownshipforallbutperhapsthemostindustrializedtowns.Suchamovewouldhaveanumberofconsequencesandtradeoffs.Forexample,theincentivefortownshipstomonitorpolicyandreduceadministrativecostsmightdeclineandpolicyimplementationmightsuffer.Inreturn,however,thescopeforredistributionwouldbroaden;administrativepersonnelcouldbereduced;andunauthorizedtaxes,fees,andleviesmaybereduced.

·Trackgrainquotataxesanddesignwaystocapturethemforcountyandtownshipbudgetsoreliminateallorconvertitintoamoreeasilycollectedtax,suchasaprogressivelandorheadtax.Assistancecouldbeprovidedinevaluatingtheresultsofconvertingallfarmertaxburdensintoagraintaxandin

expandingtheseeffortstolookatabroaderarrayoffiscalinstruments.

1.WorldBank,WorldDevelopmentReport,1997,WorldBank,Washington,DC,1997.

Traditional(backyard)livestockandpoultryproductionbalancescropproductionbyutilizingcropresiduesandsurplusfarmlaborandaddstofarmincome.

4.RuralCreditandFinance

Mobilizingandefficientlyusingavailablefinancialresourcesisimportantforachievinghighratesofeconomicgrowth,especiallyindevelopingcountrieswheresuchfundstypicallyareinshortsupply.Aseconomiesgrow,financialinstitutionsoftenplayanimportantroleindirectingresourcestotheirmostproductiveuse.Asaresult,greaterfinancialintermediation(loansasashareofGDP)usuallyaccompanieshigherincomes(GertlerandRose1996;Levine1997).However,governmentsindevelopingcountriesoftenusestatecontrolofthebankingsystemtopursuepolicygoalsthatarenotalwaysconsistentwithefficientintermediation.

TherecentAsianfinancialcrisishighlightsthepotentialdangersofweakfinancialsystems.ThecrisishasheightenedscrutinyofChina'sstatebankingsystem,whosefragilitystemsfromthecontinueduseofthefinancialsystemtosupporturban-basedstate-ownedenterprisesandotherpolicylending.Thegovernmenthasalsoimplementedstrictlendingcontrolsperiodicallytocombatinflation.Recently,stepshavebeentakentoreducetheamountofnonperformingloans,whichaccountforatleastaquarterofoutstandingloansofChina'sfourmajorstate-ownedbanks(Lardy1998).Pursuitofthesegoalshasledtostrictregulationandeffortstocontrolemergingfinancialinstitutions.Despiteanumberofimportantfinancialsectorreforms,financialmarketshavebeenliberalizedmoreslowlythanmostsectors(Tam1995).SignificantprogressinreformingChina'sruralfinancial

institutions(RFIs)thuswilllikelydependuponthesuccessofoverallSOEandbankingsystemreform.

GiventhatthemajorityofChina'spopulationresidesinruralareas,ruralincomeshavegrownmarkedlyduringthereformperiod,andruralenterpriseshavebeenthemostdynamicsectorofindustry,theruralsectorisamajorsourceandtargetoffinancialresourcesfuelingChina'sgrowth.ConcernovertheperformanceofChina'sRFIsstemsfromseveralfactors.First,thebankingsystem'shungerforfinancialresourcesmayundulytaxRFIdepositsandpolicygoalsmayinfluencelending.Second,regulatedinterestratesimplycreditrationing,makingprivateentrepreneursandfarmers,especiallythepoor,likelytohavedifficultygainingcreditaccess.TVEsalsohavehaddifficultygainingaccesstobankcredit,especiallyduringperiodsofmacroeconomicstabilization(ZhuandBrandt1995).Evenwithoutinterestrateregulation,smallfarmersareoftenrationedoutofformalcreditmarkets(Carter1988).Fieldresearchersobservethatinsomepoorvillages,localcreditcooperativeshavestoppedlendingtofarmers.Between1988and1995,ruralfinancialintermediationhasnotdeepened;infact,farmershavereducedcreditfinancingforkeyactivities,suchasfertilizerandlivestockpurchases(Table4.1).

TypesofRuralFinancialInstitutions

Theruralsectorisservicedbyfinancialinstitutionsthatdifferinsize,branchnumbers,androleintheruraleconomy.ThelargestRFIsaretheAgriculturalBankofChina(ABC),theAgriculturalDevelopmentBankofChina(ADBC),RuralCreditCooperatives(RCCs),andRuralCooperativeFunds(RCFs).

1Eachplaysauniqueroleinprovidingdepositandlendingservicestotheruralsectorandoveralleconomy.Together,theABC,ADBC,andRCCsaccountfor24percentoftotalassets,27percentoftotaldeposits,and34percentoftotallending(Table4.2).

Table4.1:PercentofHouseholdsEngagedinDifferentActivitiesthatFinance

ActivitywithLoansandAverageLoanAmount,byActivity

Year Fertilizer Livestock SmallBusiness Illness Construction Other

PercentofHouseholdsEngagedinActivitythatFinanceActivitywithLoans

1988 30 25 32 38 56 25

1995 22 18 34 37 56 24

AverageLoanAmountofHouseholdReceivingLoan(yuan,in1988prices)

1988 125 238 1,205 494 1,667 499

1995 90 143 3,767 849 2,161 550

Note:Thereare32observationsforZhejiang,Sichuan,Hubei,Shaanxi,andShandong;and24observationsforYunnan.

Source:VillagesurveybyRozelle,Park,Huangetal.,1996.

Table4.2:Deposits,Loans,andAssetsofChina'sFinancialInstitutions,1996

Deposits Loans Assets

NationalTotal(billionyuan) 6,853 6,433 12,856

Ofwhich(percent):

PolicyBanks 0.6 14.1 7.9

AgriculturalDevelopmentBank 0.6 9.7 5.5

StateDevelopmentBank 0.0 4.1 2.2

Export/ImportBank 0.2 0.2

StateCommercialBanks 65.7 64.5 72.6

AgriculturalBank 13.9 14.0 11.4

IndustrialandCommercialBank 27.7 28.0 28.2

BankofCommunication 7.1 7.1 16.4

ConstructionBank 17.0 15.5 16.5

NationalCommercialBanks 6.6 4.7 6.0

RegionalCommercialBanks 1.8 1.5 1.6

CreditCooperatives 20.8 14.0 10.1

RuralCreditCooperatives 12.8 9.8 6.8

UrbanCooperativeBanks 2.1 1.2 0.2

UrbanCreditCooperatives 5.8 3.1 3.1

PostalSavings 3.1

TrustandInvestmentCompanies 1.3 1.2 1.8

Source:DatafromChinaFinancialYearbook1997,compiledbySehrt(1998).

Interestrates,bothdepositandlending,areregulatedbythecentralbank,thePeople'sBankofChina(PBC),andareadjustedatirregularintervals.EffectiveratesasofJuly1,1998wereasfollows:

Percent

Workingcapitalloans6mos. 6.57

Workingcapitalloans1yr. 6.93

Constructionloans3-5yrs. 7.65

DemandDeposits 1.44

TimeDeposits1yr. 4.77

Source:ChinaStatisticalYearBook,1998

AgriculturalBankofChina

TheABCwasestablishedtosupportstatetradingunitsandenterprisesinruralareas,andfarmers.Ithasbranchesinnearlyeverycounty,andhastownship-levelbusinessoffices(whichapproveloans)andsmallerdeposit-takingbranchesinurbanandruralareas.Until1994loansfromthePBCwereanimportantsourceoffundswhichfinancedpolicyloans,mainlyforagriculturalcommodityprocurementbystatetradingcompanies.WhenpolicylendingresponsibilitywastransferredtotheADBCin1994,thesourcesandusesoffundschanged.Deposits,primarilybyindividuals,arenowthemajorsourceoffunds,althoughdepositsbyfirmsaregrowingmorerapidly.Householdsreceiveonly16to17percentofthelendingportfolio;themajoruseoffundsisworkingcapitalloansforindustry,commerce,andTVEs.AstheABChasbecomemorecommercial,ithasincreasinglyservedasanintermediaryintransferringfundsoutofruralareas.TheABCwasrequestedtoresumeresponsibilityforalargeandgrowinggroupofpolicyloansin1998theynowcomposeabout10percentoflendingactivity.Repaymentontheseloansremainsproblematicbecauseofaninabilitytomonitorloanseffectivelyandcrediblydemandrepayment.

AgriculturalDevelopmentBankofChina

TheADBCwasestablishedin1994toassumepolicyloanresponsibilityandallowtheABCtobecomeafullycommercialbank.TheADBC'spolicyloansincreasedrapidlyfromY356billionattheendof1994toY625billionin1996.About90percentofpolicylendingisfinancedbyPBClow-interestloans,mainlyforprocuringagriculturalcommodities(primarilygrain,butincludingcotton,pork,andoilseeds)bystatetradingcompanies.ADBClendingtograinbureaushasbecomeasignificantshareofnonperformingloansinthebankingsystemandwasanimportantreasonforreformofthegrain

marketingsystemin1997.ToallowtheADBCtoconcentrateonaddressingthisproblem,administrativeresponsibilityforpovertyandotherdevelopmentloanswasreturnedtotheABCsin1998.

RuralCreditCooperatives

RCCsarethemostnumerousRFIsandtheonlyfinancialinstitutionswithwell-developedvillagenetworks.Althoughcooperativesinname,theyarecloselysupervisedbythestatebankingsystem.Historically,theyhavehadacloseadministrativerelationshipwithABC,anduntilplacedunderPBCsupervisionin1996,servedasaconduittochannelruralhouseholdsavingstotheABC.Morethan50,000township-levelRCCsexist,operatingasindependentaccountingunits,complementedbymorethan250,000villagecreditstations.TheRCCsarethemajordepositoryforruralhouseholdsavingsand,inprinciple,havegreaterflexibilityinmeetinglocalcreditdemands.Theyhavefewpolicyloanresponsibilities,moreleewaytoadjustinterestrates,andprovidegreaterconveniencethroughdeepervillagepenetration.However,theyaresubjecttolocalpoliticalinfluencesandportionsoftheirextensivebranchnetworkareunprofitable.RCCshavebeenmoreeffective(thantheABC)inmeetingthecreditneedsofruralhouseholdsandenterprises(Park,Brandt,andGiles)butthelendingportfolioisprimarilyTVEloans;agriculturalhouseholdsreceiveonly24percentofthelendingvolume.

RuralCooperativeFunds

RCFsemergedinthe1990sinmanypartsofChinaasnewanddynamicquasi-statefinancialinstitutions,organizedatthetownshiplevelundertheadministrativesupervisionoftheMinistryofAgriculture,withlendingfocusedonlocalhouseholdsandruralenterprises.Becausetheyareunofficial,RCFsarelessstrictlyregulatedandcannotacceptdepositsormakeloans;insteadtheycollectsharesandallowborrowingbuthavestrictercollateralandguarantorrequirementsthanotherRFIs.Sharefundswereestimatedat

aboutY100billionattheendof1996(Cheng,Findlay,andWatson1997),44percentfromhouseholds(Park,Brandt,and

Giles1997).RCFsaretheonlyRFIprimarilyconcernedwithagriculture.LoanstoTVEswereinitiallyprohibitedbutlaterpermittedascapitalizationincreased.In1995householdsreceived45percentofRCFloanvolume;TVEs,24percent.

2Theirsuccesssuggestsalargeunmetdemandforruralcredit.RCFscompetewithRCCsfordeposits(shares),andbecauseoffewerinterest-raterestrictionsandtaxexemptions,providehighershareholderreturnsthanRCCs.In1998TheStateCouncilannounceditsintentiontoincorporateRCFsintotheRCCsystem.However,localgovernmentleadersandtheMinistryofAgriculturesupporttheRCFs,astheyarelocallycontrolledandfocusmoreonhouseholdagriculturalactivities.Implementationofthispolicyisstillunderdiscussionamongministriesandregulatoryagencies.

OtherFinancialInstitutions

Severalotherfinancialorganizationsoperateinruralareas.SomeruralhouseholdsreceiveloansdirectlyfromthelocalgovernmentbudgetorMinistryofCivilAffairsreliefprograms.Insomeprovinces,thatministryhassetupMutualAssistanceCreditGroups(MACGs)thatprovideproductionandconsumptionloanstohelppoorhouseholdstosmoothincomeshocks.MACGswereestimatedtoholdaboutY1.2billionattheendof1993(Zhu,Jiang,andBraun1996).However,mostMACGshaveencountereddifficultiesoffallingcapitalizationduetothelowinterestratesandrelieforientation,whichprovidespoorincentivesforloanrepayment.Informalorganizations,suchasrotatingcreditsocieties,havealsobeenrevivedinthereformera.

PerformanceofRFIs:SavingsandIntermediation

Householdsavingsdepositshavereachedhighlevelsandruraldepositshaveincreasedsteadilyalongwithrisingruralincomes.

However,theyhaveincreasedmoreslowlythanurbandepositsandcompriseamodestshareoftotaldeposits(13percent).Themarginalpropensitytosaveisrelativelyhigh(0.32)butlowerthanintheearlyreformperiod.3Also,thewealthprofileofruralhouseholdssuggeststhatsizablesavingsarenotheldintheformofdepositsorotherfinancialassets.CombiningfinancialandStateStatisticalBureaudata,afour-componentwealthprofile(housing,deposits,grain,andfixedassets)ofruralhouseholdswasconstructed.Depositsaccountedfor17percentofthiswealthin1996,andgrain,whichsitsidlyandisnotintermediatedforproductiveuseelsewhereintheeconomy,accountedfor12percent.Also,holdingsofcashbalancesreportedlyarenearlyasgreatassavingsdepositsinsomeregions.Ruralresidentshaveahighpropensitytoinvestinresidentialhousing,byfarthelargestcomponentofwealth.

InformallendingplaysaslightlymoreprominentroleinChinesevillagesthaninotherAsiancountries(Park1998).Informalborrowinghasbeen10to11percentofincomeduringthe1990s,andanationalsurveyfoundthatmorethan65percentoffarmloanswerederivedfrominformalsources.Informalloansaremoreimportantthanformalloans,especiallyforconsumption.

Eighty-fivepercentofinformalloansareatzerointerest,butwheninterestischarged,itisatleasttwicethatchargedforformalloans.Inanationalsurvey,thenumberofvillagesreportingpositiveinterestratesforprivatelendingdoubledbetween1988and1995.Theaveragemonthlyrateoninformalloanswas1.9percent(25percentperyear),considerablyhigherthantheratesetbythestate(about8to10percent).Whilethisriseininformallendingisapositivetrend,andhasbeenshowntoincreaselabormobility(Rozelleetal.1998),fertilizeruse(Xiao1998),andsmallbusinessdevelopment,itsexpansionsuggestsafailureofformallendinginstitutionstomeetthecreditdemandsofruralresidents.

Inthe1990s,rurallendingbyRFIshasnotincreasedsignificantlyasashareofruraleconomicoutput,contrarytotheexpectedpatternofgreaterintermediationwithhigherincomes.ABCintermediation,inparticular,hasdeteriorated.WhileRCCintermediationhasincreased,

manyfarmersandothersmallpotentialborrowersarestillrationedoutofformalcredit.Inaddition,moredevelopedprovinces,especiallycoastalprovinces,havelowerruralfinancialintermediationratesthanpoorerprovinces,astrikingpatternthatimpliesthatricherprovincesarebeingtaxedbythefinancialsystem.

EconometricanalysisofintermediationratesshowthatABC/ADBClendingishighlyinfluencedbypolicyconcerns,andthatfundsdonotflowasexpectedtofastergrowing,moredevelopedregions.ThepatternofRCClending,whilenothighlyinfluencedbypolicyvariables,alsodoesnotrespondtoeconomicfundamentals.Thesefindingssuggestsignificantbarrierstointerregionalinvestmentandlending.Muchofthisisduetoregulation.Forexample,recentreformshavegreatlyrestrictedhorizontalmovementoffundsamongbanks.Localgovernmentssometimesmandatethatfundsberetainedforlendingtolocalenterprisesandindividuals.Also,fieldworkhasshownthatthelackofregulatoryprotectionandclearrightstomonitor,control,andaccessinvestmentearningsmakebanksreluctanttoloanacrossjurisdictionalboundaries.

ChallengesofFinancialReform

Financialsystemreform,includingdecentralizationandcommercialization,wasoneoffivepriorityreforminitiativesannouncedatthe1998NationalPeople'sCongress.PriorityhasbeengiventoreducingthelargevolumeofbaddebtsheldbyChina'sstatefinancialinstitutions,butconcernforruralaccesstocredithasalsoturnedofficialattentiontoruralfinancialreform.InAugust1996theStateCouncilissueda''DecisiononRuralFinancialSystemReform"andestablishedaninterministerialCoordinationGroupforRuralFinancialSystemReform,ledbyPBC(ThePeople'sBankofChina1997).

4Thereformsarenotcompletelynew,aschangesintheruralfinancialsectorarepartofabroadreforminitiativethatbeganinthe1980s.

WithstabilityanationalpriorityandcontinuedfinancialsupporttoSOEsstillanecessity,thegovernmentmaintainscontroloverfinancialresourcestoinfluencethecompositionandlevelofbanklending.ThedecisiontosupportpoorlyperformingSOEsmayreducethefinancialresourcesavailabletotheruralsector.This,inturn,createspressurestotaxresourcesratherthanencourageefficientfinancialintermediation.

Thepriorityfocusofcurrentfinancialreformistopreservethesolvencyofthebankingsystemwhileaddressingthebank'snonperformingloansaprocessthatalmostsurelywillrequiresignificantbankrecapitalization.WhiletheannualreportsofboththeABCandADBCshowmodestprofits,thesefigureslackcredibility;ADBCofficialshaveopenlyacknowledgedaninabilitytocovercosts.5TheABCalsohasalargestockofoverdueloanswithlittleprospectofrepayment.SimilarproblemsplaguetheRCC.Inrecentyears,morethanone-thirdofRCCbrancheshavereportedlosses,6andasof1994,31percentofRCCoutstandingloansweredelinquent(Shen1998).Thesefiguresunderestimatethetrueamountsofoverdueloansbecauseloansareoftenrolledover(refinancedwithnewloans)ratherthanbeingclassifiedasoverdue.

Improvingprofitabilityoffinancialinstitutionsiscloselytiedtoimprovingloanrepayment,whichinturnistiedtoeffectivelyscreeningandmonitoringprojects.Inthisway,banks'pursuitofprofitspromotesefficientresourceallocation.Someruralfinancialinstitutionshaveinstitutedbetterincentivesystemsfortheirmanagersandstaffs.Insomeareas,localbrancheskeepindependentbooks,chartinglocalprofitsandloanportfoliocomposition,andbasecompensationpackagesoneachunit'sperformance.Branch

restructuring,adoptionsofnewloanapprovalprocedures,anduseofcredithistoriesarebecomingmorecommon.

Regulatedinterestratesondeposits,loans,andinterbankborrowingandlendingprobablyplaythelargestroleindistortingresourceallocationdecisionsbyinvitingmisallocationandrent-seeking.Inflationhasledtonegativerealinterestratesondepositsandloansinsome

years.Officialratesarewellbelowthoseforinformallending,andwithouttheabilitytorespondflexiblytothedemandcharacteristicsofdifferentgroups,theformalfinancialsectormustexcludesomeofthem.Between1996and1998manylocalbranchbanksreducedlendinginfavorofdepositingadditionalfundswiththePBCwhichwasmoreprofitablegiventheinterestratesoffered,expectedrepaymentrates,andthecostsoftransactions.Inearly1998thePBCadjustedthedifferencebetweenreservedepositandloaninterestratestoencouragegreaterlending.

TheABCandRCCpermitindependentbranchestoadjustofficialinterestrateswithinregulatedbands,butlocalgovernmentshavetheauthoritytonarrowthesebands.RCFshavethemostflexibilitytoadjustinterestspreadsbyadjustingdividendpayments.

Theabilitytotransferfundsacrossregionsandinstitutionsisnecessarytodiversifyriskandintermediatefundstotheirmostproductiveuse.Theinterbankmarketwasgraduallyliberalizedoverthe1980sandearly1990s(Xia1995).However,in1996,controloverfundflowswasstrengthenedandtheinterbankmarketcentralized.Withoutnationalofficeauthorizationfundtransferswereallowedvertically,butonlywithinthesamebank.RCCscanfreelytransferfundstootherbranchesinthesamecountythroughthecountyassociationofRCCs,buttransfersbetweencountiesmusthavePBCauthorization.

Otherpolicyfactorsinfluencingprofitabilityincludeill-definedincentivesforbankmanagerstomaximizeprofits;excessivereserverequirementsandloanquotas;pooraccountingandcreditratingsystems;andthecombiningofpolicyandcommerciallendinginthesameinstitutions.Institutionalconstraints,suchasinabilitytoseizecollateralandalegalsystemthatpoorlyenforcesloanrepayment,stillremain,makingitdifficultforbankstosupporthigh-returnbutrisky

ventures.

Astatedaimofthereformsistomoreclearlyseparatepolicylendingfromcommerciallending,buteffortstoseparatethesefunctionsinseparateinstitutionshaveachievedlimitedsuccess.SomeADBCloanshavebeendivertedtocommercialusesandsomeABCloansremainedpolicyoriented.TheADBCtookovertheABC'spolicyloanportfolioin1994,butsomeofthepolicyloanswerereturnedtotheABCin1998.Delinquentpolicyloanscontinuetobeamajorproblemandwillrequirestrongermeasuresthansimplyisolatingloansinpolicybanks.

PartofChina'sfinancialreformshavebeentodiversifytherangeoffinancialinstitutionsandtoincreasecompetition.Regionalbanks,privatebanks,trustandinvestmentcompanies,othernonbankfinancialinstitutions,andevenafewforeignbankshavegraduallyenteredthefinancialsector.Thegovernment,aftersegmentingthelendingresponsibilityofstate-ownedspecializedbanksinthe1980s,hasencouragedmoreopencompetitionamongtheminthe1990s.However,therecentfailureoftheGuangdongInternationalTrustandInvestmentCompanysuggeststhatnonbankinstitutionsalsomaybesaddledwithbaddebt,raisingconcernsaboutthesystem'sabilitytoprudentlyregulatebanks.

Localgovernmentsthathaveinfluenceoverlocalbankbranchesalsomayseektoprotectthedepositbaseof"their"bankstofurthertheirownagendas.Thesefactorscreatepressurestorestrictcompetitionfromnewandinnovativefinancialinstitutionsandtoresistimplementationofreformsthatgrantfullindependencetobankmanagers.Inrecentyears,thegovernmenthassoughttoincreaseregulationoverurbancreditcooperatives,organizingmanyintoUrbanCooperativeBanks(Sehrt1998).In1998,theStateCouncilannounceditsintentiontoincorporateRCFsintotheRCCsystem:eachRCFwouldeitherbecomeanewRCCbranch(ormergewith

one)orbedisbanded.Evenifthesetakeoversarenotcompleted,manyrulesstillrestricttheexpansionofactivitiesoflesstraditionalRFIs,suchasRCFsandprivatebanks.Atthesametime,prudentfinancialregulationofnewfinancialinstitutionsmustbemaintained.

ReachingthePoorandtheRoleofMicrofinance

MostobserversbelievethatChina'sregulatedfinancialsystemhasbeenespeciallyhardonthepoor,whohavehaddifficultygainingaccesstoloans.However,poorareasmayhavebenefitedfrominterregionalbarrierstointermediation;recentsurveysinpoorcountiessurprisinglyfindthatmanyhouseholdshaveatleastpartialaccesstoformalcredit.8Asthesystembecomesmorecommercial,however,morefundswilllikelyflowfrompoortorichareas.Newmicrofinanceinstitutions(MFIs),whichbeganin1994,holdpromiseforeventuallyprovidingfinancialservicestolargenumbersofthepoor.However,theyfacedifficulties,giventhestrictregulatoryenvironment,lackoffinancialexpertise,influenceoflocalgovernments,andremotenatureofpoorvillages.

Formalfinancialinstitutionsoftendenyloanstopoorruralhouseholdsbecausethesehouseholdslackcollateral,faceriskierenvironments,andneedsmallloansthathavehightransactioncosts.Thegovernmenthastriedtoreachtheruralpoorthroughatargeted,subsidizedloanprogrambegunin1986.Aswithprogramsinotherdevelopingcountries,ithasfailedtoreachthepoorandhasachievedlowrepaymentrates(Park,Wang,andWu1997).9Subsidizedinterestratesof2.88percentperyearmaketheloansattractivetorichhouseholds,enterprises,andlocalleaders.Theloansareconsideredtohaveawelfaredimensionthatencouragesdelinquency.On-timerepaymentratesin1991,1992,and1993averaged53,55,and48percent(ChinaScienceandTechnologyCommissionResearchGroup1995).10

Internationalexperiencehasshownthatimprovedaccesstocreditcan

promoteentrepreneurialactivityandhelpliftthepoorfrompoverty.Someoperationalmodelsforprovidingfinancialservicestohouseholdshavebeenexcludedtraditionallyfromthebankingsystem.Thesemodelsrangefromexpandingsustainablefinancialservicesbycommercialbanks(BRIinIndonesiaandBancoSolinBolivia)togroup-basedloanstargetingthepoor(GrameenBankinBangladesh).Theirsuccessesstemfromtransactioncostreductions(byreducingtraditionalbranch-bankingstructures)andtheuseofcollateralsubstitutes(e.g.,harnessingpeermonitoringthroughgroup-lendingcontractsandimprovingincentivesbyincreasingloansizesontheconditionofrepaymenthistory).PilotmicrofinanceinstitutionsandprogramsinChinahaveexperiencedpositiveresultssincetheirintroductionin1994.However,mostofthesehavebeensupportedfinanciallybydomesticandinternationalorganizations.In1997severalprovincialgovernmentsbeganreplacingtraditionalsubsidizedloanprogramswithmicrofinanceprogramssupportedbypovertyalleviationfunds.

MFIsholdpromiseforincreasingcreditaccessforChina'spoorbutrequireverycarefulmanagementandaflexibleregulatoryenvironmenttoflourish.Severalfactorscreatechallengesnotfacedelsewhere,includingtheinabilitytouselandascollateralbecauselandandland-usemarketsdonotexist.Microfinanceinmostcountriesalsoisprimarilynongovernmental.However,inChina,pilotmicrofinanceprogramstypicallydrawstafffromlocalgovernmentsandmustoperatewithinrestrictiveregulatoryenvironments,despitefinancialsystemreformefforts.Finally,China'spoorarelocatedinmountainous,sparselypopulatedregions,providingfeweropportunitiesforpettytradersandsmallbusinessesthatarethemaindemandersofmicrocreditinothercountries,andwhichprovidecashflowenablingweeklyloanrepayment.

Strictenforcementofofficialinterestraterestrictionswilldoommicrofinanceprograms.Manymicrofinanceprogramshavebeen

allowedtochargeeffectiveratesofinterestaboveofficialrates,andthispolicyshouldbecontinued.InterestraterestrictionsshouldbeliftedinexperimentalortargetareastopermitRFIstoreachmoreofthepoorinafinanciallysustainablemanner.RFIsservingpoorareasshouldalsobeallowedtoexperimentwithcollateralsubstitutesintheirlendingoperations.Thegovernmentmayhavearationaletooffertemporary

subsidiesorguaranteestosomeRFIstoencouragethemtoattemptchangesthatmayberiskyorrequireaperiodoflearning.Partiallysubsidizedmicrofinanceprogramsthatarefocusedonalleviatingpovertyholdthepotentialforreachinganevenlargerportionofthepoor.

TheextenttowhichfinancialsustainabilityandpovertyalleviationgoalsconflictdependsontheabilityofMFIstoeconomizeontransactioncostsandreducelendingrisk,andtheelasticityofcreditdemandofthepoortotheinterestrate.Manymicrofinanceprogramsaroundtheworld,includingallofthoseoperatinginChina,relyonexternalsubsidiestocovercosts.Somematureinstitutions,suchasBancoSolinBolivia,haveachievedfinancialsustainabilitythroughexperienceandbyrealizingeconomiesofscale,butdonottargetthepooresthouseholds.GrameenBankdoesabetterjobtargetingthepoorbutreliesonsubsidies.Wenotedearlierthattheaverageinformalloanrateofpositiveinterestwas1.9percentamonth(Park,Brandt,andGiles1997).Itisunclearhowlongitwilltake,ifever,forChina'smicrofinanceprogramstoachievesustainabilityatthoserates.

ManytimestheurgencyofpovertyalleviationmayinduceagovernmentagencytoinvestinthepoorbysupportingMFIexpansion,evenifsuchexpansionisnotself-sustaining.Arethecoststothegovernmentanddonorsworthit?Theanswerdependsonwhetherthecostsofthesubsidiesaresubstantiallybelowthenetbenefitstothepoor.Thisdependsonthedegreetowhichsubsidizedloansactuallyreachthepoor,themaintenanceofoperationalefficiency,thedegreetowhichkeepinginterestrateslowincreasesthecreditdemandofpoorhouseholdspreviouslynotborrowing,thedegreetowhichsubsidieslimitthescaleoftheMFI,theconfidenceincontinuedfundingovertime,andwhetherpublicfundswouldbebetterspentonotherprojects,suchasschoolsandhealthclinics.Recentsurveysofpilotnongovernmentalorganization(NGO)and

governmentprogramsfindthatrepaymentrateshavebeenhigh,buttargetingofthepoorhasnotbeenverysuccessful.

However,awillingnesstosubsidizemicrofinanceprogramsshouldnotbeconfusedwithawillingnesstosupportinefficientlyrunmicrofinanceprograms.Financiallossesandinefficienciescansignificantlyandquicklyincreasethetotalcostofachievingpovertyalleviationgoals.Howonesubsidizesprogramsisimportant,withanimportantgoalbeingtoprovidestrongincentivesforprogramstomaximizeefficiency(Morduch1997a).Thisrequirescontinualdatacollectionandclearaccountability.TodatenodomesticmicrofinanceprogramofwhichweareawarerunbyNGOs,donors,orgovernmenthasdevelopedatimeframeforachievingorimprovingcosteffectiveness.Lackingarecarefulevaluationsbothoffinancialsustainabilityandoftargetingeffectivenessandimpact.AlthoughplansexisttosupportimprovedaccountingproceduresforChinesemicrofinanceprograms,measuresofhousehold-levelimpactsarealsoneededtoproperlyconsiderthedesirabilityofsubsidies.ThisisespeciallytruegiventhatChina'spilotmicrofinanceprogramsareheavilysubsidizedbyinternationalordomesticgovernmentsources.

Long-termsolutionstoChina'sruralfinancialproblemsultimatelydependonsolvingorreducingthenation'sSOEproblem.Somegovernmentreformshaveaimedtoincreasecompetitioninthefinancialsector,butatthesametimethegovernmentisreluctanttoyielditscontroloverfinancialresources.Inindustry,competitionfromthenonstatesectorhasbeenanimportantdiscipliningforceforimprovingSOEperformance(Naughton1996).Extendingthisstrategytothefinancialsectorwouldpermitfreeentrybynew,innovativefinancialinstitutions(suchasRCFs)tomeetthedemandofmarketnichesandprovidegreaterperformanceincentivesformanagersofexistinginstitutions.Inothertransitioneconomies,new

entryhasledtomorereformthansimplybankrestructuring(Claessens1996).

Aregulatoryframeworkisalsoneededto

safeguardtheinterestsofdepositors,butover-regulationinterfereswithefficientintermediation.Wideninginterest-ratebandsandexperimentingwithgreaterdecentralizationandderegulationofinterest-settingauthoritycouldincreasethevolumeofruraldepositsandloans.

Werecommendthefollowingchangestothepoliciesgoverningruralfinancialinstitutions:

·Asanoverallstrategy,createaruralfinancialsectorwithadiversityofinstitutionsthatfacecompetitionandspecializeinmeetingtheneedsofgroupswithdifferentdemandcharacteristics.Theseinstitutionscouldrangefrombankstocooperativestomicrofinanceinstitutions.Regulationmustbeprudenttoensurethestabilityofthesystemandsafeguarddeposits,butmustavoidexcessiverestrictions(e.g.,oninterestratesandinterbanklending)whoseeffectistoexcludegroupsfromcreditaccess.

·Permitandencouragefinancialinstitutionstocreatenewdepositinstrumentsthatprovideattractivecombinationsofreturnandliquiditytobetterservicethesavingsneedsofruralresidents.Thiswillbenefithouseholdsdirectlyandincreasethestockofinvestablefunds.

·Deregulateinterestrates.Expandeddiscretionarybandsforonlendinginterestratesisanimportantstepinreformingruralfinance,butgreaterderegulationwillberequired.Inthecurrentreformenvironment,furtherliberalizationoftheruralfinancialsystemwilllikelybepostponedbecauseoftheprioritybeinggiventoSOErestructuringandtoreducingthefragilityofthebankingsystem.Still,governmentshouldencourageexperiments,onalocalbasis,withnewinstitutionalformsandderegulatedinterestrates,especiallyinareaswherehigherratesarenecessaryforprofitablebanking(suchaspoorareas).

·Encouragecompetitionandinnovationwhilemaintainingprudentfinancialregulation.Thismeansregulatingratherthaneliminatingorco-optingRCFs.Theemergenceofnewinstitutionalformsshouldnotbeheldhostagetothegovernment'sdesireforcontroloffinancialresources.Rather,competitioncanincreaseperformancebyimprovingincentives,andthegovernmentshouldconcentrateoninfluencingfinancialflowsindirectly.

·Developinstitutionsthatsupporttheabilityofbankstoscreenloansandenforceloanrepayment.Itshouldexpandtheuseofloanhistoriesandcreditratings;reducethecostoflawsuits,assetvalueassessments,andrepossessions;developresalemarketsforcollateralitems;standardizeaccountingandreportingproceduresbyfirms;andallowfinancialinstitutionstorestructurebranchsystemsandadjustpersonnel.

·Improvefinancialmanagementandbankingskills.MuchoftheChineseliteraturecitesthepoorqualityofbankemployeesasakeyconstrainttodevelopmentofcommercialbanking.Improvingtechnicalexpertiseonfinancialriskmanagementandotherbankmanagementskillsshouldbeatoppriorityofthegovernmentandthedonorcommunity.Allowingentrybyforeignbankswouldgreatlyenhancesuchefforts.

·Continuetostriveforaclearseparationofpolicyandcommerciallendingindifferentinstitutions.ThefollowingcanhelptheADBCbetterrealizeitsroleasapolicybankwithoutaddingafinancialburden:(a)therecentdecisiontoreturnsomepolicyloanstotheABCshouldbereversed;(b)theADBCshouldbeempoweredtodemandaccountabilityforrepaymentofpolicyloans,whichmayrequirereformofthegrainmarketingsystem(below),andtohavetheauthoritytorefuseloanswithunacceptablerisk;and(c)PBCfinancingofADBClendingshouldbegraduallyeliminated.

·Discontinuethesubsidizedcreditprogramforpovertyalleviation.

Thisprogram,likesimilarprogramsinothercountries,failstoreachthepoorandachieveslowratesofrepayment.Instead,itshouldfocuson:(a)supportingthemicrofinancemovementtohelpthosepoorforwhomlackofcreditisanimportantinvestmentconstraint;and(b)providenoncredit

support(e.g.,education,infrastructure)forthosepoorwhowillnotbenefitfromcreditbecauseofothermorepressingneeds.

·Providefinancialsupportorsubsidiestomicrofinanceprograms,butonlyiflinkedtoconditionsoncosteffectivenessandfinancialsustainability.Variousorganizations,whetherinternationalordomestic,governmentalornongovernmental,canprovidethissupport;however,decisionsonwhichmicrofinanceprogramstosupportandonsubsidylevelsshoulddependonarigorousassessmentofthecostefficiencyofdifferentprogramsandtheaddedbenefitsgeneratedbysubsidies.Organizationscanalsotrainprogrammanagersinfinancialmonitoringandaccountingskillsorattractindividualswiththoseskills;trainprogramevaluatorsandsupportresearchonprogramdesign;financialsustainability,andimpactassessment;supportwaystobroadenthescopeoffinancialservicesprovidedbyexistingRCCsandRCFssothattheseservicesreachthepoor,eitherindependentlyorcollaborativelywithmicrofinanceinstitutions(especiallytoincludesavingsasacomponentofmicrofinance);supportinstitutionalformsthatguaranteetheindependenceofprojectmanagersfromlocalgovernmentsandprovidestrongincentivesforcostefficiency.

1.Ruralresidentsalsosaveinotherspecializedbanks,thepostoffice,andotherquasi-governmentinstitutions;purchasegovernmentbonds;andinvestsharesdirectlyinlocalenterprisesorthestockmarket.

2.CreditsurveyinZhejiang,SichuanandShandongreportedinPark,Brandt,andGiles,"GivingCreditWhereCreditisDue:theChangingRoleofRuralFinancialInstitutionsinChina",WilliamDavidsonInstituteWorkingPaperNo.71,UniversityofMichigan,1997.

3.Basedonfixedeffectsestimateusingprovincialdataonpercapitaincomesandexpendituresfrom1985to1996.

4.NewreformsaimtoseparateRuralCreditCooperativesfrombranchesoftheAgriculturalBankofChina,increasethecollectivenatureofRCCsandthecommercialnatureofABCs,preparefortheestablishmentofnewruralcooperativebanksinrelativelyadvancedareas,andincreaseoperationalagenciesofthe

AgriculturalDevelopmentBank(responsibleforpolicyloans).

5.AlbertParkinterviewsinvariousprovinces,1997and1998.

6.AlbertParkinterviewwithnationalRCC,August1997.

7.ThissectiondrawsheavilyfromMorduch,Park,andWang(1997).

8.AlbertParksurveysof450householdsinsixpoorcountiesinsixprovinces.

9.SeeAdams(1984)foradescriptionofproblemsfacedbysubsidizedcreditprogramsinothercountries.

10.TheprogramsaredescribedingreaterdetailinPark,Wang,andWu(1998).

Higherrisk,higherlaborinput,higherincomes,andincreaseduseofseasonalcreditforpurchasedinputscharacterizesspecializedhouseholdproducersofimprovedlivestockandaquatic

products.Intensiveaquaticproductionalsomakesefficientuseofopenwatersandmarginalcroplandifwaterisavailable.

5.TheDevelopmentofMarkets

TheDevelopmentofMarkets

WiththeintroductionoftheHouseholdResponsibilitySystem,Chinasolveditsbasicfoodproductionproblemsalthoughproductionproblemscouldreturnifagriculturalresearchandtechnologytransferaredeprivedofresources.Agriculture'smoreseriousproblemsnowinvolvethecontinuingdevelopmentofahealthymarketingenvironmentinagriculture,oneinwhichfarmersmaketheirresourceallocationandmarketingdecisionsbasedonundistortedpricesignalscreatedbycompetitivetraders,andinwhichofficialsshifttheirattentiontopromotingmoreefficientmarketsandinterveningonlytobufferpricesagainstextremefluctuations.Inshort,theagriculturalmarketingchallengeisa"second-generation"problemthatmustaddressbothpolicyandinfrastructure.

WhilegradualismhasbeenthehallmarkofChina'sruraltransition,thepaceofreformincommoditypricingandmarketinghavebeenvaried.Perishablecommoditieshaveexperiencedthemostrapidtransition.Themarkettransformationforgrain,vegetableoil,andcottonhasbeenmarkedbyalternatingreformandretrenchmentcyclesthatcontinuesinthelate1990s.Byearly1998,China'sgrainmarketshadbecomesurprisinglyintegrated,competitive,andincreasinglyefficient.TheGovernment'sreformplan,announcedinspringof1998,waspoisedtoinitiateanewsetofreformsthatverylikelycould

havecreatedamarketingandpolicyenvironmentthatwouldhavepromotedevenmoreefficientallocationofresourcesandprovidedpolicymakersindirectmeanstoguidemarketsandstabilizeprices.However,grainmarketingpolicyinitiativessincemid-1998havereversedmarketliberalizationbyprohibitingprivatesectorinvolvementincrucialareas,andreassertingexpensiveandinefficientadministeredprocurement,storage,andtradebyparastatalorganizations.

Improvedmarketingefficiencyreducestransactionscostsandallocatesanincreasedshareofconsumerexpenditurestoproducerstherebyincreasingproducerincomes;butitalsobenefitsconsumersthroughreducedcost.Physicalmarketshavedevelopedrapidlyinruralandurbanareas.Thenumberoffreemarketsattheendof1997exceeded87,000,ofwhichabout25percentwerelocatedinurbanareas.Despitethesmallernumberofurbanmarkets,thevalueoftheirtransactionshasexceededthatofruralmarketssince1994.Followingdecontrolofperishableproductmarketingin1984,free-marketsalesledbyfruit,increasedrapidly;butgrainandedibleoilmarketingcontinuedtobecontrolledthroughoutthe1980s.Bytheendofthedecadefree-marketgrainsalesonlydoubledwhilethesalesvalueofothercommoditygroups

Figure5.1FreeMarketSalesIndexofAgricultural

Products(constantvalue)

quadrupledorquintupled.However,asgrainpolicyliberalizedintheearly1990s,free-marketsalesofgrainandedibleoilacceleratedtobecomethefastestgrowingcommoditygrouponthefreemarket(figure5.1).Salesvolumeinopenmarketsdemonstrateasimilargrowthpattern.

Policyandinfrastructureconstraintsaffectthegrainandnongrainmarketdifferentially.Pricingandmarketingpolicystronglyaffectgrains,forwhichmostmarketingandmarketinfrastructureisundertheauspicesofstategrainenterprises.Alternatively,theefficientdevelopmentofperishableproductmarketsisconstrainedbyinformationshortages,interregionalprocurementrestrictions,andlimitedinfrastructure.

GrainMarkets

Thehighfiscalcostsofgovernmentinterventioninthegrainmarketcausedthecentralgovernmenttomoveincreasinglytowardcommercializationduringthe1990s.Mostgrainresponsibilitiesandpolicyactivities,exceptforanationalreserve,weretransferredtotheprovinces,includingresponsibilityforlocalsupply-demandbalancesundertheProvincialGovernor'sResponsibilitySystem(GRS).Intheory,commercialoperationsofstategrainenterpriseshavebeenseparatedfrompolicyresponsibilitiesundertakenonbehalfofgovernment(e.g.,procurementofthegrainquotaandstorageofStateGrainReservestocks)toensuresubsidiesareallocatedonlytothelatter.Commercializationpolicyfocusedontheprofitabilityofgovernmentgrainagenciesandrationalizinggrainbureaustaffing,butprivatesectorcompetitionemerged,handlinganestimated25to35percentofcommerciallymarketedgraininthemid-1990s.

Overthepastdecade,governmenthasenactedfrequentpricingandmarketingreforms,whichareoftenpartiallyretrenchedandwhichled

tothree-tierpricesallofwhichremainedbelowtheborderprice,atshadowexchangerates,until1994.Estimatesofnominalprotectionratesindicatethatallmajorgrainsweretaxedthroughtheearly1990s,butby1995priceshadincreasedtointernationallevels(rice)orabove(wheat,maize,andsoybeans).Thedisequilibriumbetweendomesticandworldpriceisdueinlargeparttothepartiallyclosedgrainmarketsandstate-controlledtradingsystem.Historically,themostheavilytaxedgrainswereexportedinmostyears(riceandmaize),butrisingdomesticpriceshavemitigatedthispricebias.

Althoughthegovernmenthasmaintainedstrongcontrolovergrainmarkets,the"freemarkets"havecontinuedtoflourish.Cointegrationanalysesconcludethatreformshaveimprovedspatialmarketintegrationandthatsubsequentpolicyretrenchmentshavenotreversedthisintegrationtrend(Rozelle,PrayandHuang1997;WuandHuang1998;ZhouandWan,1999).Recentanalysesusingparityboundsandspatialequilibriummethods(Rozelleetal.1999)alsofindthatthroughouttheearlyandmid-1990sgrainmarketsbecameincreasinglycompetitive,lessfragmented,andmoreefficient.Transactioncosts,includingthosefortransportation,handling,andmarketing,remainedhighuptofourtimesthelevelsfoundindevelopedcountriesbutarelikelyafunctionofthecongestedtransportsystemandantiquatedgrainhandlingmethods.Unfortunately,marketcommercializationeffortshavebeendiscontinued.

RecentPolicy

Facedwithrisingfiscalburdens(duetohigherlevelsofgovernmentgrainstocks)andfallingfarmgatepricesinthelate1990s(causedprimarilybyrecordlevelsofgrainproductionin1995to1997andadeclineindemandgrowth),thegovernmentreassesseditsgrainpolicyinearly1998.Themaingoalsofthenewreformswereto:(a)correcttheinefficienciesinthegrainmarketingsystem(includingproblemsofconcurrentcommercialandpolicyoperationsbythegrainbureaus);

(b)reducethefiscalburdenofthegrainsystem;and(c)stabilizegrainpricesandfarmerincomes.Whiletheoverallgoalsofthereformwerenotnew,anewsenseofur-

gencywaspresent,duepartiallytotheneedforfiscalsavingsandpartiallytogovernmentconcernsforrisinggrainpricesiffarmersreducedsownareasandappliedfewerinputs.

Themajormeasuresadoptedtoimplementtheongoingreformandmeetthechallengingsetofannouncedobjectivesincludethefollowing:

·Clearseparationofcommercialandpolicyfunctionstoparalleltheseparationofcommercialandreservegrain.Commercialcompanieswillberesponsibleforfarmprocurementandinterprovincialgraintransferswithfinancingindependentofthestatebudget.

·Clearseparationofcentralandlocalgovernmentresponsibilities.Bufferstocksforpricestabilizationanddisasterreliefstockswillbetheresponsibilityofthecentralgovernment.LocalgovernmentswillberesponsibleforstabilizinglocalpricesandtheGovernors'ResponsibilitySystemwillberetained.

·Clearseparationofoldandnewgraindebts.ThegrainfinancingdebtisapproximatelyY200billion,ofwhichY130billionrepresentsdefaultedpolicyloanswiththebalancerepresentingborrowingforcommercialoperations.Thesedebtsaretoberepaidovera10-yearperiod.

·Settingthestateprocurementpriceabovethecurrentmarketpricetoprotectfarmers'incomeandensureastablesupplyofmarketedgrain.

Thisambitiousgrainpolicyagendaaddressedseveralcrucialissuesandifimplementedasplanned,acommercializedtradingsystemwithstate-ownedandprivatefirmcompetitionwouldhaveemerged.Also,agovernment-ownedpolicy-oriented,stock-holdingagencywithsufficientreservesandstoragecapacitytocreateaneffectivebufferstocksystemwouldhavebeencreatedandtheseparationofpolicyandcommercialfunctionswouldhaveledtolargefiscalsavings.

Dependingupongovernment'sperceptionofreservestockadequacy,additionalstockscouldhavebeenpurchased(andfarmerincomessupported)ornotpurchased(supportingfiscalobjectives)althoughfarmerincomesmayhavebeenaffecteduntilproductionpatternsadjusted.

However,thisagendawasnotfollowedandmarketliberalizationeffortswereabandonedinmid-1998.Instead,governmentadoptedapolicymixthatwilllikelybeunabletosimultaneouslymeetitsgoalsofcreatingamoreefficientmarketingsystem,reducingitsfiscalburden,andmaintainingstableprices,including:

·remonopolizationoffarmgateprocurement;

·arenewedcommitmentofthegovernmenttoprocureallsalesbyfarmersatthestate-setprocurementprice;and

·prohibitionofthegrainbureaufromsellinggrainatapricelowerthanthestate-setprocurementprice.

Thenewpolicieshavemanycharacteristicsofearlygrainmarketingreformefforts.Itistooearlytoempiricallyevaluatetheimpactsofthisnewreformprogram,butitisquestionablewhetherthepolicymixwillstabilizethedomesticgrainmarket,improvegrainmarketcompetition,andreducethegovernment'sfiscalburdeninmanagingthegrainsystem.

GrainReserves

Mosteffortstocontrolcommoditysupplyandpricevolatilitythroughbufferstocks,stabilizationfunds,internationalcommodityagreements,andgovernmentinterventionincommoditymarketshaveendedinfailure.Bufferstockprogramsoftenaccumulatelargereservesofcommodities(U.S.andE.C.)withresultanthighcostsfor

interestandstorage,stabilizationschemestypicallyendinbankruptcybecauseoftheirunsustainablehighcost(Australia),anddifferentcountryobjectives,alongwithhighcost,havecausedmanyinternationalcommodityagreementstolapse(WorldBank1999).Governmentinterventionisverycostlyandeventuallyhasbeenfiscallyunsustainableformostcountries.

Industrialcountrygovernmentshavebeendivestingfromgrainstoragebecausethecostofholdingreservestocksexceedstheperceivedbenefitsofgrainpricestability.Reservesaremaintainedascommercialstocksbymoreefficientandcompetitiveprivateenterprises.Foodgrainsinthesecountriescompriseasmallpor-

tionofagriculturalincomesandconsumerexpenditures,andpriceinstabilityisrelativelyunimportant.Nevertheless,thereareeconomicargumentsforpricestabilizationindevelopingcountrieswherefoodgrainsareamajorcostelementinthefoodbasket.

2Severalcountries,notablyIndiaandIndonesia,havestabilizedpricesemployingmodifiedbufferstockprogramsbutathighfiscalcost.JhaandSrinivasan(1997)determinedthatIndia'sbufferstockprogramwasthemostcostlypolicyinstrumentforpricestabilizationcomparedwithotheroptions.

TheStateAdministrationforGrainReserve(SAGR)managesreservestocksonanoncommercialbasisandpaysProvincialGrainBureaustohandlegrainonitsbehalf.Thestategrainreservetargetof40milliontons,togetherwithreservesmaintainedbyprovincialandotherjurisdictions,and90milliontonsofcommercialandsemicommercialgrainprocuredbyStateGrainEnterprisesisanextraordinaryquantityofgrain(andproportionofmarketedgrain)handledbytheStatetomaintainpricestability3andisextraordinarilycostly.InformationonthevolumeofChina'sreservestocksandstockreleasesareunavailable;thus,costsandefficiencycannotbeevaluated.Butpricestabilitycouldsurelybeeffectedwithsmallerreserves.

Largereservesprotectagainstpossibletransitoryshortages,butlesscostlyalternativesareavailable.TyingChina'sfoodgrainsecuritytotheglobalmarketsandmakinggreateruseoftheseinstrumentsshouldbemoreefficientatstabilizingpricesandshouldcostlessthanthelargestockprogramcurrentlyfollowed.Althoughgreaterrelianceontheinternationalmarketwouldbemoreefficientthanmaintainingstockforthemostseverecontingency,additionalportandhandlingcapacitymaybenecessary.Priortothemid-1990s,whendomestic

grainpriceswerebelowinternationalprices,maintaininglargestrategicgrainreservestockswasrelativelylesscostly;however,domesticgrainpricesarecurrentlyaboveinternationalborderpriceequivalentsmakingitverycostlytocarryoverstocks.EstimatedcarryovercostsareindicatedinTable5.1basedon1998farmgategrainprices(marginallydifferentfrom1997prices).

PerishableProductMarketing

Livestockandaquaticproducts,andfruitsandvegetables,werethefirstfoodcommoditymarketstobeliberalized.However,thesemarketscanbecharacterizedas"constrainedcompetitive"atbest.Aseriesofinformationandregulatoryconstraints,bothlegalandquasi-legal,inhibitthedevelopmentofeconomiesofscaleandafullyfreeandcompetitivemarket.Thisappliesparticularlyintheareaofcross-border(township,county,andprovincial)marketing.

Table5.1:CostofCarryoverStocks(Yuan/ton)

FarmgateGrain/a

1998UnitPrices/b Storage Interest StorageTotal

Prices(1998)

Import Export loss5%/c

Cost10%/d

fee/e Cost

Rice 2,175 4,108 2,047 108.8 228.9 126.0 463.7Wheat 1,445 1,560 72.3 152.1 126.0 350.4Corn 1,270 646 63.5 133.7 126.0 323.2/aAverageofgovernmentandmarketprices./bImportandexportunitvaluesderivedfromtradestatistics./cGrainlossesinstorageareassumedtobe5percent./dInterestcostsare10percentofthevalue(perton)ofstoredgrainafterstoragelosses./eTheStateAdministrationforGrainReservespaysY120/tonofgrainplacedinstorage;thesecostsareincreasedby5percenttoaccountforstoragelosses.

Farmersdeliveringseedcottontobuyingstation.

CommodityProcurementandEconomiesofScale

Somejoint-venturefirmsandwholesalemarketshavedevelopedscaleeconomiesinprocurement,processing,anddistribution,butcounty-specificprocurementandprocessinglinkageshinderthedevelopmentofscaleeconomiesbylocalenterprises.Countyfood-developmentcorporationsthatprocessperishableproductsareprohibitedfromcrossingcountyboundariestocontract(withfarmers)forproduce,thusforcingprocessorstoturntoin-countywholesalemarketsthatattractproducefromadjacentcounties.Otherfoodmarketingfirmshavebeguntospecializeinhigh-valuefreshproductsinresponsetostrongdemandbyurbanconsumersandbyhotels,restaurants,andinstitutionsandcompetewithimportedproductsformarketshare.

Smallcountyprocessingplantshavebeenencouragedtocreatevalue-addedproductsandabsorbagriculturalproductswithinlocalareas.Thisstructuremayhavebeenjustifiedearlier,whentransportationnetworkswerepoor.However,withimprovedtransportationandroadinfrastructure,intercountytransportofproducthasbecomecompetitive.Restrictingfirmsfromsourcingproductsfromneighboringlocaleshasoftenleftthesefirmswithexcesscapacity,anddespitefavorablelendingpracticesbylocalfinancialintermediaries,theyoftenwereunderutilizedandnoncompetitiveleadingtoinsolvency.Theuncertainlegalframework

forfirmconsolidationanddiscriminatorysourcingpracticescontinuestoinhibitfirmsfromexpandingacrosscountyboundaries,andborderingcountiescontinuetooperatesuboptimalprocessingplantsinthesameproductcategories(e.g.,slaughteringplants,fruitjuiceplants).

TransportationandDocumentation

Alackofrefrigerated,containerized,andintermodaltransportservicesfurtherconstrainsmarketing.Inlandaccesstothemajorurbancoastalcitiesstilllargelydependsonrailwaytransport,buttrafficflowsmustconformtothepriorityroutesestablishedduringthecommandeconomyperiod.Forexample,meatcanbeshippednorthfromChengdubutnotsouth.Railtransportisfurtherhamperedbydelayedrail-caracquisition,frequentspacecancellation,andlengthytransittime.TransittimeforexpressrailcargoservicefromChengdutoBeijing(2,000+kilometers)is15days,versus7daysbytruck.

Interprovincialbarrierstotradeinperishableandprocessedfoodsincludeinconsistentweighing,inspection,andotherprocedures,andthelackofnationalstandardizedquarantineandphytosanitaryinspectioncertificatesandclearancedocuments.Inspectionandcontrolauthoritiesateachprovincial(municipal)boundarymayquestiondocumentationvalidityparticularlyattheboundariesofprovincesproducingcompetingcommodities.Jurisdictionstreatagriculturalcommoditytransportdifferentially,requiringdriverstopresentvariouslicensestoinspectionauthorities.Bordercheckpointsaremaintainedforquarantineinspection,paymentoftransitandshippingfees,andotherdocumentclearances,butdriversoftrucksfromoutofthecountyorprovincemayfacedelayswhichdamagescommodityqualityandvalue.Driversalsomayberequiredtopayunofficialfees.Governmentsofmostothercountriesrequirethattruckstransitingjurisdictionsinwhichtheyarenotregisteredpayfeesbasedonobjectivecriteria(e.g.,grossweight,numberofaxles,etc.).

MarketInformation

Indevelopedmarketeconomies,government-fundedinformationnetworkse.g.,U.S.DepartmentofAgriculture(USDA)provideongoingmarketinformationforeachlevelofindustryactivity,withinformationaccessavailabletoallorganizationsandindividuals.InChina,marketinformationhashistoricallybeencollectedasinputsforgovernmentpolicydecisionsratherthantohelpmarketsperformmoreefficiently.Publicinformationonmarketpricesandvolumesislimitedtoafewnationalandmajorregionalwholesalemarketsandcommodityexchanges.Althoughsuchdataarerecordedbyotherwholesalemarketmanagers,informationonproduction,stock,andflowsisrestricted,andforsomeproducts,disaggregatedpriceandproductturnoverinformationiskeptproprietary.ProducersorwholesalemarketmanagersatthecountylevelrequireclearancefromtheprovincialStateStatisticsBureautoaccessdisaggregatedcensusdataoncountyorprovincialproductionstatisticsandregionaltradeflowsbyproduct.InadditionlocalproducersandwholesalemarketshavelimitedaccesstoinformationfromtheMinistry(orBureaus)ofAgriculture.Publicinformationoninterprovincialtradeiseitherdifficulttoaccess,orisunavailable.Contractualdeliveryagreementsareprincipallynegotiatedbetweenproducersandjoint-ventureprocessingplants(aswellasstateexportagencies).Theseareproprietaryagreements,andconfidentialityofcontractcontent(e.g.,prices,volumes,deliveryarrangements)ismaintained.

ProducerMarketingAssociations

Historically,producerassociationswereformedtoimprovefarmerbargainingpowerwithrespecttodownstreampurchasersandtoimprovefarmerincome.Theseassociationsareadministeredbyproducersonbehalfoftheirmembership,andvirtuallyallorganizationalandoperationalcriteriaareestablishedandenforcedby

members.InChina,afewfarmerorganizationshavedevelopedfromvillageassociations,focusingprimarilyonproductionpromotingmodernproductiontechnologiesandhusbandry,ratherthanmarketing.Membershipfeespayfortraining,specializedextension(oftenfromanagriculturaluniversityorresearchcenter),andotherservices,suchaspublicizingapplicableregulations.

Thesuccessofproducermarketingassociationsrequiresanumberoffacilitatingfactors.Forpositivereinforcementinestablishingmarketingassociations,alegalframeworkfortheirdevelopmentandaregulatoryframeworkdefiningthecommercialobligations(e.g.,contractenforcement,adjudication)ofassociationsandtheirmembersarenecessary;thelackofprohibitinglegislationisinsufficient.Technical,managerial,andtrainingassistanceisrequiredtoeducatefarmers(andlocalofficials)oncommercialprinciplesandalleviatesuspicionsofcollectivedecisions.Intheabsenceofmarketlinkagesandmarketingalternatives(high-valueprocessingplantsorfreshmarkets),farmersareunabletoobtainpricepremiumsforhigher-qualityproducts.Thus,marketingassociationsmusthaveanintegratedmarketintelligenceandsalesunittoassembleprice,quality,andquantityinformationindifferentiatedmarkets.Centraltothedevelopmentofproducerassociationsistheabilitytoextendtheirstructuresacrossadministrativeboundariesintoneighboringproductionareastoassuresupplyaccessandcontrol.

Determininghowthenewpolicieswillmeettheobjectivesisdifficult.Theproposedmeasuresmightnotstabilizefarm-gateprices(orfarmerincomes),improvegrainmarketingefficiency,orreducetheaggregatefiscalburden,althoughaportionoftheburdenmaybetransferredfromthecentraltoprovincialgovernments.Consequencesofthenewpolicieswilllikelyincludethefollowing:(a)Asubstantialoverprocurementofgrainmaystresstheprocurementandstorage

capacity,physicallyandfinancially,andinhibitcommercializationofstategrainenterprises.Theenormousprocurement

andstoragecostswillalsobedifficulttofinance,creatingincentivestopurchasegrainatdiscountprices(belowthegovernmentdeterminedprice),withIOUs,ordeclinetoprocuregrainbeyondanticipatedsales.(b)Urbanconsumerpriceswillincrease,whichwillreducebothgraindemandanddiscretionaryurbanincomes.(c)Thegrainmarketgainsinefficiency,integration,andcompetitivenessacquiredduringtheearlyandmid-1990swillbereduced.

Thenewpolicieswilllikelyreturnthestructureofthegrainmarkettothatofthelate1980s.Evenwithtotalseparationofday-to-daycommercialoperationsandspecializedgovernmentagenciestoimplementpolicies,commercialtradingwillbedifficultwhilethegovernmentcontinuestosetprocurementpricesatabove-marketlevels.

Althoughprivatetraderswillbepermittedtoparticipateinwholesaleandretailmarketing(afterprocuringsuppliesfromthestategrainenterprises),whetherthebasisforprivateandnon-privatecompetitionwillbeequalintermsofsimilaraccesstooutputandcreditmarkets,consistentlicensing,andsimilartaxarrangementsareunclear.Also,thestateenterprisesmaycontinuetosufferfromoperationalhandicaps,suchasexaggeratedemploymentorexcesswelfareresponsibilities.

Officialsdisapproveofsignificantimportrelianceforgrainsuppliesforfearofdestabilizingtheworldmarket,ifChinaimportsverylargevolumesofgrain.Thisconcernisusedasadefenseforinterveninginproduction,marketing,andtrade.However,theinefficienciesandfiscalcostsoftheseinterventionsareenormousandseriouslyaffectfarmerincomes.Elsewhereintheworld,governmentsinbothdevelopedanddevelopingcountriesaredivestingtheirgrainprocurementandsupplysystemsandbufferstocks.

WerecommendthefollowingtofurtherdevelopChina'smarkets:

·Commercializationmeasureshavebeensuspendedtoaccordprioritytootherreformmeasures,howeverthepolicymeasurestocommercializethetradingactivitiesofthegrainbureausanddiscontinuemonopolygrainprocurementshouldbereinstatedasearlyaspracticable.Ascurrentlyimplemented,thegrainmarketingpolicywillincurenormouscostsanddrainbudgetaryresourcesfromotherpotentialruraldevelopmentinvestments.

·Transformtheenormousstockofgrainreservesheldbycentralandprovincialgovernmentsintoatransparent,marketfriendlybufferstocksystem.Thiswouldrequire,interalia,intensiveanalysesontheoptimumsizeofreserves,stocklocations,internationalmarketlinkages,pricebandstobedefended,andtriggermechanismsforopen-markettransactions.

·Investinpublicgoodsthatpromotemarketdevelopment:transportandcommunicationsinfrastructure;marketinstitutions,suchaswholesaleandfuturesmarkets;marketinformation;thedevelopmentofuniformgrainqualitystandards;andcontractenforcementmechanisms.Inanincreasinglycommercialenvironment,thegovernment'sroleistoserveasanimpartialarbiteroffairmarketcompetition,steadfastlyprohibitingratherthanencouragingbarrierstointerprovincialtrade.Closingorisolatingmarketsdestroysincentivesforproducersandtraders,exacerbatesinequities,andmakesstabilizationthroughbufferstockoperationslesseffective.

·Encourageflexiblesourcingandprocurementstructuresforagroindustrialcommodities.Suchstructuresarenecessarytoensureappropriateandefficientscaleprocessingtechnologyandtopromotereinvestmentinfuturecost-reducingtechnologies,whichinturnarenecessarytomaintainfirmprofitability.

·Consolidatethemarketinginformationsystemundertheauspicesofasingleagency,andmakeitmorecomprehensive(i.e.,includequantityandqualityalongwithprice).Toensureadequate

informationwasprovidedtothecentralmarketinformationagency,licensingandlicenserenewalofwholesalemarketscouldbeconditionalonthetimelysubmissionofmarketinformation.Situation

andoutlookinformation(assessmentofproductionconditionsandprobablemarketing)ofperishablecommoditiesshouldbedisseminatedsimilartothatcurrentlyreleasedbytheMinistryofAgriculture(MOA)forgrainsandoilseeds.

·Assistinbroadeningandstrengtheningfarmerassociationmanagement,throughtrainingprograms.Few,ifany,farmerassociationshavetheskillsandknowledgebasetoadviseproducersonmarketchannelsfordifferentiatedproducts.However,broadeningandstrengtheningassociationmanagementtoengageinmarketdevelopment,promotionandothermarketingactivitiesandthusfurtherempowerproducersinthemarketplacewouldimproveagriculturalincome.Producerassociationscouldimprovetheplanninganddistributionofhorticulturalandlivestockproducts,linkingproductionwithefficientscaleprocessingindustries.Theycouldalsoextendconsumerdeliveriesbyexploitingregionalproductspecializationandseasonality,therebyimprovingincomelevelsandstability.

·Standardizenationalquarantineandphytosanitaryinspectionprocedures,certificates,andshippingdocuments,andapplythemequallytoallinterprovincialcommoditytransport.Thiswouldimprovemarketingefficiencyandincreasefarmerincome.Ifnationalquarantinecertificationconditionsweremet,lowerjurisdictionsshouldhavenoauthoritytorestrictcommoditymovement.Theestablishmentofpreclearancequalificationsandprocedureswouldfurtherincreaseefficiency.Processing-plantcertificationforquarantinepurposeshasmadefrozenshrimpexportstotheUnitedStateslessbureaucraticandmoreefficientthaninterprovinciallivestockmarketing.Inspectionandcertificationproceduresshouldbetransparentandstandardfeesshouldapply.

Requiretruckstransitingprovincesinwhichtheyarenotregisteredto

payfeesbasedonobjectivecriteria.Thesefeesalsoshouldbetransparent,standardized,anduniversallyapplied.Transitfeesandleviesbeyondthoseofficiallysanctionedshouldbevigorouslydiscouraged.

1.ThissectionreliessubstantiallyonWorldBank1997b.

2.RicepricestabilizationbyIndonesia'sBulog(BadanUrusanLogistik)isestimatedtohavecontributedalmostonepercentagepointtoGNPgrowthinitsearlyyears,1969-74(Timmer1996).

3.Indonesia'sBulogstabilizeddomesticricepricesduringthepastthreedecadesbyrelyingheavilyonprivate-sectortradersandperformingonlyamarginalmarketrole.Bulog'smaximumannualricepurchasewas25percentofproductionanddesignedcarryoverstockswere1.0milliontons.

6.InternationalTradeandForeignCapitalFlows

A.Trade

Introduction

Chinaisanimportantglobalplayerinthetradeofselectedagriculturalcommodities.AtvarioustimesoverthepastdecadeChinahasimportedasmuchas17percentoftheworld'stradedwheat,25percentofitsfertilizer,and28percentofitssoybeanoil,whileexportingasmuchas10percentoftheworld'stradedcorn.Agriculturaltrade,whichinthefollowingdiscussionincludesaquaculturalandmariculturalproducts,wasreasonablywellbalancedoverthe1990s,withsmallsurplusesinmostyears.

ThenominalvalueofChina'stotalexportsandimportsgrewatannualratesof13and12percentover1980-96;theratioofforeigntrade(exportsplusimports)toGDPincreasedmarginallyto7.1percent,valuedatpurchasing-powerparity,orPPP(WorldBank1998).Agriculturalexportsandimportsgrewconsiderablyslowerataverageannualratesof7.1and5.9percentandaccountedforjustunder3percentofglobalagriculturaltradein1996.However,growthintherealvalueofagriculturaltradeaveragedonly2percentannually,from1980to1997lessthanhalfthegrowthrateofrealagricultureGDP.

TradeObjectives,PoliciesandInstitutions

Thehighlyvisibleproductionandtradepolicygoalofgrainself-sufficiencyisinconsistentwithothernationalefficiencyobjectives.Thisobjectivehaschangedonlymarginallyoverthereformperiod.Throughthe1980sexternalgraintradewasbasicallytobalanceindividualfoodandfeedgrains.Inthe1990s,asitbecameincreasinglyapparentthatChinadoesnotenjoyacomparativeadvantageingrainproduction,thedomesticgrainself-sufficiencytargetwasredefinedasof95percentofconsumption.

Otherobjectives,suchasimprovingtheefficiencyandresponsivenessofthetradingsysteminmeetingnationalrequirements,areconsistentwithotherefficiencyobjectives.Policyandinstitutionalreformsinitiatedduringthe1990sinclude;consolidationofexchangerates,eliminatingmostgovernmentdeterminedprices,encouragingcompetitionbydecentralizinganddemonopolizingthetradeofmanycommodities,commercializingoperationswheremonopoliesremained,transformingtradingcompaniesintohandlingagents,reducingthenumberofcommoditiesrequiringimportandexportlicenses,andreducingtariffs.Removingtheremainingdistortionstopermittradetoreflectproductioncomparativeadvantageisanimportantelementinacceleratingruralincomegrowth.

Thetwo-tierexchangeratewasconsolidatedinDecember1993.Duringthemid-1990smarketdeterminedpricesforagriculturalcommoditiesincreasinglyreplacedgovernmentdeterminedprices.Tradedecentralizationincreasedthenumberoffirmseligibletoengageinforeigntradefromabout1,200in1986toabout200,000in1996.

StateTrading

Rapidprogressinliberalizingotheraspectsoftradeaccentuatesthelackofreforminstatetrading.Whileanylicensedforeigntrade

companymaytradecertainagriculturalcommodities-externaltradein''strategiccommodities,"suchasfoodgrains,textilefibers,andchemicalfertilizers,continuestoberestrictedtospecializedandmonopolynationaltradingcorporations.Somenationaltradingcorporationshavebeentransformedintofor-profitenterprises,includingtheCereal,Oil,&Foodstuffs

ImportingandExportingCorporation(COFCO),forgrain,edibleoil,andsugar;ChinaNationalChemicalsImportandExportCorporation(SINOCHEM),forchemicalfertilizer;andtheCottonImportandExportCompanyofChina.COFCOhandlesgrainasamonopolyagentforimportersandexporters,butgraintradingstillremainssubjecttoimportandexportlicensesandquotas.COFCOisnotonlyalargetrader,italsoisanerraticone,generatingwideyear-to-yearswingsintradevolume.LackofinformationcharacterizesChina'stradetransactions,causinguncertainlytoboththosewhoCOFCOrepresentsandthosewhoCOFCObuysfromandsellsto.

ImpactofReforms

Unlikemanyneighboringcountries(wheregovernmentshaveprotectedagriculturalpricesandsubsidizedfarmers),Chinaconsistentlytaxedfarmersuntilthemid-1990sbymaintainingfarmgatepricesbelowborderpriceequivalentsexceptforsmallvolumesofgrainsoldtonongovernmentbuyersatmarketprices.Nominalprotectionratesestimatedatofficialexchangeratesforthemajorgrains,oilseeds,andcottonclearlyshowdecliningnegativeprotection(i.e.taxation)overthe1980sand1990s,andnowhoverwithina10percentbandaroundzero.By1997mostgrainandcottonprocurementandmarketpricesapproachedinternationalpriceequivalentsandby1998,exceededinternationalprices.

Exportablecommoditiessuchasrice,maize,soybeans,andcottonweremoreheavilytaxedthanimportablecommodities,suchaswheat.Iftheimpactoftheovervaluationofthedomesticcurrencyandthetariffprotectionsystemisconsidered(recentlyreduced),agriculturalincentivesarefurtherdistorted,depressingfoodpricesandredistributingincomefromfarmerstourbanconsumersandtheagroprocessingsector.Ontheotherhand,thegradualliberalizationofpricesandagriculturalmarketshassignificantlyreducedthe

distortionsinrecentyears.

Whileimporttariffshavebeenreducedandmanytradingcompaniesarepermittedtoimportvariousagriculturalcommodities,monopolytradingcorporationsandimportquotasstillapplytosomeofthemajoragriculturalimportscereals,oilseedsandvegetableoils,andwool.Furthermore,thesizeofthequotasarenotpublicized.

Comparativeadvantageinagricultureoftendeclinesintheprocessofeconomicgrowth,andthisisexpectedtohappeninChina.Innationswherearablelandisscarce,thecomparativeadvantageinagriculturetendstodeclinemorerapidly(Anderson1990).Ingeneral,thecomparativeadvantageofChina'sagriculturalsectorhasbeendecliningforland-intensivecrops.China'snetgrainimportswilllikelyincreaseinthefuture;andagradualchangeintradecomposition,includingimportshiftsfromfoodtofeedgrains,seemsinevitable.

ShiftsinTradePatterns

Althoughthegrowthrateofagriculturaltradehasbeenbelowthatofindustrialexports,China'sshareoftheworld'sagriculturaltradehasincreased,suggestingthattradeliberalizationhasbeeneffectivedespitetheremainingbarriers.Tradestructurechangeshaveaccompaniedrapideconomicgrowth.Agriculture'sshareofGDPandtradewasabout30percentin1980,decliningtoabout20and10percentrespectivelyby1997.Therechangesreflectimprovedsectoralresourceallocationandthetransferringofcomparativeadvantagefromagriculturaltomanufacturedproducts.

Thevalueofagriculturalexportswas$20.2billionin1997,ofwhichgrains(Chinesedefinition),primarilyoilseeds,composedabout11percent.China'sagriculturaltradebalance(Table6.1)andtradeinmajorcommoditygroups(Figure6.1)indicatesthechangingcompositionoftradeandsuggestsanexporttrendtowardproductsin

whichChinahasacomparativeadvantage.ImportdatadonotyetsuggestatrendincommoditiesinwhichChinaiscomparativelydisadvantaged.Grainimportsin1997and1998wereparticularlylowprobablyaconsequenceofthe95-percentgrainself-suffi-

Table6.1:China'sAgriculturalTradeBalance,1992-97(milliondollars-nominal)

1992 1993 1994 1995 1996 1997BulkCommodities/a 1931,439 78-4,955-3,529-1,253ConsumerReadyProducts/b 1,9852,0302,520 3,458 3,836 1,463HorticulturalandOtherFoodProducts/c

9511,0731,426 1,281 1,177 1,085

ProcessedIntermediaryProducts/d 1,1291,208 400-1,259 -811-2,614TotalTradeBalance 4,2595,7504,424-1,475 673-1,319OtherAgriculturalandResourceProducts(OARP)/e 2,7462,8854,761 6,130 4,580 743TotalBalanceIncludingOARP 7,0058,6359,185 4,655 5,253 -576/aGrains,seeds,rawtobacco,cotton,andrawsugar./bProcessedmeat,dairyproducts,processedvegetablesandfruits./cTrees,flowers,freshfruitsandvegetables./dLiveanimals,floursandmeals,gums,saps,oils,hidesandskins,rawwool./eSeafood,beverages,leather,forestproducts,woolyarnandfabrics,cottonyarnandfabrics.Source:CompiledfromChina'sCustomsStatisticsYearbook,variousyears.

ciencyobjective.Thenetexportsofland-intensivebulkcommodities,suchasgrainsandoilseeds,havefallen,whileexportsofhigher-valued,morelabor-intensiveproducts,suchashorticulturalandanimal(includingaquaculture)products,haverisen(Figure6.1).Thecerealexportembargo,ineffectduringportionsorallof1994to1996,severelyconstrainedgraintrade,butgrainexportsdidnotnoticeablyrecoverfollowingtheliftingoftheembargo.Theimportanceofgrainexports,whichaccountedforabout23percentoftotalagriculturalexportsinthepre-embargoperiod,havefallenbyabouthalf.Thustheembargoappearstohavesimplyemphasizedthedecliningtrendincerealexports.In1997horticulturalproducts,

primarilyfruitsandvegetables,andanimalandaquaticproducts,accountedformorethan80percentofagriculturalexports.Grainstypicallymakeupmorethanone-halfthevalueofimports,withwheatandvegetableoilsandfatsthemajorcomponents,butweresubstantiallylessin1997,whenanimalproductswereofmajorimportance.TheseexternaltradetrendsreinforceagriculturalproductionpatternsobservedbyPark,Rozelle,andCai(1994),andRozelleetal.(1997b),whofoundthatdomesticproductionisincreasinglymovingtowardcommoditiesinwhichacomparativeadvantageisenjoyed.

Figure6.1MajorCommodityGroupsasaProportionofAgriculturalTrade

TradeBarriers:HowSevere?

Chinahassignificantlyreducedtariffsoverthepastdecadefornonagriculturalcommodities,andadditionalreductionsareunderdiscussionaspartoftheWorldTradeOrganization(WTO)negotiations.Chinareduceditssimpleaverageimporttarifffrom42percentin1995to17percentin1997(U.S.TradeRepresentative1998).Agriculturalimporttariffsof40to60percent,althoughhigherthantheaverageforallcommodities,areconsiderablybelowthoseofmostdevelopingcountries.Thesetariffreductionsareprogressivebutmasksignificantnontariffbarriers.Avarietyofnontariffbarriersrestrictimports,includingtariffquotas,importquotas,importlicenses,phytosanitarymeasures,andstatetradingapplyingparticularlytograins,cotton,vegetableoils,andfertilizer(U.S.TradeRepresentative1998).

AlthoughChinamaintainsahightariffforabove-quotaimports,tariffsforsomeofthemajorimportitemssuchasgrain,soybeans,andcottonarebelow5percent,ifwithin-quota.WithintheWTOcontext,Chinahasofferedtoreduceitsweighted

2average,binding(i.e.,maximum)tariffto41.3percentbytheyear2004,includingareductionongrainsfromthecurrent66.9to51.6percentaverylowlevelfordevelopingcountriesandmoresimilartothoseadoptedbylargegrain-exportingnations.IfWTOmembershipisagreedandacceptedontheseterms,itwouldprecludeChinafromfollowingaprotection-basedagriculturaltradepolicyoptionusedbyitsmore-developedEastAsianneighbors.

Thesetariffsmustallbeinterpretedcautiouslybecausetheyareoftencombinedwithquotas.Forexample,themostfavorednation(MFN)tariffonwheatwas114percentasof1996andtheWTO-boundrateis

65percentfortheyear2004;butatariff-ratequotaappliesandimportsunderthequotaaresubjecttoonlya1.0percenttariff.Therateis114percentforimportsabovethequota.Similarlicensingoftariff-quotaimportsappliestorice,maize,soybeans,edibleoils,andwool.Thewithin-quotatariffrateisrelativelylow:1percentforallcerealgrains,3percentforsoybeans,13.8percentforedibleoils,and1to3percentforwool.Theabove-quotatariffsarequitehigh,butwhetherthesehightariffshaveeverbeenappliedisuncertain.

ImpactofWTOAccessionandTradeProtocols

TheprocessofWTOaccessionhasinvolvedseveraltradeliberalizationcommitments,andadditionalcommitmentsdoubtlesslywillfollowallofwhichwillimpactdirectlyondomesticagriculturalcommoditypricesandruralincomes.Thecommitmentsincludeterminatingthetradingmonopoliesnowenjoyedbystatetradingenterprises.Thiswillpermitnonstatetradingentitiestoimportportionsofthetariff-ratequotas,rangingfrom10percent(wheat)to67percent(cotton)to90percent(soybeanoilin2006)andrepresentsimportantstructuralreformwhichwillimprovetradingefficiency.Inaddition,domestictradinganddistributionrightswillbeliberalizedoverathree-yearperiod,permittingtransnationalfirmstoengageindomesticdistributionincludingfertilizer,whichheretoforehasbeenhighlyprotectedfromdistributioncompetition.Further,Chinahascommittedtodiscontinueexportsubsidiesandtradedistortingdomesticsubsidiesandbaseagriculturalimportprotectionsolelyontariffs,therebyeliminatingprotectionist(nonscientific)elementsofagriculturalsanitaryandphytosanitaryregulations.IfChinaistoremainanexporterofriceandcorn,domesticpriceswillnecessarilydeclinetolevelsconsistentwithinternationalpriceequivalents.AlthoughpreciseimpactsofWTOaccessioncanbedeterminedonlythroughdetailedsupplymodeling,itisclearthatpricesforandproductionofthesecropswoulddeclineandnear-termagriculturalincomeswillbereducedunlessyieldscanbeincreasedorproduction

costsreduced.

Tariffbindingsandtariff-ratequotas(TRQ),areanintegralelementofthetariffbasedregime.Averageimporttariffsforagriculturalproductswoulddeclineto17percentby2004,leavingagriculturesomewhatmoreprotectedthanin-

dustry,wheretheaverageimporttariffwillbereducedtoabout9.5percent.However,verylowtariffs(3percentorless)willapplytoTRQsofmostbulkcommoditiesthosecommoditiesinwhichChinadoesnotenjoyacomparativeadvantagecerealgrains,cotton,soybeansandsoybeanderivatives(mealandoil).TheexistenceofaTRQdoesnotnecessarilymeanthatimportswillimmediatelyincreasetomeetthequota.Forexample,theTRQforriceis2.7milliontonsin2000risingto5.3milliontonsin2004;buttheinternationalricemarketisvery"thin"andrarelyhasanycountryimportedmorethan2milliontonsannually.And,ifimportsofthatmagnitudewereattemptedin2000,internationalricepriceswouldincreasedramatically,similartotherapidpriceincreasesfollowingChina'simportof1.6milliontonsin1995.Nevertheless,giventhatinternationalcottonandsoybeanpricesarebelowdomesticprices,theavailabilityofcottonandsoybeanTRQswillinevitablyresultindomesticpricedeclinesandincomereductionforproducersofthesecommodities.

PriceandSupplyVolatility

Long-termtrendsinglobalgrainprices,whichhavebeendecliningforwelloveracentury,areforecasttocontinuedecliningoverthenext10to15yearsaccordingtorecentstudiesbytheWorldBank,theFoodandAgricultureOrganization(FAO),andtheInternationalFoodPolicyResearchInstitute(IFPRI).

3Sharpshort-term(2-3year)priceincreases(anddecreases)haveandwilloccurinreactiontomajorpolicydecisionsongrainproductionandstoragebymajorproducingandtradingcountries,exceptionallyfavorableorunfavorableweatherwithresultingharvestimpacts,wars,naturalcalamities,andsimilarevents.Forexample;thedramaticpricespikein1995-96followedasell-offof220milliontonsofinternationalgrainstocksduringthepreviousdecade,coupledwitha1995droughtinsomeU.S.grain-producingareas.

Futuregrainpricevolatility,aroundthedecliningtrend,islikelytobegreaterthanofrecentdecadesbecauseofpolicychangesinthemajorexportingcountries.ThesechangesincludeboththosemadeduetotheWTOAgreementsonAgricultureandunilateraldecisionsbytheU.S.andtheE.U.governmentstoreducestockholdingsforbudgetaryreasons.Thesechangeswillkeepworldgrainstockslowinthefutureandlowerstockscouldleadtogreaterprice

volatilitybecausethesmallerbufferagainstapoorharvest.

Themonopolystructureofthestatetradingcompanycreatesinefficienciesanddistortionsinthedomesticeconomyandmayevencreateuncertaintyinworldmarkets.Pricestabiliza-

Modernbulkgrainhandlingsystemsarereplacingbaggedgrainhandlingindomesticandinternationaltrade.

Figure6.2DomesticandInternationalGrainPrice

Volatility(dollarsperton)

tionisbecominganincreasinglyimportantgoaloftradepolicy.However,importingduringperiodsofrelativeabundanceandexportingduringperiodsofrelativescarcityhavemadepricesinChina'sdomesticmarketmorevolatilethaninternationalmarketprices.Huang(1998)demonstratedthatdomesticpricesofallthreemajorcerealshavebeenmorevolatilethaninternationalprices(Figure6.2).

4Similarlygrainsupply(produceandnetimports)fluctuationshavebeenexacerbatedbytrading.

Thecalculationofstandarderrortermsaroundpricetrendlines(199097)clearlydemonstratesthatdomesticgrainpricesaremore

volatilethaninternationalprices.(Table6.2).Also,ananalysisbyChen(1999),usingprovincialaveragefarmgateprices(weightedaverageofquota,negotiated,andmarketprices),determinedthatpricevariation,asmeasuredbycoefficientsofvariation(CV)hadincreasedovertimeCVsforriceandcornpricesdoubledbetweenthe1975/85and1985/95decades,whiletheCVforwheatpricesincreasedby50percent.

Furthermore,nettradeinriceandcornhaveexacerbatedproductionfluctuationsasnetexportshavetendedtobelessinyearsofhighproductionandmoreinyearsoflowproduction.Theimpactoftradeisindicatedbythehigherstandarderrortermfor"production+nettrade"inTable6.2.Thisapparentanomalyprobablyderivesfromexecutingexportplanswhicharedevelopedseveralmonthspriortoharvest.Storagestatisticsareunavailable,thusitisuncertainwhethertradeexacerbatestotalsupplyvolatility.However,wheattradedampensproductionfluctuationsasadditionalsuppliescanberapidlyimportedifneeded.An

Table6.2:GrainPrice,Production,andSupplyVolatility(1990-97)Wheat Rice Corn

Sy.x CV Sy.x CV Sy.x CVDomesticMarketPrice/a 29.4 0.18 54.2 0.20 26.3 0.19InternationalPrice/a 21.2 0.15 30.6 0.12 19.7 0.18DomesticProduction/b 5.9 0.055 8.5 0.046 8.7 0.091DomesticProduction+NetTrade/b 4.6 0.040 8.7 0.046 13.2 0.132/aMonthlydata Sy.x=StandardErrorofEstimate/bAnnualdata CV=CoefficientofVariation

argumentcouldbemadethatcornsupply,whichisharvestedlateintheyear,isafunctionofthepreviousyear'sharvestandthecurrentyear'snettrade.However,laggedproductiondoesnotdampenfluctuationsastheestimatedstandarderrorissimilartothatforproduction.

Duringtheearlyandmid-1990sanumberoffuturesmarkets,includinggrains,wereestablishedinChina.Whiledesignedtofacilitatepricehedgingbetweensuppliers,users,andtradingcompanies,tradingwas"thin"andthemarketswereconsideredspeculative,subsequently,governmentclosedorconsolidatedseveralfuturesmarkets.However,globalcommoditymarketsandmarketliberalizationpermitshorttermsupplyandpriceriskstobemanaged(hedged)throughcommodityderivativesmarkets(futuresandoptions).Futureshedgingisanefficientmanagementtoolwhenannualimportsarerequiredtomeetconsumptionrequirementsbutinappropriateasinsuranceforpossibleimports.China'sdeficitwheatpositionispartiallyhedgedininternationalfuturesmarkets.Thisisrelativelyeasygiventhatinternationalfuturesmarkets,suchastheChicagoBoardofExchange,isveryliquid,andChinaisanannualnetimporterofwheatthusaminimalamountcanalwaysbehedged.Similarly,aslongasChinaremainsanetcornexporter,aminimalamountoftheexportscouldbehedged.Itismuchmoredifficult,however,tomanagepriceriskforuncertainquantitiesofimportsandexports,becauseifahedgedpositionisnotfulfilled,significantsumscouldbelost(orgained).Itisimportanttorealize,however,thatrelianceontheinternationalmarketforannualrequirementsusuallywillbelesscostlythanattemptingtostoreorcarryoverlargestocks.Futuresoptionsarerelativelyinexpensivetheoreticalalternatives,butmarkettransactionsintheseinstrumentsaretoofewtobeaviableoptionforChinagiventhemagnitudeofyear-to-yearfluctuationsinimports.

UndocumentedImports

Chinatendstoimportbulkagriculturalcommoditiesdirectly,butalargeshareofprocessedfoodandconsumer-readyproductsarefirstimportedintoHongKongandthenre-exportedtomainlandChina.HongKongofficiallyre-exportsabout55percentofitsagriculturalimports.InadditiontorecordedshipmentsfromHongKongtoChina,alargeunofficialtradeexists(USTR1998;Wong1998).EstimatingthedollarvalueofundocumentedagriculturalexportsfromHongKongtoChinaisdifficult,butitcouldexceed$1billionperyear.UndocumentedshipmentsoffreshfruitintomainlandChinamayaccountforupto70percentofHongKong'sfruitimports(Wong1998).

Also,thevalueofofficialre-exportsfromHongKongtoChinatendtobeunderreported.Wong(1998)reportsthatmorethan50percentofHongKong'sagriculturalproductre-exportstoChinahadunitcoststhataveraged6.2percentlessthantheirimportvalue.Alternativelytheexport-importmarginsforagriculturalproductsre-exportedfromHongKongtonon-ChinadestinationsshowthatagriculturalproductsimportedintoHongKongfromnon-Chinasourcesandre-exportedtonon-Chinadestinationshaveanaveragemarginof15.3percent.Positivemarginsforre-exportstonon-Chinamarketsandnegativemarginsforre-exportstoChina,stronglysuggestthatthevalueofagriculturalproductexportstoChinaisunderrecorded.

Thegovernmentlargelymonopolizesinternationaltradeinbulkystrategicagriculturalproducts(cereals,vegetableoils,cotton)anddeterminesannualimportandexportgrainquotas;butwithlittletransparencyregardingeitherthequantityorvalueofthequotas.Importtariffshavelittlepracticalmeaningbecausenumerousnontariffbarriersexist.Inaddition,importquotasaresubjecttoalternativetariffschedules.

AsChinaliberalizesthetraderegime,consistentwithjoiningWTO,acontinuingshiftinthepatternoftradewillbegenerated.However,itremainsuncertainwhetherChinawouldremainanear-term,netagriculturalexporterand

graduallyincreasegrainandotherbulkimports(Wang1997)orifproducerswouldmeetrisingdemandbyshiftingsupplyfunctionsthroughincreasedinvestmentsinagriculturalresearch,irrigation,andotherproductivity-enhancingactivities(Huang,Rozelle,andRosegrantforthcoming).

Werecommendthefollowingchangesintradepolicytohelpimprovetheruralsector:

·Promotetradecompetition.EvenifChinamaintainsaclosedtradepolicy,competitionwillincreaseefficiency,transparencyandtheeffectivenessoftradepolicy.

·Permitthemarkettohaveagreaterroleindeterminingtradepatternstoreapcomparativeadvantagegains.Thiswouldprobablymeanincreasedoverallagriculturaltradeand,inaddition,ashifttowardimportingmoreland-intensiveagriculturalproducts(grains,oilseeds,andcotton)andexportingmorelabor-intensiveagriculturalproducts(fruits,vegetables,livestockandaquaticproducts).Toachievecomparativeadvantagegains,China'straderegimemustbemoreopenandmightinvolveremovingimplicittaxesonfarmers,reducingperversetradingincentivesforstatetradingagencies,andmakingthestatetradingagenciesmoretransparentandmoreaccountabletomarketdiscipline.

·Changethegrainself-sufficiencypolicy.The95percentgrainself-sufficiencygoalisinconsistentwithanopen-tradepolicy.Acontinuingpolicycommitmentto(near)grainself-sufficiencymeanslargeinflowsofgrainwillnotbepermittedevenifChinaopensitsbordersto(otherwise)freeagriculturaltrade.Ifthispolicyispursuedthroughfuturegrainpricesubsidies,itcouldbeachievedonlybyclosingthebordertolessexpensiveforeigncerealsbeyondthe5percentimportquota.

·Inliberalizingtrade,assessthewelfareimpacts,andmeasuresrequiredtocushionanyadverseimpactonportionsoftheruralpopulationwhoareatriskandlessabletopartakeofnewproductionopportunities.Inanopeneconomy,grainpriceswouldalmostcertainlydecline,accordingtorecentanalysesbytheCenterforChineseAgriculturalPolicy(CCAP).Thus,grainfarmerswouldsufferincomelosses,butconsumerswouldgain,aswouldthoseproducersabletoproducehigher-valuespecialtycommoditiesforbothdomesticandexportmarkets.Theimpactonsubsistencefarmersinpoorareaswoulddependuponwhethertheywerenetproducersorconsumersofgrain.

·Phaseoutstatetrading.EvenifChinaremovesexplicitnontariffbarriers,amonopolystatetradingfirmcouldunilaterallyblocktradedespiterulesandregulations.Eveniftraderemainssubjecttoquantitativecontrols,morecompetitionwouldgeneratecompetitiveefficiencies.

·Designaneffectivesetofreleaserulesforgrainstocksandcoordinatereleasesofbufferstockwithimportsandexportsandmaintainsmallergrainreservesatareducedcost.Tensofmillionsoftonsofgrainstocksmaintainedatcostsoftensofbillionsofyuanhavebeenunabletostabilizegrainpricesbecauseofconflictingincentives,unclearcontrolrights,andpoorlydefinedreleaserulesandmanagementpractices.Chinahascreatedasystemofgranariesthatisextremelyexpensiveandisnotcontributingtostableprices.

·EnactWTOaccessionrelatedagriculturalpoliciespromptly.SomeofthebenefitsofWTOaccruethroughreformofvarioustradeinstitutions,structures,andpolicies,thereforewaitingforWTOaccessiontoimplementthereformsmerelydelaysreceiptofthebenefits.Also,ChinawillbedeprivedofseveralagriculturalpolicyinstrumentsafterjoiningWTO,thusthetransformationtoamorecomparativeadvantageandmarketorientedproductionstructure

shouldbeinitiatedwhileallpolicyinstrumentsremainavailabletomoderateanynegativetransitionalincomeeffects.

Figure6.3ActualCapitalFlows

B.CapitalandTechnologyFlows

AnimportantfactorinChina'srapideconomicandemploymentgrowthhasbeentheinvestmentprovidedbyexternalcapitalinflowoverrecentyears.Actualcapitalinflowhasincreasedcontinuouslyduringthe1990s(Figure6.3),although,by1997inflowcommitments(loanssignedandFDIagreed)declinedby50percentfromthehighof$123billionin1993.ThelargeinflowsofFDIsince1993hasbeentheprimarysourceofincreasedcapitalaslendingvolumeshaveincreasedonlymarginally.Inadditiontoprovidingcapital,FDIhasperformedanimportantroleintransferringnewtechnologiesandmanagementapproachestotheeconomyasawholeinmanycasescontributingelementsthatotherwisewouldhaveconstrainedgrowth.UnderstandingtheroleofFDIinChina'seconomicgrowth,thepolicyenvironmentthatencouragesanddiscouragesagriculturalinvestment,andtherecordthatChinahasbuiltinimportingtechnologiesfrominternationalsourcesareimportantindesigningmoreeffectivepoliciestofacilitateincreasedinflowsofmoreadvancedagriculturalinvestmentandtechnologyandaccelerateruraleconomicandincomegrowth.

GlobalForeignDirectInvestmentandChina

In1992,however,FDIinChinaexceededloans.Duringthe1990sFDIquadrupled,comprisingthree-fourthsoftheactualcapitalinflowin1996($54.8billion).Contractedcapitalwas$81.6billionin1996,butdeclinedprecipitouslyto$51billionin1997.

Globally,mostforeigndirectinvestmentoccursbetweenOrganizationforEconomicCooperationandDevelopment(OECD)countries(UNCTAD1997).EightypercentofcapitaloutflowfromOECDcountriesistootherOECDcountries,primarilyforacquisitionofexistingmanufacturingandserviceenterprises.Only0.1percentofFDIoutflowfromOECDcountriesisdirectlyforagriculturealthoughaportionofthemanufacturingFDIinvolvesagriculturalinputsandprocessing.

TheUnitedStatesreceivesthelargestvolumeofFDI.However,85to90percentoftheinflowalsoisforacquisitionsandmergers,makingtheprincipaleffectanownershipchange,whichoftencreatesscaleefficiencyatthecostofminoremploymentreductions.Incontrast,ChinaistherecipientofthelargestFDIinflowsfornewinvestmentsandexpandingexistingenterprises.ThesourceofFDIinflowalsoisunique,asmuchofitoriginateswiththerelativelywealthyChinesediaspora,scatteredworldwidebutconcentratedinSoutheastAsia.Totalcontractedinflowsandactualutilizationsince1992havetotaled$417billionand$151billion,respectively.HowevertheFDIinflowissomewhatoverstated.Aportionoftheinflows(estimatedat25percent,HarroldandLall1993)representsrecycledfundsfundsthatoriginateinChina,whicharesentoffshore(primarilyHong

Figure6.4FDIInflowasPercentofGrossFixed

CapitalFormation,'91-95

Kong)andreturntoChinaasFDIinflow.Suchrecycledfundsenjoypreferentialpoliciesunavailabletodomesticinvestors.Inaddition,about70percentoftheinflowsare"in-kind"equipmentandtechnology,whichisoftenovervalued.

WhiletotalFDIinflowintoChinaismassive,themagnitudeissimilartoseveralothercountrieswhenmeasuredrelatively.During1991-95(whencomparabledataareavailableforothercountries),inflowsaveraged16percentofcapitalformation,somewhatlessthanMalaysiaandArgentina.(Figure6.4).(SingaporeandHongKongwereomittedbecauseoftheiruniquecharacteristicsasfinancialcenterswithlargecapitalinflowsandoutflows.)However,preliminarydatafor1997indicatethatFDIinflowsrepresented25percentofChina'sgrossfixedcapitalformation.Byothermeasures,Chinaranksevenlower:inflowstockrepresented18percentofGDPin1995andinflowstockpercapita,at$106,isthesmallestinEastAsia,exceptfor$100percapitainthePhilippines.ChinahasmodestFDIoutflowsfortheacquisitionofmodernandproprietarytechnologyinnonagriculturalindustries.

FDIRegulatoryReformandtheTaxEnvironment

China'sFDIpolicy,hasevolvedgraduallyandmethodically.Followingadoptionofthe"OpenDoorPolicy"inlate1978andtheissueoftheEquityJointVentureLawin1979,ChinaopenedfourSpecialEconomicZones(SEZs)forFDI.ThiswasfollowedbyexpandingtheSEZconceptto14coastalcitiesandHainanIslandin1984,tothreedevelopmenttrianglesin1985,theentirecoastalareain1988,andallprovincialcapitals(excepttwo)andmajorYangtzecitiesin1992.Foreigninvestmentregulationsclassifyinvestmentsintocategoriesof"encouraged,""permitted,"and"restricted"inadditionto

a"prohibited''categorythatdescribescharacteristicsofactivitiesinwhichforeigninvestmentsaredisallowed(ratherthanidentifyingspecificindustrialsubsectors).ThebusinessincometaxandVATthatapplytodomesticenterprisesis33and17percent,respectively.However,varioustaxandtariffincentivesapplytoFDI.Beyondthestandardsetofincentives,incometaxesforfirmsengagedinagriculturearereducedby10to30percentforanadditional10years.

Copyright,patent,andotherintellectualpropertyright(IPR)protectionshavedevelopedslowly.Thepatentlawbecameeffectiveonlyin1985butdidnotapplytochemicalsandpharmaceuticalsuntil1993.Plant-varietyprotectionbecameavailablewithpassageoftheplantbreeder'srightslawin1997.

ConstraintstoInflows

Despiteimprovementstotheinvestmentenvironment,manybarriersexisttothefurtherinflowsofagriculturaltechnologythroughtransferorinvestment.ExtensiveinterviewswithcorporateofficialsoftransnationalcorporationsinvolvedwithagriculturalinputmanufacturingorcommodityprocessinginvestmentsinChina,identifiedfourcommonfrustrationswhichrestrainsthemfrominvestingmorefundsandtransferringadditionalnewtechnologies:

·Foreigninvestmentpolicyisnottransparent,whichismanifestinfrequentpolicychanges.

·Theextensiveregulatoryenvironmentrequiresmultiplenegotiationsasnationalregulationsapplyonlyiftheforeigninvestmentexceeds$30million.Otherwisenegotiationsmustbeheldwithofficialsineachprovincewhereproductsaretobesold.Conversely,itmaybeeasiertosatisfyprovincialthannationalregulations,resultinginseveralsmallinvestmentsthatmightbelessefficientthanonelargeinvestment.

·TheweakenforcementofIPRsisamajorconcernforcorporations

withcopyabletechnologies.Transnationalcorporationsthatcanpreventtechnologylossbytechnicalmeansdoso;butagrochemicalsarewidelyreportedtobereverse-engineered,exceptwhentheactiveingredientsareverycomplexmolecules.

·Evenwhentechnologycanbeprotectedandwhenmarketdemandishigh,fragmented

retailingandwholesalingnetworksreducemarketpenetration.Someoftheseconstraintsareafunctionofpoorphysicalinfrastructure.Otherconstraintsareregulatorywhichprotectthedomesticservicesectorfrominternationalcompetition.

FDIinChina'sAgriculturalSector

ThenaturalincentivesforFDIinChina,are(a)alargedomesticmarketand(b)alaborsurpluseconomy.Thegovernmenttypicallystructuresforeigninvestmentstobelabor-intensiveandabout60percentofChina'sFDIinflowshavebeeninlabor-intensivemanufacturingactivities.Thishelpscreatenonagriculturalemploymentandcontributestoincomegrowthgenerally,butdoesnotaddressmodernizationoftheagriculturalsector.

GiventhesmallholdernatureofChina'sagriculturaleconomy,agriculturalFDIwouldbeexpectedtobemodest.Indeed,"projectsthatuseuplargetractsoffarmland,thatarenotbeneficialtotheprotectionanddevelopmentoflandresources,..."areprohibited(MOFTEC1998).AgriculturalFDIinflowsaccountedforonly1.3percentoftheactualFDIinflowsduringthe1990s,andwereconcentratedinlabor-intensive(horticulturalcrops,poultryandaquatic)production(Table6.3).Thelargestinvestmentswereforcropproductionbutwerebelowthecropshareofgrossvalueofagriculturaloutput(GVAO);forestryreceived15percentoftheinvestmentconsiderablygreaterthanitsshareofGVAO

Thepastpolicyenvironment,unfortunately,hasnotprovidedequalopportunityorencouragementforalltoinvestinagriculture.TheearlyrestrictionsonFDIlocation,andsubsequentliberalization,madepolicytheprimarydeterminantofinvestmentlocation.AneconometricanalysisofagricultureFDIconfirmedtheimportanceofpolicyandsupportedtheconclusionofotherstudiesthatthelevelofaccumulatedFDIstockgreatlyinfluencescurrentinflows(Petri1995;

Dobson1993).Thus,officialpolicyconcentratedinvestmentsalongthecoastinthe1980sandtheinvestmentaccumulationcontinuedtoattractFDIinthe1990s.Aslateas1996,some85percentofagriculturalFDIinflowswereintothecoastalprovincesplusBeijingandHebei.Otherimportantlocationdeterminantsweretransportintensity,urbanpopulation(marketsize),andtherealwagerate.

FDIinAgriculturallyRelatedManufacturing

Regulatory,IPR,andmarketingconstraintshavebeenimportantfactorsinkeepingtheinflowofFDIforagriculturalmanufacturingrelativelysmallevenmorethandirectinvestmentincropandlivestockproductionhas.AccumulatedFDIinflowsforagriculturallyrelatedmanufacturing,overthe1987-96decadewere$6.0billionrepresentingonlyafractionofaggregateFDI.

Investmentsinagriculturalinputsinclud-

Table6.3:AgriculturalSubsectorDistributionofContractedFDIInflows(1994-96)

FDIInflow GVAOSubsector $million PercentShare PercentShareCropFarming 1,211.9 33 58Forestry 534.2 15 4Livestock 845.8 23 30Fisheries 906.5 25 8AgriculturalServices 160.2 4 -Total 3,658.6 100 100Source:MinistryofForeignTradeandEconomicCooperation(unpublishedmaterials).

AmoderncottonspinningmillnearShanghai

ingfertilizer,pesticides(andotheragrochemicals),seeds,andagriculturalmachineryhavesubstantialmodernizingpotentialfortheagriculturesector.AlthoughChinalistsalloftheseinputsinthe"encouraged"category(exceptforseedsofgrain,vegetableoils,andcottonwhicharerestricted),investmentsremainexceedinglysmall-$195million(in1995)andaccountedforonly3.0percentofChina'sagriculturalinputsales.MarketingproblemsplaguecompaniesthattrytodistributetheirproductsinChina'svastgeographicmarket,inpartbecauseofwholesalingrestrictions,vaguerules,andpoorlyenforcedIPRmeasures.

ThedistributionofagriculturalmanufacturingFDIisshowninTable6.4.

Astable6.5indicates,technology-intensiveinvestmentsrepresentonly2.5percentofagriculturalmanufacturingFDI.

FDIandAgriculturalModernization

FDIassistedinmodernizingthepoultryindustrybyimportinggrandparentgeneticstockandbreedingparentgeneticmaterialsdomestically.Theintroductionofsuperiornutritionfeedmillingandmixingparalleledthedevelopmentofthepoultrygenetics.Also,almostalloftheplantbreedingandscreeningresearchby

Table6.4:FinancialIndicatorsofAgriculturallyRelated

Foreign-FinancedEnterprises,1995(Billionyuan)

Subsector TotalFDI TotalAssets TotalSalesAgriculturalInputs 1.58 5.55 4.64Fertilizer 0.58 1.57 1.28Pesticides 0.38 1.55 1.33VeterinaryMedicines 0.16 0.71 0.61AgriculturalMachinery 0.46 1.72 1.42AgriculturalProcessing 38.71 150.89 128.24FoodProcessing 12.00 54.85 60.58FoodManufacturing 12.18 39.51 28.33Beverage 11.58 44.04 28.50Tobacco 0.20 1.20 0.56FiberProcessing 0.80 2.65 1.61LeatherProcessing 1.47 7.91 7.76TimberProcessing 0.63 1.42 0.90Total 40.29 156.44 132.88Note:ThesedatamaynotcaptureallagriculturalmanufacturingFDIassomeagrochemicalandagriculturalequipmentmaybemanufacturedbyenterprisesthatareprimarilyinvolvedinproducingothermechanicalequipmentandnonagriculturalchemicals.Source:OfficeoftheThirdNationalIndustrialCensus,DataoftheThirdNationalIndustrialCensusofthePeople'sRepublicofChina:State-Owned,Foreign-FundedandTownshipandVillageEnterprises,ZhongguoTongjiChubanshe,Beijing,1997.

Table6.5:DistributionofForeign-FinancedEnterprisesinAgriculturallyRelatedManufacturing,byFactorIntensity,1995(Percent)

FDI TotalAssets SalesValueLabor-Intensive/a 66.9 67.7 74.6Capital-Intensive/b 30.5 29.8 22.8Technology-Intensive/c 2.5 2.5 2.5Total 100.0 100.0 100.0/aIncludesfoodprocessing,foodmanufacturing,naturalfiberprocessing,leatherandfeatherprocessing,andtimberprocessing./bIncludesbeveragemanufacturing,tobaccoprocessingandfertilizermanufacturing./cIncludespesticide,veterinarypharmaceuticals,andagriculturalmachinery.Source:OfficeoftheThirdNationalIndustrialCensus,"DataoftheThirdNationalIndustrialCensusofthePeople'sRepublicofChina;State-Owned,Foreign-FundedandTownshipandVillageEnterprises,"ZhongguoTongjiChubanshe,Beijing1997.

foreign-financedenterpriseshasbeenonhybrids(corn,sunflower,sorghum,andrice)becausehybridvarietiesaredifficulttocopy.Aslongastheconfidentialityofthehybridparentsismaintained,theIPRsaretechnicallyprotected.

Intheagrochemicalsectorthepesticidesthatallegedlyhavenotbeenreverseengineeredarethosewhoseactiveingredientsarecomplexmoleculeswhicharedifficulttocopy.Others,despiteofficialagreements,areallegedlycopiedandsoldwithoutanycompensationtotheinventors.AlthoughthelegalenvironmentprovidesadequateprotectionforIPR,enforcementremainsweak.ThecurrenteffortbyMonsantotomarketitsBtvarietyofcottonseedwillbecloselywatchediftheseedsbecomewidelyavailablefromnon-Monsantosources,otherhigh-technologyandbiotechnologyfirmswillbereluctanttoinvestinChina.

Nationally,loanswerethemostimportantelementofforeigncapitalflowsuntilreplacedbyFDIin1992.Theseloansarelargelysourcedfrombilateral(50percent)andmultilateral(30percent)agencies,withonly20percentcomingfromcommercialsourcesprimarilytofinanceexports.However,fortheagriculturalsector,overseasdevelopmentassistance(ODA),loansandgrants,remainamoreimportantsourceofforeigncapitalthanFDI.AgriculturalODAisoverwhelminglysourcedfrommultilateralagencies(80percent),withabout20percentprovidedbybilateralsandaverysmallamountfromNGOs.ArecentevaluationofODAdeterminedthat$8.28billionwasgrantedorloanedtotherural-agriculturalsectorduringtheperiod199497(UNDP1998);morethandoublethe$3.66billionFDIinflow(1994-96).Loans,primarilyfromtheWorldBankandsecondarilyfromtheAsianDevelopmentBank,compriseabout90percentoftheassistancewiththebalanceprovidedintheformofgrantsprimarilyfromUNDPandWFP.

NearlyallODAistiedtoprojects,someofwhicharenationalinscopeandcannotbeallocatedtoanyparticularregion.However,theEastern,Central,andWesternregionsequallyshareODAgrantsfornonnationalprojects;ODAloanshavebeenprimarilytotheCentralregion(50percent),followedbytheWesternregion(30percent)andtheEasternregion(20percent).ThesedistributionpatternscontrastsharplywithFDIinflowswhichhavebeeninvestedoverwhelminglyintheEasternRegion(85percent).TheimmediateimpactofODAisincreasedbudgetarysupportforruralinfrastructureandserviceinvestments(includingon-farminvestments),whichwillleadtoincreasedruralincomes.Totheextentthatmanyprojectshave

Table6.6:ODAAllocationsbySubsector(Milliondollars)Subsector Amount PercentIntegratedAgriculturalDevelopment 2,773 33.5WaterResources 1,608 19.5SupportServices 1,196 14.5AgriculturalInputs 1,053 12.7Forestry 802 9.7Livestock 265 3.2Crops 127 1.5Fisheries 86 1.0Other 366 4.4Total 8,276 100.0Source:UNDP.ChinaAgricultureandFoodSecurityResourceBook:ACompendiumofDonorActivities(1994-1997),Beijing,1998.

researchandtechnologytransfercomponents(eitherdomesticextensionorinternationaltransfer),longertermproductivityandincomeimpactswillbegenerated.Integratedagriculturaldevelopmentprojectswerethelargestrecipientofdonorassistance,followedbywaterresourcemanagementanddevelopmentandsupportservices(Table6.6).

TheWorldBankprovidedabout70percentofODAresourcesoverthe1994-97period,butwiththephasingoutofsoftloansbetween1997and1999WorldBankassistancetoChinadiminishedbyabout45percent.Thus,itisuncertainwhetherODAwillcontinuetoproviderobustsupport;however,ODAcomprisesarelativelysmallportionofruralinvestmentsupportanditsdeclineisunlikelytoseriouslyimpactonruralgrowth.

Giventhefiscalconstraintsfacingagriculturalresearchandtechnologytransfer,FDIinagriculturalinputscouldbecomemuch

moreimportantformodernizingChina'sagriculture.AlthoughFDItaxpolicyisfavorabletoagriculture,ithasbeenaninsufficientincentivetoattractsignificantinvestmentinagriculturalinputs.

IfChina'sfarmersaretohavereadyaccesstothelatestandmostmodernproductiontechnology,either(a)FDImustbeattractedintotheinputindustry,(b)agriculturaltechnologyimportsmustbeunrestricted,or(c)domesticresearchonmodernagriculturaltechnologymustbeintensified.

Thefollowingpolicyinitiativeswouldimprovetheinvestmentenvironmentandprovideincentivesforrenewedinvestmentinagriculturalinputmanufacturingandcontributetoagriculturalmodernization:

·Designincentivestostimulateinvestmentinthoseactivitiesofpriorityinterest.IncludeagriculturalmodernizationasanFDIobjectiveandactivelysolicitmultinationalinvestmentinmoderncropandlivestockgeneticsandbiotechnology,pesticidesandotheragrochemicals,andsophisticatedfarmmachinery.

·Attractinvestmentintothecountry'schemicalfertilizerindustry.Thetechnologyofmodernhigh-analysisfertilizermanufactureiswellknown,butcapitalrequirementsarehigh.TheexistingFDIstockinfertilizermanufactureofabout$70millionistrivialrelativetothe$350to$600millionrequiredforasinglemodernscale-efficientureaordiammoniumphosphateplant(500,000tonsofelementalnutrients).IncreasedFDIinnitrogenandphosphateplantswouldintroduceknowntechnologyandneededmanagementskills

andreducefertilizerimportrequirements.Ifinternationalfirmswereinvolvedinrawmaterial(phosphaterock)mining,fertilizermanufactureandblending,andwerepermittedtomarketdirectlytofarmers,theyalsowouldbepreparedtoinvestintechnologytransferservicecenters

6(e.g.,soiltestinglaboratories).

·HavestrictandpublicizedenforcementofIPRprotectionforagrochemicals,veterinarypharmaceuticals,plantandanimalgeneticsandbiotechnology,andotheragriculturaltechnologiestoreassureinvestorsthattheftofproprietarytechnologywouldnotbetolerated.Thelegalframeworkisinplacebutitsenforcementremainsuncertain.

·Eliminatethe'jointventureswithmajorityChineseownership"restrictiononFDIforgrain,oilseedandcottonseeddevelopment.Thisrestrictionhashinderedinvestmentandtechnologytransferintotheseactivities,anddisallowedChinesefarmersfromenjoyingthemostmodern,internationallydevelopedseedvarieties.

·Liberalizedomesticmarketingconstraints.ThecurrentrequirementthatChinesepartnersmusthaveamajorityshareindomesticmarketingenterprisesmakestransnationalfirmsreluctanttomanufacturehigh-technologyproducts,astheyareunabletocontroltheirdistribution.Firmsthatmanufactureagriculturalinputsneedtheopportunitytomarkettheirproductsdirectlytofarmers.Also,marketcompetitionwouldimprovedistributionefficiency.

·ImprovethetransparencyoftheFDIregime.Taxation,theapplicationofimporttariffs,andforeignexchangerulesareadequatelydefined.However,applicationandapprovalproceduresarecomplexrequiringseparatenegotiationswithofficialsineach

provinceinwhichinvestmentandoperationisproposed.ThereisalsoaproblemofChina'schangingtherulesafterinvestmentshavebeenmadewhilethismaybenecessaryforequityorotherreasons,aprovisionfor"grandfathering"theforeignenterprisesoveranadjustmentperiodisneeded.

1.ThesetradebalancedataarebasedonChina'sCustomsStatistics,andareonacalendaryearbasis.TheydonotaccountforundocumentedtradebetweenHongKongandChina.Thedatamustbeinterpretedcarefullybecauseofalternativedefinitionsofagriculturaltrade,whichmayormaynotincludecertainseafoodandlumberproducts.ThispaperfollowstheUSDAclassificationsystembutincludesaquaticproductsasagricultural.TheFoodandAgriculturalOrganizationoftheUnitedNations(FAO)includesmorecommoditiesintheirdefinitionofagriculturaltradeandthustheFAO'svalueofagriculturalexportsandimportsexceedsthatreportedbytheUSDA.

2.Incomputingtheaveragebindingratesfor2004,the1994-96importvalueswereusedasweights.

3.Islam,Nurul(ed.),PopulationandFoodintheEarlyTwenty-FirstCentury:MeetingFutureFoodDemandofanIncreasingPopulation.InternationalFoodPolicyResearchInstitute,Washington,DC,1995.

4.Asdifferentexchangeratesappliedtocertaintradedcommoditiesduringtheearly1990s,computinganaccurate"average"exchangerateisdifficultandcouldintroduceadistortioninthesedataforinternationalcomparisons.

5.In1994,aninvestigationbytheStateAdministrationforImportandExportInspectionrevealedthattheactualvalueofequipmentin5,500FDIProjectswas19percentbelowcontractualcommitments.UNCTAD,DivisionofTransnationalCorporationsandInvestment;WorldInvestmentReport1995.TransnationalCorporationsand

Competitiveness,UnitedNations,Geneva,1995.

6.Fromdiscussionswithplanningandinternationalsalesstaffoftransnationalfertilizercorporations.

PARTIIIMANAGINGRURALDEVELOPMENT

7CultivatedLand

Introduction

Landownershiporthepossessionofkeyland-userightsprovidesruralhouseholdsseveralbenefits.Long-termtenuresecurity,andfreedomfromthearbitrarylossoftheserightswithoutcompensation,iscriticaltoprovidingincentivesforlong-terminvestmentandlandmaintenance.Transferorrentalrightsplayasimilarroleandcanbeinstrumentalinpromotingefficientlandallocationacrosshouseholds.Byprovidingsmallfarmerswithaformofcollateral,secureandwell-definedlandrightsalsocanhelpthedevelopmentofruralcreditmarkets.Landalsoservesasanimportantsourceoffoodsecurityandsocialinsuranceandcanhelpabsorbfamilymembersunabletoworkoff-farm,orwhoseoff-farmjobshavebeenterminated.

RuralreformsandtheintroductionoftheHouseholdResponsibilitySystem(HRS)intheearly1980sradicallyalteredtheorganizationofagriculturalproductionandtheincentivesfacingruralhouseholds.Withtheextensionofland-userightsandresidualincomerightstohouseholds,agricultureproductionshiftedfromacollectivetoafamily-basedfarmingsystem,butlandwasnotprivatized.Ownership

remains"collective,"andlocalgovernmentseithercontrolorinfluencehouseholdlanduseandlanddecisions.

Theinitialruralreformstriggeredanunprecedentedaccelerationofagriculturalgrowth

inChina.Empiricalstudies(McMillanetal.1989;Lin1992;HuangandRozelle1996)attributeapproximatelyhalfofthisincreasetotheincentiveeffectsassociatedwithbetterresidualincomerights.Followingreducedgrowthafter1984,attentionhasincreasinglyfocusedonthelandmanagementsystem,thedimensionofthefarmeconomythathasbeenprobablyleastalteredsincetheinitialreforms.Poorincentivesrelatedtotenureinsecurity,forexample,arethoughttohavediscouragedinvestmentinagriculture,slowingproductivityandeconomicgrowth.However,otherfactorsalsonegativelyaffectagriculturalproductivity.

Theconsequencesofchanginginstitutionalarrangementsgoverningcultivatedlandusearepotentiallyenormous.Thedebateonlandpolicysuffersfromanumberofweaknesses,principallythelackofanenumerationofbasicfactsaboutdomesticlandtenureastheyhaveevolvedoverrecentyears.Empiricalworkonthedeterminantsoflandrightsandtheireffectonhouseholdbehaviorandthefarmsectorisminimal,thusfewdataexisttosupportthedevelopmentoflandpolicies.

IssuesofOwnership

Theruralreformsvestedownershiprightswiththe"collective,"whichisusuallytakentomeanthevillage,althoughambiguityoverownershipissurfacinginanincreasingnumberofareas.Insomevillagesthevillagegroup(theoldproductionteam)isrecognizeddefactoastheowneroftheland.Inothervillages,however,ownershipiswiththevillage(theoldproductionbrigade)andinasmallminorityofcases,ownershipreportedlyresideswiththetownship.Ownershipdisputeshavedevelopedbetweenvillagegroupsandvillages,particularlywherelandistobeconvertedtononagriculturaluseswithahighcommercialvalue.Nevertheless,thecollective"owns"thelandrightsandtheinternaldebatefocusesonhowtoconstructanewsetof

rightsoncollectiveland.Legalprivatization(asopposedtodefactoprivatizationthroughextendedtenure,rental,andinheritancerights)isnotapolicyissue.Themajorityoffarmersreportedlydonotsupportit,anditisnotonthegovernment'spolicyagendaofanygroup.Moreover,Chinalackstheancillaryinstitutions(creditmarkets,landregistration,andlegalsystem)thatcouldmakelandprivatizationsuccessful.

Management,FormsofLandTenure,andPropertyRights

Fivemajorformsoflandtenurearesanctionedbythenationalgovernment.Thesetenureformsandtheirshareofhouseholdtenuredareasare:(a)responsibilityland79.4percent,(b)rationland8.3percent,(c)contractland5.5percent,(d)privateplots5.7percent,and(e)reclaimedland1.1percent.Responsibilityland,comprisingmorethanthree-quartersofthecultivatedland,typicallyhasacommoditydeliveryquotaassignedandfacesthepossibilityofreallocationtoothervillagehouseholds.Thesetenureforms,inturn,arepackagedintoseveraltypesoflandtenuresystems,includingthetwo-fieldsystem(combinedresponsibilityandrationland),andthree-fieldsystem(addscontractland).

Althoughthesetenuretypesdifferintermsofhouseholdrightsandobligations,theyprovidealessthansatisfactorywayofdifferentiatinglandtenuresystems.Theresidualincomeandnonresidualrightsthatfarmershaveonresponsibilitylandmaydifferinvillageswithinthesameregion.Therefore,thefollowingdiscussiondisaggregatesthetenureformsintotheircomponentrights,includingsecurityoftenure,rentalortransferrights,freedomofcropselection,andconversiontoalternativeagriculturaluses.

Inmostvillages,land-userightsarelost(orgained)throughvillage-widereallocations(landtransfersamongfarmhouseholdsinitiatedbythevillageleadership).Tenuresecurity,thus,isinverselyrelatedtothefrequencyofreallocations.Surveydatafor215randomlyselected

villagesineightprovincesshowthattheaveragenumberofreallocationspervillagesincetheimplementationofHRSintheearly1980sis1.7(Brandt1998).In60ofthesamplevillages,however,landhadnotbeenreallocated

Stockingratesonlowrainfallgrasslandsmustbemanagedcarefullytoavoiddegradation.

sinceHRS.Themagnitudeofreallocationsalsodiffersfromcommunitytocommunitybutonaverageentailsabout50percentofavillage'scultivatedlandandaffectsabout65percentofhouseholds.Fortheentiresample,slightlymorethanhalfofallcultivatedlandhasbeenreallocatedatleastonceduringthereformperiod.

Nearly70percentofsurveyedvillagesreportthathouseholdsarefreetotransfertheiruserightstootherhouseholds.Intheremaining30percent,constraintsontransfersmostoftentaketheformofrestrictionsonrentingtononvillagersandtheneedtoobtainpriorauthorizationfromvillageleaders.Thetransferofland-userightsamonghouseholdsistypicallyshortterm,andentailsthepaymentofafeeandtheassumptionoftaxandquotaliabilityinreturnforuseoftheland.Despitethehighpercentageofvillagesreportingunconstrainedtransferrights,thepercentageoflandrentedinChinaislow.In1995,morethanthree-quartersofthesurveyedvillagesreportedsomerental,buttherentalmarketisthin,representingabout3percentofthelandarea;mosttransactionsarebetweenrelatives.Thus,mostinterhouseholdtransfersoccuradministrativelyratherthanthroughlandrentalmarkets.

Inthree-fourthsofvillages,householdsarereportedlyfreetodecidecropmix.Thisstatisticshouldbeinterpretedcarefully,however,asconstraintsoncropchoiceneednotbeexplicit.Quotasandlimited

freedomtoconvertquotasintocashalsomayaffectcropchoice.InLiaoning,forexample,grainquotasaverageabout25percentofgrossoutput,andtypicallycannotbefulfilledincash.CottonquotasinpartsofHebeiandShandongappeartohavesimilareffects.Householdautonomytoconvertcultivatedlandtoalternativeagricultureuses(e.g.,constructingagreenhouseorfishpond,convertingdrylandtopaddy)alsoisrestricted.Morethanhalfofallvillagesreportsuchrestrictions.

Althoughbroadlandpolicyisdeterminedbythecentralgovernment,thedifferencesinpropertyrightsacrosscounties,townships,andvillagesindicatethatthereallocusofland-usedecisionmakingisthevillage(Li1998).Infact,China'sOrganizationLawoftheVillageCommitteevestsvillageleadersandgovernmentwithlegalauthorityoverlandrights.

1Thetransferofdecision-makingpowerfromthecentraltolocalandvillageauthoritiesissoextensivethatChinaisarguablynowoneofAsia'smostdecentralizedcountries(Liu,Yao,andCarter1998).

LandReallocation

Empiricalliteraturehasidentifiedanumberoffactorsthatappeartoaffectvillagereallocationpolicy.WiththeintroductionoftheHRS,landwastypicallyallocatedtohouseholdsinafairlyegalitarianwayonthebasisoffamilysize,demographiccomposition,andlaborsupply(Putterman1993).Landreallocationshelpmaintainequalaccesstolandashousehold-leveldemographicschange.Asnewhouseholdsareformed,anddependinguponnonagriculturalemploymentopportunities,householdincomedisparitiesarecreatedthatarecontrarytothevillage'soriginalegalitariandistributionofland.Thesedisparitiescreatepressuretoredistributeuserightstomaintainminimumconsumptionlevels.Also,landreallocationshelpeliminateinefficiencycausedbydemographicandlaborsupply

changesandpoorlyfunctioninglaborandlandrentalmarkets(Turner,Brandt,andRozelle1998).

Leadersinsomeaffluentsuburbanvillagesmaybeusingtheirpositionstoextractrentsthroughperiodiclandreadjustmentsandlandsalestononagricultural,nonvillageinterests(Johnson1995).Inotherlocations,directrent

seekingfromlandislesscommon,asnonvillagedemandisminimalandonlyasmallproportionoffarmersactuallypaycashforuserights.Morecommonly,villageleadersusetheircontroloverlandtoensurestateinterestsareprotectedandstatepolicies(i.e.,taxesandquotafulfillment)areimplemented.Thiscanbeachievedbythreateninglandexpropriationfromhouseholdsthatdonotmeetpolicyobligationsandbyrewardingfarmerswhodowithadditionalland.(Rozelle1994;LiandRozelle1997).Alternatively,landmaybereallocatedfromfarmerhouseholdswithhighoff-farmearningswhofindagriculturerelativelyunprofitable(Turner,Brandt,andRozelle1998).Theseactionsalsoareself-promotingifpolicyobligationsaremet,thevillageleadersmaybepromoted,gainstatuswithinthecadrecommunity,orreceiveotherbenefits.

Tenuresecurity,andotherpropertyrights,aretheoutcomeofacomplicatedinteractionamongtheinterestsofthestate,villagers,andvillageleadersinteractionsthatneedtobebetterunderstoodbeforeconclusionscanbederived.Theinfrequencyoflandreallocation(averagingeverysixyearsinvillageswhichhavereallocatedland)anddifferencesintheamountoflandinvolvedsuggeststhattransactioncostsareimportantinexplainingreallocationbehavior.Thesecostsincludethedirectcostofconductingthereallocation,andtheindirectcostsofagriculturaldisruptionandthepotentialimpactoninvestmentbehavior(i.e.,tenureinsecuritycosts).

ImpactofChina'sLandManagementSystem

Empiricalworkonproperty-rightformationanditseffectsisquitelimitedandisinadequateforpolicyformulation.Thatundertakenhasfocusedonthreekeydimensionsoftheimpactofvillagelandpolicy:(a)landallocationdecisionrules,(b)impactsonstaticefficiency,and(c)impactsondynamicefficiency.Unfortunately,noavailableworkrigorouslyexamineshowlandrightsaffectincomedistribution,

povertyalleviation,orprovisionofsocialinsurancethreeoftheimportantaspectsusedtojustifythecurrentsystem.

LandAllocationandEquity

Analysesofhousehold-leveldatasupporttheviewthatlandinmanyvillagesoriginallywasallocatedonthebasisoffamilysize,possiblyadjustedfordemographiccomposition(Burgess1998).Universalandegalitarianaccesstolandincreasedcalorieconsumptioninaneconomycharacterizedbyuncertainfoodmarketswithhightransactioncosts.However,morerecentreallocationsappeartobefinetuningratiosoflandtolabortoreflecthouseholdparticipationinoff-farmlabormarkets.Inmanyvillages,householdswithfamilymembersworkingoff-farmreceivelesslandpercapita.Inafewvillageswithextremelaborshortages,leadersareconsolidatinglandintolargerfarmsthat,inturn,areoftenmajorbeneficiariesofsubsidiesforexpendituresoncurrentandcapitalinputs.Iftheselandallocationpatternsaretypicalofvillagesthroughoutthecountry,andifsuchtrendscontinue,theoriginal,purelyequity-based,criteriamaybegivingwaytoanefforttomakeallocationsmoreefficient.

Withconstrainedrentalmarkets,theonlywaysignificanthouseholdlandreallocationcanoccurisbyadministrativedecree,whichcanbeviewedasamarketsubstitute.However,highinformationandimplementationcostsmake"fine-tuning"reallocationslessefficientthanwell-functioningrentalorsalesmarkets.An

Tocontrolerosionandconservelimitedrainfall

ontheLoessPlateau,thelandisterracedbeforeplantingeitherannualortreecrops.

analysisofhouseholddatafor1994forvillagesinHebeiandLiaoningfoundthatdespiteeffortstoshiftlandamonghouseholds,landdistributionacrosshouseholdsisstillinefficient(BenjaminandBrandt1998).Betteraccesstooff-farmopportunitiesandreallocationsthatredistributelandfromthelandrichtothelandpoorattenuatebutdoesnoteliminatetheselosses.

Theimpactoftenureinsecurityoninvestmentbehaviorisbehindrecentcallstoextendtenureto30years,butestimatesofthesedynamicincentiveeffectsarelimited.ArecentanalysisusinghouseholddatafromHebeifoundthathouseholdsapplymorefertilizerandlabortotheirprivateplotsthataremoresecureandtoplotstheyhavefarmedforlongerperiods,receivinghigheryields(Guo,Rozelle,andBrandt1997).However,theimpactofseveralotherimportantfactors(e.g.,sizeofplot,landqualitydistancefromplottohomestead)werenoteconometricallydifferentiatedandyieldimpactswereonlyminimal.AnotheranalysisofZhejianghouseholdsexaminesotherlong-terminvestments,(e.g.,wellsanddrainage),findsasimilareffect,andsuggeststhatareductioninthefrequencyofreallocationbyhalfwouldresultinanoutputincreaseofonly5percent(CarterandYao1998).

Theseresultsmustbeinterpretedcarefully.Thestudiesonlyshowthereturnstoalternativetenurebutdonotcapturethepotentialreturnsofshiftingtoanalternativeproperty-rightsregimeinwhichhouseholdsenjoymoresecuretenureandarelessconstrainedinotherdimensions.Theyare,also,geographicallynarrow,makinggeneralizationofthefindingsdifficult.Becauseofregionaldifferencesinagronomic,climatic,andsocioeconomictraits,opportunitiesforlong-terminvestmentwouldbeexpectedtodiffersignificantlybetweenlocalities.Theanalysesignorevillage-levelinvestmentanditspotentialinteractionwithhouseholdinvestment.

Landreallocationthathelpsequalizeland-laborratiosbetweenhouseholdsmaygiverisetoaninverserelationshipbetweendynamicandstaticefficiencies.Reallocatinglandmayequateresourceintensitiesandimproveshort-termallocativeefficiency,butitmayunderminesecurityoftenure,therebyreducinginvestmentincentivesandlong-termefficiency.Thisillustratesthedichotomybetweenmarketandadministrativeallocations:rentaltransactionsinawell-functioningmarketwouldnotunderminetenuresecurityorleadtodecreasedinvestment.Thisdichotomyhighlightstheimportanceofunderstandingwhyrental-markettransactionsaresofew.Ifrentalmarketscouldbemadetooperateeffectively,theymightbeabletoreplaceleader-implementedlandreallocationswithouttheadverseincentiveeffects.Potentialreasonswhyrentalmaynotexist,however,include(a)ideologicalormoralrestrictionsonlandrental,(b)problemsofcontractenforcement,(c)''useitorloseit"rulesthatdiscouragerental,and(d)villageleaders'discouragingrentalbecauseitmakesquotafulfillmentmorecostly.

Empiricalstudiessuggestthatimprovedtenuresecuritywouldimprovehouseholdinvestmentsandoutput.However,incrementalproductivityismarginalandthesestudiesdonotincorporatenontenureoptions(e.g.,villageinvestments)andfactors(e.g.,differencesinclimate,geography,andgeneralagroenvironment,andincreasedfreedomincropchoice)thataffectproductivity,output,income,andwelfare.Nevertheless,therecentdecisiontoextendtenureonresponsibilitylandto30yearsisgenerallyperceivedtoimprovefarmerincentivestoinvestinlandimprovements.Althoughthisimprovestenuresecurity,thesystemlikelyhassignificantshort-andlong-termefficiencycosts.Theinabilitytouselandascollateralmaybeslowingthedevelopmentofcreditmarkets,asfarmershavefewothercollateralizableassets.Ifrental-marketbarriersarecreatedbynonsecurityfactors,extendingsecuritymayincreaseinefficiencyin

landallocationasruralresidentsincreasinglybecomeemployedoff-farmorasotherdemographicchangesoccur.Also,theinabilityofnonagriculturalhouseholdstoleaseouttheirlandcouldloweron-farmin-

vestmentsandinhibitagriculturalhouseholdaccesstoadditionalland.

China'srecordforrapidruralgrowth,stability,andpovertyalleviationmayormaynotbelinkedtoitsflexiblelandsystem.Thelackofknowledgeonalternativetenurestructuresmakesundertakingrigorousresearchonproductivityandequityimpactsimperativeifinformedpolicyjudgmentsaretobemade.Giventheuncertaintiessurroundinglandtenurechanges,andbeforefurthertenurialreformsareintroduced,testingrentalmarketsandalternativelandtenurearrangementsisimperativeforcarefulmeasurementofimpactsonincome,equityandsocialsecurity,investments,short-andlong-termefficiency.

Withinthisframework,wemakethefollowingrecommendations:

·Asaninterimstrategy,continuetoallowvillagedeterminationofpropertyrightsregimes.Difficultiesanddifferencesthatexistinpropertyrightsacrossvillagessuggestthatthiswouldbethebeststrategyfornow.However,thegovernmentshouldconsiderhowtoimprovevillagegovernancetoeliminateegregiousabusesoflocalpower(suchasillegallandsales)andtoensurethattheallocationofpropertyrightsinlandreflectthewishesofthelocalcommunity.

ThiskindoflocalflexibilitymaybeadvantageousshouldtheadverseeffectsoftheAsianfinancialcrisisandtheongoingrestructuringintheSOEandcollectivesectorsintensifyinthenearterm.Inearliermacroeconomicretrenchments,off-farmemploymentopportunitiesdriedupformanyruralresidentsandmigrants,forcingareturntoagriculture.Asharpdeclineinurbangrowth,combinedwithareductioninlocaloff-farmopportunities,wouldrequirereabsorbingperhapstensofmillionsofunemployedintheruralsector.

·Continuetoexperimentwithrentalmarketsandalternativetenure

arrangementstodevelopsomeformofmarketableland-useright.Thisshouldalsoincludecontinuingtoassessincome,socialinsurance,andpovertyalleviation,equity,investment,andshort-andlong-termefficiency.Farmers'apparentpreferenceforvillageownershipandperiodiclandadjustmentsemphasizestheneedtoproceedcautiouslywithtenureadjustments.Acharacteristicofruralreformhasbeenexperimentation(oftenconductedintheRuralReformExperimentalZonesundertheauspicesoftheMOA'sResearchCenterforRuralEconomy)successfulexperimentsareadoptedwidelyandthosedeemedunsuccessfularediscarded.Asruralhouseholdsbecomemoredistinctlynonagriculturaloragricultural,thelattermusthaveaccesstoincrementallandtomaintainincomegrowthparity.

·Aslanduserightsbecomesmarketable,conductadditionalmodestexperimentationtodevelopland-userightsthatallowfordevelopmentofcollateralandtohelpdevelopcreditmarkets.

·Ensuresomeformofsocialinsurance.ThesocialsecurityroleofarablelandissoimportantthatChinacanonlyignoreitbyreplacingitwithsomeotherformofsocialinsurance.

1Article4,OrganizationLawoftheVillageCommitteeofthePeople'sRepublicofChina,China'sAgriculturalYearbook(ZhongguoNongyeNianjian)1988,pp.459-460.

8.WaterResources

Asthesinglemostimportantnaturalresourceconstraint,watermanagementiscrucialtoChina'scontinueddevelopmentinallsectors.Althoughadditionalwaterisneededforagriculture,futurewaterrequirementswillincreasemostinthenonagriculturalsectors,particularlymunicipalandindustrialuses.Withouteithermore-efficientwateruseorthedevelopmentofadditionalsupplies,economicgrowthcouldbeseriouslyimpaired.

WaterScarcityandScarcityAllocation

China'srenewablewaterresourcesconsistof2,711billioncubicmeters(bcm)meanannualriverrunoff(includinginflowsoriginatinginothercountries,butexcludinganaverageoutflowof732bcmtolowerripariancountries)andgroundwaterresourcesestimatedat760bcmthat,generally,arenotadditionaltotherenewablewaterresourcesbecausetheirrechargeisdependentuponsurfacewaterresources.Aswaterbalancestatisticsfor1993(lastyearinwhichwaterbalancestatisticsareavailable)indicateonly518.6bcmofwaterwasused,Chinawouldseemtohavemorethanenoughwatertomeetforeseeablerequirementsifitweredeveloped(Table8.1).However,muchoftherunoffcannotbeeconomicallyexploitedbecauserainfallandrunoffareconcentratedin3or4summermonths.Also,China'swaterresourcesaremaldistributedspatially,similartootherlargecountrieswithmultipleagroclimaticzones.Thelocational

imbalanceresultsinsouthernChina(thebasinssouthof,andincluding,theYangtzeriverbasin)receivingabout80percentofthenationalrunoff,butcontainonly36percentofthecultivatedland.

Althoughirrigationcomposedtwo-thirdsofthewaterconsumed(1993),agricultureisaresidualwateruser,followingallocationsformunicipal,industrial,andruralhouseholduses.However,manymunicipalallocationsaresupplyconstrainedandfallseriouslyshortofurbanrequirementsanddemand.The343.4bcmusedforirrigationrepresentsabout80percent

Table8.1:WaterBalanceandEstimatedWaterRequirements,1993,2000,and2010(Billioncubicmeters)

IndustryUrban RuralHouseholds

Irrigation OtherAgriculture

1993Requirements 83.8 24.1 24.4 424.3 36.5 593.1Supply/Use 88.9 24.1 23.1 343.4 39.2 518.6Balance +5.1 0.0 -1.3 -81.0 +2.7 -74.5Requirements2000 126.8 50.4 32.4 433.5 32.4 688.42010 206.5 79.7 43.1 448.3 56.1 833.7Note:1993precipitationandrunoffwasassumedtobeat75percentprobabilitylevel.Source:NanjingInstituteofHydrologyandWaterResources,ReportontheMid-andLong-TermPlansforWaterDemandandSupply,November1996,asreportedinUN-ESCAP,"China:WaterResourcesandTheirUse,"1997.

ofthewaterrequirementforoptimumcropyields.Ruralhouseholdwateruseincludesconsumptionbybothruralresidentsanddomesticlivestock."Other"agricultureuseisprimarilyforaquaculture,butalsoincludesforestryandpastures.Portionsofurbanandindustrialwastewaterarereused,thussectoralusesarenottotallyadditive.

Toinhibittheexistingnegativewaterbalancefromworsening,watermustbeappropriatelypricedtoencouragegreaterefficiencyinwateruse(forallapplications,includingindustryandirrigation),waterdeliverysystemsmustbeefficientlyoperatedandmaintained,andconveyanceandapplicationefficiencyimproved.However,improvingefficienciesoflocalschemeswillresultinonlymodestwatersavingsfortheentirewaterbasin.Thisisbecausemostofthelossesfrominefficientirrigationschemesreturntothehydrologic(surfaceorgroundwater)systemandareavailabletodownstreamusers.Theactualwatersavings(availableforincrementaluse)withinawaterbasin,isonlythereducedamountofnonbeneficialevapotranspirationandnonbeneficialoutflowtotheocean.Actualwatersavingscanbegeneratedonlythroughagronomicandirrigationmanagementmeasuresthatimprovewateruseefficiencyandreducesnonbeneficialevapotranspiration;forexample,improvedcropgenetics,plasticandorganicmulching,andirrigationscheduling.Giventhelimitedabilitytoimprovethewaterbalancethroughimprovementsinoverallirrigationsystemefficiency,developingadditionalwatersuppliesisimportant;butundevelopedsuppliesalsoarelimited.TheMinistryofWaterResources(MWR)hasproposedseveralhundredwaterdevelopmentprojects,includingwater-savingirrigationtechnologies,improvedirrigationefficiencyprojects,andnewsupplydevelopmenttoincreasewatersupplies.Toassistinmaintainingagriculturalandruralincomegrowth,andtoaddressfoodsecurityneeds,theMWRproposestoexpandtheeffectiveirrigatedareato53.3millionhectaresby2000and58.0millionhectaresby2010.

Theterm"irrigatedarea"mostquotedinstatisticalreferencesappliestoeffectiveirrigatedarea,whichencompassesthecroplandthatisleveledandisbundedandconnectedtoasourceofirrigation.However,thisareamaynotnecessarilyreceiveirrigationwater.Effectiveirrigatedareawasestimatedat50.4millionhectaresin1996.Actualirrigatedareaistheareacultivatedatleastonceduringtheyearandreceivesirrigationwateralthoughnotnecessarilyoptimumsupplies;andstableirrigatedareaistheareasuppliedwithsufficientwatertomeetaverage-yearcroprequirements.

ChinahasnineWaterRegions,whichconformtothemajorwaterbasins.

1Also,thecountryisdividedintothreeirrigationzones,broadlybasedonprecipitationpatternsandthe"irrigationindex"(thepercentageofcropwaterrequirementsthatmustbemetfromirrigation)andthatcutacrossthewaterregions.Theirrigationzonesaredefinedasfollows:

·Perennialirrigationzone.Meanannualprecipitationis400mm(15.7inches)orlessandtheseasonaldistributionisgenerallyinsufficienttomeetcropneeds.

·Unstableirrigationzone.Meanannualprecipitationis400to1,000mm(15.7to39.3inches)andincludesthemajorportionofChina'sagriculturalland.Rainfedagricultureispossibleandwidespread,butoptimalyieldscanbeobtainedonlywithensuredirrigationanddrainage.

·Riceirrigationzone.ThiszonecomprisessouthernandsoutheasternChina,whererainfallismorethan1,000mmandtheclimateishighlyfavorableforagriculture.Twoorthreecropsperyeararecommon.

TheirrigationzonesandwaterregionsareshowninFigure8.1.

FinanceandManagement

Previousworkhasdemonstratedthatirrigationinvestmentsmakeimportantcontributionstoagricultural(crop)growth(WorldBank1997;HuangandRozelle1997).Waterconveyanceisoneofthefewrural-sectorareaswhererealinvestmentshaveincreasedoverthepastdecade;growingatanannualrateof17per-

Figure8.1WaterRegionsandIrrigationZones

centbetween1987and1996andexceeding¥18trillionin1997.Budgetaryresourcesareallocatedprimarilyfornewirrigationprojectsastheproportionofinvestmentsforrehabilitationandexpansionofexistingschemeshasdeclined(Figure8.2).Waterchargestoandcollectionsbyfarmers,whileminimallyadequateforroutineoperationandmaintenance,areinsufficienttocoverperiodicrepairsandrehabilitationofsystemstructures.(Yetfarmerobligations,includingcorvéelaborandwaterfees,aresubstantial.)

TheMWRisresponsibleformanagingChina'swaterresources,butalargepartofMWR'sresponsibilityisdelegatedtosevenmajorriver-valleycommissionscoveringtheYangtze,Yellow,Huaihe,Haihe,Pearl,Songhua,andLiaoheriversandTaihuLake.Regional-levelresponsibilityrestswiththeProvincialWaterResourceBureau,withofficesineachprefectureandcounty,andchargedwithmanagementofthemaincanals,systemimprovementprograms,andsupervisionoftheTownshipWaterManagementStations(WMSs)thelatterareresponsibleformaintenanceandmanagementoflowersystemcanalsandgatesand,throughvillagestaff,forschedulingwaterandcollectingwatercharges.Atthevillagelevel,WaterManagementCommittees(WMCs)incollaborationwiththeTownshipWMSandAgriculturalServicesStationareresponsibleforlocaldistribution.The

WMCisalsoresponsiblefororganizingfarmerlaborformaintenanceandsystemexpansionandforcollectingwatercharges.Groundwaterforirrigationuseislargelymanagedbylocalgovernments.

Thegovernment'sstrategyistotransformirrigationmanagementagenciesintoself-financing,independentlegalentitiesasystemincreasinglybeingadoptedinothercountries.Oneofseveralexperimentalinstitutions,theSelf-FinancingIrrigationandDrainageDistrict,hasbeensuccessfullypilotedforseveralyearsandit,orsimilarinstitutions,willincreasinglyberesponsibleforholisticwatermanagement.ThestructurecomprisesaWaterSupplyCorporationandWaterUserAssociations(WUAs).TheWaterSupplyCorporationisformanagement,organization,andmaintenanceofthemainirrigationsystemandsupplyofbulkwater.The

Figure8.2ProportionofInvestmentsinWater

Conservancy,byType

WUAsareestablishedbyfarmergroupsforconstruction,management,andoperationandmaintenanceoflateralcanalsandon-farmsystemsandwouldpurchasethemeasuredvolumeofwaterdelivered(i.e.,attheheadofeachlateral).InthepilotstageWUAshavebeenhighlysatisfactoryinimprovingwatermanagementefficiency(reducingwaterusewhileincreasingproduction),rationalizingfieldchannels,andreshapingplotstofacilitatemechanicalcultivation.Giventhefinancialconstraintsandtheaccumulateddeferredmaintenance,thetransferofsystemresponsibilityandmanagementtoself-financingenterprisesshouldproceedasrapidlyasexpertisecanbedeveloped.

ConstraintsandtheirAlleviation

Fewoptionsareavailabletoalleviatebasin-widewatershortages;developmentofnewwatersupplies,whereundevelopedsuppliesexist,isanobviousoption.Numerousprojectsareproposedtoincreasewatersuppliesfromsurfacesources.ThemultipurposeXiaolangdiandWanjaizhaiprojectsintheYellowriverbasinwillcollectivelycontributeonlyabout4bcmtotheannualwatersupplywhencompleted.Asthecostofthesetwoprojects(excludingresettlement)isabout$3.6billion(whichincludeshydropowerandotherbenefits),themagnitudeofthewatersupplycapacityproblembecomesclear.Certainly,theThreeGorgesprojectwillincreaseavailablesuppliesandstabilizewaterresourcesforalargearea.Also,eitherrouteoftheSouth-Northtransferschemewouldbringabout14bcmperyearofabundantYangtzewatertothedriernorth(Liu1996).However,thevolumeinvolvedwouldbelessthanthecurrentlevelofgroundwateroverexploitationinthenorthandsuppliesfromsuchtransferswouldbeavailableonlyaboutadecadeafterinitiatingtheproject.

Beyonddevelopingnewsupplies,onlyinvestmentswhichreduce

nonbeneficialevapotranspirationandnonbeneficialoutflowstotheocean,orthatimprovecropuseefficiencyactuallycontributetomakingadditionalwateravailablesystem-wide.Investmentswhichreducewaterpercolationsaveswaterforindividualschemes,butimprovesbasinefficiencyonlymarginallyaspercolationandrunoffrechargesthegroundwateranddownstreamsurfaceflows.However,someagronomicandmanagementeffortswouldgeneratewatersavingeffects.Theseincludecropgeneticresearchwhichhasthepotentialtosavewaterbycreatingnewdrought-tolerantvarietiesthatproducemoreoutputusinglesswaterinput.ThiswillnecessarilybecomeanincreasingimportantresearchagendaaswaterbecomesincreasinglyscarceinthenorthChinaplainandothermajoragriculturalareas.

LandLeveling

Surfaceirrigationaccountsfor99percentoftheirrigatedareabuttheplotsarestillleveledbytraditionalmethods.Tomakeefficientuseofwater,fieldsmustbelevel;precisionlevelingwillsavewaterasreducedwaterapplicationwillreduceevapotranspirationandyieldperunitofwaterappliedwillincrease.Laserlandlevelingisadecades-oldtechnologybutisrelativelynewtoChina.Internationallythecostoflaserlevelingisabout$300perhectareorY165permu(assumingmaximummovementof300cubicmetersperhectare)andgenerallyproducesyieldgainsof30to50percentandreduceswaterapplicationneedsby10to25percent.Thistechniquemaynotbeapplicabletoallareasbutshouldbeconsideredwhenfieldsizesarelargeenoughtoefficientlyaccommodatelaserequipment.

PlasticFilmMulching

Thistechniqueconsistsofcoveringthesoilwithafilmtoreduceevaporation.Ithasdevelopedrapidlyandisnowappliedtomorethan1.3millionhectares.Remarkablewater-savingandyield-increasingeffectshavebeenachieved,withwaterefficiencyreaching90percent.CottonexperimentsonplasticfilmmulchinginXinjianghasachieved

watersavingsofmorethan70percent.

Full-CostandVolumetricWaterCharges

TheStateCouncildocument,IndustrialPoliciesonWaterConservancy(1997),addressedtheneedforappropriatewatercharges.Waterchargesforneweconomicprojectsaretobesetsufficientlyhightocoveroperationandmaintenancecosts,paytaxes,repayloans,andyield

rationalprofits.Waterpricesonexistingschemesaretobeadjustedupwardoverathree-yearperiodtoconformtothesameprinciples.

Irrigation-watermeasurementissteadilyincreasing,butinmostsystemsthemeasurementisundertakenonlyatmajorofftakesandbranches,sofarmerseffectivelypayflatrates.WatermeasurementisonlynecessaryatthelateralcanaloperatedbytheWUA,whichbuysthewaterandensuresabalancedallocationtothemembers.Also,watermeasurementisessentialforcorrectirrigationschedulingtomeetcroprequirementssystem-wideandflattenpeakdemandperiods.

DemandManagement

Croppingpatternsremaindeterminedbyacombinationofclimaticconditions,marketforces,andgovernmentdirection.Thegrainquotasystemcontinuestooperateand,thus,waterchargeswillnotinfluencethegrainareaplanted.

SystemRehabilitationandImprovement

ManyofChina'sirrigationschemeswereconstructedinthe1950s.Severalwereinadequatelydesignedandconstructedandwereofteninadequatelymaintained.Consequently,manyschemesrequirerehabilitationandmodernizationnotonlybecauseoftheseproblems,butbecauseofnaturalaging.A1990surveybyMWRfoundmorethanone-halfofthestructuresandcanalssurveyedhaddeterioratedinvaryingdegreesandabouttwo-thirdsofthedeterioratedinfrastructurewasduetonaturalaging(ChenandJi1995).Investmentsintheseactivitieswouldimproveirrigationschemeefficiencyandperhapsfarmerequity,butmaynotimprovebasin-wideefficiencysignificantly.

CanalLiningandPipelines

Thisisthemostwidelyadoptedwater-savingpractice.Canallining

alsoimprovesoperations.Antiseepagetechniquesforcanalsincludeliningsofstone,concrete,plasticfilm,asphalt,andasphalt-felt.Theeffectofthesetechniqueshasproducedwatersavingsexceeding50percentwithinanindividualWUA.Muchoftheseepageisreturnflowwithinabasin,thusthesumofindividualschemesavingswouldbeconsiderablygreaterthanactualbasinsavings.Insomenorthernprovinces,canalnetworkshavebeenreplacedwithpipelines,thuspreventingseepageandevaporationfromthedistributionnetworkandpermittingthecultivationoflandpreviouslyusedforcanals.Lowpressurepipelineconveyancesystemshavedevelopedrapidlyinthetubewellirrigationareas.

AdvancedIrrigationTechniques

Thesetechniquesincludesprinkler,trickle,andlowpressuresystems;gatedpipes;andseepageirrigation.Theyhavebeenintroducedandsomeequipmentismanufactureddomestically.Usehasyettobecomewidespread(sprinklerirrigationisestimatedtocoveronly700,000hectares),exceptforsomemedicinalandotherhighvaluecrops.Surge-flowirrigationsystemsprovideswaterinacyclicalmannerandhastheeffectofreducingsurfaceinfiltration.Thissystemismorecomplexthanconventionalgravitysystems,butwouldconservesomeirrigationwater,assmallerwaterapplicationswouldreducenonbeneficialevapotranspiration.

WastewaterReuse

Reusingmunicipalandindustrialwastewaterwillimproveoverallwaterefficiency.Anestimated37.3bcmofmu-

Liningirrigationcanalsreduceswaterpercolationlosses.

nicipalwastewaterwasproducedin1995,ofwhich23.3bcmwastreated.Wastewatercontainsconsiderablequantitiesoffertilizernutrientsandthus,iftreated,isparticularlyusefulforirrigation;however,carefulmanagementisrequiredtoavoidsoilandgroundwatercontamination.TreatmentcostsaretypicallyY1.00/cubicmeter,butitsvalueinirrigatinghighvaluecropsontheperimeterofcitiesismuchgreater.

TheImportanceofIrrigationtoAgriculturalProductionandIncomes

In1996about95.5millionhectareswerecultivatedinChina,ofwhichabout50million(52percent)wereirrigated.However,irrigatedareasaccountforfarmorethan52percentofcropproduction.Firstly,croppingintensitiesonirrigatedlandareabout203percent,whereasonrain-fedlandtheyareabout114percent.Thusabout66percentofsownareaisirrigated.Secondly,theproductivityofirrigatedlandismuchhigherthanthatofrain-fedlandinmostofChina.Aboutthree-fourthsofthecroplandlieseitherintheperennialirrigationzoneorintheunstableirrigationzone.Croppingintheseareasisriskywithoutensuredirrigationsupplies.

Availablestatisticsdonotpermitdirectlycomparingrain-fedwithirrigatedcropyields.ControlledexperimentsundertakeninShanxiProvinceandestimatesderivedfromFAO'sCROPWAT

2model(anirrigationschedulingmodel),underconditionsoffullirrigationandnoirrigationindicatedthatinwetterlocations(RegionsV,VI,VII,andVIII),nonricerain-fedyieldsarenearlyidenticaltoirrigatedyieldsexceptforvegetablesandmelons.Indrierregions,yieldsofirrigatedgrainsarealwayshigher.IntheInlandRegion(IX)mostyields,includinggrains,aremorethandoublerain-fedyields.Otherwise,irrigatedyieldsrangefrommarginallytosubstantiallyhigher,particularlyintheYellowRiverBasin(IV),whereirrigated

winterwheatyieldsareaboutdoublerain-fedyields.

Toestimatetheroleofirrigationinthegenerationofruralincomes,wemappedthe1996ruralpopulationandprovinciallevelpercapitaincomedataintothewaterresourceregionstoderivetotalruralincome.Wethenconvertedtheresultsto"IncomefromAgriculture"and"IncomefromCrops,"firstlybyremovingtheproportionofruralincomesderivedfromnonagriculturalsources,andsecondlybyremovingtheproportionofagriculturalincomederivedfromnoncropactivities15.8and20percent,respectively.(Substantialregionalvariationwouldexistintheproportionofincomederivedoutsideofagricultureandofagriculturalincomederivedfromlivestock.)Theresultindicatedthatabouttwo-thirdsoftotalruralincomesderivefromcroppingactivities.Usinggrossrevenuefromcroppingasanincomeproxy,wedeterminedthat58percentofcroprevenuecamefromirrigatedareasinthenorthernregions(IthroughIV,andIX);and77percentinthesouthernregions(VthroughVIII).

CropYieldandIncomeResponsetoWater

InnorthernChina,rice,vegetables,andmelonsaregivenpriorityinirrigationapplicationdecisions.Othergraincrops,particularlywheatandcorn,areonthemargin;theyreceivesupplementalirrigationwhenavailable.TheShanxiexperimentaldataandestimatesusingFAO-CROPWATmethodologyproducedsimilarresults.WediscusstheCROPWATresultsbelow.

Themodelassumeda20percentreductioninirrigationsuppliestoeachcrop(fromthefullwaterrequirement).Theresultsindicatethatvegetablesandmelonsarethehighestmarginalrevenueproducers;themarginallosswasatleastY4.00percubicmeterinallregions,andnearlyY9.00percubicmeterinRegionII.Vegetablesandmelonswouldbethelastcropsonwhichafarmerwouldreduceirrigationwater.Nextwouldbecotton(northernregions)andthen

cornororchards.Thefirstcropstocutwouldprobablybewheat,soybeans,tubers,orothergrains.

Ricetypicallycannotbestressed,thuswaterreductionsforricemeansreductionsinricearea.Kutcher(1998)modeledtheimpactsof

convertingallthericeareainWaterRegionsIthroughIVtowheatorcorn.Thericeareasarerelativelysmall,(exceptRegionI),butgiventheirdisproportionatewaterrequirements,couldmakeasubstantialvolumeofwateravailableforothercropsiftheseareaswerenotproduced.(However,ricemaybegrowninspecificareasbecausewaterloggingorotherfactorsmayprecludeothercropproduction.).Fortheamountofwaterricerequires,uptotwiceasmuchwinterwheatareacouldbesown,about2.5timesasmuchspringwheatarea,andmorethanthreetimesasmuchcornarea.Furthermore,wheatandcornhaveanabsoluteadvantageoverriceingeneratinggrainoutputandrevenuepercubicmeterofirrigationwaterunderP75rainfallconditions.Thetablebelowcomparesthesealternativesonthebasisof1995estimatedyieldsand1997cropprices.Wheatgeneratesupto50percentmoregrainperunitofwaterthandoesrice,andcorn,betweentwoandthreetimesasmuch.Theresultsaresimilarwhencomparingrevenuepercubicmeterofirrigationwater.

Averagerevenue,ofcourse,isnotaverageincome.SeparatesurveydatafromHenanProvince(whichincludespartsofRegionsII,III,andIV)for1996indicatedtheincomeperhectareforwheatY3,658,cornY5,349,andriceY10,040(HenanAgriculturalStatisticsYearbook1996).(Ricepriceswereparticularlyhighin1996.However,exceptforricewedonotknowwhethertheseaveragecropincomesarebasedonadequateorinsufficientwatersupplies.)And,ifneithertheavailabilityofwaternoritscostwereaconcern,farmerswouldclearlyprefertogrowriceratherthanwheatorcorn.However,ifwaterbecomesthe(physicallyorfinancially)constrainingfactorintheseregions,asseemslikely,farmerswillneedtoconsiderreturnstowateraswellaslanduse.Farmerswhoproducericewouldsuffermodestincomelossbyshiftingriceareatowheatandcornunless(a)nonricecropsareseverelystarvedofwatercurrently,or(b)additionalcultivatedlandisavailableforcroppingwiththereleasedwater

supplies.However,riceaccountsforonlyabout4,5,and6percentofcropincomeinRegionsII,III,andIV,respectively;thus,excludingricefromthecroppingpatternwouldhaveminimalincomeimpactsregionally.Incomeestimatesperhectare(ormu)arequitesensitivetowaterapplication,thusoptimizingcroppingpatternsonavailablelandandwaterneedcarefulstudyineachlocation.

TheImportanceofImprovingIrrigationSystemEfficiencies

Grossconsumptionofirrigationwaterdeclinedmarginallybetween1980and1993,butnationalplanscallforasharpincreaseby2000andafurthermarginalincreaseby2010.Given

Table8.2:AverageGrainOutputandRevenueperCubicMeterofIrrigationWater

Crop/Region I II III IVAverageGrainOutputperCubicMeterofIrrigationWater(kg):WinterWheat n.a. 1.58 1.82 0.98SpringWheat 2.04 1.54 n.a. 1.21Corn 6.07 4.09 4.36 2.22NorthernRice 1.57 1.36 1.33 0.94AverageRevenueperCubicMeterofIrrigationWater(yuan):WinterWheat n.a. 2.33 2.69 1.45SpringWheat 3.02 2.28 n.a. 1.79Corn 6.95 4.68 4.99 2.55NorthernRice 2.04 1.77 1.73 1.22n.a.=notapplicable.

competingwaterdemandsandthehighinvestmentcosttoincreasewatersupplycapacity,coupledwithashortageoffinancialresources,theproposedincreasesareunlikelytobeachieved.However,improvingthewaterdeliverysystemisimportantandshouldbeundertakenwheneconomicallyefficient,particularlywhenitalsoimprovesintra-schemedistribution.

Thenationalaverageoverallirrigationsystemefficiencywasreportedtobe54percentinthe1980s(ESCAP1997).RecentdiscussionsindicatethatstatisticstillappliesinmuchofNorthernChina.

3However,theESCAPstudy(1997)impliedthatthenationalaverageefficiencyhadimprovedto66percentby1993.Thus,grossirrigationconsumptionof343.4bcmin1993couldhaveresultedinnetconsumptionaslowas187bcm(usingthe1980efficiencies)orashighas230bcm(usingtheimplied1993efficiencies).Thenetconsumptiondifference,43bcm,islargeandrepresentsoneofthemajorsourcesofuncertaintyinwaterresourceinformationandplanning.Dependingonhowmuchirrigationefficienciesareimprovedbefore2000,meetingthegrossirrigationrequirementof433.5bcmcouldresultinnetirrigationsuppliesofbetween236and337.5bcm(ignoringnaturalintrabasinreturnflows).ThemarginalvalueofirrigationisatleastY1/cubicmeter,implyingthattherangeofuncertaintyduetotheseefficienciesismorethanY100billionperyearofagriculturaloutput,andasimilarvalueintermsofruralincomes.

Althoughwaterresourceplanningcallsformoderatelyincreasingallocatedsuppliesofwatertoirrigationoverthenextdecade,thiswillbeverydifficulttoachieve.Moreprobableisacontinuationofrecent

trends,withmodestreductionsinirrigationwaterallocationsbecausemostnonfloodseasonsurfacewaterisalreadyconsumed,andgroundwaterisheavilyoverabstracted.Furthermore,siltingofreservoirsandneglectofmaintenanceoftheirrigationsystemimpliesthatlocalsurfacewatersuppliesmayevendecline.

Thehighcostofnewinvestmentsinwater-resourcedevelopment,coupledwithincreasingeconomy-widedemandsforlimitedfiscalresources,willlikelyconstrainrapiddevelopmentofnewwaterresources.Althoughwatercancontinuetobeadministrativelyallocated,itismoreefficientandwillleadtohighergrowth,ifwaterisappropriatelypricedandmarketforcesallocatethewatertouseswithhighereconomicvalue.Astheeconomybecomesmoremarket-oriented,thelong-runsustainabilityofirrigationanddrainagewilldependincreasinglyonself-financingentitiesthatarebasedonhydraulicboundaries(notadministrative),withmaximummanagementresponsibilityandcontrolaccordedtofarmerusers.

Fromamacroeconomicview,thevastlyhighereconomicvaluesofwatergeneratedbytheurbanandindustrialsectorsshouldnotbesacrificedforincreasedagriculturalproduction.TheabilityofChina'sindustrialsectortogeneratetradesurpluseseasilyoffsetsforeseeablereductionsinagriculturaloutputthatmayarisefromirrigationwatershortages.However,three-fourthsofChina'spopulationisrural,anddependonagriculturefortwo-thirdsoftheirincomes.Protectingandincreasingtheseincomesandmaintaininggrowthinagriculturalproductionisanationalconcernonethatdependsinpartonmoreandbetterirrigation.

Rehabilitatingandcompletingsurfaceirrigationanddrainagesystemsincludingtheinstallationofcontrolstructuresandwatermeasuringdevicestoimproveefficiencycanyieldlocalbenefits.Rehabilitationshouldbeundertakenwhereeconomicbenefitsjustifytheinvestment,particularlyifitprovidesamorereliableandequitable

supplyofirrigationwatertofarmersandincreasesdeliveriestowater-deficientareaswithinthescheme,typicallylocatedinthelowerreachesoftertiaryandquaternarycanals.Investmentsinimprovingandextendingexistingsystemswouldlikelyprovidebetterreturnsthannewconstruction.(Between1989and1995,themarginalcostofirrigationexpansionwasaboutY10,000per

hectare,(1990terms),representingveryefficientinvestments.However,futureinvestmentswillprovemoreexpensive.)

Ifirrigationwatersuppliesdonotincreaseasplanned,ordecrease,thenegativeimpactonagriculturalproductionandincomescouldbeminimizedbythefollowingactivities:

·Conductacomprehensivestudyofsystem-wideefficiency.Suchastudyissorelyneeded.

·Rehabilitatetheirrigationanddrainagesystemswhereeconomicallyjustified,toincreasetheoveralldeliveryefficiencyandimproveon-farmfacilities.Suchinvestmentswillhaveanincomeimpactbyensuring''tail-end"farmersreceiveaequitableshareofwater,butsystem-widewatersavingswillbemodest.

·UndertakeoneormoreroutesoftheSouth-Northtransferscheme,whichwouldbringplentifulYangtzeriverwatertothewater-starvedregionsII(HaiBasin),III(HuaiBasin)andIV(partoftheYellowBasin)asearlyaspossible.Delayswillincreasethecostintermsoflostindustrialandagriculturaloutput,socialcostsofchronicwatershortages,andenvironmentaldamagefromoveruseofgroundandsurfacewater.

·Introduceimprovedland-levelingtechnology(e.g.,useoflaserguidedequipment).Thistechnologyappearsfinanciallyattractiveandshouldbeexploredasameansofsavingwaterandincreasingyields,particularlyonnewlyreclaimedlands.GivenChina'ssmallcultivatedplots,landlevelingmaynotbepracticalinallareasbutwouldbefeasibleinnewlandreclamation.Full-cost,volumetricallybasedwaterchargeswouldprovideanincentivetosavewaterandmakeprecisionlevelingfinanciallyattractive.

·Expandcollection,treatment,andreuseofmunicipalwastewater,particularlyaroundlargerurbanareas,withsuitablemonitoringand

controltopreventcontaminationbyhazardouswastes.

·Encouragefarmerstorefinecroppingpatternsinwater-shortareastomorewater-efficientcrops.Insomeareasconsiderablymorewheatandcorncouldbegrownwiththewaterricecurrentlyconsumes,withlittleornoreductioninfarmincomes."Encouragement"wouldbestcomeintheformofappropriatewaterpricingsupportedbyfarmereducation.

·Introduceandenforcearationalsystemofwaterpricingandvolumetricmeasuring.Overthelongterm,volumetricmeasurementwouldconsiderablyimprovewateruseefficiency.Farmerscannotbeexpectedtoconservewateroraltertheircroppingpatternswheneffectivewatercostsareloworunrelatedtotheamountused.Waterchargesthatfullyrecovercostwouldencouragebetterwatermanagementonallcropsandwouldinfluencenongraincroppingpatternsbyincreasingtheproductioncostforcropswithhigherwaterdemand.

·Expandself-financingwaterenterprisestomanagewatersuppliesandoperateandmaintainirrigationsystemsasrapidlyasmanagementexpertisecanbedeveloped.

·Ensureagriculturalresearchandextensionprogramsaccordappropriateprioritytocropwateruseefficiency(droughttolerance).

WaterRegions:RegionName ComponentProvinces MajorRiver

Basins

I Northeast Heilongjiang,Jilin,Liaoning,NeiMongol

Heilong,Liaohe,Songhua

II Haihe Hebei,Beijing,Tianjin,Shanxi,Henan,Shandong

Haihe,Luanhe

III Huai/ShandongShandong,Henan.Jiangsu,Anhui HuaiheIV Yellow Qinghai,Gansu,Ningxia,Nei

Mongol,Shaanxi,Shanxi,Henan

Yellow,Weihe,Fenhe

V Yangtze Hubei.Hunan,Anhui,Jiangxi,Jiangsu,Zhejiang,Henan,Guangxi,Sichuan,Shanghai,Guizhou Yangtze

VI South Guangdong,Guangxi,Yunnan PearlVII Southeast Fujian,Zhejiang,Guangdong Qiangtang,

MinjiangVIII Southwest Yunnan,Tibet Yarlung-Zangbo,

Nujiang,Lancang,Yuanjiang

IX Northwest NeiMongol,Qinghai,Xinjiang,Tibet

Tarim,Yilo,Ertix

2.CROPWATisanirrigationschedulingmodeldevelopedbytheFAO,UN.ItisdescribedinFAOIrrigationandDrainagePaperNo.46(Rome:FAO,1992).

3.DiscussionswithriverbasincommissionofficialsattheHai.Huai,andYellowRiverheadquarters,April/May1998.

9.TechnicalChangeandTechnologyTransfer

Duringthereformperiod,higherpricesandimprovedincentiveshaveincreasedagriculturalinputusageandsubstantiallyraisedagriculturalproductivity.TFP,whichisthebasisofimprovedefficiency,increasedrapidlyduringtheearlyreformyears,buthassincetaperedoff.TFPimprovementis,generally,theresultofadaptingnewandimprovedproductiontechnologies,whichinturnrestsprimarilyonagricultural(andallied)researchandisthefundamentalelementforlong-termincreasesinfarmers'percapitaincomes.

Thecomprehensiveextensionsystemduringtheearlypost-revolutionperiodplayedacrucialroleinmeetingexpandingfoodneeds,disseminatingtechnology,andmodernizinglargepartsofChina'sbackwardandlow-productivityagriculturalsector.Intheearlyreformyears,theextensionsystemcontinuedtoassisttechnologytransfertofarmerhouseholdsmuchasithadearlier.Villagescontinuedtohirestafftoliaisewithtownshipextensionagentsonplantprotection,seedandfertilizeruse,andothertechnologies.However,financialresourceshavedeclinedinrecentyears,resultinginadeclineinagriculturaltechnologyresearchandpromotionefforts.

Agriculturalresearchandtheextensionofnewcropvarietieshavebeenshowntobeamajorengineofagriculturalgrowthduringthereform(HuangandRozelle1996,andLin1992).Whilefarmerswereresponsiveinpursuingnewtechnologies(e.g.,hybridrice),following

introductionoftheHRSreformstheadoptionrateofnewtechnologiesdeclined,whichmightbebecauseofweakeningofthetechnologydistributionsystem.

A.AgriculturalResearch

FundingforagriculturalresearchinChinaisallocatedorgeneratedinthreeways.Corefunding,whichfinancessalariesandsocialbenefits(e.g.,retirement,housing,medicalbenefits),constitutesabout50percentofgovernmentfundingforresearchinstitutesandcenters.Tomakeagriculturalresearchmoreeffectivebyrewardingthosewithgoodideas,successfulpastrecords,andwhoareworkingonkeyprojects,theremainderofpublicsupportconsistsofcompetitivegrantsallocatedforprojectsproposedbyscientists.Researchbudgetsalsoareallowedtobesupplementedbyadditionalfundsgeneratedthroughcommercialsalesbytheinstitutesandcenters.

PublicSectorFinancing

Historically,agriculturalresearchhasbeeninthepublicsectordomaininmostcountries.Marketfailurecharacterizesagriculturalresearch,asitisapublicgoodinvolvinguncapturableexternalities,isrisky,andislongterm.Withoutpublicsectorinvolvement,suboptimalamountsofagriculturalresearchwouldlikelybeconductedandthatresearchwouldlikelyfocusoneasilymarketabletechnologywithcapturableprivatebenefitsandignorebasicandlong-termresearchthatmaximizesociety'sbenefits.IntheOECDcountries,theprivatesectornowaccountsforabout50percentofagriculturalresearch,asIPRprotectionenablesmoreofthebenefitstobecaptured.

China'scropagriculturehasbeenwellservedbythepublicresearchsystem,particularlyriceChinapioneeredthebreedingofsemidwarf,high-yieldingvarietiesandtodayisstilltheonly

countryintheworldwithlargeareasofhybridrice.Successinthenongrainsubsectorshasbeenlessdramatic.Theimportanceofagriculturalresearch,intermsofhighratesofreturnandcontributiontogrowth,iswelldocumentedinChinaandelsewhere.FanandPardey(1997)foundthatgovernmentinvestmentinresearchanddevelopmentresultedina20-percentgrowthinagriculturalproductivityinChinaover196594.Fan(1996)estimatedthattheinternalrateofreturntoagriculturalresearchoverthesameperiodwas94percentimplyingaseriousunderinvestmentinagriculturalresearch.Asurveyofmorethan150studiesofratesofreturntoagriculturalresearch(worldwide)concludedthatratesofreturnaretypically40+percentandoftenexceed100percent(Echeverria1990).GrowthaccountinganddecompositionanalysesdemonstratedthatgrowthinChina'srice,wheat,andmaizeproductionover198495wasoverwhelminglyattributabletoresearchinvestments(Huang,RosegrantandRozelle1995andWorldBank1997b)

DecliningResearchInvestments

Oneofthegovernment'sobjectivesistoincreaseagriculturalresearchinvestments,butthatobjectivehasbeenelusive.Asinmanyotherfacetsoftheruraleconomy,agriculturalresearchsuffersfromfiscalconstraints,aspublicresourceallocationshavebeenwoefullyinadequate.TheNinthFive-YearPlanrecommendedincreasingagriculturalresearchexpendituresto29percentoftotalgovernmentresearchexpenditures,butthroughoutthe1990sagriculture'ssharehasremainedat13to14percent.Agriculturalresearchintensity(ARI),definedasinvestmentsinagriculturalresearchasaproportionofagriculturalGDP,declinedfrom0.49inthelate1970sto0.38inthemid-1990sandalthoughnationalagriculturalresearchbudgetsincreasedduringthereformperiod,thenumberofresearchscientistsemployedincreasedevenmorerapidly(Fan1995).Recentcomprehensivedataongovernmentexpenditures,includingprovinces

andlowerjurisdictions,foragriculturalresearchactivitiespresentsanequallyalarmingpicture.Realagriculturalresearchexpenditures,asmeasuredbydeflatingcurrentexpendituresbytheCPI,grewmarginallyduringthelate1980s,butallocationsincreasedduringtheearly1990s.However,Huang,HuandFan's(1998)analysisofdisaggregatedagriculturalresearchbudgetsclearlydeterminedthatafterdeductingexpendituresforcapitalconstruction,salaries(whichincreasedmuchmorerapidlythanthegeneralpricelevel),overheads,etc.therealexpendituresforresearchprojectsdeclinedatanannualrateofabout4percentduringthe1990s.Thesefacts,coupledwiththerapidincreaseinthenumberofagriculturalresearchscientistsreducedtherealresearchfundsperscientistby25-30percentduringthe1990s.TheARIdeclinedthroughouttheperiodreachinganall-timelowof0.38in1996and1997(Table9.1).ThedecliningARIislikelytoreducefutureagriculturalgrowth.Aninternational,"ruleofthumb"istospendabout1percentofagriculturalGDPforagriculturalresearch(FAO1990).Asseenabove,thedownward-trendingARIisbelowboththislevelandthedevelopingcountryaverage(Alston,Pardey,andRosebloom1997).Also,researchcostsareincreasingasadditionalobjectivesareincorporatedintotheresearchprogram(e.g.,pestresistance,droughttolerance)andresearchisincreasinglyturningtomorecostlyapproaches(suchasinbiotechnology),leavingfewerresourcesfortraditionalresearch.TheWorldBank'sFoodSecurityReport(1997b)summarizestherecentresearchonthedeterminantsofagriculturalsupply,whichdemonstratedthatincreasesinChina'scerealproduction,post-1985,wasoverwhelminglycontributedbyagriculturalresearchandtechnology.

MakingChina'sResearchInvestmentsMoreProductive

In1982theChineseAcademyofScienceinitiatedacompetitivegrantsprogramthatallocatedfundsdirectlytoresearchscientistsaspartofashiftinnationalscienceandtechnologypolicythatencouragesresearch-fundingagenciestomakegrantsbasedonthe

bestpro-

Table9.1:AgriculturalResearchBudgetsandResearchIntensity,1986-'96

AgriculturalResearchBudgets

ResearchProjectFunds

AgriculturalGDP

AgriculturalImtensity(ARI)

Current(millionyuan)

Constant(1995)(millionyuan)

Constant(1995)(million

yuan)(billionyuan) (percent)

1986 1,346 3,529 766.9 276 0.491987 1,403 3,429 560.7 320 0.441988 1,782 3,674 811.2 382 0.471989 2,095 3,668 747.5 423 0.501990 2,050 3,515 522.7 502 0.411991 2,381 3,967 729.1 529 0.451992 2,761 4,366 622.8 580 0.481993 3,273 4,572 673.6 688 0.481994 4,409 5,061 627.1 944 0.471995 4,856 4,856 570.7 1,199 0.401996 5,238 4,854 548.4 1,388 0.381997 5,377 4,795 1,397 0.38Note:Theagriculturalresearchexpendituredatareportedinthistableinclude(a)agriculturalresearchexpenditureinresearchinstitutesystemunderallministries,theAcademyofSciences,andtheAcademyofAgriculturalScienceatnational,provincial,prefectural,andcountylevels;and(b)agriculturalresearchexpenditureintheuniversitysystem.Agriculturalsectorincludescrop,forestry,livestock,fishery,water,andagriculturalservices(e.g.,machinery,information).ConstantpricesderivedbyusingCPIdeflator.Source:TheStateSciencesandTechnologyCommission(providedbytheCenterforChineseAgriculturalPolicy).

posals.Nationalresearchadministratorsalsocreatedanumberofspecialresearchfundingprograms,particularlyinhightechnology.Fundsfromthesenewprogramshavemostlycomefromcorebudgets,

meaningresearchinstitutionsthathavenotbeensuccessfulinthegrantscompetition,haveexperiencedfallingsupport,whichearliercametothemonthebasisofstaffinglevels.

Sincethemid-1990sChinahasattemptedtocommercializeaportionofagriculturalresearchbyrequiringresearchcenterstodevelopcommercialproductsintheirinstitutesandselltheirresearchfindings.Oneoftheoverallgoalsfromtheprogramistousecommercialprofitstofinancefurtherresearch.Ifintellectualpropertyrightswerebetterprotected,researchcenterscouldlicensenewtechnologytocommercialentitiesandenjoytheroyaltyrights.Instead,theinstituteshaveestablishedtheirowncommercialenterprisesandjointventuresasawayofprotectingtheirbreakthroughs.However,thesecommercialventureshavehadanumberofadverseconsequences.Commercializationalsohasdivertedskilledscientistsawayfromresearch.StudiesbyRozelle,Pray,andHuang(1997)showthatinsomecasesmorethan20percentofthescientistsinresearchinstitutesareengagedinactivitiesthatarenotrelatedtoresearchanddevelopment(R&D).Institutestaffarenottrainedtoengageinnon-R&Dactivities,andthushavehighfailurerateswhentheydo.Othercentershavehiredstafftoruntheirnewbusinessventures,whileatthesametimelayoffsareoccurringbecauseofalackoffunding.

Mostsignificantly,despitealloftheeffort,commercializationappearstoprovidefew,ifany,supplementalfundsforresearch.Researchfundingregulationsstipulatethat30percentofcom-

mercialnetrevenueshouldflowbackintoresearchprograms.Inreality,nomorethan15percentofnetrevenuesofprofitableventures(inthosecentersfocusingonriceresearch)havebeenreturnedtoresearchbudgets.Mostearningssupportsalariesandbenefitsofcommercial-enterprisestaff(Rozelle,PrayandHuang1997).

Jin(1997)determinedthattheactionsofgovernmentofficials,whoobservethecommercialactivityintheresearchsector,furtherunderminestheoriginalgoaloftheprogram.Foreach1yuanofcommerciallygeneratedincome,governmentfundinghasbeenreducedby0.80yuan.Thus,despiteabsorbinglargeamountsoftime,energy,attention,andcapital,commercializationhasledtoanetfundingincreaseofonly4percent(Jin1997).Asgovernmenthasreducedfunding,researchcentersareforcedtoseekalternativesources,which,exceptforanoccasionalinternationalgrant,arelargelylimitedtocommercialincome.However,thelackofpriorityforresearchsupportcreatesadownwardspiral.Generatingadditionalcommercialincomeresultsinfurtherreductionsinresearchfundingfromthebudget.

PotentialNewSourcesofResearchFunds

ProducerandUserCesses

Nonsubsistenceandprocessedagriculturalcommoditieswithcommercialmarketscouldappropriatelybesubjectedtocessesonsalesearmarkedforspecifiedpurposes,includingcommodityresearch.Processedcommodities,suchastea,tobacco,andsomenonfruittreecrops(e.g,rubber),arewellsuitedtothecollectionofsuchcesses.Whetherthefeeisleviedontheproduceroruserdependsontherelativeeaseofcollection.Fortobacco,imposingafeeonusersthroughastamp(orsimilar)taxcollectedfromthemanufacturerisrelativelyeasy.Forothercrops,suchascotton,levyingthefeeonproducersthroughdeductionsattheprocessingpoint(ginnery)may

beeasieradministratively.Wheresuchasystemisemployed,producersshouldhaveavoiceindeterminingthefocusofresearchfinancedinthismanner.Subsistencefoodcommoditiesareunsuitedforcessfundingbecauseonlyasmallportionofproductionismarketedtypicallyinsmall,uncontrolledmarketplaces.Norarecessesapracticalmethodofobtainingfundsfornoncommodityresearch,suchasfarmingsystems,soilconservationandotherenvironmentaltopics.

InternationallyFinancedNonprivateResearch

ChinahasaccesstotechnologygeneratedbytheConsultativeGrouponInternationalAgriculturalResearch

1(CGIAR)institutionsandbenefitsthroughadaptiveresearchbytheFAO,whichoftenincludestraining,andbysomeactiveNGOs.FundsforCGIARcenterscomeprimarilyfromdevelopedcountries(Europe,UnitedStates,andJapan)andtheWorldBank;fundingfromdevelopingcountriescomprisedonly2percentofthetotalbudgetin1995.Developingcountries,includingChina,havebenefitedenormouslyfromtheresearchofthesecentersatlittlecost.ChinahasactivecooperativeprogramswiththeInternationalRiceResearchInstitute,orIRRI(rice);theInternationalCenterforMaizeandWheatImprovement,orCIMMYT(maizeandwheat);theInternationalPotatoCenter,orCIP(potatoes);theInternationalPlantGeneticResourcesInstitute,orIPGRI(plantgenetics);theInternationalFoodPolicyResearchInstitute,or

AnIRRIbiotechnologylaboratorywhereforeigngenesareintroducedintorice

cellsusingbiolisticprocess.CourtesyofCGIARPhotoLibrary

Box9.1:IndiaGrowthAccountingAnalysis

IFPRI examined factorproductivity and governmentspending linkages withagricultural growth and povertyreduction in India. The resultshave implications for China.India's TFP increased at anaverageannualrateof1.1percentbetween 1957 and 1987with aslightlyhigheraverageduringthe1967-77 "Green Revolution." Agrowth accounting analysisindicated thatpublic researchandextension contributed most (59percent)toTFPgrowth.However,surprisingly,domesticandforeignprivate researchanddevelopmentalso made importantcontributions13 and 23 percent,respectively.The contributions ofvarious factors to TFP areindicatedinthetablebelow:

TotalFactorProductivitybySourceofGrowth,India,1957-87

Contribution

Factor Percentage Percent

Agri.Research

Publicdomestic

0.258 22.8

PublicHYV 0.070 6.2

Privatedomestic

0.145 12.8

Privateforeign

0.261 23.1

PublicExtension

0.331 29.3

Markets 0.035 3.1

Irrigation 0.084 7.4

Other -0.054 -4.7

Total 1.130 100.0

Source:IRPRI,EPTD,TotalFactorProductivityandSourcesofLong-TermGrowthinIndianAgriculture,April1995.

IFPRI(foodpolicy);andtheInternationalIrrigationManagementInstituteorIIMI(irrigationmanagement).

ResearchandTechnologyTransferbyPrivateEnterprises

Anotheralternativetogovernment-financedresearchandextensionisthroughprivatesectorsupport.Asnotedabove,theOECDcountriesrelyheavilyontheprivatesectortogeneratenewagriculturaltechnologies,asdosomedevelopingcountries.Forexample,domestic

andforeignprivateenterpriseshaveprovidedthetechnologythathascontributedabout36percentofIndia'sproductivitygrowthsince1957(Box9.1).Mostmajorinternationalseedcompaniesconductresearchandsellfield-cropseedsinIndiaacountrywithagroclimaticconditionsmuchdifferentfromNorthAmericaandEuropeandwithafarsmallerseedmarketthanChina.Incontrast,onlytwointernationalcompaniesaresellingsmallamountsofseed(otherthanvegetableseed)inChina.

AfewmultinationalorganizationsandtransnationalcorporationshaveresearchunderwayinChina.Oftentheresearchisdemonstrationinnatureandservesmoreasanextensionorsalesmechanism.TheseincludethePotashandPhosphateInstituteofCanada(PPI);theAmericanSoybeanAssociation;andtransnationalseed,chemical,andfoodandfeedcorporations.Thesegroupshavehadvaryingdegreesofsuccessandhavemadevaryingcontributions.Forexample,incooperationwiththeSoilandFertilizerInstituteoftheChineseAcademyofAgriculturalSciences,thePPIhasdemonstratedthebeneficialeffectsofapplyingmorepotassiumfertilizers,whichhasledtoincreasedpotashimports(andincreasedproductivity).ChiaTai(theChinasubsidiaryofCharoanPokphand)producesalargeportionofChina'smanufacturedfeedastheresultofpoultryfeeddemonstrations.Inadditiontothesesuccesses,trialsundertakenwithgovernmentagencieshaveproducedampleevidencethatadaptingadditionalforeigntechnologycouldsignificantlyincreaseproductivityincrops,livestock,andagriculturalmachineryandequipment.Forexample,Chinacouldtakeadvantageofforeigntechnologyformaize,rapeseed(canola),andsoybeans.ResearchinNorthandSouthAmericaandEuropehasproducedvarietiesthatyieldmuchhigherthanChinesevarietiesundersimilarclimaticenvironments.

Chinabenefitsonlymarginallyfromagriculturaltechnologydevelopedbytheprivate

sector.However,giventhesizeofChina'sagriculturaleconomyandsimilarityofagroclimaticconditionstothoseinNorthAmerica,Japan,andEuropewhereprivateresearchisquiteimportantChineseagriculturehasenormousopportunitytogrowmorerapidlybyusingtechnologydevelopedbycommercialenterprisesandforeignfirms.Farmersneedtobegivenaccesstothattechnology.

IntellectualPropertyRights

Copyright,patent,andotherIPRprotectionhavedevelopedslowly.Thepatentlawbecameeffectiveonlyin1985butdidnotapplytochemicalsandpharmaceuticalsuntil1993.Plantvarietyprotectionbecameavailablewithpassageoftheplantbreeder'srightslawin1997althoughtheapplicationofficehasyettoopen.Thelegalframeworkseemsadequate,butenforcementisperceivedtobeweak.IntheabsenceofstrongIPRprotection,fewlargemultinationalcompaniesdoresearchin,ortransfercutting-edgeagriculturaltechnologytoChina.OnlycompaniesthatcancontroltechnologythroughmeansotherthanIPRsandareconfidentoftheirjoint-venturepartnerscantaketherisk.

FDIassistedinmodernizingthepoultryindustrybyimportinggrandparentgeneticstockandbreedingparentgeneticmaterialsdomestically(thiscouldbedonewithsomeconfidencebecausethetechnologydidnotrelyonIPRprotectionbutsophisticatedhybridgenetics).Theintroductionofsuperiornutritionfeedmillingandmixingparalleledthedevelopmentofthepoultrygenetics.Almostalloftheplantbreedingandscreeningresearchbyforeign-financedenterpriseshasbeenonhybrids(corn,sunflower,sorghum,andrice)becausehybridvarietiesaredifficulttocopyaslongasthehybridparentsarekeptsecretthustheIPRwastechnicallyprotected.

Intheagrochemicalsectorthepesticidesthathavenotbeenreverseengineeredarethosewhoseactiveingredientisacomplex,and

difficulttocopy,molecule.Manyothers,despiteof-

Apromisingsuper-hybridricevarietyunderdevelopmentattheNationalHybridRiceResearch

andDevelopmentCenter,Changsha,Hunan,China.

PhotocourtesyofCNHRRDC

ficialagreements,havebeencopiedandsoldwithoutanycompensationtotheinventors.AlthoughthelegalenvironmentprovidesadequateprotectionforIPR,enforcementremainsweak.ThecurrenteffortbyMonsantotomarketitsBtvarietyofcottonseedwillbecloselywatchediftheseedsbecomewidelyavailablefromnon-Monsantosources,otherhigh-technologyandbiotechnologyfirmswillbereluctanttoinvestinChina.

Othernontariffbarrierstotechnologytransferincludeweakcontractlaw,restrictionsontheroleofmultinationalsintheagriculturalinputindustry,andgovernmentmonopoliesonthesalesofsomeagriculturalinputs.Forexample,theamountofimportedcottonseedallowedfortestingislimitedto500kgpervariety,seriouslyslowingdowneffortstotesttheapplicabilityofforeignvarietiesinChina.Otherregulationsdictatethatcompaniescanonlyimportfemalepigs,andthehealthprotocolsforimportingbreedingpigsrequirebloodtestsconductedinChinaatacostof$300perheadfordiseasesthat

alreadyexistinChina.

Relyingsignificantlyontheprivatesectorforagriculturaltechnologydevelopmentcarriespotentialhazards,particularlyintermsofresearchfocusandpriority.Theobjectivesofprivatefirmsareunlikelytocoincidewithsociety's,

asoptimizinglong-termfinancialgainsisnotnecessarilyconsistentwithoptimizingsociety'seconomicbenefits,whichincludeenvironmentalandpovertyalleviationobjectives.SomeofficialsinChinaworrythatforeignfirmswithadvancedR&Dmethodsandtechnologywilldisplacedomesticexpertiseandunderminethenation'sabilitytogenerateitsownresearch.

ResearchPrioritiesandEfficiency

Decentralizationandfinancialreorganizationhasresultedinthestateprovidingadecliningproportionofagriculturalresearchfundingandgreaterrelianceonprovincialandlowerjurisdictionfinancing.Usingprovincialdata,Jinetal.(1997)identifiedseveralfactorsthatinfluencegrowthingovernmentfundingofagriculturalresearch.Inthestudy,governmentrevenues,agriculturalGDP,provincialgrainexports,andnumberofscientists(allonapercapitabasis)werepositivelyrelatedtoagriculturalresearchfinancing.Thesefindings,althoughunsurprising,haveseriouswelfare,poverty,andequityimplicationsforregionswherethepositivefactorsarelowerthanthemoreeconomicallyadvancedcoastalprovinces.

Giventheoverwhelmingcontributionofresearchtoagriculturalgrowthandpovertyreduction,realinvestmentsinresearchmustbebettermanagedtoensurethatefficiencyandlong-termobjectivesaremet.Aconsolidationandreorganizationoftheresearchsystemeliminatingunnecessaryduplicationandrestructuringitalongagroecologicalzonesalsowouldimproveefficiency.Thiswouldincluderesearchapplicabletopoverty-strickenandresource-poorareasbothhighelevationtemperateandtropicalzones.Peopleinpovertyareasoftenrelyonsubsistencecropvarietiesandlivestockspeciesthathavenotreceivedasignificantresearchfocus,particularlyunderadverseenvironments.Theseincludepotatoes,sorghum,

Box9.2:AgriculturalResearchConsiderations

The agricultural research budget allocated to various commodities isunknown, but food grains has been a major focusand production ofcerealshasincreasedimpressively.However, inrecentyearsChinahasturnedfromanetexporterofvegetableoils,oilmeals,andoilseedstoanet importer, reflecting increasingdemand for protein supplements forlivestockfeeds.However,China'srapeseedishighinglucosinolatesandmuch of the meal is exported because of its toxicity to nonruminantlivestock(China'sneedsforproteinsupplementsisprimarilyforpoultryandpigs).Canadaembarkedonaresearchprogramtoimproverapeseedyieldandqualityinthe1960sand1970sthatyieldedratesofreturnof100percent in theearlyperiod,declining to50percent inmorerecentyears.China'srapeseedyieldshavegrownatonly1.6percentannuallyoverthelate1980sandearly1990sandremainbelowthoseofCanada,Argentina,andFrance.AlthoughsoybeansoriginatedinChina,Chinesesoybean yields remain far below that of other major producers(Argentina,Brazil,Canada,andtheUnitedStates).ThegrowthratesofChina'scerealsandoilseedsyieldsareshownbelow.

GrowthRatesofCerealsandOilseedsYields,1985-96

CommodityGrowthRate(percent)

CommodityCommodity

GrowthRate(percent)

Cereals OilseedsRice 1.0 Rapeseed 1.6Wheat 1.2 Soybeans 2.3Corn 3.3 Peanuts 3.7Millet 3.0 Sunflowers 3.2Sorghum 4.6 Sesame 4.3

millet,barley,buckwheat,beans,goats,poultryandpigs.RecentworkonIndia'sresearchinvestments(FanandHazell1996)concludedthatorientingadditionalresearchinvestmentstononirrigatedagriculturewouldyieldgreaterproductivityandpovertyalleviationbenefitsthanmaintainingaheavyfocusonirrigatedagriculture.

Asresearchbudgetsbecomeincreasinglyconstrained,Chinamustusefundsefficientlyandappropriatelyidentifyresearchpriorities.Whilesomeprioritiesandbroadfinancingallocationscanbeestablishedonobjectivecriteria,suchaspercentofagriculturalGDPorimpactonthebalanceoftrade,otherprioritiesmustbeassessedmoresubjectively.Obviousexamplesoftheformeraredrought-tolerantplantvarieties(inanticipationofreducedirrigationsupplies),feedgrains(tosupportthelivestocksector);livestockandfisheries(whichareanincreasingshareofagriculturalGDP),andoilseedsandtheirderivatives(whichareanincreasingproportionofimports).Examplesofthelatterarefarmingsystemsandvarietalimprovementinresource-poorareas(forequityandpovertyalleviationreasons),marketingandagroprocessingissues,andnatural-resourcemanagement(wherelong-termbenefitsarenotcapturedineconomicassessments).

Chinaisconcernedaboutunduerelianceonexternalmarketstosupplysubstantialportionsofdomesticneeds.ThisisbecauseChina'slargesizecouldpotentiallydisruptinternationalmarketsandbecausethegovernmenthasalatentfearthataforeigncountrymightapplypoliticalpressurethroughtradeembargoes.Theseconcernspartiallyunderliethegrainself-sufficiencypolicy.

Improvementsandtransfersintechnologyarecrucialinimprovingthehealthoftheruralsector.Agriculturalresearch,alongwithextensionservices,isamajorengineofgrowth.Toensurenewandcontinually

improvingtechnology,researchneedssupport.Stepsthegovernmentcantaketoprovidethisincludethefollowing:

·Financeasmuchofthe"publicgoods"agriculturalresearchaspossible.Thereturnstoagriculturalresearchhavebeenfoundtobeveryhighandoneofthelargestpastandpotentialcontributorstoincreasingfoodsupply.Bygivingfinancialsupporttoresearch,thegovernmentwillaccelerategrowthandthusisagoodinvestment.Creatingan"enablingenvironment"tostimulateagriculturalresearchbytheprivatesectorisalsoimportant.

·Makecompetitiveresearchgrantsaccessibletotheentireresearchsystem.Conceptually,thisshouldenhancethequalityofproposalsandproduceimprovedresultsasproposalsareratedonthebasisofproposedmethodology,originality,andexpectedcontributiontofarmers,amongotherthings.However,competitivegrantsforprojectscannottotallysubstituteforlong-termfundingforresearchprograms,whichenablesmoresustainedeffortonbasicR&Dissuesandmoreroutineresearchactivities.Thisprocessmayfavorexperienced,centrallysituatedscientistsattheexpenseofyounger,andperhapsbettertrained,scientists.Indeed,olderscientistsatnational-levelinstituteshavebeentheprincipalbeneficiariesofthecompetitivegrantsinitiative.Widelypublicizingthecompetitivegrantsprogramanditsevaluationcriteria,includingabroadrangeofscientistsandinstitutionalrepresentationontheevaluationpanel,andensuringprogramadministrationwasfullytransparentwouldhelpmeetprogramobjectives.Also,ablindfirststageevaluationmightbeundertakeninwhichthesubmissionexcludestheproposedresearchersandtheaffiliatedinstitution.

·Developagrantprogramthatmatchedaresearchcenter'scommercialearningsallocatedtoresearchratherthanautomaticfundingreductions.Suchaprogramcouldstrengthentheresearchprogramandgivetheresearchstaffofthecentersmoreincentiveto

supportcommercialactivities(Pray1997).

·Rigorouslysuperviseanycesscollectionsto

ensuretheyareusedfortheirintendedpurposesandnotdivertedtoalternativeuses.Wherecessesareemployedproducersshouldhaveavoiceindeterminingthefocusofresearchfinancedinthismanner.

·Increaseparticipationofinternationalfirmsinagriculturalresearch.Thiswouldhelpaccelerateagriculturalmodernization.Withoutgreaterparticipationoftheprivate(domesticandinternational)sector,China'sagriculturalproductivitywillbelower,asfarmerswillnotbeassuredaccesstostate-of-the-arttechnology.Ifimportedtechnologyistosupplantgovernment-supportedresearch,animprovedIPRpolicyenvironmentisnecessary.

·Increaserelianceontheprivatesectorforresearchinwhichthebenefitsarecapturable.Thiswouldenablethegovernmenttofocusmoreofitseffortsonresearchissuesrelatedtonaturalresourcesustainability,poverty,andequitythatcommercialcompaniesareunlikelytoaddress.Theseissueswouldinclude,forexample,researchonsoilconservation,andonrain-fedandsubsistencecropsforresource-poorareas.

B.Extension

FinancingAgriculturalExtension

Technologydevelopmentandtransferplayedacriticalroleinthepastgrowthoffoodproduction,buttotalrealexpenditureshavestagnatedsincetheearly1990sandrealexpendituresperextensionstaffmemberhavedeclinedfrommorethanY7,000inthelate1980stoaboutY5,000in1994/95(Table9.2)Littleinformationisavailableabouttheeffectivenessoftheextensionservice,butrecentdeclinesintechnologyadoptionratesandincreasingfiscalproblemshaveweakenedtheextensionsystem,andgovernmentinterestinassessingandimprovingtheextensionperformancehasincreased(Huang,etal.

1998).

China'ssmall-scalefarmingrequiresintensiveextensioninput,creatinghighextensioncostperunitofoutput.However,China'sshare

Table9.2:AgriculturalExtensionExpendituresinChina,1986-95TotalExpenditures Extension Expendtr/Staff Agric.

ExtensionCurrent(millionyuan)

Constant1995(millionyuan)

Staff(thousandyuan)

Constant1995(yuan)

Intensity(percent)

1986 1,136 2,978 385.3 7,729 0.411987 1,270 3,103 404.7 7,667 0.401988 1,406 2,899 411.1 7,052 0.371989 1,513 2,649 429.3 6,169 0.361990 1,740 2,983 454.5 6,564 0.351991 2,051 3,417 495.7 6,895 0.391992 2,275 3,598 615.7 5,844 0.391993 2,554 3,568 604.2 5,905 0.371994 3,120 3,582 733.0 4,886 0.331995 3,721 3,721 674.9 5,512 0.311996 5,706 5,269 0.411997 6,848 6,151 0.49Note:AgriculturalExtensionIntensityisdefinedastheratioofagriculturalextensionexpenditurestoagriculturalgrossdomesticproduct.Source:Huang,Jikun,RuifaHu,JunSong,andScottRozelle,''PolicyBrief:AgriculturalTechnologyExtensioninChina,"WorkingPaper,CenterforChineseAgriculturalPolicy,ChineseAcademyofAgriculturalSciences,Beijing,China,1988.

ofagriculturalextensioninvestmentinagriculturalGDP(agriculturalextensioninvestment-AEI)becameoneofthelowestintheworldinthemid-1990s.TheAEIdeclinedby25percentoverthe1986-1995decadeandstoodat0.31in1995,butlargeexpendituresin1996and1997appearstohavereversedthedecliningtrend.Internationalextensionexpendituresurveysarelessfrequentandcomprehensivethanresearchsurveys;however,anFAOsurveyof57countriespresentedregionalaverageAEI,whichindicatestheAsia-Pacificregionalaveragewas0.56in1988(downfrom0.68in1985),considerablyaboveChina's.The1993AEIoftheUnitedStateswasestimatedat0.81(AlstonandPardey1997),ahighlevel,especiallyconsideringthelargeeffortspentbyprivatecompaniesinprovidingextension-likeservices.

Extensionstaffwagesandbenefitshaverisenrapidlyduringthe1990sbutremunerationlevels,relativetootheragriculturalsectorpersonnel,declinedfrom87to79percentbetween1985and1995.Compensationlevelsarestipulatedbystateandprovincialgovernments,butmostwagemandatesareunfunded;thuslocalauthoritiesareleftwiththeresponsibilityofmeetingthesecostsfromlocalbudgets.Tomeetcosts,localauthoritiesmustassessfarmersordivertresourcesfromotherexpenditurecategories.Salarypaymentsasaproportionoftotalagriculturalextensionexpendituresrosefrom43percentin1986tomorethan70percentinthe1990s.Insomeagriculturalextensionstations,actualpublicexpenditureshavefallenbelowstaffsalaryandretirementobligations.Somelocalgovernmentshavedeclinedtopayextensionstaffsalaries(oronlypartoftheirbasicwage)andinsteadhaveencouragedstafftocommercializetheiractivitiesorengageinmarketingagriculturalinputs(fertilizer,pesticide,andseed).Anecdotalevidenceindicatesthatthelackoffundsgreatlyreducestheabilityofextensionstafftocontactfarmersandconductfieldtrialsandthat,inpoorinlandcounties,salarieswere

asmuchas12monthsinarrears(Huang1998).

FiscalImpactonAgriculturalExtensionPerformance

Chinahasacomprehensive,six-level(national,provincial,prefectural,county,township,andvillage)extensionnetwork,withabout675,000full-timeextensionworkersemployedatthenationalandsubnationallevelsincludinganumberinlargerandmoreprosperoustownships.Thesystemalsoreliesonmorethan500,000full-andpart-timeextensionworkers(farmertechnicians)attownshipandvillagelevelsinthemid-1990s.

Despitetheseimpressivenumbers,workbytheCenterforChineseAgriculturalPolicy(CCAP)infourprovinces(Zhejiang,Henan,Sichuan,andHeilongjiang)foundthattheextentoftheextensionnetworkhaddeclinedandcontinuestodeteriorateinsomelocales.Morethan70percentofvillageextensionpersonnelreportthatthefrequency,scope,andcoverageoftheirserviceshasfalleninthe1990s.About50percentoftownshipextensionstationsreportsimilartrends.Largenumbersofstaffhavelefttheextensionserviceandnumerousvillageextensionofficeshaveclosedoverthepastdecade.

Effectivenessofextensionwork

Declinesinagriculturalextensionexpenditureperworkerandinrelativeincomearedisincentivesforextensionworkers.CCAP'sstudydiscoveredthatactiveextensionworkersspent76percentoftheirtimeonextensionworkin1996,about10percentagepointslessthanin1985.(Nonextensiontownshipofficialsreportthatfewextensionworkersspentevenone-halfoftheirtimeonextensionactivities.)Regressionanalysesshowthatthemostsignificantfactorsaffectingextensionworkers'effort(i.e.,timeallocatedtoextensionworkandfrequencyofvisitingfarmers)arewagesandextensionexpenditures.

Manyofthosewhohaveremainedintheextensionsystemareemployedinpart-timejobselsewhereorengageinwork-related

businessessellingchemicals,seeds,andfertilizerasnewpoliciesallowandencouragethis.

Unfortunately,staffalsoengageinactivitiesunrelatedtoextension,suchasoperatingguesthouses,restaurants,orotherbusinessestablishments.Divertingattentiontootheractivities,whilehelpingtosupplementincomesandkeeptheextensionsysteminmanyareasintact,alsohasitsdirectandindirectcosts.Inrecentfarmerinterviews,onlyasmallminorityacknowledgedbeingvisitedorvisitinganextensionagent,althoughfarmersstillbenefitfromextensionleaflets,radioprograms,andotherservices.Localleadersindicatethatthefrequencyofvillagevisitsbyextensionstaffhasfalleninrecentyears.Encouragingextensionstafftoundertaketradeinagriculturalinputscreatespotential,ifnotactual,conflictsofinterest,assalesincentivesmayoutweighthevalueoftheproducttofarmers.Suchindirect,policy-induceddistortionsareincreasinglycommoninmanyareasofpublicgoodsprovisionandarelinkedtotighteningbudgets.Theyarealsolinkedtoapropensityforlocalleaderstoaddressthefiscalconstraintbyallowingpolicyagentstocombinethepublicservicestheyarechargedwithprovidingandcommercialactivities(inthiscase,farmmanagementadviceandinputsales).

Inindustrializedcountriestheresearchandextensionagendaislargelydeterminedbyproducersthroughfarmerorganizations.However,indevelopingcountries,researchandextensioninstitutionstypicallylackaccountabilitytofarmersandoften"push"technologiesratherthanelicitingfarmerneeds.ThiswasdemonstratedinarecentsurveybyCCAPthatfoundagapbetweentheopinionsofextensionagents(andofficialsandbreeders)andfarmersregardingthetypesoftechnologiesneeded.Forexample,higher-yieldingvarietieswereperceivedby81percentofextensionagents(butonly69percentoffarmers),tobeahighpriority,and19percentoftheextensionstaff(but31percentoffarmers)feltthatfarmersdemandedhigh-qualityvarieties.

ImpactofSeedCommercialization

Astheseedindustryhasbecomemorecommercialized,seed-enterprisemanagershavebeguntopursueprofitsandsomeofthelongstandingtiesbetweentheextensionsystemandseedsystemhavebeguntochange(HuangandRozelle1997).Insomecases,seedcompaniesselltheirseeddirectlytofarmerstoretainthemarginthatextensionagentsmightotherwiseearn.Furthermore,asseedcompaniesattempttoprotecttheirbusinessinterests,theysometimesdonotshareinformationonnewvarietieswithextensionstaff.Consequently,extensionagentsoftenlackinformationontheavailabilityofnewseedvarieties.Asseedcompaniescontinuetocommercialize,theseproblemsmayintensify,especiallyifextensionagentscontinuetodependoncommercialincomesupplements.

China'sextensionsystemhasperformedanimportantroleinboostingagriculturalproductivityinthepast.Withnearly200millionsmallfarmsandrisingwages,Chinaneedsacost-effectiveextensionsystemtohelpitmeetfutureproductiongoalsandobjectives.Currently,however,theextensionsystemisindisarray,andthequalityandquantityofextensionservicesaredeclining.Thegovernmenthasshownakeeninterestinstemmingthisdeterioration.

Someoptionsarecurrentlybeingpursuedthatmaypointtothefuturedirection.Althoughrelativelyrare,farmersarebeginningtoformproducergroupsandassociationsinrelativelycircumscribedareasthatcontractwithprofessionalagriculturalists,aquaculturalists,foresters,andlivestockspecialiststopurchasethelatestinformationonvarietiesandspecies,pestcontrol,andotherculturalpractices.Thesegroupsarenoticeablyinorchardproductionandfresh-wateraquaculture.Whilethisapproachseemsworthwhilefornonstaplecommercialcommodities,chargingforadviceonstaplecropsinpoorareaswouldnotbefeasible;forthis,governmentextensionwill

remainnecessaryandwillbeoneofthefewsourcesofnontraditionalinformationforfarmersinremoteregions.

Werecommendthefollowingstepstomaintainandimproveagriculturalextensionservices:

·Improveeffectivenessofagriculturalextension.Thismayincludeimprovinglinkswiththeresearchsystemandestablishingformalrelationshipswiththeacademysystemanduniversities.Improvedinformationsystemsareneededbothintermsofnewideas,technologies,andtechniquesandtospeedtheirdeliverytofarmers.Also,newissues,suchasmarketing,willbecomeincreasinglyimportantandneedtobeincorporatedintotheextensionprogramastheeconomydevelopsandfarmersincreaseproductionofnontraditionalcrops.Trainingprogramstoupgradetheskillsoflocalagentsandprovidethemwiththetoolstounderstandmarketsandfollowmarkettrends,shouldprovideahighrateofreturn.

·Permittheprivatesectortoparticipateinagriculturalinputmarkets.Thiswouldlikelyprovidesometypesofextensionservices,suchassoiltestingandfertilizerrecommendation.Astheseresponsibilitiesareassumedbytheprivatesectortheresponsibilitiesofgovernmentextensionwillbereduced.

·Baserestructuringofextensionprogramsontheirimpactonagriculturalproduction.Althoughagriculturalextensionmustberestructured,intensiveanalysisofextension'simpactonagriculturalproductionisneededbeforegovernmentofficialscanredefinestructuresanddeterminepolicyoptions.Determiningtheappropriatepolicyoptionswillbedifficult,aslittleresearchandinformationexistsaboutextensioninChina;withtheexceptionofrecentpreliminaryworkbyCCAP,quantitativeanalysesofhigh-qualityextensiondeterminantsandtheimpactofextensiononagriculturalproductionislacking.Newresearchshouldexaminetheseissues,assessingattheinstitutionallevelthetraitsandvalueofsuccessfulprograms,theimpactsofpolicies,andalternativewaysofdelivering

betterinformationtofarmersinamoretimelyfashion.

1.CGIARisaloose-knitgroupofdonorsthatsupport16institutesaroundtheworldwithspecificresearchfoci,includingspecificcrops,livestock,aquaculture,waterresourcemanagement,foodpolicy,andagriculturalresearchsystems.

10.RuralIndustry

RuralindustryhasmadeanextraordinarycontributiontoChina'srapideconomicgrowthoverthepast20years.Itscontributiontonationalgrossindustrialoutputrosefrom10percentin1979tonearly40percentin1996(DongandPutterman1997).Outputintheruralindustrialsectorgrewatanaverageannualrateofnearly20percentduringthe1980s,andthesectorcreatedmorethan5millionnewjobsannuallyover1978-96.In1997TVEemploymentdeclinedby5millionfromthe1996highof135millionemployees,butstillaccountedforabout40percentoftotalnonfarmemployment(JinandQian1998;Rozelle,etal.1997).Ruralindustryalsosupplied25percentofthenation'stotalexportsinthemid-1990s(DongandPutterman1997).

PerformanceofTVEs

Despitethissterlingrecord,ruralindustry'srecentperformanceparticularlyincertainsubsectorshasraisedconcernsoverthesector'seconomichealthandlong-termsustainability.Thecapacitytocreateemploymentdeclinedinthe1990s(Table10.1),andthemarginalpropensityofruralindustriestocreatejobsfellevenasoutputcontinuedtoincrease.Employmentintownship-runenterprises,thebackboneoftheinitialruralindustrialmovement,hasfallensince1994andemploymentinvillage-runfirmshasstagnated.TVEexpansionmayhavereachedaturningpointin1997whenthe

totalnumberoffirmsandoverallTVEemploymentdeclined.Someofthesharpestemploymentdeclines(ordecelerationsinthegrowthrates)haveoccurredinsomeofthecoastalareas,thetraditionalstrongholdofruralindustries.Nevertheless,totalvalueadded(whichhasreplacedgrossoutputvalueasthemeasureofoutput)continuedtoincreasein1997.

Ruralindustrycontinues,however,tohavesomebrightspots.Privatefirmshaveincreasedtheirshareofemploymentandoutput(Figure10.1).Incontrasttotheshrinkingcollectivesector,privateandcooperativefirmsincreasedtheirvalueaddedby9.5percentin1997,increasingtheirshareofruralindustry'stotalvalueaddedtomorethan50percent(Du1998).Onoccasionemployersinruralareashavehiredmigrantsatahigherwageratethanemployersinurbanareas(LohmarandRozelle,1999).

Table10.1:TVEEmployment,byOwnership(millions)Year Total Township Village Other/a1980 30.0 13.9 16.1 n.a.1985 69.8 21.1 22.2 26.51990 92.6 23.3 22.6 46.71995 128.6 30.3 30.3 68.01996 135.1 29.6 29.9 75.61997 130.5/aIncludescooperativeandprivate,butprimarilyprivate.n.a.=notavailable.Source:ZhongguoXiangzhenQiyeNianjian(variousyears).

Figure10.1PercentofTVEOutputValue,byOwnershipType.Sources:ZhongguoTongiNianjian,ZhongguoQiye

Nianjian,andZhongguoNongyeNianjian,variousyears

KeyIssuesandCriticalQuestionsFacingTVEs

Thefuturedirectionofruralindustrializationiswidelydiscussedanddebated.InsideChina,scholars'opinionsaresharplydividedastowhetherthecurrentshakedownsignalsmanagerialtransformationandconsolidation,whichwouldleadtoanevenmorevibrantsector;orwhethertheirsmallscale,limitedcapital,oftenremotelocations,andpoormanagementandmarketingskillsmakeruralfirmsinherentlyinefficientwithpoorgrowthpotential.Somearguethattheinabilitytoletweakfirmsfail,inpart,aconsequenceofthequasi-publicnatureofalargepartofthesector,couldcreateanotherfinancialcrisis.Thismorepessimisticargumentassertsthattheshiftinmanagerialauthority(gaizhi)currentlyunderwaydisguisesthesector'spoorperformanceandmorecompetitiveandefficientindustrialfirmswillnotreemerge.Theargumentfurtherstatesthatfiscal,financial,andmanagerialresourcesshouldnotbewastedonasectorthatisnotevolvingonthebasisofcompetitivemarketprinciples.Stillothersarguethatthecurrentstructuraltransformationsignalsafundamentalshifttowardsamoremarket-orientedsector,withimprovedmanagementincentivesandautonomy.

Theincidenceofprivateownershiphasrisen

Figure10.2ManagerialContractEvolutioninTVEs,

SampleData,1984-'93(Percent)Source:Chen,Hongyi,andScottRozelle,"Leaders,

ManagersandtheOrganizationofManagerialContractsinChina,"WorkingPaper,DepartmentofAgricultureandResourceEconomics,UniversityofCalifornia-Davis,1998.

Box10.1TypesofTVEOwnershipandControlinRuralIndustry

Type 1: Conventional Public. Managers are salaried employees;governmentissoleresidualclaimantthroughtaxesandprofits;officialsare deeply involved inmajor business decisions; and profits, loss, andriskareborneentirelybygovernment.

Type2:LiberalizedPublic.Managershaveincentivecontractsbasedonfirm profitability, government receives income flows both in taxes andprofits,managers risk only reduced income for poor performance, andgovernmentbearsallfinancialrisks.

Type 3: Contract Partnership. Government shares residual withmanagers while firm also pays taxes to government, government andmanagersarejointresidualclaimants,riskissharedbybothparties,andgovernment commitment isnot firmlycommitted tobailingout a loss-makingcompany.

Type4:Leasehold.Managerspayfixedrentstogovernmentinadditiontotaxes,managersareresidualclaimants,riskisbornebymanagers,andgovernmentisnotcommittedtobailingoutthecompany.

Type5:Private.Managersmayseekallianceswithgovernmentofficialsfor favors or protection, especially for licensing as Type 2 or 3, butownership and control lies completely with the manager or owner, asdoes all the risk; and government is not financially committed to loss-makingcompanies,althoughprofitablecompaniespaytaxes.

dramatically,andprivatizationofcollectivefirmsiswidespread,eveninregionswithastrongcollectiveheritage.Also,managementauthoritywithincollectivefirmsisbeingdecentralized,aswitnessedbythemarkedshiftfromfixed-wagecontracttoprofit-sharingandfixed-leasecontracts(Figure10.2).Policyplaysanimportantroleinencouragingthisownershipandmanagerialevolution,butthesepoliciesresultfromeconomicpressurestoinnovate.Otherforces

(e.g.,fledglingfinancialreformsincertainareas)havealsocreatedindependentandspontaneousrestructuring/reorganizingofruralfirmssuggestingthesectorisrespondingtoachangingeconomicenvironment(JinandQian(1998);Kung1999).Effortstoresolvethisdebatehavebeenhamperedbylackofinformationonrecentchangesandthefactorsaffectingrecentperformanceofruralindustry.

TheEvolutionofFirmManagement

Fivedifferentinstitutionalformshaveemergedtodominatetheenterpriselandscapeatdifferenttimesandlocations(Walder1998).AsshowninBox10.1,thesefirmtypescanbearrangedalongacontinuumthatrangesfromconventionalleader-runfirms(Type1)totraditionalprivatefirms(Type5),andthreeintermediatemanagementstructuresthathavebeenimportantthroughoutmostofthereformera.Thesefirmstypesaredifferentiatedbythenatureoftheincentivesfacedby,andthescopeof,propertyrightsassignedtofirmmanagers.Theextentoflocalgovernment'sconcernwithlossesandwillingnesstobailoutfirmsintheeventoffinanciallossesalsovariesalongthiscontinuum.

Chinaneededparticipationbylocalleaderstoexploiteconomicopportunitiesandcreateprofitableenterprisesinthe1980s,asthecountrylackedwell-functioningfactorandproductmarketsandhadminimalexpertiseinbusinessmanagement,andthepoliticalenvironment(exceptinthesouthernprovinces)eschewedprivateenterpriseefforts.Thestrongincentivetogeneratetaxrevenuesandcreateasourceoflocalincomepushedlocalleaderstoinitiateruralindustrialization.Atthesametime,highdemandandtheperceptionofrichearningsattractedthemintoenterprisemanagement.InGuangdongandFujianProvinces,however,moredevelopedmarkets,amoreliberalpoliticalen-

vironment,andfinancialinflowsfromoverseasChinesereducedtheneedforleaderstobeinvolved.Becausehighdemandandlowinterregionalcompetitionguaranteedhighprofitsformostearlyentrants,varioustypesoffirmscoexisted,evenifsomewererelativelyinefficientandpoorlymanaged.

Overtime,however,theopportunitytogeneratequickandlargeprofitsgraduallydisappearedundereconomicpressures,causinglocalitiesandenterprisestorethinktheirtraditionalmanagerialstrategies.Growthcreatedmonitoringproblemsforleadersbyincreasingthenumberoffirms(ChenandRozelle1998).Risingcompetitionfromthemassiveentryoffirmsreducedprofitmargins(Naughton1994),anddecliningprofitscreatednewfiscalconcernsandreducedtheabilityoflocalofficialstosavefalteringfirms(Walder1995).Atthesametime,improvingmarketsforsomeinputsreducedtheneedforleadershipinterventioninbusinessactivities(PanandPark1998;ChenandRozelle1998).Thesetrendsinducedlocalleaderstoseekenterprisedivestitureandencouragedprivatization,andbetter-motivated,more-independentmanagershaveemergedinmanyoftheremainingcollectiveenterprises.Economicandtransitionpressuresalsohavetriggeredtherapidexpansionofprivatefirms.

Otherproblemsaffecttheperformanceofruralindustries.Economistsplacemuchoftheblameforthesector'scurrentillsonfallingdemandandfalteringinvestment.Demandhasfallen,partlybecausetheAsianfinancialcrisishasaffectedexportsandweakeneddomesticconsumerconfidence,andpartlybecauseofdomesticmarketconditions.Lowerremittancesduetomigrantlayoffshaveconstrainedruralpurchasingpower,whileSOEandgovernmentreorganizationhaveadverselyaffectedurbanincomes.Concurrenttightcreditpoliciesin1996and1997,newregulatorylimitsontheactivitiesofinformalfinancialinstitutions,andpolicyfailuresrelatedtointerestrateceilings,managementofnonperformingloans,andfinancialsectorreforms

haverestrictedinvestmentcapital.

CreditShortageandCreditworthiness

Ruralfinancialreformshavecurtailedcredittoallbutthebest-performingfirmsinthe199798period,anactionwhichhasseverelyrestrainedTVEdevelopment.Bothinvestmentandoperating-fundshortagescontinuetoconstrainTVEgrowthandconsolidation,includingprivate-sectorenterprises,asaccesstoformalcreditislimited.Capitalaccessdependsonthesupplyofdomesticsavingsandcapitalinflow,itscompetitiveallocation,thecreditworthinessoftheapplyingenterprise,andpressuresbyleaderstoinfluenceloandecisions.Throughoutthereformperiod,capitalfromtheformalbankingsectorABCandRCCshasbeeninsufficient

Box10.2:TVECreditConstraintsWeak credit relations between TVEs and bank centers on operatingcriteria,financialpositions,andfirmprofitability.TVEsfrequentlyhavemultiple financial and accounting records,which are used for differentpurposes (e.g., taxauthorities,banksandcreditauthorities,governmentowners).TVEs lackqualified accountants, auditors, andother financialstafffamiliarwithmodernaccountingmethods.Intheabsenceofalargetraining program, this problem will remain, leading to continuedmisinformed lending decisions. Profits, taxes, and defined fees areroutinely submitted to appropriate government authorities; but localgovernment departments also impose unauthorized fees and levies thatmakeplanningcashflowsdifficult.TVEassetsareoftenoverstatedanddebtfinancingisexcessive,andalthoughdebtratiosaregenerallylowerthan those of SOEs, and present excessive credit risks to financialinstitutions.

tomeetTVEneeds.Consequently,enterpriseexpansionhasbeencloselytiedtothecapacityofTVEstogenerateinternalfundsorobtaininformalcredit.

TVEsaredisadvantagedbycreditpolicy,astheyareamongthefirsttosufferwhencreditistightenednationally(ZhuandBrandt1997).TVEgrossoutputvaluehasdeclinedonlyonce,in1989alsotheonlyyearthatABCandRCClendingdeclined.However,otherlow-growthperiodsin1988,1990,and1994similarlycoincidewithlowcreditexpansion.Thus,totheextenttightcreditwasintendedtocooloffanoverheatingeconomy,ithassucceededwithTVEs.OtherofficialswouldarguethattighteningcredittoTVEsisarationalpolicythatshouldcontinueregardlessoftheoverallmacroeconomicenvironment,sincethesectorhasaninherentlypoorfuture.

ThefallingaccessbyTVEstoloansfromtheformalsectoralsohasamorechronicelement.TVEborrowingdeclinedappreciablybetween1986and1995fallingfrom7to8percentofthenationalloanportfoliointheearly1990sto3to4percentin1996/97and,asaproportionoftotalliabilities,declinedfrommorethan40percenttolessthan30percent.Loans

3asaproportionofTVEoutputvaluedeclinedfromabout15.5to6.5percentduringthedecade(Figure10.3).Loansasapercentofnetfixedassetsshowasimilarpattern(atahigherpercentagelevel)withlargeratiodeclinesin1988-90and1994.ThesefindingsaresupportedbyasourceoffundsitemizationforcollectiveTVEsbyCheng(1998)whichshowsa30percentreductionintheproportionoffundsprovidedbyABCandRCCsbetween1991and1994(somewhatlessthanthedeclineshowninFigure10.3,whichincludesallTVEs).

TheplightofTVEsintheirquestforfinancialresourcesalsomay

result,inpart,fromtheirownmanagementandcharacteristicsofthefirmsinthesector,generally.Banks,especiallythosewhorecentlyhavebeengrantedbetterincentivestoearnprofits,mayhavegoodreasontoquestionthecreditworthinessofsomeTVEs.ProblemsassociatedwiththecollectiveownershipandmanagementofTVEs,include(a)financialpositionandoperationmisinformation,(b)feeirregularitiesimposedbylocalgovernments,(c)excessiveprofitremittances,(d)idiosyncraticmanagementchangesandstrategicbankruptcies,and(e)excessivedebt.NotallTVEssufferfromthesedeficiencies.NeitherareallthesedeficiencieslikelytoapplytoanyparticularsetofTVEs.However,thesedeficienciesarefoundincreasinglyinmanyTVEs.

Whilepartoftheseproblemsstemfromunderdevelopedinstitutions,anotherpartarisesbyconsciouschoiceandisaninevitableconsequenceofChina'slegacy.Governmentatvariouslevelshasmultipleobjectivesbeyondprofitmaximization,includingexpandingemployment,sales,taxrevenues,andgrossoutputvalue.Inpursuitofrevenues,thelocalgovernmentsoftenrequirespecificamountsoffundsberemitted,regardlessofwhethertheenterpriseisprofitable.WhenlocalgovernmentschangemanagementofheavilyindebtedTVEs,thenewmanagementoftenwillnotrecognizedebtaccumulatedbypreviousmanagement.Althoughtheowners(localgovernment),notthemanagers,arelegallyliableforthedebt,andcreditinstitutionsareunlikelytoseekjudicialintermediation.

Figure10.3

BankBorrowingasaPercentofTVEOutputValue

Source:Bankstaffestimates

Thecontinuinginterestofleadersinnoneconomiccriteriaisanobstacletocreatingmoreefficientruralfirms.Leadersinmanyareasremainconcernedwith,andfrequentlyarerewardedonthebasisof;enterpriseandemploymentcreation,jointventurecapitalattracted,exportvolume,potentialtaxextractionorreceipts,andindicatorsotherthaninvestmentprofitabilityandviability.Totheextentthatnonprofitcriteriareceiveconsideration,leadershavemotiveandopportunitytointerveneinmanagementandoperationaldecisions.Insomeinstances,interventionshavebeenhighlydistorting,andmayhaveplayedasignificantroleintheevolutionarypathofruralfirms.RecentfieldworkbyWalderhasshownthatinterventionbylocalleadershavekeptfailingfirmsafloatforemploymentandothernonpecuniaryreasons,thusreducingloanaccessandvolumeforprivateindustry.Incontrast,extensivefieldworkbyateamfromStanford,Toronto,Michigan,andCaliforniafoundthatinmanyprivatizedandquasi-privatizedfirms,profits,efficiency,andfinancialmanagementhavebecometheprimaryobjectivesoffirmownersandmanagers,andthatlinkswithlocalgovernmentshaveweakenedconsiderably(Shen,1998).ThedebateonthefutureofTVEscentersonwhetherornotstructuralchangewillleadtoreductioninimportanceofnonfinancialgoals.

CapitalMarkets,PropertyRights,andConstraintstoCross-JurisdictionalInvestments

UnderdevelopedcapitalmarketsareaseriousstructuralproblemforTVEsandpotentiallycancauselargedistortionsininvestmentsandothermanagementdecisions.Also,weakpropertyrightsoverfirmassetsandambiguousbankruptcyrulesandprocedureshaveminimizedtheeffectivenessofusingcollateraltosecureloans(Shen1998).Instead,banksrelyonexpensivemonitoringandtheguaranteesoflocalgovernmentstoreduceriskexposure.

Fuzzyaccountingprocedures,weaklegalenforcement,andcontinuedinterventionsbylocalpoliticalleadersalsomakeinvestingacrossjurisdictionalboundariesdifficult.Investinginanothertownship,county,orprovincefrequentlyremovesdefactocontroloverassetsfromtheinvestor.Inaddition,becausemonitoringisalsodifficult,investmentfundusersfrequentlyhaveanopportunitytounder-compensatetheinvestorwithlittlefearofdetection,orofredress,ifdetected.Receivingafairhearingoutsideone'sownjurisdictionisperceivedtobequitedifficult.

ThesejudicialimperfectionsandundevelopedcapitalmarketsmeanthatsuccessfulTVEsusuallymustreinvesttheirearningsintheirhomelocaleregardlessofrateofreturn.Inaddition,mostopportunitiestoexploitscaleeconomiesbycombininginvestmentfundswiththoseinanotherjurisdiction,forinvestmentinthatjurisdiction,areforegone.Scarcemanagementskillsandfallingshadowratesofreturnoncapitalinareasofexpandingruralindustrymaypartlyexplainreducedemploymentgrowth.Thelowerrelativevalueofcapitalmakesinvestmentsinlabor-intensiveindustrieslessattractive,butfieldvisitshavenotedthatleadersinless-developedareasareincreasinglyinterestedinattractingoutsideinvestment.Somelocalitieshavetriedtoincreasetheinflowofinvestmentcapital,technology,andmanagementskillsbyofferingconcessionpackagesdesignedtoovercomethereluctanceofinvestorstoinvestoutsidetheirjurisdictions.Concessionstoattractinvestmentincludereducedtaxes,guaranteesagainstfee

Ruralindustry,suchasthissilkreelingfactory,typicallyeitheruseslocalrawmaterialsor

producescommoditiesforlocalmarkets.Ruralindustryemploysone-thirdofthenation's

nonagriculturallaborforce.

assessments,assurancesofindependentmanagerialauthority,andprovisionofinfrastructure.Althoughsomecross-jurisdictionalinvestmenthasoccurred(Du1998),theperceptionsofriskarestillsubstantialandconstrainsincreasesintheflowvolume.

RuralindustryhasbeenahugecontributortoChina'srapideconomicgrowth.However,theinitialconditionsthatfavoredtherapiddevelopmentofruralindustryinthecoastalprovincesandsuburbandistrictsaroundlargecitiesnolongerexist.Productcompetitionisfarmoreintense,andthelargeprofitsoftheearlyyearsarenolongerfeasible.Increasedcompetitionanddecliningprofitshaveforcedconsolidationofruralindustrialenterprises.Thisisoccurringespeciallyrapidlyinthemoreprosperousruralregions,andhasbeenunderwaysincethebeginningofthe1990s.Thisconsolidationwillbeacceleratedforfirmsthatrelyheavilyonexports,astheAsianfinancialcrisishasreduceddemandinAsia,anddevaluedcurrenciesmakecompetingcountryproductscheaper.

Tosupportruralindustry,Chinashoulddothefollowing:

·Theadvantagesofthetraditionalleader-runmodelhavedeclinedrapidlywithgrowthandincreasedcompetition,andareinappropriatefordevelopinginteriorregions.Thetraditionallypro-collectiveregionsaremovingrapidlytowardleasingandprivatizationsolutionstotheirfiscalproblemscausedbyunprofitabletownshipandvillagefirms.Theinteriorregionsshouldbuildonthesemanagementandownershiptrendsinimplementingindustrializationprograms.Inlessdevelopedregions,emphasizeagricultureandrelatedsidelineproductionmorethanindustry,andsmall-scalefamilyenterprisesoverlargervillage-andtownship-ownedfirms.Marketsmustbeallowedtoguideinvestmentdecisions,notgovernment-developed

strategicplansbasedonfiscalneeds.Thepatternofruralindustrialgrowth,andtheevolvinginstitutionalforms,suggeststhatattemptsbytheless-developedregionstotrytoemulatethepoliciesandinstitutionsofanerathatnolongerexistswouldbecounterproductive.

·Usedifferentrural-industrialstrategiesonthebasisofgeographicalandeconomicarea.Evenwithoutrapidindustrialization,incomesincoastalprovinceswouldhaverisenmarkedlythroughincreasedyields;highercropprices;anddevelopmentoflivestock,aquatic,andsidelineactivities.Forpoorer,inlandareas,focusingonimprovementsinagricultureandsidelineactivitiesandestablishinglinkstotheoff-farmlabormarketsaremorepromisingstrategiesthanestablishingruralenterprises.Formiddle-incomeareas,oneoptionistoestablishefficientruralenterprisestomeetlocalmarketdemandsandexploitcomparativeadvantageslowwages,cheapland,andbetteraccesstoresourcessuchaselectricity,water,andrawmaterials.

·Establishinstitutionalstructuresthatwilllimittheliabilityofinvestors(andbanks),rewardandpenalizemanagersfortheirperformance,andcompensateshareholdersfortheirinterests.Jurisdictionswithlarge-scaleTVEsmayfaceincreasingproblemsiftheyareunabletofindwaysto''privatize"orprovidebetterincentivesfortheircapital-intensiveenterprises.AmajorchallengetothetransformationofTVEpropertyrightsistofindwaystomanagetheriskoflargefirms.Privateownership(orgoodmanagementincentives)isneeded,butcompletingthetransitionwillbedifficultunlessChinacanfindtheappropriateinstitutionalarrangements.

·IncreaseTVEaccesstocreditbutONLYwhensuchloansarebasedonfinancialcriteria.IfTVEscannotoperateprofitably,theyshouldbeallowedtogooutofbusiness.TVEfinancialneedsarenotwellmetbythefinancialmarkets.Despitebeingthemostdynamiccomponentoftheindustrialsector,duringperiodsoftightmoney,

TVEsarethefirsttobecutoff.Giventheirimportanceinthenationaleconomy,AwaymustbefoundtoincreaseTVEaccesstocredit.Oneoptionfor

improvingcreditaccessistoprovideexplicitfundingforonlendingorloanguaranteesforsmallandmediumenterprises,andcross-jurisdictionalinvestmentchanneledthroughtheexistingfinancialinstitutions(ABCandRCCs).However,property-rightreformsandtheincentivestoenforcethemmustaccompanyacreditprogramtopermitsecuredlendingandimproveloanrepayment.Tobefullyviable,Chinawouldneedatrainingprogramformangersofthecreditinstitutions,andTVEs;aprogramtoimprovemanagementskillsmightinclude,projectdesign,evaluation,monitoring,accountingandauditing,andfinancialmanagement.Thecostofacquiringtheseskillscouldbeacomponentofaloan.

1.Ruralindustryincludesconstruction,manufacturing,transportation,andserviceenterpriseslocatedandfallingunderthepurviewoftownship(andlower-level)authorities.Theyarethoseenterprisesthat,becauseoftheirruralnature,aresupervisedbytheMOAand,forstatisticalpurposes,areclassifiedasTVEs.

2.Thissectionreliesheavilyon,Cheng,Enjiang,"ReportbySeniorExpertonFinancialSystems"in"AsianDevelopmentBank,TownshipandVillageEnterprisesDevelopmentProject(PartB),"ChineseEconomicResearchCenter,UniversityofAdelaide,SouthAustralia(undated).

3.Outstandingloansatyear-endfromABCandRCCs.Workingcapitalloansdoubtlesslyrolloverduringtheyearbutassumingnochangeinrolloverfrequencychangesintheratiowouldindicatechangesintheimportanceofcredittooutputvalue.

11.PovertyReduction

Introduction

Sincethelaunchingofeconomicreformsinthelate1970s,Chinahasmaderemarkableprogressinitswaronpoverty.

1Duringthisperiod,morethan210millionruralresidentsescapedabsolutepoverty.Povertyreductionwasexceptionallyrapidintheearlyreformyears,between1978and1984thenumberofruralabsolutepoordeclinedby171million(WorldBank1992).[Applyingthepovertylineof$1.00percapitaperdaysuggeststhat300millionresidentsescapedpovertybetween1981and1995,andthatabout176millionremainedinpovertyattheendof1995(WorldBank,1997b).]Improvingincomessufficientlytolift171millionpeoplefromthegripofpovertyinsixyearsaremarkablefeatwasprincipallyachievedthroughintroducingthehouseholdresponsibilitysystemandtherapideconomicgrowththatfollowed.Realpercapitaincomeandgrossvalueofagriculturaloutputgrewatannualratesof19.1and7.5percent,respectively,duringthisperiod.

Thepovertystrickengenerallyliveinremoteandresourcepoorareas,butthoseresidinginsomewhatmoreaccessibleandlesshillylocations,withevenmildlyresponsivesoils,wereabletocapitalizeontheneweconomicenvironmentusheredinwiththe1978reforms.

Improvedmarketsandoutputpricesmademodestuseofmoderninputsattractiveandledtoincreasedfarmoutput.Manyofficialsandobserversbelievedthatpovertyreductionachievedthroughrapidagriculturalgrowthwaslargelyexhaustedby1984.Theresidualpoorremainedentrenchedinpovertyinareasthatareveryresourcepoor,withminimalpotentialforfurtheragriculturalproductivitygains.Alleviatingtheirplightwillrequiremoreintensiveefforts.

Theabsolutepoortypicallycompriseentirevillagecommunitiesisolatedinuplandareas.Landqualityintheseareasisgenerallysopoorthatmanyhouseholdsareunabletoachievefoodself-sufficiency,consumesubsistencefoodsbeyondtheirownproductionlevels,andarenegativelyaffectedbyfoodpriceincreases.Asthepoorareriskaverseandafraidoflackingfoodstaples,theyareunwillingorunabletorelyonmarketsforthebulkoftheirconsumptionneedsanddevotemuchoftheirlandtograineveniftheyhavenocomparativeadvantageinitsproduction.Withinthesecommunities,thepooresthouseholdsaremostoftenthosefurtherdisadvantagedbyhighdependencyratios,illhealth,andotherdifficulties.Minoritypeoplesareknowntorepresentadisproportionatelylargeshareoftheruralpoor.Noevidenceexiststhatwomenareoverrepresentedamongthepoor.Confrontedwithsuchachallenges,authoritiesdecidedthatalleviatingtheremainingpovertyrequiredamoreintensiveeffort.

GovernmentPovertyReductionProgram

Withtheslowingofpovertyreduction,thegovernmentintroducedseveralantipovertyprogramsbetween1984and1986.ItalsoestablishedtheLeadingGroupforPovertyReduction(LGPR)undertheStateCounciltocoordinatethoseprogramsandexpediteeconomicdevelopmentinpoorareas.Economicgrowthdidrevive,andsince1991another40millionresidentsescapedpovertyabout49million,orabout6percentoftheruralpopulation,remainedinabsolutepovertyattheendof1997(Figure11.1).

Thegovernmenthasastrongcommitmenttopovertyreduction,andmostgovernmentagenciesandministrieshavespecialpoverty

Figure11.1RuralAbsolutePoor

reductionresponsibilities,including,educationandhealthprogramsadministeredbytheirrespectiveministries.However,likemanyotherelementsofruralsociety,theantipovertyeffortsuffersfromfiscalproblems.TheLGPRcoordinatesspecialdevelopmentgrantfunds,administeredthroughthefiscalsystem,andthePovertyReductionFund,whichprovidessubsidized

Figure11.2RealInvestmentinPoorAreasPovertyReductionProgram

loansfordevelopingpoorareas.TheregionalofficeoftheStateDevelopmentPlanningCommissionadministersaFoodforWork(FFW)programthatsupportstheconstructionofroads,potablewatersystems,irrigation,terracing,andothercapitalconstructionworks.FundscoordinatedbytheLGPRhavefluctuatedinrealterms,overthelifeoftheprogram,withlittleapparenttrend(Figure11.2).Between1986and1995thefundsadministeredthroughthefiscal

budgetdeclinedbytwo-thirdsinrealterms.However,thegovernmentreviveditscommitmenttopovertyalleviationwithasharpincreasein1997funding,reversingthedecadeofdecline.

SubsidizedcreditthroughthePovertyReductionFundhasbecomethemostimportantelementofthepovertyprogram.Duringthelate1980sthesefundswereallocatedprimarilytohouseholdstosupportagriculturalproductionandotherincome-generatingactivities(WorldBank1992).However,bytheearly1990sborrowedfundsweregenerallyperceivedasfinancingconsumptionratherthanproduction,repaymentrateswereverylow,andeconomicgrowthinpoorareashadstagnatedasevidencedbythelackofreductioninthenumberofabsolutepoor.Thecreditfocusshiftedawayfromhouseholdstoward"economicentities"orenterprisesthatcouldbettercoordinateactivitiesrequiringnewtechnology,greaterinputuse,andmarketingsupport(StateCouncil1991).Fiscaldecentralizationhadcreatedabudgetarycrisisinnearlyallpoorcounties(Parketal.1996),which,inturn,createdstrongincentivesforlocalofficialsinpoorareastoinvestinrevenue-producingenterprisesratherthaningrowth-orientedactivities,ortodivertearmarkedinvestmentfundstomeetfixedexpenditureobligations,suchaswagepayments.

Bythemid-1990s,itbecameclearthatsubsidizedcreditdirectedtoenterpriseswasnotmeetingruraldevelopmentandgrowthobjectives.Thecreditdidnotappeartostimulatelocaldevelopmentandloanrepaymentratesdidnotmarkedlyimprove.Theinvestmentapproachwasoften"top-down"aslocalofficialsidentifiedcollectiveprojectswithoutdueconsultationwithfarmersthenallegedlyrequiredtheirparticipationinpursuitofscaleeconomies.Rozelle,Park,HuangandJin(forthcoming)haveempiricalevidenceofthefailureofChina'ssubsidizedcreditprograminShaanxiduringtheearly1990s.

Whenleadersreassessedthepovertyreductioneffortinthemid-1990s,thefocusofsubsidizedloansreturnedtopoorhouseholds.

Sincethen,adebatehasragedabouthowtocreateaneffectivestructure.Officialsaresearchingforaprogramthatwillleadtogrowth,reducepoverty,reducelendingcosts,andimprovere-

Box11.1MicrofinanceinYilongCounty

The government and donorsexperiment with substitutes forcollateral, screen projects, andprovide support and disciplinein microfinance programsusingpeer monitoring to manageinvestmentsandrepayloans.

Whilemicrofinance has proveneffectiveinothercountries,suchprojects in China rarely havebeen evaluated. One evaluationof an UNDP-fundedmicrofinance program inSichuan Province's Yilongcounty found that householdassets, especially householdproductive assets, of programparticipants increasedsignificantly. Participants' otherwelfare improvements includedmore diversified croppingpatterns, more grain storage,andmoremonetarysavings.

paymentrates.Thishasledtowidespreadexperiments,oneofthemosthigh-profilebeingtargetedmicrofinanceprogramswhich,todate,havehadmixedsuccess.Box11.1containsanexampleofan

effectivelymanagedandtargetedmicrocreditprogramthatiscontributingtohighergrowth.

Targeting:IdentifyingPoorAreas

Antipovertyeffortsmightwellbenefitfromanarrowingofthegovernment'stargetingcriteriafromcountiestotownshipsorsmallerunits.Thegovernmenthasapproachedpovertytargetingbyidentifyingcountieswithlowpercapitaincome.Acountywasidentifiedaspoorifits1985averageruralpercapitaincomefellbelowY300,Y200,orY150,dependingonlocationalandpoliticalfactorsincludingthepresenceoflargeminoritypopulations.Followingnumeroustargetingcomplaints,anewtargetingoperationwasundertakenin1994byrevisingthepovertylineandadjustingthedesignationofpoorcounties.Somecounties"graduated,"andotherwereadded.Countiesincludedinthepovertyprogramnownumber592.

Evenaftertheseadjustments,2ofthe10poorestcountiesremainedoutsidetheprogram.Theuncertainreliabilityoftheincomedatacallsintoquestionwhetherthecountiesincludedwerethepoorest.PercapitaincomestatisticsfromtheMOAdatabasegenerateadifferentlistofpoorcountiesthanthatintheStateStatisticsBureaudatabase.Riskin(1993)suggeststhatin1988morethan60percentofthepoorhouseholdslivedoutsideofficiallydesignatedpoorcounties,thoughhissurveywasnotdesignedfortestingthesequestions.Riskin'sworkarguesthatthepovertyprogramshouldfocusontownshipsorpoliticalunitssmallerthancounties.

ImpactoftheProgram

Intheabsenceofacomprehensiveevaluationofthepovertyprogram,animpactassessmentmustrelyonprovincialanalysisandanecdotes.DatafromSichuan(Rozelle,Zhang,andHuang1998b)clearlyindicatethatin1985bothgrossandnetpercapitaincomeswerelower

inprogramcountiesthaninpoor,nonprogramcounties.Overthefollowingdecade,incomesincreasedinbothgroups,butby1995incomesintheprogramcountieswereconsiderablyhigher.Incomeincreasesinprogramcounties,however,didnotkeeppacewithincreasesinthenonpoorcounties.

Ourstatisticalanalysisofthedifferencesingrowthratesbetweencountygroupingssupportedtheconclusionthatprogramparticipationincreasedgrowthinpoorcounties.AneconometricassessmentofincomegrowthinSichuan(1990-95)indicatedthatgrowthinpoverty-programcountieswasabout3.0percentlessthaninnonpoorcounties(whichgrewabout4percentannually).Growth,however,wasevenslower,inthepoor,nonprogramcounties.

DeterminantsofGrowthInvestmentPriorities

Giventhatthepovertyprogramshavehadpositiveincomeandgrowthimpacts,whichelementshavebeenmoreefficientinreducing

povertyinparticipatingcounties?Intheabsenceofacomprehensiveevaluation,werelyonassessmentsofindividualprovincesandanecdotes.Rozelle,Zhang,andHuang(1998b)estimatedaseriesofregressionstoexaminethegrowthandlevelofincomeinSichuanthatcouldbeexplainedbythepovertyprogram.Theresultsshowthatincreasesineconomicactivitiesthatcreatelinkageswiththerestoftheeconomy,suchastheriseinnonfarmemploymentoranincreaseinsownareasforcashcropping,addtogrowth.Investmentinagriculture,healthandeducation,andelectrificationalsopositivelyaffectsgrowth.Infrastructureinvestmentsalsoshouldpositivelyaffectgrowth,butsuchinvestmentsmustbeintruepublicgoods(e.g.,roads),shouldbewelldesigned,andrequireclosemonitoring.Also,theyshouldnotimposehighlaborinvestmentsonfarmers.

DespitetheinvestmentofY96.1billion(nominal)inpoorprogramcounties,povertyprogramshavenotincreasedtotalgovernmentexpendituresintopoorareas.Thismaybeaconsequenceofthefiscalstressthatpervadespoorareasandthefungibilityofresources,allowingofficialstosubstituteantipovertyfundsforbudgetaryresourcesinprogramcountiesanddivertbudgetaryfundstoothercounties.Acommonproblemofpoorareainvestmentmanagementisthediversionofloansandgrantfundstootherusesbeforetheycanreachlocalinvestmentagencies.Onlythroughcreativefundmanagement,whichprimarilydependsonkeepinginvestmentfundsoutofthefiscalsystem,canlargeinvestmentsbeeffectedinremoteruralareas.

Rozelleetal.(1998a)foundthatinShaanxithetargetingofsubsidizedcredittofarmersincreasedgrowth.Placingfundsinthehandsoffarmersforagriculturalinvestmentshadpositivegrowthimpacts.However,subsidizedinvestmentsintoruralcollectiveenterprisesandlocalSOEsdidnotincreasegrowth.Surprisingly,investmentsinagriculturalinfrastructurealsohadnopositiveimpact

onagriculturaloutputgrowth,suggestingeitherthattheprojectstheyselectedwerepoorlychosenorrun,orthatinvestmentsinothertypesofinfrastructureshouldbeaccordedhigherpriority.Projectsthatcreateaneconomicenvironmentfosteringentrepreneurshipandlabormovement,suchasincreasinghumancapital,alsosupportgrowth.

FFWprogramshavebeenbetterthansubsidizedcreditinincreasinggrowthinpoorareas,althoughitisnotalwaysthepoorestthathavebenefitedthemost.ZhuandJiang(1995)showthatincomerisesinFFWprojectareas,withroadinvestmentsgeneratingthegreatestbenefits.Theyarguethatnarrowlydefinedprojects(roadbuilding,drinkingwater,andirrigation)facilitateeffectivemonitoring,andthatdiversionpressuresonFFWresourcesarelessthanthoseappliedtodevelopmentgrantstransmittedthroughthefiscalsystem.Unfortunately,projectsoftenarenotplacedinthepoorestareas,thustheverypoorgainonlyindirectly.

InvestmentOptions

EducationandHealth

Investmentsineducationandhealthinmostdevelopingcountrieshavehighreturnsandarethemostdirectwaytoincreaselaborproductivity.Also,educationenhanceslabormarketabilityandimprovesthelikelihoodofsuccessfulmigration.EducationandhealthstrategiesforpovertyalleviationarenotcomponentsoftheLGPR'santipovertyprogrambutareimplementedbythesectorministries.Unfortunately,thefairlyregressivefiscalsystemrequireslocalresidentstobearthecostsofeducation,whichcanreach25percentofpercapitaincomes(Fan1994).Lowrevenuebasesleadtopoorquality-schoolsandunderpaidteachers;andthehighcostofattendingschoolcangreatlyreducethedemandforeducationbythepoor,whoaremoreresponsivetothecostofeducation.Thepoormustalsohaveaccesstoproductiveemploymentopportunitiesthatmakeeducationinvestmentworthwhile,highlightingtheneedforeconomic

integrationandwell-functioningmarkets.

Box11.2India:GovernmentSpending,Growth,andPoverty

IFPRIconductedoneof themost comprehensiveevaluationsofdirectand indirect impacts of infrastructure investments on TFP and onpoverty reduction. Investments in roads had little direct impact onpoverty reduction by the indirect impact through improved TFP wassignificant and greater than any other infrastructure investment. Theresultsarereproducedbelow:

GovernmentExpenditureElasticitiesonTotalFactorProductivityandPovertyReduction

RuralRoads Education

Soil/WaterConservation

Research&DevelopmentIrrigationElectricity

TFP 0.0670 0.0427 0.0280 0.0160 0.0116 0.0031

Poverty-0.2250 -0.1760 -0.0057 -0.0033 -0.0024 -0.0014

Note:Thecoefficientsareelasticities;therefore,ifgovernmentincreasesruralroadexpendituresby1percentTFPwillincreaseby0.067percentandpovertywilldeclineby0.225percent.

Source:IFPRI,EPTDDiscussionPaperNo.33,GovernmentSpending,GrowthandPoverty:AnAnalysisofInterlinkagesinRuralIndia,1998.

Infrastructure

Theimpactofinfrastructureinvestmentonlaborproductivityandpovertyreductionalsoispotentiallyverysignificant.Investmentsinroadsandcommunicationsincreasesaccesstooutsidemarkets,raisesreturnstolabor,makesproductioninputscheaperandmoreaccessible,andfacilitateslabormobility.Marketdevelopmentwillreducepricevariabilityandallowgreaterexploitationofcomparativeadvantage.Reliableinfrastructureisrequiredtointegratepovertyareasintotherestofaneconomicsystem.Internationalexperienceshowsthatratesof

ofaneconomicsystem.Internationalexperienceshowsthatratesofreturnandtheimpactofpovertyalleviationvarywidelybythetypeofroadbuilt;e.g.,interprovincialexpresswaysversusdirtroadsthatpenetrateintoremotemountainouslocations,andall-weathertrunklinesintoruralfarmingregions(Jacoby1998).InvestmentsinroadswerefoundtohaveapowerfuldevelopmentimpactinIndia(Box11.2).

Improvedtransportnetworksfacilitateoff-farmandseasonalemploymentoutsidehomevillagesandreducesthetransportcoststherebyreducingfarmers'costsoffertilizerandotherinputs,improvesreliableaccesstooutputmarketsandgenerallyreducesmarketingmargins(GannonandLiu).AWorldBankimpactevaluationreportonaruralroadprojectinMoroccoconcludedthatimprovedroadsledtoincreasedagriculturaldiversificationandincreaseduseofagriculturalinputsandextensionservicesandledtoincreasedvalueaddedperhectare.Theimprovedroadsalsoledtoincreasedoff-farmearnings,improvedqualityofeducationandimprovedaccessanduseofhealthservices(WorldBank1996).

LandQuality

Wherelandqualitycanbeimproved,doingsoincreasesreturnstolabor.Givenrelativelyequitabledistributionofland,improvementinlandqualitycanalsomeetdistributionalgoals.Theimpactoflocalinvestmentinland-enhancingprojectsbylocalofficialsoftenhasbeenshowntohaveasignificantimpactonagriculturalproductionandonincomes.WorldBankexperiencewithinvestmentsinlandimprovementandruralinfrastructureprojectshaveshownmixedresultsindicatingtheneedformorecomprehensiveexante(whatisplannedcomparedwithwhatactuallyoccurs)appraisalofprojects.Whilesomeprojectshaveprovidedhighfinancialreturnstofarmers,indirectsub-

sidieshavemadetheprojectsofdubiouseconomicvalue(seeJingtaiPhaseIIprojectdiscussedinWorldBank1992).Stateinvestmentinbasicagriculturalconstructionhasunfortunatelydeclinedinrecentyears.Theproportionofthecentralbudgetdevotedtoagriculturalinvestmentshasdeclinedtoonly3percent,andeventheseareincreasinglydivertedtomeetotherpressingexpenditurepriorities.Localinvestmentsinprojectsthatenhancelandproductivityhaveshownasignificantimpactonagriculturalproductionandincomes(Dong1998).DatafromtheMinistryofAgriculture,however,showthatlocalinvestmentsoccuronlyinwealthierregions,whichrepresentsonlyafractionoftheruralsector;elsewheretheproportionoflocalbudgetsdevotedtoagriculturalprojectshasalmostdisappeared.

Accordingly,mostlandinvestmentsrelyonlaborcontribution.Thishasmanypositiveaspects,butisnota"free"investment.Withincreasedreturnstotemporarymigrationandotheroff-farmactivities,corvéelaborcanhaveahighopportunitycost,evenintheslackseason.Theimportanceofwell-designedinvestmentsisillustratedbycomparingyieldsfollowingimplementationoftwoterracingprojectsonmoderatelyslopedlandinShanxi(Li1994).Oneuseddesignspreparedbythelocalagriculturaltechnicalcollegeandemployedheavyequipmentalongwithlocallabortocreatedeep,straight-cutterraceswithreconditionedsoilineachterracebed.Theotherwasa"traditional"terracedesignedbylocalofficialsandconstructedwithlocallaborandhandtools.Subsequentcropyieldsonthewell-designedterracesweresignificantlygreaterthanonunimprovedmoderatelyslopingland,butyieldsdidnotimproveonthe"traditional"terraces.Farmerperceptionsofspendingtimeandeffortonconstructingtraditionalterracesarebestsummarizedbythe1997commentofaHenanfarmer:"Wework,wedonotgetpaid,wecannotmakeothermoney,andwedonotseeourlandgetanybetter."However,theexperienceofTheWorldBankinShaanxiprovincesupportsthecontentionthatwell-designedagriculturalinfrastructureprojectshavehighratesofreturn.

ResearchandExtension

ResearchandextensionhavebeenthemostimportantsourceofyieldandTFPgrowthinthepost-reformperiod.(WorldBank1997).Thenationalandprovincialresearchsystem,however,hasgivenlowprioritytoagriculturalR&Dinrecentyears;veryfewtechnologieshavebeendevelopedforresourcepoorareas(Rozelle,Huang,andPray1998).Thebiasagainstpoorareasisevengreaterforextensionandagriculturalmanagementservices.Lowsalariesandfundshortageshaveleftextensionstationsinmanypoorareasseverelyunderstaffed(Hu,Huang,andRozelle1998).

IndustrialDevelopment

Manylocalleadersfeelthatonlythroughcapturingthehighvalueaddedofsuccessfulindustrialdevelopmentwilltheplightofpoorareaschangenoticeably.Industrialgrowthisalsoperceivedasthekeytoresolvingthefiscal

Povertyisoftenconcentratedinresourceandinfrastructuredeficientareaswherearableland,forsubsistencecropproduction,isofpoorqualityandavailableonlyinsmallplots.

crisis(Wong1997).Eveninpoorcounties,taxesonindustryandcommerceaccountforthebulkofgovernmentrevenues.However,TVEsinpoorareashaveahighfailurerateandhavebeenaseriousdrainonscarcefinancialcapital.TargetinginvestmentandcredittounviableTVEprojectsmaybelesseffectiveinsuccessfullypromotingTVEsthanhavinglong-terminvestingineducation,vocationalskills,andinfrastructure(Rozelle,Park,Huang,andJinforthcoming).By1990,only4percentoftherurallaborforceinChina's120poorestcountieswereemployedinruralenterprises,incontrasttothe22percentinthenationasawhole.

Migration

Thelargedifferencesinwageratesbetweenruralareas,particularlypoorruralareas,andprosperousurban(andrural)areasarepowerfulmigrationincentives.Thegovernmentdoesnotmaintaincomprehensivetime-seriesstatisticsonmigrantlabor,butvariousestimateshaveplacedthenumberashighas100million(Rozelleetal.1998,HuangandCai1998).Migrationdestinationshavechangedfrombeingprimarilyintraprovincialinthelate1980stoalmostequallybalancedbetweenintra-andinterprovincialmovementinthemid-1990s.TheurbanmarketsintheYangtzeandPearlriverdeltasaremajorinterprovincialdestinations.Thecharacteristicsofmigrantsalsoarechanging;womenarenowenteringthemigrantlaborforceatrateshigherthanmen.

Migrationhasmadeanimportantcontributiontoemploymentopportunitiesformanyruralcommunitiesthroughoutthenation.Migrantremittancestatisticsareanecdotalbutindicatetheimportantcontributiontopoorareas.TheMinistryofLaborestimatedthatin1994some37millionruralmigrantsin23largecitiesremittedY75billion;theSichuanLaborBureaureportedthattheprovince's6millionmigrantworkersremitmorethanY16billionannually(World

Bank1997d)andtotalremittanceswereY200billionin1997(ChinaDailyAug.7,1998).Perworkerremittancesofthismagnitudefarexceedsthepercapitaincomeofpovertyhouseholds.However,evenwithoutmigrantremittances,poorhouseholdsbenefitfromthedecreaseddemandforfoodsupplies.Migrationmayalsoprovidelesstangiblebenefits,suchasaccesstobetterinformationandavailabilityofcapital.

Mostmigrationoccursoutsideofficialjobplacementprograms.Forexample,anestimated15percentofShaanxi'sinterprovincialmigrantsusedofficiallabormarketchannels,butfewofthesewouldhavecomefromthemoreremoteandpoorestcounties.Whilethepotentialrewardsofsuccessfulmigrationaresubstantial,soaretherisks,particularlywithspontaneousmigration,wherethereisnotonlytheuncertaintyofobtainingemploymentbutalsothepossibilityofexploitationasmigrantslackproperdocumentationandcredentials.Theoverwhelminglyimportantmigrationdeterminantisa"villagenetwork."Pastmigrationwillleadtofuturemigrationfellowvillagerswhocanberelieduponforinformation(andpossiblefinancialassistance),includingpotentialjobprospects,provideachaintoattractnewvillagersintothemigrantlaborforce.

AlthoughChinahasmaderemarkableprogressinitswaronpoverty,thegovernmentcandomore,includingthefollowing:

·Improvetargetingofpovertyprogramstoaimatsmallerpoliticalunits,suchastownships.Thepovertyprogramhassuccessfullytargetedpoorcountiesandhashadpositiveimpactsoneconomicgrowth.However,improvedtargetingisneededtoensureallthepoorarereached.

·DevelopandexpandTVEsinpoorareascautiously.ProjectsforcarryingoutanyTVEinvestmentsshouldfocusonsimple,labor-

intensiveproductiontechnologiesusinglocalinputssuchasprocessingofagriculturalproductsthatmightofferacomparativeadvantage.

·Promotelabormarketdevelopmentandexpandlabormobilityprogramstargetingpoorhouseholds.Thequickestmeansofovercoming

povertyissuccessfulmigration,thereforeincreasingandexpandingtheseprogramswouldhaveanimportantandimmediatepovertyreductionimpact.SuchprogramscouldexpandthepilotpovertyreductionactivitiesinitiatedwithWorldBankassistance.

·ExplorewaystoexpandFFW-Typeprograms.FFWactivitieshavebeenparticularlysuccessful,inpartbecausethefundsbypassthefiscalsystemandbecauseprojectsarenarrowlydefined,easilymonitored,andfocusedonhigh-returninvestments.Experiencesfromothercountriesthatpaylow,self-targetingwagesforworkersonFFWprojectsshowthatsuchprogramscanleadtobothincreasedgrowthandtargetpoorhouseholds.

·Designpoverty-reductionprogramsonthebasisofdetailedconsultationwithlocalleadersandplannedparticipants.Considerableprogressinstrengtheningcommunityparticipationhasbeenmadeintwopoverty-reductionprojectssupportedbytheWorldBank.

·Expandeffectivemicrofinanceprograms.Whenproperlydesignedandimplemented,microfinanceprogramsareaprovenmeansofachievingsustainedreductionsinpoverty.Asexperimentationwithmicrofinanceschemesexpands,theirdesignandimplementationwillbecomemorecriticalanditiscrucialthatinterestratecontrolsbediscontinued.Correctingthemistakeslatermayprovedifficult.

·Investinruralinfrastructure.Investmentsinagriculture,ruralenterprise,roads,andotherruralinfrastructurecanincreasetheproductivityandincomeofthepoor.However,resourceconstraintsinmostpoorareaslimitefficientinfrastructureinvestments.Thegovernmentshouldavoidmakinginvestmentsthatdonothavereasonablyfavorableratesofreturn.

·Increasetheamountandqualityofresearchandtechnologysupport,

todevelopnewandbettertechnologiesforresource-poorareas.Littleresearchandtechnologysupportexistsforcropsandlivestockinsuchareas.Provincialagriculturebureausextendexisting"off-the-shelf'technologypackages(oftendesignedforirrigatedlowlands)touplandrainfedareas.Developmentofappliedtechnologiesforresourcepoorareasisurgentlyneeded.LGPRshouldworkcloselywithagricultureofficialstodevelopsuchtechnologies.

·Maintainandreinvigoratetheextensionsystem.Thisshouldcontinuetobeahighpriorityinallpoorareas.Subsistenceagriculturewillbecharacteristicofpoorareasformanyyearstocome,andonewaytoincreaseproductivityandpreventthenearpoorfromfallingintopovertyisinvestmentinnewcroppingandlivestocktechnologies.

1.TheincidenceofpovertyinChinaiscalculatedbyapplyingpovertylines(twolevels)toaconstantpricedistributionofpercapitaincome.TheabsolutepovertylineestablishedatY318percapitaperyearin1990pricesreflectstheincomerequiredtomeetminimumnutritional(2,100caloriesperday)andnonfoodrequirementsandcorrespondstoabout$0.70perdayin1985PPPdollars.ThehigherpovertylineissetatY454(in1990prices)equivalentto$1.00perdayin1985PPPdollars.BothofthesemeasuresarebelowtheWorldBankstandardof$1.00perday(in1995PPPdollars)ofconsumptionexpenditure.TheChinesedefinitionofabsolutepovertyisthebasisofthediscussionunlessotherwiseindicated.

12.NaturalResourceManagementandtheRuralEnvironment

PhotoCourtesyofNationalZoologicalPark

Rapideconomicgrowthhascontributedtoincreasingpressureonthenaturalresourcebase.Mostscholarsagreethatenvironmentalstressandnaturalresourcedegradationareprimarilyfunctionsofinappropriategovernmentpolicy,lackofappropriatepropertyrights,populationgrowth,andpoverty.Increasedincomeandmorerationalpropertyrightshave,accordingtosomescholars,ledtoimprovementsinChina'sruralenvironmentquality.Furtherimprovements,coupledwitheffectiveregulation,canimproveresourcesustainability,soilerosion,andland,forest,andgroundwaterdegradation.

TheevidenceonthedevelopmentofChina'snaturalresourcesinthiscenturyisambiguousandsubjecttoconflictinginterpretations.Time-seriesdataonChina'slandqualityshowfertilityhasrisenandfallenduringthe20thcenturyandgenerallyhasnotworsened(Lindertforthcoming).Othermeasuressuggestthatthelandresourceisimprovingcontrolshavecontinuouslyreducedtheareasufferingfromsalinityanderosion,forestedareashaverecoveredfromlossesinthe1980s,andpreventionmeasureshavereducedtheareassubjecttofloods(Table12.1).Duststormsand''mudrains"inBeijingandother

northerncitieshavediminishedinfrequencyfollowingtheintroductionofforestryshelterbelts(U.S.Embassy1998)TheYellowriverstilltransportsmoresedimentthananyotherriver,butsilttrappinghasreducedthesedimentloadsfrom1.6billiontonsannuallybefore1960to1.2billiontonssubsequently(WorldBank1993).Nationalstatisticsclearlydocumenttheincreaseinforestcoverfrom12to14percent(18millionhectares)between1980and1995.Theareaofnaturereserveshastripledinthepastdecade,althoughprotectionofthesereservesisnotensured.

However,othermeasuressuggestChinafacesadeterioratingenvironment.PasturesinnorthwestChinaandontheTibet-Qinghaiplateaucontinuetobeovergrazedandconvertedtocultivatedlands,althoughsomeoftheconversionssubsequentlyreverttograssland.Coastalwetlandsaredrainedforagriculture(primarilyrice)orconvertedforaquaculture.Statisticsaredifficulttofind,butdesertificationissaidtobeincreasing.Muchofthereforestedareaismonocultured,andthedropinnaturalandold-

Table12.1:IndicatorsofRuralEnvironmentandNaturalResourceConservation

WaterErodibleArea

SalinityArea

FloodArea

Forest

Total Controlled Total Improved Total Improved Cover(millionhectares) (percent)

1975119.6 40.7 7.1 3.9 22.1 16.1 13-141980118.3 41.1 7.1 4.2 23.4 17.8 121985132.0 49.5 7.6 4.8 24.3 18.5 131990136.0 53.0 7.5 5.0 24.4 19.3 141995163.0 66.8 7.6 5.4 24.4 20.11996182.7 69.3 7.6 5.5 24.6 20.3 n.a.n.a.=notavailable.Source:China'sMinistriesofWaterResources,Agriculture,andForestry.

growthforestmaysignaladeclineinbiodiversity,wildlifehabitats,andotherenvironmentalservicesprovidedbynaturalforests.

Technology'srelationshiptoenvironmentalandnatural-resourcedegradationalsoisambiguous.Usingmodernmechanizedterracingequipmentontheloessplateauwillleadtodecliningerosion,increasedproduction,andrisingincomesandwillinitiateapositivecycleofrisingincomesandenvironmentalimprovement.Thedevelopmentofnewcold-tolerantvarietiesofcerealshasencouragedtheirintroductionintomarginalareas.Inmanyinstances,however,technologyimprovesresourceusenewcropvarietiesthatincorporatepestresistancewillreducepesticideuse.Whileheavyapplicationsofchemicalfertilizersandpesticideshavepollutedruralwater,thisprobablyhasbeenmoreafunctionofinadequatefarmereducationthanthetechnologyitself.

Interpretationsoftheimpactofenvironmentaldegradationongrowthconflict.Estimatesrangefrom0to15percentofGDP,butthehigherestimatesarebasedongrossassumptionsandanecdotesratherthanonsystematicnationaldataanalyses.TheResearchCenterofEnvironmentandDevelopment,CASSestimatedtheimpactofenvironmentalpollutionandecologicaldegradationontheeconomy(1992)atY200billion,about7percentofGDP,andconcludedthatagriculturesufferedabouthalfthoselosses.AnanalysisbyXu(1998)determinedthatGDPlossesfromecologicaldestructiondeclined7.5percentinnominalterms50percentinconstanttermsover1985-93.Asimilar1992studyconcludedpollutionanddegradationcostswere4.0percentofGDP(Xia1997).AstudyandanalysisbyYu,basedondatacollectedbytheMinistryofAgriculturefound,thatecologicallossesdeclinedinprovinceswhereeconomicgrowthwasmorerapidandroseinslower-growthprovincesinnorthwestandsouthwestChina.Thesefindingslendcredibilitytothetheorythatgrowthreducespollutionanddegradation.However,somescholarsfindnolong-term

impactongrowth(LiZhou1998).

LegalandRegulatoryFramework

Chinahasahierarchyoflawstoaddressabroadrangeofurbanandruralenvironmentalissues,withtheEnvironmentalProtectionLawattheapex.SupportingitaretheWaterPollutionPreventionandControlLaw,theAirPollutionPreventionandControlLaw,MarineEnvironmentalProtectionLaw,ForestryLaw,FisheriesLaw,WaterLaw,WildlifeConservationLaw,GrasslandsLaw,andLandManagementLaw,whichgovernspecificenvironmentalandecologicalissues.Whilethelawsestablishthegeneralenvironmentalprotectionframework,implementationauthorityisvestedintheStateEnvironmentalProtectionCommission,aStateCouncilorganization.TheStateEnvironmentalProtectionAgency(SEPAformerlytheNationalEnvironmentalProtectionAgency,orNEPA)istheexecutivearmresponsibleforsupervisingandmanagingenvironmentalprotection.BelowSEPA,inallprovincial-leveladministrativeregions,areEnvironmentalProtectionBureaus(EPBs).Actualmonitoring,implementation,andenforcementislefttosubnationalagencies.Directcontrols,implementedthroughpermitsorlicenses,aretheprimaryregulatoryinstruments.Effectiveenvironmentalconservationandprotectionproblemslienotwiththeobjectivesidentifiedinthelawsandregulations,butwiththeirenforcement.

Becauseoffiscalresourcelimitations,SEPAhasdelegatedmostsupervisionauthorityovernaturalresourceandruralissuestolineministriesandtheirenvironmentalprotectionunits(asistrueinmostcountries)but,unfortunatelyproduction-orientedagencieshaveobviousconflictsofinteresttheirofficialsareevaluatedon,andrewardedfor,meetingproductiontargets,notenvironmentalprotectionefforts.

FiscalEnvironment

Inadequatefiscalresourcesarethemostseriousconstrainttoenvironmentalandnaturalresourceprotection.Thegovernmentallocatesminimalfinancialresourcestoenvironmentalprotectionandnaturalresource

Table12.2:NationalInvestmentinEnvironmentalProtection,1991-95Investments Proportionof

Year CurrentYuan

1990YuanYuan

GNP BudgetaryExpenditures

TotalExpenditures/a

(billion) (percent)1991 17 19 0.81 5.01992 21 16 0.75 5.61993 27 17 0.68 5.8 4.41994 31 17 0.63 5.4 4.01995 35 19 0.57 5.1 3.8/aIncludesextrabudgetaryexpenditures.Source:ChinaEnvironmentalYearbook,1997;andChinaStatisticalYearbook,1996.

conservation,andonlyasmallportionofthatisdirectedtotheruralenvironment,primarilyforforestprotection.Whilerealexpendituresforenvironmentalprotectionincreasedmodestlyduringthe1990s,relativeexpendituresdeclined(Table12.2).

Fiscalconstraintshaveledtoinactionandconflictsofinterest.Staffingresourcesaremodest,andlocalbureausoftenhaveonlypart-timeandinadequatelytrainedstafftoimplementandenforceantidegradationpolicies.Withintheconstrainedfiscalatmosphere,localleadersfrequentlygiveresourcecontrolrightstotheagenciesresponsibleforprotectingresourceswhoarethenencouragedtousethoserightstogenerateincomeforstaffsalariesandotherexpenses.Thiscaneasilyinduceagencyofficialstoexploittheveryresourcetheyarechargedwithprotecting.

Thesefiscallimitationsandresponsescanleadtosevereconsequencesfortheruralenvironment.Forexample,officialschargedwithprotectingthenaturereservesareprovidedinsufficientbudgetstoimplementtheirresponsibilitiesandoftenencouragedtousethereserve'sassetstogeneratetherequiredincome.However,

suchincome-generatingactivitiesoftenexploittheveryresourcetheyarechargedwithprotecting.Harkness(forthcoming)reportsthatanationwideauditbytheMinistryofForestryandtheWorldWildlifeFundfoundthatthesetypesofactionshadleftseveralnaturereservesdevoidofbiodiversity.Thesystemlacksanindependentmonitoringoroverseeragencytoresolvegrowthandenvironmentalconflicts.

TheStateofChina'sRuralEnvironmentandResourceBase

LittleauthoritativeinformationexistsonthestateofChina'sruralenvironmentandnaturalresourcebase.Severalstudieshavebeendoneonvariousaspectsofdegradationandtheresponseofvariousgovernmentaljurisdictions.However,theevidenceisfragmented,anecdotal,andbasedondataofvaryingdegreesofreliability.Theseproblemsfrequentlyleavewell-intentionedobserversconfusedandfacedwithconflictingevidenceandunclearpolicyoptions.Inothercountries,theWorldBankhasbegunanEnvironmentalIndicatorsProgram,aneffortthattriestomakeasystematicassessmentoftheavailablestudies,establishinacountrywhatisandisnotknownabouttheenvironment,andmaketheresultsknowntointerestedpartiesbothinsideandoutsidethecountry.

Chinafacesanumberofchallengesbuthashadsomesuccessinsolvingproblemsinsomeofthemostcriticalareasofruralenvironmentandnaturalresourceprotection.Themajorruralenvironmentalproblemsarediscussedinthefollowingparagraphs.

RuralWaterPollution

Soilerosion,inappropriatefertilizernutrientmixtures(particularlyexcessivenitrogenapplication),andexcessivepesticideuse,coupledwiththelackofintegratedpestmanagement(IPM),atthefarmlevelcontributetoruralwaterpollutionandcreateotherenvironmentalproblems.Industrialandmunicipalwastewaterdischargesarethemajorpollutersofruralwatersupplies.

TVEsareprimarilyproducersoflabor-intensiveproductsbutalsoproduceproductsthatgenerateairpollution,includingcement,brick,andtile.WhileTVEsaccountforonly10percentofthenation'sindustrialwastewaterdischarge,theytreatonlyasmallportionoftheireffluentandcontributemorethan10percentofindustrialwaterpollution.Paper-makingisthemosthighlypollutingTVEactivityandaccountsfor44percentofTVEwastewaterdischargethuswastewatertreatmentofpapermillsmustbeaccordedpriority.

Applicationofchemicalfertilizersurgedfollowingtheintroductionofreformsgrowingatanannualrateof7.2percent,evenwhenpricesubsidieswereliftedandwasimportantinthespectaculargrowthofagriculturalproduction.Elementalapplicationwas38.3milliontonsin1996.Fertilizerbalancesheetsfor1995(Sheldrick1997)indicatethatnutrientapplicationisunbalanced,withexcessnitrogenandphosphateapplicationsrelativetopotash.Whilesomeoftheexcessnutrientsmayhaveremainedinthesoil,theexcessnitrogenismorelikelytobeeithervolatizedorleachedintothegroundwater,streams,andrivers.SoilandFertilizerInstitutesurveys(1991-93)determinedthatnitrateconcentration,primarilyfromnitrogenrunoff,ingroundwatersurpassedpotablewaterstandardsbyasmuchas50percentinafewlocations.Runoffofexcessfertilizernutrientshasbeenblamedforfrequent"redtides"alongthesoutheastcoastthataretoxictohumansthatconsumeinfectedshellfish.Fertilizerapplication

methods,placement,andtypeoffertilizerappliedalsocontributetoenvironmentalpollution.Muchofthefertilizerisbroadcastontofieldsandvolatizesorleachesnutrients(particularlynitrogen)beforeitreachescroprootzones.Ammoniumbicarbonate,whichisaparticularlyvolatileformofnitrogenanduniquetoChina,remainsasubstantialportionofthenitrogenfertilizerapplied.Inpartthismayresultfromtheconflictingrolesofextensionstaffwhoretailagrochemicalstoearnrevenuebutalsoareresponsibleforeducatingfarmersonplantprotectionandrestrainingagrochemicaluse.

Excessivepesticideapplicationhasledtoenvironmental,ecological,andeconomicproblems.Heavyandfrequentapplicationshaveeradicatedthenaturalenemiesofsomepestsandledtochemicalpestresistanceleadingtoevenheavierpesticideapplications(InternationalOrganizationforPestResistanceManagement1993).Thisisparticularlytrueinthecontrolofcottonbollworm,wherethecostofbiweeklyapplicationhasseriouslyreducedcropprofitabilityinthetraditionalcottonarea.Also,unenforcedchemicalpesticideregulationshaspermittedindividualsandfirmstoconcoctandsellpestcontrolcocktailsofuncertainstrengthandcompositionwhichhascontributedtothepestresistanceproblemandmaybehazardous.Thegovernmentbannedtheuseoforganochlorinepesticides(suchasDDT)in1983,butresiduesarestillfoundinthesoilalongtheYangtzeriver.Regulationsstipulateminimumtimeperiodsbetweenfinalpesticideapplicationandharvestingoffruitsandvegetablesandsetlimitsforpesticideresiduesonfoodproducts.However,thelackofmonitoringandenforcementresultsinfrequentpesticidepoisoningandpreventstheexportofsomefoodproductstoOECDcountrieswherethetoleranceforpesticideresiduesinfoodimportsisverysmall.Some10to15millionhectaresoffarmlandarereportedtobepollutedbypesticides(U.S.Embassy1997).

Large-scale,continuousmonocroppinghascontributedtotherapidincreaseingrainproductionbutmayalsohavecontributedtoa

declineincottonyieldsinthetraditionalcottonareas.IPMresearchisaprovenalternativeto

chemicalpestanddiseasecontrol.WhileChinaisaleaderinIPM,chemicalpestcontrolremainsthenorm.IfIPMistobecomeimportantitmustbepromotedatthefarmlevelandinfarmertrainingprograms.

Salinization

China'smassiveinvestmentinirrigationfacilitiesduringthe1960sand1970swasfinancedlargelybythecentralandprovincialgovernments.Lower-levelinfrastructure,includingminorandtertiarydrains,wasthefinancialresponsibilityoflowerjurisdictions.Becauseofinsufficientfinances,thesedrainswereneverconstructedinsomeareas.Muchofthesalinizationthataffects7millionhectaresofirrigatedfarmlandcanbeattributedtoinadequatedrainageand,toalesserextent,toinadequatewaterforflushingsaltsthroughthesoilandintothedrainagesystem.About2.7millionhectaresofthesalinizedareaisintheNorthChinaPlain,affecting12to15percentofthecultivatedareaintheHai,Huai,andYellowriverbasins.Themildlevelsofsaltfoundwillmoderatelyreducetheyieldsofrice,corn,soybeans,wheat,andevencotton,amoderatelysalt-tolerantcrop.WorkbyHuangandRozelle(1995)concludedthatsalinizationreducedgrainyieldsbyanaverageof7.8percentinthemid-tolate1980s.About75percentofthesalinity-affectedareashavereceivedsomeremedialtreatment.

SoilErosionandDesertification

Anoft-quotedstatisticsuggeststhatChinalosessome5milliontonsofsoil(includingnonagriculturalland)towatererosionannually(U.S.Embassy1997),butwewereunabletodeterminehowthisstatisticwasderived,orbywhom.Whenslopingorfragilelandsarenotprotectedwithgroundcover,orarecultivatedinappropriately,acceleratedsurfacerunoffandsoilerosionareinevitable.Some1.53

millionsquarekilometersareclassifiedasmorethanslightlyeroded(NEPAandSPC,undated).Themostseriouslyaffectedareasaretheloessplateau,theredsoilsareasouthoftheYangtzeriver,theblacksoilsofthenortheastplains,andthegrasslandsofthenorthwest.Whiletheprimarydirecteffectoferosionisadeclineinsoilproductivityandcropyields,cropareaalsodeclinesaserosionworsens,althoughthishasnotbeencapturedinavailablestatistics.Also,anareaof1.53millionsquarekilometersisclassifiedasdesert(Ning1997).Increasingratesofdesertification(landturningintodesert)havebeenreported,suggestingthattheannualrateofdesertificationreached2,460squarekilometersinthe1990s.Whilethespreadofdesertlandsmayberapid,thereportedlevelofdesertificationisuntenable.Ifinfactthedesertwereexpandingattheratessuggested,allthegrasslandswouldhavebeenlostyearsago.

AreportbytheResearchCenterforEnvironmentandDevelopmentfoundthaterosionanddesertificationhadthegreatestimpactonGDP.Subsequentwork(HuangandRozelle1995)ontheimpactoferosiononcropyieldsdeterminedthatitwassmall,butstatisticallysignificant.Haditnotbeenforerosion,China'sgrainyieldswouldhavegrownabout5percentperyearmore(1983-89).Someerosionisnatural,andsomeiscausedbyinappropriateagricultural/cultivationpractices.TheLoessPlateauhasbeenerodingforcenturies,exacerbatedbyinappropriatecultivationpractices,butmosterosionislikelytobethedirectresultofeitherpastureovergrazing,inappropriateconversiontocultivatedcropland,andremovalofvegetativecoverthroughdeforestationandclearingofmarginallands.Erosionwasmostseriousduringthe1950sand1960swhenlarge-scaleforestandpastureconversionwasundertakentomeetgrainproductiontargets.Inrecentyears,pasturelandconversionhasdiminishedandforestryconversionhasreversed,butlargeareashavebeenseverelyerodedordegradedbycultivation.Erosioncontrolmeasureshadbeenimplementedonalmost700,000squarekilometers

through1996.

Grasslands

Convertinggrasslandintocultivatedland,andoverstockingandovergrazing,aremajor

contributorstodesertification.Agriculturalpolicy,particularlythegoalofincreasedgrainproductionandself-sufficiency,historicallyhasbeenadrivingforcebehindgrasslandconversionanddestruction.Althoughprecisedataseriesareunavailabletoevaluatetheseverityofgrasslanddegradationanddesertification,Li(1998)reportsthat30millionhectaresofgrasslandshavebeenconvertedtocultivatedland,contributingtosoildeteriorationanddesertification.China'sEnvironmentalActionPlan(NEPAandSPCundated)indicatesthatinadditiontothe1.5millionsquarekilometersofdesertifiedland,that1.3millionsquarekilometersoffarmlandinnortheast,northandnorthwestChinawerevulnerabletowinderosion.

TheconversionofgrasslandtocroplandforannualcropsinlowrainfallareassuchasNeiMongoloftenishighlydestabilizingunlessirrigable.Plantingperennialfoddercropswouldprovideyear-roundvegetativecovertolimiterosionandprovidelivestockfoddertoreducethepressureontheremainingnaturalgrazingland.However,grasslandisstillbeingbroughtundercultivationonalargescale.CultivatedlandinNeiMongolhasexpandedby1.0millionhectaressince1990,buttheeffectivelyirrigatedareahasincreasedbyonly0.3millionhectares.However,lowerqualitycultivatedlandalsoisrevertingtograssland;inthelate1980sandearly1990sabout100,000hectaresoftheannualdeclineincultivatedlandrepresentedgrasslandreconversions.

AnalysesbytheLanzhouInstituteofDesertificationconcludedthat85percentofdesertificationwascausedbyexcessivelandconversion,overstocking,anddenudation;12percent,byinappropriatewateruseandindustrialconstruction;andonly3percent,bynaturaldunemovement(Jin1995).

Forestry

Perhapsbecausetheconsequencesoftheirdestructionaresoevident,forestshavefaredsomewhatbetterthanotherecosystemsinthe1980sand1990s.Thecatastrophicfloods,ero-

Oneofmanynurseriesproducingconiferseedlingsforcommercialtimberplantations

andreforestationofwatersheds.

sion,andsiltationthatresultedfrommassiveillegalcuttingofforestsforfuelandlumberfromthe1950sthroughthe1970spromptedthegovernmenttolaunchaseriesoflarge-scalenationalafforestationandwatershedprotectionprograms.Someanalystshaveconcludedthatforestdenudationisthemostseriousnaturalresourceproblem(Smil1996);thismayhavebeenvalidinearlieryearsbutthereislittlehardevidencetosupportthisviewinthemid-1990s.China'safforestationsuccessinthe1980sand1990shasbeenamongtheworld'sbest,andChinaisoneofthefewdevelopingcountriesinwhichforestcoverisslowlyincreasing18millionhectaresbetween1980and1993.However,thenetincreasemaskschangesintheforeststructureandquality(Table12.3).

WhileTable12.3illustratestheimportanceandcontributionofshelterbeltsandcommercialplantations,italsoindicatesdecliningforestdiversitythroughcuttingofoldgrowthstandsandreplantingwithmonocultureplantations,whichcontributestodeterioratingplantandwildlifehabitats,decliningcarbonsequestration,andlossofnontimberproducts(suchasmedicinalplantsandfungi)thatare

importantincomesourcesforpoorhouseholds.

HuangandRozelle(1998)identifiedtheprincipalfactorsinincreasingforestcoverasinvestmentsthatimprovedlandqualityprimarilyirrigation,whichincreasedmultiplecropping;growingoff-farmemployment;andland-tenurearrangementsforforestedlandforestsunder

collectivemanagementhaveexpandedmorerapidlythanforestsunderstatemanagement.Negativeinfluenceswereincreasingpopulationdensityandforestpolicy.Inareaswhereindividualpropertyrightshaveimproved,forestareahasincreasedsubstantially.Nevertheless,biasedforestpolicieshaveinducedfarmerstocutoldgrowthnaturalforestsandreplantwithmonoculturetreesandorchards.

Chinaisintheforefrontofagroforestrytechnology,includingthesuccessfuldevelopmentofmethodsforinterplantingtreeswithcrops.Thegovernment,andlocalauthorities,encourageandfinancetreeplantingtolimitsoilerosionbywindandwater.Thepracticeofplantingtreesaroundvillages,canals,androadshasbeenwidelyadopted,anditspositiveimpactonlocalwindandwatererosionhasbeendemonstrated.Themostcommonuseofcorvéelabor(afterroadandcanalmaintenance)isfortreeplanting(RozelleandHuang1998).Chinahasembarkedonanumberoflargeafforestationprograms,includinglargeshelter-beltdevelopmentprojectsin13northernprovinces,autonomousregions,andmunicipalitiestoprovidewindbreaks,stabilizesanddunes,conservesoilsandwater,andprovidetimberresources.However,manyshelter-beltdevelopmentsaresinglespeciestands,whichreducesinvestmentcosts,butincreasessurvivalrisks.Othermajorprogramsincludesoil-andwater-conservationforestsintheup-

Table12.3:ReforestationinChina(1980-93)

TypeofReforestation Area(millionhectares)

Totalarea +18Timber +5Afforested(primarilysinglespecies)

Clear-cut,nonreforested

Shelterbelts +6Commercialplantations(includingorchards)

Other(fuelwood,nationalreserves)

Source:HuangandRozelle1998.

perandmiddlereachesoftheYangtzeriver,acoastalshelterbelt,afforestationinthenortherngrasslands,andrapid-growingcommercialforests.Chinaplanstointensifytheseprogramsoverthenextdecade.

Biodiversity

China,richinbiologicaldiversity,containsabout10percentoftheworld'splants,mammals,birds,reptiles,andamphibians.However,overthepastfewdecades,increasingpopulationpressuresanddevelopmentactivitieshaveerodedChina'sbiodiversityresources.Thecombinationofalargepopulationandlimitedlandhasledtoextensivelossofhabitatstoagriculturalandaquaculturalproduction,logging,fuelwoodcollection,andlivestockgrazing.TheChineseAcademyofSciencesreportsthatabout200plantspeciesarebelievedtohavebecomeextinctandanestimated5,000speciesendangeredinrecentyearsbecauseofhumanactivity.

Recognizingtheseproblems,thegovernmenthassignificantlystrengthenedthepolicyframeworkforenvironmentalprotectioningeneral,andforbiodiversityinparticular.Newenvironmentalprotectionandwildlifeconservationlawswereputintoeffectin1989,whichfacilitateddevelopmentofacomprehensivesystemofnaturereserves,andrationalizedcategoriesofprotectionforendangeredwildlife.Chinahasalsobecomeincreasinglyvisibleininternationalefforts;In1992ChinabecamepartytotheConventiononWetlandsofInternationalImportanceespeciallyasWaterfowlHabitat(the

RAMSARConvention)andtheConventiononBiologicalDiversityin1993.Thesepolicychangeshavebeenaccompaniedbyincreasedemphasisonsectorplanningandmanagement.In1987Chinaproducedanationalstrategyfornatureconservation.ANationalEnvironmentProtectionActionPlanapprovedin1994includesbiodiversityobjectivesandpriorities.TheStateCommissiononEnvironmentalProtectionapprovedaBiodiversityConservationActionPlan(BAP)in1994.TheBAPreviewsthepresentstatusofbiologicaldiversityandconservationef-

fortsinChinaandsetsoutacomprehensiveprogramofrequirementsforinvestment,policyreform,andtechnicalassistancetostrengthennationalbiodiversitymanagementandconservation.

Asinmanyothercountries,biodiversityprotectioninChinahasfocusedonestablishingnaturereserves.Theamountofprotectedareashasdramaticallyexpandedoverthepast10years.China'smorethan700naturereservestotalsome56millionhectares5.5percentofthecountry.TheStateForestryAdministrationhasjurisdictionovertwo-thirdsofthereserves,andtheStateEnvironmentalProtectionAgency,MinistryofAgriculture,StateOceanographyAdministration,ChineseAcademyofScience,andotheragenciesadministertheremainder.Despitethegovernment'sstrongcommitmenttobiodiversityconservation,stafflevels,managementbudgets,andtrainingandperformancestandardshavenotkeptpacewithreserveexpansion.Fewareasareprotectedormanagedeffectively,andifcurrenttrendscontinue,biologicaldiversityinmanycriticalreserveswilldiminishdramatically.Themainconstraintisfiscalresources,whichleavesnaturereserveswithinsufficientfundsandstafftoeffectivelyperformtheirprotectionandmanagementresponsibilities.Giventheprevailingfiscalconstraint,reducingthenumberandareaofnaturereservesandimprovingthemanagementoftheremainingreservesmayimprovebiodiversityprotection.ThiswouldnecessitateareviewoftheentireNatureReservesystemtorationalizepublicholdings.

Chinaisrichinfloraandfaunabiodiversity,but

habitatlosshasendangeredsomeuniquespecies.

Chinahashadenvironmentalprotectionachievementsandfailures.Beneaththenationaltrends,severalcharacteristicsappearthatmaybeunrelatedtoaregion'snaturalecosystem.Wecannotdeterminewhetherthesepatternsarerelatedtotheenvironmentalawarenessandcommitmentoflocalleaders,progressinpovertyalleviation,reductionsinpopulationpressure,orimprovementsinpropertyrights.Particularlyimpressiveprogresshasbeenmadeinincreasingforestresources.Theseincreasesaredue,inpart,toinvestmentsinirrigationandtoimprovedincomesandeconomicgrowth.Thus,furtheragriculturalinvestments,andpoliciesthatshiftfarmersintooff-farmemploymentwillpromotefurtherimprovementinforestryresourcesalthoughincreasedincomeinequalitycouldmitigatesomeofthepositiveincomeeffects.

Afewscholarshaveattemptedtoquantifythecostsofenvironmentalandnaturalresourcedegradation,butlittleanalysishasbeendoneonthecostofdegradationpreventionorreduction.Itisthecomparisonofthecostsandbenefitsofenvironmentandnaturalresourceprotectionthatisrelevanttopolicymakers.Stronganalyticalevaluationsofthecostsandbenefitsofdegradationpreventionandreductionareneededasabasisforderivingmorerationalpoliciesforenvironmentalandnatural-resourceprotection.ChinamightconsiderinitiatingcollaborationwiththeWorldBank'sEnvironmentalIndicatorsProgramtocollectandanalyzetheenvironmentalresearchavailableonChina.Thequalityofenvironmentalresearchvaries,andthusthefindingsmustbeinterpretedcautiously.Moreresearchisneededtodefineaccuratelytheproblemsandremedies.

Financialconstraintshavepushedprotectionresponsibilitiestolocalproductionagencies,whichhaveinadequateenvironmentaltraining,fewresourcesavailableformonitoringandenforcement,andmost

cruciallyfewincentivestoimplementnationalandregionalregulations.However,evenifotherconstraintswereremoved,thefiscalshortagesaresose-

verethatofficialsmayhavetoexploittheveryresourcestheyarechargedtoprotecttoearnincomeforstaffsalariesandexpenses.Withappropriateincentives,ruraldevelopmentcanattractprivateinvestmentintoseveralactivities,butenvironmentalprotectionisnotamongthisselectgroup.Therefore,resourcestoprovideenvironmentalprotection,maintainingbiodiversity,andsustaininglong-termuseofnaturalresourcesmustcomefromgovernmentbudgets.

Theissuesofenvironmentalprotection,pollutioncontrol,andsustainablemanagementofnaturalresourcesaresocomplexandhaveimpactsoversuchlongtimehorizonsthatwithoutwelldesignedregulations,marketfailure(exacerbatedpollutionandunsustainableexploitationofnaturalresources)isquitepossible.Experienceindicatesthatrapideconomicgrowth,fertilitydeceleration,andpovertyreductioncontributetoalleviatingenvironmentaldegradation,butfullyadequateprotectioncanbeprovidedonlyifaregulatoryprogramisenforced.Tomakesucheffortsmoresuccessful,severalchangesareneeded,includingthefollowing:

·Makeregulationsspecifyingstandards,penaltyschedules,monitoringcriteria,andenforcementprovisionsmoreprecise.

·MaintainNaturalResourcepolicywiththelineagenciesbutallocatetheresponsibilitytobureausabovethecountyleveltoavoidlocalfiscalandstaffingconstraints.

·CommitmorefinancialandstaffresourcestostrengthenthecapacityofSEPAandProvincialEPBstomonitornaturalresourceprotection,developdatabases,andprovideindependentadvicetogovernmentonthestateofnaturalresources.Thisshouldincludeanationallandusemappingexerciseusingsatelliteimageryandotheravailabledata,toprovideacomprehensivebaselineagainstwhichfurthertrendscanbemeasured

·Thenumberandsizeofnaturereservesshouldberationalizedconsistentwiththeresourcesprovidedfortheirmaintenanceandprotection.Asmanynaturereserveshavelocalcommunitieswithintheirboundaries,thedevelopmentofsustainableparticipatorymechanismsforcommunity-basedresourcemanagementisahighpriority.

·Reformagriculturalregulatoryinstitutions/agenciesrelatingtoplantprotectionandpublichealth(livestockandfood)processing,etc.

·Providebettereducationforfarmersonbalancednutrientapplicationandtiming,fertilizerplacement,soilincorporation,andpollutionimplicationsofoveruse.

Tosupporttheforestrysector,Chinashouldtakethefollowingsteps:

·Eliminateremainingdistortionsinthepolicyframework,particularlythehighlevelofdomesticprotectionthatimpedesefficientinternationaltrade,andtheveryhighleveloftaxationontimberproducts.

·Morerigorouslyimplementsustainablelanduserequirementsinthelegalframework,particularlygreaterenforcementofrulesrelatedtoannualallowablecutsinnaturalforests.

·Expandforestryresourcestosupportcontinuedgrowthinconstructionandagroprocessingwithanemphasisonproductivitygainsthroughimprovementsinsilviculturaltechnologies,particularlyplantingstockdevelopmentandsilviculturalmanagement.

·Shiftgeographicalfocusofafforestationactivitiesfromthemoredevelopedsouthernandcoastalprovincestothepoorerinlandprovinces,withappropriateadjustmentstosilviculturaltechnologiesthatreflectthesocioeconomicrequirementsofpoorhouseholds.

·Developmoreparticipatoryapproachesfordesigningandcarrying

outlarge-scaleafforestationcampaignstostrengthenincentivesforsustainableresourcemanagementbylocalcommunities.

·Developcomprehensiveintegratedmanagementplansforforestresources,particularlynaturalforests,tomaximizeeconomicandenvironmentalbenefitsforlocalcommunities.

ANNEX:POLICYANDACTIONMATRIXIssue Action MacroeconomicPoliciesandFramework

·Policyframeworkisurban-industrialbiased·Ruralincomesarelow.·Rurallaborforcebuffersurban-industrialneedsbyprovidinglaborduringboomperiodsandabsorbinglaborduringslackperiods.·Massiverural-to-urbanfinancialtransfersoccurthroughthebankingandcreditinstitutions

·Removeanyremainingbarrierstoruralmigration.(M-L)·Developprogramstoretrainandredeploylaid-off(redundant)urbanlaborersandnotdisplaceruralmigrantlaborers,forcingthemtoreturntoruralareas.(M-L)·Discontinueadministeredinterestratesandothertransferpoliciestoensurefinancialflowsrepresentonlyrationaltransfersoffundsfromlow-tohigh-returnsectors.(M)

RuralFiscalPolicyandManagement·Ineffectivecontroloftaxeshasresultedinpoorredistributionandreallocationofcollectedrevenues.·Low,inadequateandseculardeclineintaxrevenues(aspercentofGDP)andthereforelackofresourcestoundertake:·Ruralinfrastructureinvestment;

·Recentralizetaxationauthorityandcontrolandestablishreallocationmechanismsandprovideincentivesthatensuresignificantresourcesaretransferredfromaffluenttopoorareas.(M)·Broadentaxbase,including;expandedusertaxes/fees,legitimizetransparentoff-budgetlevies,makegrainquotataxesexplicit,considertransferringlowestfiscalaccountabilityfromtownshiptocountytoreducesalaryandwagecostsandimplementiffeasible.(M)·Providefundsformandatedexpenditures.

·Manageandprotectresources;and·Providepublicgoodsandservices.·Largeoff-budgetrevenuecollection.·Unfundedexpendituremandatesencouragesmisuseofbudgetaryresourcesandunderminesincentivestoimplementpolicies.

ExternalTradePolicyandInstitutionsTraderemainsgovernmentcontrolled.

Permitmarkettodeterminetradepatterns.

·Statetradingmonopoliescontrolthetradeingrains,cottonandmajorproductioninputs·Graintraddequotasbutaremaintainedasconfidentialinformation,unavailabletothepublicandexacerbatesdomesticsupplyandpricevolatility.

·Promote,andphase-intradecompetition,overamanageableperiod.EvenifChinamaintainsaclosedtradepolicy,marketcompetitionwouldincreaseefficiency.(S-M)·Phaseoutstatetrading;evenifChinaremoveson-tarifftradebarriersamonopolystatetradingfirmcouldunilaterallyblocktrade.(M)·Discontinuetradequotasandthegrainself-sufficiencypolicy;addressfoodsecuritythroughtradelinkageswithmultiplesuppliersandlong-termcontracts.(S-M)

Issue ActionForeignDirectInvestmentinAgricultureandAgriculturallyRelatedManufacturing·Lackoftechnology-intensiveforeigndirectinvestmentsinagriculturalindustries.

·Designincentivestostimulateinvestmentsinprioritysubsectors.(M)·Eliminateunnecessaryinvestmentrestrictions,suchasjointventurerequirements.(S-M)·Publicizeandstrictlyenforceintellectualpropertyrightsforagriculturaltechnology.(S)·Liberalizedomesticmarketingconstraintspermittingtransnationalfirmstoestablishandcontroldistributionnetworks.(S-M)

AgriculturalPricingandMarketingPolicyandInstitutions·Governmentinterventioningrainsubsectorremainsstrongandcostly.Rolesofvariousgovernmentaljurisdictionsinimplementinggrainpolicyhavebeenunclear.·Farm-deliveryquotasstillleviedonfarmers.·Farmgatepricesforgrainaregovernmentdetermined.·Farmgateprocurementofgrainsismonopolizedbyparastatalgrainbureaus.·Governmentmaintainslargevolumesofgrainstocksalthoughexactamountisconfidential.·Pricevariabilityhighandincreasing.·Thecommercialandpolicy

·Relymoreontheprivatesectorandmarketforcestoimproveagriculturalresourceallocationandfarmerincomes.·Discontinuegovernmentdeterminedgrainquotasandprices.(S-M)·Liberalizegrainprocurementandpermitprivatetraderstocompeteonanequalbasiswiththegrainbureaus.(S)·Reevaluateself-sufficiencyandgrainreservepolicieswiththeobjectiveofreducinggovernmentgrainstocksandcost.(S-M)·Clearlyseparatethecommercialandpolicyfunctionsofthegrainbureau.(S)·Assesscosts,benefits,andfeasibilityofestablishingpricestabilizationprogram.(S-M)·Design,establish,andenforcenationalquarantineandphytosanitarystandards

functionsandfinancialaccountsofthegrainbureaucompaniesoverlap.·Thelackofstandardizedphytosanitaryprocedures,shippingdocuments,andtransitfeesimpedesinterprovincialmarketingofnongraincommodities.·Theabsenceofcomprehensiveandconsolidatedinformationonmarkets(prices,quantities,andqualities)handicapsthemarketingoffarmersandtraders.·Intheabsenceoffarmermarketingassociations,farmershavefewmarketingoptionsandreceiverelativelylowprices.·Toincreasetaxbasesandaddvaluelocallysomecountiesprohibitcrossborderprocurementofagriculturalcommoditiesforprocessingresultinginmanyscale-inefficientagroprocessingplants.·Insufficientpublicinfrastructureimpedesefficientmarketingandtransportofagriculturalcommodities

applicabletoallinterjurisdictionalcommoditymovement.Andifstandardsaremet,prohibitinterjurisdictionalembargoesonagriculturalcommodities.(S)·Consolidatemarketinformationsystemsundertheauspicesofasinglecentralagency.(S)·Encourageandpromotefarmermarketingassociationsthroughlegislationandintroducetrainingprogramsforassociationmanagementstaff.(S)·Investmoreinruralinfrastructurewhereeconomicallymerited.(S-M-L)

Issue ActionRuralFinance·Ruralcreditinstitutionsmoreconcernedwithpolicylendingthancommerciallending·Ruralcreditinstitutionshaveweakcapacitytoevaluateloans.·Bothruralindustriesandfarmhouseholdsarecreditstarved.·Lackofalternativedepositinstruments·Unsustainablecreditsubsidiesforanti-povertylending

·Assignpolicylendingtoaninstitutionwithoutcommercialresponsibilitiestoensurepolicyandcommerciallendingarefullyseparated.(S)·Permitandencouragecompetitionandinnovation,suchasnewdepositinstrumentswithattractivecombinationsofreturnandliquidity.(S-M)·Deregulateinterestrates.(S-M)·Discontinuesubsidizedandunsustainablecreditprogramsforpovertyalleviationandrefocusonmicro-financeprogramsorotherhousehold-basedpovertyalleviationprograms.(S-M)·Developinstitutionsandintroducetrainingprogramsforstaffofruralfnanceinstitutionsincludingmicro-financeprogramsstaff.(M-L)

ResourceManagementLand·Lackoflandrentalmarketinhibitsefficientuseoflandandlabor·Tenuresecuritymaybeundermininginvestmentincentivesandtheemergenceofcreditsincelandcannotbeusedascollateral.Manyfarmersfavorcurrentlandtenuresystembecausecollectivelyheldlandprovides

·Continuetoanalyzecostsandbenefitsofalternativelandrightsregimesandexperimentwithrentalmarketsandtenurearrangementstoimprovelandmanagement.(S-M)

security.Water·InsufficientwaterresourcesavailableinnorthernChinatomeetaggregaterequirements.·Inefficientuseofexistingwatersupplies.·Largebudgetaryrequirementsformaintainingsystems.

·ExpediteconstructionofoneormoreroutesoftheSouth-Northtransferscheme.(M)·Conductastudyofconveyanceanddeliveryefficiency;rehabilitatesystems,linecanalsandintroduceimprovedtechnologieswhereeconomicallyefficient.(M)·Expandcollection,treatment,andreuseofmunicipalwastewater.(M)·Introducearationalsystemofvolumetricmeasurementandwaterpricing.(S-M)·Expandself-financingwaterenterprisestomanagewatersuppliesandoperateandmaintainirrigationsystems.(S-M-L)·Establishtrainingprogramformanagementstaffofwaterenterprises.(S-M)·Discontinuegrainquotasandotherproductionconstraintstopermitfarmerstoproducecommoditiesconsistentwiththeircomparativeadvantage.(S-M)

Issue ActionNaturalResourcesandForestry·Naturalresourceandenvironmentaldegradation.

·Consolidatenaturepreservesandcommitmorefinancialandstaffresourcestonaturalresourcemanagementandprotectionservices.(M)·Improvetrainingofnaturereserveandforestrystaff.(M)·Fornaturereserveswithlocalcommunitieswithintheirboundaries,developparticipatorymechanismsforcommunity-basedresourcemanagement.(S-M)·Developintegratedmanagementplansandrigorouslyenforceregulatoryframework,includingpricestructureforexploitationandpenaltiesfornoncompliance.(S-M)·Investinrehabilitationofwatershedsandgrasslandswhereeconomicallyefficient.(M)·Removeforestpolicydistortionsincludingpricingandtariffprotectionthatimpedesefficientinternationaltrade.(S-M)·Improvefarmertrainingonapplicationandplacementofpesticidesandfertilizers.(S-M)

AgriculturalTechnologyResearch·Declineingrowthoftotalfactorproductivityinagriculture.·Agriculturalresearchfundinghasdeclinedinrealterms.·Inefficient

·Establishresearchprioritiesincludingsubsistencecommoditiesforpovertygroupsinresourcepoorareas.(S)·Centralizeandincreasebudgetaryallocationstoagriculturalresearch.(S)·Evaluatealternativefinancingsources,suchascommoditycesses;andifimplemented,rigorouslymonitorcollectionstoensurefundsarenotdiverted.(S)

allocationofresearchresources.·Lackofsubstantiveresearchbydomesticandjointventurefirms.

·IncreasecooperationwithinternationalagriculturalresearchcenterstoobtainandadaptnewtechnologytotheChineseenvironment.(S)·EncourageinternationalfirmstoparticipateinChina'sagriculturalinputindustry.(S)

Extension·Formalextensionserviceisineffectiveandnearcollapse.·Extensionfundinghasdeclinedinrealterms.

·Restructureandrevitalizeextensionservice.(S-M)·Improveextensionstafftraining,incorporatingnewissuessuchassolutionstomarketingproblemsandunderstandingproductiontechnologiesfornontraditionalcommodities.(S-M)·Permittheprivatesectortoparticipateinagriculturalinputmarketingandtechnicaladvice.(S)·Promotetheformationofcommodityproducergroupsandencouragethemtoretainspecialiststoprovideup-to-dateinformationonvarieties,pestcontrol,andotherculturalpractices.(S-M)

Issue ActionRuralIndustry·Ruralnonagriculturalemploymenthasbeguntodecline.·TVEprofitabilityisdeclining.

·IncreaseTVEaccesstocreditandimprovecreditagencycapacitytoevaluateinvestments,monitorandrecoverloans.(S-M)·CautiouslyexpandTVEinvestmentsininlandprovincesandonlyaftercarefulevaluationofanycomparativeadvantage.(M)·Promoteprivatesectorownershipanddevelopinstitutionalstructureswhichwilllimittheliabilityofinvestors,rewardandpenalizemanagersfortheirperformance,andappropriatecompensateshareholders.(S-M)

PovertyAlleviationAbout50millionruralresidentscontinuetoliveinabsolutepoverty.

·Excessiveleakageofpovertyreductionfundingtononpoor,alsoinadequatesupervisioncontributestopoorqualityofprogramworksandservices·Theremainingpoorwillrequiremorethaneconomicgrowthtoescapepovertybecausetheyliveinveryresourcepoorareas.·Limitedfundingfordevelopmentofappliedtechnologiesforuplandagricultureimproveduplandagricultureproductivityis

·Improveidentificationofthepoortopermitbettertargetingofantipovertyprograms.(S-M)·Augmentsupervisionofpovertyreductionprogramsatthelocalleveltoimprovequalityofworksandservices.(S-M)·Investinservicesandinfrastructurethatwillassistthepoormigrateorotherwisetransferoutofagriculture,includingeducation,transportandcommunicationservices.(M)·Continueexperimentingwithmicrofinanceandotherpovertyalleviationprogramsthataredesigned

crucialtoliftingthepoorabovethepovertyline.

topromotehouseholdinvestment.(S-M)·Designandimplementantipovertyprogramsonthebasisofdetailedconsultationwithlocalleadersandplannedparticipants.(S-M)·Promotesmallbettertargetedprojects,suchasFood-for-Workwhichhaveprovensuccessful.(S)·Useaportionofcentralgovernmentpovertyreductionfundingfordevelopingapplieduplandagriculturaltechnology.(S-M-L)

Note:ThecharactersS,M,andLfollowingtheindividualrecommendedactionsrefertoshort-,medium-,andlong-timeperiodslikelyrequiredtoimplementtheactions.

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